Corporate America is over-caffeinated | Financial Times
Starbucks isn’t just the world’s largest coffee chain; it’s a bellwether stock, one that tells us a disproportionate amount about the American economy and where it may be headed.
When Barack Obama was president of the US, he used to call Starbucks founder and former chief executive, Howard Schultz, for a read on the American consumer. The store sales figures coming out of thousands of communities around the country, four times a day, were much more sensitive than any Bureau of Labor Statistics data.
Last week, Starbucks told us something important and disturbing. The company’s stock took a dive after it signalled, during a presentation at a Goldman Sachs retail conference, that its recent 10 per cent rate of profit expansion wouldn’t carry into next year. In large part, this was because the benefits from President Donald Trump’s tax cuts were tapped out.
As Patrick Grismer, the chief financial officer of Starbucks, put it, “far and away the driver of our outperformance in fiscal 2019 relative to our original expectations was our effective tax rate”. Now that the tax boondoggle is over, so is Starbucks’ outperformance. The company also announced it was pulling forward $2bn worth of share buybacks it had planned for 2020 into the current year, as its sales and earnings are falling short of expectations.
Using equity repurchasing to bolster share prices is nothing new for Starbucks, which has seen its share price grow by some 80 per cent in the past year thanks not only to those Trump tax cuts, but to share buybacks (much of the company’s earnings per share growth comes from them).
The money raised from new bond issuances is often used to pay for those buybacks. Starbucks’ own debt load has roughly tripled over the past few years as it has pivoted to what it calls a “more highly leveraged model”.
Starbucks is of course by no means alone in its employment of such financial engineering. One of the biggest market stories of the past several years has been corporations capitalising on cheap money, using record low rates to issue bonds and then using the money raised to buy back their own equity in order to bolster share prices.
It’s a shell game that has always made my head spin, particularly when done at a market peak, rather than a trough, which tells you that the strategy isn’t a bet on a real, underlying growth story but an attempt to make headlines.
I thought we’d reached a peak in such Faustian financial wizardry a while ago, but no. In recent days, Apple, which has $200bn dollars of cash or cash equivalents on hand, announced a $7bn bond offering, part of a slate of $54bn worth of corporate debt issuances in the past week or so. Just when you think the bond bubble can’t get any bigger, it does.
Given the looming risk of recession, a spate of recent corporate trouble (involving heavyweights such as GE, Kraft Heinz, Boeing, PG&E, and now Johnson & Johnson, which is under fire for its role in the opioid crisis), you would think investors might steer clear of even “high grade” corporate debt. But the asset class seems to fill an existential need for something between equities, which many worry could crash, and the glut of negative-yielding government bonds.
In today’s bizarre and bifurcated market, any middle ground, it seems, is better than none. To me, all this says that corporate America is over-caffeinated and due for a crash. Starbucks would say the American consumer is not.
As Mr Grismer says, “we see in the US a very healthy consumer”. And it’s true that, while tax cuts and buybacks have been a big part of the Starbucks story over the past couple of years, they aren’t the only part. Consumer confidence in the US has, at least so far, been surprisingly resilient in the face of the US-China trade conflict, monetary policy uncertainty, and the sound and fury coming out of the White House. Starbucks same-store sales growth, a good measure of underlying demand, has been robust.
But policymakers worry that this resilience may not last. As New York Federal Reserve president John Williams put it recently, “the consumer is now carrying all of the weight, or much of the weight, for growth going forward.” Or, as Dallas Fed chief Rob Kaplan, who worries that bad macroeconomic data could shift consumer sentiment, says, “if you wait to see weakness in the consumer, you’ve likely waited too long”.
This reminds me of something Mr Schultz told me in February of 2015. Starbucks had just released impressive quarterly numbers. But Mr Schultz worried that economic bifurcation and political dysfunction following the 2008 global financial crisis had created a new and more “fragile” consumer, one that was quick to button up their wallet at the first real sign of economic trouble.
“There is no company you can point to that is as dependent as we are on human behaviour, the human condition,” he told me back then. In a nation divided between latte makers and latte drinkers, any small piece of bad news could trigger a downturn.
Economic bifurcation, political dysfunction, and our dependence on the fragile American consumer has only increased since then. For the sake of the markets, and the global economy, let’s hope they’ve had their double shot.