In the first four weeks of the fall season (beginning September 21, 2012), U.S. public companies have announced intentions to repurchase a combined $28 billion in stock. When fully executed, share buybacks offer liquidity to the market and have the potential to nudge valuation higher. Historically, investors have done well taking long positions in companies announcing repurchase programs. Those high minded remarks aside, many buybacks are suspected as nothing more than an offset to the exercise of options by the management and employees.
Among the companies pledging to open up the purse strings to buy shares I found four industrial suppliers which appear willing to go beyond simply covering future option exercises. What is more, these four have some muscle on their balance sheets and show strength in profits.
Industrial Gas Supplier Airgas
The board of Airgas, Inc. (ARG) recently authorized a plan to buy back up to $600 million worth of its 77.3 million shares outstanding. At the current price level the company could buy as many as 7.3 million shares, representing 10.6% of the float (the number of shares not held by insiders and generally available for trading). Airgas had 4.1 million options outstanding at the end of December 2011, only some of which are in-the-money, suggesting the buyback plan could have a meaningful impact on shares outstanding.
Airgas is a distributor of specialty gases used in industrial and medical processes. The company also supplies safety clothing and gear, durable medical equipment and welding products. With a debt-to-equity ratio of 1.19, Airgas carries a bit more leverage than its industry peers, which average just over half as much debt as equity. Airgas is not expected to borrow to support the buyback. With only $55 million in cash on the balance sheet, it looks like Airgas will need to rely on future cash flows to support its share purchases. That might be possible. Airgas recorded $4.8 billion in total sales in the twelve months ending June 2012, and managed to convert 11.2% of that revenue to operating cash flow.
Perhaps cash in the bank is not the real issue for Airgas management. The stock only trades an average of 241,000 shares each day. That means it would take 31 trading days - six weeks on the calendar - to execute the Airgas buyback plan. Of course, that is not possible from either a practical or regulatory standpoint as a company cannot monopolize the market in its own stock. Thus investors can expect a "slow play" repurchase program from Airgas. That could dilute the 'buyback' effect on valuation.
Pumps and Meters from IDEX
IDEX Corporation (IEX) will have a bit easier time in repurchasing its shares, at least in terms of trading volume. The company plans repurchase up to $250 million worth of stock, or approximately 6.0 million shares at the current price level. That represents only 15 days of trading volume at the current pace of trading in IEX.
IDEX also has more readily available resources to support its buyback plan. Its leadership has shied away from leverage. The debt-to-equity ratio is a paltry 0.48 compared to an average 2.16 for its peer group. However, IDEX is not likely to borrow to support share purchases. The company reported $221 million in cash on its balance sheet at the end of June 2012. What is more IDEX converted 14.2% of its $1.9 billion in sales in the last twelve months to operating cash flow, suggesting there could be even more cash coming into the coffers in coming quarters.
IDEX offers a mix of health, science, fire and safety products to various end-users. It is conventional product line sold to buyers in established industrial and manufacturing settings. They are a conservative bunch at IDEX. So it is not surprising that options outstanding totaled only 2.8 million at the end of December 2011, representing potential dilution of 3.4% and less than half the proposed buyback.
Investors have accorded IDEX higher multiples than averages in its industry peer group. That is probably due to IDEX's above-average performance in generating returns on investment and profitability. That comparison, along with a net reduction in shares outstanding after options are soaked up, could help drive valuation even higher.
Unappreciated Materials Science
Even if its sales have been stubbornly flat over the past few years, Materials Science Corporation (MASC) consistently delivers strong profits. The company develops and sells acoustical and coated metal products to industrial customers. MASC is valued at multiples well below averages for its peer group. The appearance of slow growth and reduced earnings may be at the foundation of this rebuff by investors. The year-over-year earnings comparison is difficult in the current fiscal year after the company reported a one-time income tax benefit in last year. Only one analyst has published sales or earnings estimates for Materials Sciences, so the company's prospects are getting little scrutiny.
The company added 1.0 million shares to an existing share buyback program, bringing the total to be bought over the coming months to 1.4 million. That represents 18.2% of shares in the float, i.e. shares not held by insiders. Only 22,000 shares per day are mustered up for trading in MASC. Thus the share repurchase activity could bring welcome liquidity to the market.
Cash from Railcars
Trinity Industries, Inc. (TRN) offers diverse product lines to multiple industries around the world. Sales and leasing of railcars account for over half of the company's $3.7 billion in annual sales. Inland barge and energy equipment sales account for the balance. My firm Crystal Equity Research initiated coverage of TRN earlier this year. Trinity is expected to grow at a compound annual growth rate in excess of 15% over the next few years. Since the stock trades at a multiple of ten times earnings, it appeared undervalued.
Trinity does a good job of generating cash, converting 8% of sales to operating cash flow in the twelve months ending in June 2012. That success has put $294 million in cash on Trinity's balance sheet. The company proposes to use $200 million to repurchase shares. That represents 6.2 million shares at the current price level. With only 200,000 options outstanding, the share count could be reduced by close to 8% if the entire program is completed.
Trinity management should have little difficulty in executing on the repurchase plan. TRN trades over 1.0 million shares a day. While the buying activity may not be needed to provide liquidity, it may have an impact on short interest. Currently shares representing as much as 3.5% of the float have been sold ahead of anticipated share price declines. The company's presence in the market could put a squeeze on those positions.
Summary: Repurchase programs have historically offered bull case investors good returns. These four industrial suppliers - ARG, MASC, IDEX and TRN - also offer upside from solid growth potential, consistent profits and strong balance sheets.
Neither the author of the Small Cap Strategist web log, Crystal Equity Research nor its affiliates have a beneficial interest in the companies mentioned herein. Crystal Equity Research has a Buy rating on TRN.