Buyback Fever

Today’s Wall Street Journal discusses the link between stock buybacks and the rising stockmarket. See Boom in Buybacks Helps Lift Stocks To Record Heights.

In case you didn't know, the big three drug wholesalers – AmerisourceBergen (ABC), Cardinal Health (CAH), and McKesson Corp (MCK) – have been major participants in this trend.

Thanks to the fee-for-service transition, wholesalers have been able to reduce inventory investments and generate unprecedented levels of cash flow from operations. Wholesalers have used their cash to repurchase shares ($8.4B since January 2004), repay debt, and fund acquisitions. As a result, all 3 wholesalers now have very strong balance sheets and respectable Earnings per Share (EPS) growth.

Here are the total value of share repurchases by the Big 3 from 2004:Q1 through 2007:Q1, courtesy of Larry Marsh at Lehman Brothers:

ABC = $2.0 billion
CAH = $4.4 billion
MCK = $2.0 billion

You can see their relative stock performance using this nifty Yahoo! stock chart. Since January 2004, McKesson’s stock has doubled and AmerisourceBergen is up 80%. Cardinal’s stock performance has lagged the other two wholesalers, but they have also bought back more stock than the other two combined. Perhaps this is a signal that the company considers its shares to be undervalued.

The WSJ article suggests a few reasons for buybacks.

• Buybacks are a tax-efficient way to return cash to shareholders. Dividends are taxable but there is no tax due on a share buyback unless investors sell their shares.
• Buybacks signal that the company doesn’t know how to grow.
• Buybacks can benefit corporate executives, especially if their compensation is tied to EPS and share-price targets. Buybacks also benefit executives with large holdings of stock options.

I see at least three major ways for wholesalers to grow their core distribution businesses, so I’ll let you judge the relative merits of the other two possible explanations.