Early this month, McDonald’s Corp. CEO Steve Easterbrook announced a major restructuring of the company’s operations, including returning $8 billion to $9 billion to shareholders this year.
Over the next three years, McDonald’s will return “the top end” of its target, of giving $18 billion to $20 billion back to shareholders.
Of everything in McDonald’s turnaround plan — which includes $300 million in annual general and administrative cost cuts, which will likely result in layoffs — its decision to return more cash to shareholders has come under the most scrutiny.
The Harvard Business Review recently said that McDonald’s “has to do more than manipulate its share price.”
This week, four pension fund leaders questioned why McDonald’s and other large companies are returning so much cash to shareholders.
Additionally, McDonald’s debt was downgraded by all three major bond ratings services — Moody’s, Fitch Ratings and S&P. Each of them was concerned by the company’s decision to increase its returns to shareholders.
The problem isn’t that McDonald’s is giving cash to shareholders; it’s how. Much of the cash the Oak Brook, Ill.-based company plans to return to stockholders is in the form of share buybacks, in which the company buys its own stock.
Buybacks are all the rage these days, and they’ve been especially popular in the restaurant industry — one that, not coincidentally, has been beset of late by activist investors demanding higher returns.
In theory, buybacks let companies boost the value of their shares when they are at a low price. Companies that perceive their shares to be undervalued can acquire shares, increase the share price and provide some benefit to existing shareholders by distributing earnings over fewer shares.
But consumer stocks, including restaurants, are currently trading at stratospheric values. McDonald’s, for instance, is trading at an enterprise value multiple of more than 11 times cash flow, which makes it among the cheapest stocks in the industry.
Thus, companies buying their shares are purchasing them at high prices. And buybacks provide only a short-term lift to the company’s stock.
That makes buybacks fundamentally different from, dividends, for instance, which are distributions of earnings over all shares. Dividends solidify a company’s long-term shareholders and provide some downward protection for the stock. Many shareholders of McDonald’s are long-term holders who like the periodic cash distribution.
That’s why buybacks have been getting under the skin of so many long-term investors.
By buying back stock, companies trade long-term investment for short-term gains. What’s more, many companies fund these buybacks with debt, increasing leverage and worsening their credit position.
Buybacks only benefit large stockholders who benefit from short-term manipulations in stock. That includes hedge funds and investment banks. It also includes company executives, who are largely paid in company stock.
Long-term shareholders, however, would prefer that companies pay out dividends and invest in their businesses to fund growth. In a statement this week, New York City Comptoller Scott Stringer, New York State Comptroller Thomas DiNapoli, Chicago Treasurer Kurt Summers and California Controller Betty Yee took issue with buybacks.
Singling out McDonald’s, they pushed companies to make more investments over the long-term, noting that “95 percent of corporate earnings are being distributed to shareholders.”
“If the pendulum swings too far in favor of returning capital to shareholders, the future viability of the companies in which we invest may be placed at risk,” they said.
McDonald’s problem is not necessarily its stock price, which has remained steady, even as its sales have weakened over the past two years. Rather, its problem is the company’s sales. It’s tough to imagine how more share buybacks will help McDonald’s sell more burgers and fries.
Yet short-term investors push companies to avoid capital spending. And investments in strategies to improve sales long-term rarely provide the stock boost investors demand. The company’s board must also be wary of activist investors who could pounce if stock performance or sales don’t improve. Activist investors are quick to demand buybacks and other short-term stock price solutions, like refranchising.
Panera Bread Co., for instance, is doing both, after “dialogue” with an activist investor.
But those short-term ideas may not work anymore. Similarly, McDonald’s investors yawned at its turnaround plan.
Indeed, share repurchases don’t quite have the stock-boosting impact they once did. And capital spending, research and development don’t quite have the drag on share price.
This story has been revised to reflect the following correction:
Correction: May 29, 2015 An earlier version of this story misstated information related to Panera's stock price.
Contact Jonathan Maze at [email protected].
Follow him on Twitter: @jonathanmaze
