HSBC Securities upgraded Canon (NYSE:CAJ) yesterday to "overweight" from "neutral" despite lowering its target share price, but still leaving it with about 20% of upside. One of the reasons behind the upgrade was the chance of more share repurchases.
Here is what has happened to Canon this week:
I. Ordinary shares of Canon (Tokyo: 7751) traded down to their lowest levels since early December, reaching a three month low at ¥6,040 intra-day on Monday.
II. Canon's shares came under selling pressure as:
(1) it was recently trading near all-time high levels and thus, there was naturally profit-taking, and
(2) there was additional pressure due to the global stock sell-off, simultaneously causing the yen to gain 3.7% in one week and creating uncertainty over future profits for Japanese exporters such as Canon, which makes 75% of its sales overseas.
III. On Wednesday, Canon announced it completed a ¥100 billion (approx. $850m at ¥117.4/$1) 15.423 million share buyback on the Tokyo Stock Exchange during the period between Feb. 16, 2007 and Mar. 6, 2007.
IV. Yesterday Canon was upgraded by HSBC as mentioned above, but its target share price was reduced to ¥7,500 ($63.90), from ¥7,750 ($66.00). HSBC cited recent share price weakness during the global stock sell-off, expectations of continued growth despite a stronger yen and the possibility of further dividend hikes and share repurchases.
V. Late yesterday, Canon announced another share buyback, approved up to ¥100 billion, up to 17 million shares (equal to 1.3% of shares outstanding). The buyback will take place starting today, until April 9, 2007, on the Tokyo Stock Exchange. Following the completion of its latest buyback on Wednesday, Canon has 1.316 billion common shares outstanding.
Canon finished the trading week at ¥6,290 ($53.60), its highest close in a week. Its ADRs closed yesterday at $53.11.
Some might wonder why Canon is buying back stock near all-time high levels. Why doesn't it increase its dividend?
One reason behind the buyback is it's sitting on nearly $10 billion in cash and less than $150 million in long-term debt as of the end of December. It generated over $1 billion in free cash flow in 2006. Plain and simple, Canon is looking to further enhance shareholder value and one way is to return some of its cash hoard.
Surely there will be dividend hikes on the horizon, but excluding a special dividend, a share repurchase is the most logical way to enhance shareholder value -- I think this is true even at its recent trading levels.
Dividends are best from a company's standpoint when raised incrementally, so as not to have to face cutting or eliminating the dividend in the future. Canon would have to raise its payout significantly in order to use the same amount of cash it did in its buybacks, a rate it could not sustain as a dividend on annual basis.
Given Canon's $70 billion plus market cap, it is certainly not going to be a takeover target.
Lastly, I would argue a combination of buybacks and dividend hikes are more reasonable and value enhancing than engaging in M&A that could potentially destroy value.
In closing, I want to mention that all the focus on the yen carry trade of late is not only becoming annoying, but it is also ridiculous to think Japanese exporters are going to collapse in the face of a stronger yen. Canon's ordinary shares lost about 10% between last Tuesday's high and yesterday's low.
The yen by the way, has gone from ¥122/$1 at the end of January (a multi-year low), to under ¥115.5 on Monday and was last trading around ¥117.5. The risk of the yen carry trade unwinding persists, but I wouldn't be afraid. I think we have to believe in management at Japan's leading exporters. Also, I think there are a lot of forces at work trying to keep the yen carry trade in play. (Click here to see my reasoning and read related articles by FT.com and The Wall Street Journal).
Note: Along with its Q4 earnings release at the end of January, a Canon financial executive commented that "this year will be the firm's slowest earnings growth since 1999, primarily due to an expected lack of positive currency impact, but the good business environment won't change." At that time, Canon said it expected 2007 revenues to grow 7.1% to ¥4.45 trillion ($37.9b).
* A ¥/$ conversion rate of ¥117.4/$1 was used throughout this article for convenience.
Disclosure: The author does not own shares of any stocks mentioned in this article.
Canon Inc (CAJ) 1-year chart: