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McDonald's joins companies irking bondholders for equity's sake
[NEW YORK] McDonald's Corp. joined the ranks of companies drawing the ire of bondholders and the attention of ratings companies after it said it plans to accelerate shareholder rewards, which may increase its debt burden.
The burger chain's Monday statement that it would return as much as $9 billion to shareholders this year resulted in a reduction of its credit rating at Standard & Poor's. The plan "will necessitate higher leverage than we forecast and represents a more aggressive shift toward shareholder returns that we previously assumed," analysts led by Robert Schulz in New York said in cutting the company's rating to A- from A. Moody's Investors Service put its A2 rating on review for a ratings cut.
McDonald's joins investment-grade companies in the S&P 500 index that purchased a record US$429 billion in shares last year amid a treasurer push to boost return on equity while the cost of debt remains low relative to that of stock, according to Morgan Stanley.
"This is sort of a classic conflict. It's certainly shareholder-friendly activity but it comes at the expense of bondholders," Sivan Mahadevan, who heads U.S. credit strategy at Morgan Stanley, said by telephone. "You're raising leverage in the company, so that's not good for bondholders." Rising Leverage Stock buybacks reward equity investors who hold onto their securities by improving metrics such as earnings per share. That comes at the cost of draining cash or increasing debt, which puts upward pressure on leverage, the ratio of debt to earnings.
Companies issued US$1.1 trillion of high-quality debt last year. That's pushed gross leverage levels among investment grade, non-financial issuers up to about 2.2, higher than the levels reached at its previous cyclical peak in 2009, Mr Mahadevan said.
Still, re-leveraging for stock buybacks isn't the worst thing treasurers could be doing to their capital structures, Mr Mahadevan said. He said raising debt to increase capital spending or fund acquisitions would be riskier for creditors.
Investment-grade companies earmarked 13 per cent of new bond issues for shareholder payments, compared with the 12 per cent of bonds whose proceeds went to fund capital expenditures among 1,553 debt issues bigger than US$25 million that specified use of proceeds in the past two years, according to data compiled by Moody's and Bloomberg.
McDonalds' latest strategy, which includes dividend increases as well as stock buybacks to directly reward shareholders, also includes cost reductions, a shift of company- owned restaurants to franchisees and a focus on fast-growing countries to counteract slumping revenue.
The plan failed to aid McDonald's shares, which fell 1.7 per cent this week to US$96.13. They've dropped 5 per cent over the past year while the S&P 500 index has gained 11 per cent, Bloomberg data show.
The company, which has US$13.1 billion of bonds and loans, saw its US$850 million of 6.3 per cent notes due in October 2037 fall to 123 cents on the dollar, 6.3 cents less than before the Monday announcement, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The securities, which traded at 134 cents in February, now yield 4.64 per cent.
"In the broad sense the global trend to boost buybacks and dividends is negative for credit quality," Ben Garber, a capital markets economist at Moody's, said by telephone April 28.