After reporting strong profits, retaining solid profit margins and improving balance sheets, we think many companies will begin loosening some of their conservative practices of the last 18 months. Management teams are increasingly comfortable running businesses with a BBB credit rating, as opposed to an A rating, and with capital markets wide open, we expect to see more merger and acquisition (M&A) activity and other potential changes to corporate structures as companies seek ways to realize value.
Already, several conglomerates have announced break-ups to optimize capital structures and allow for more efficient capital allocation by eliminating the need for one business to subsidize the other. While size has been an advantage in terms of profit margins and credit ratings, we believe that capital restructurings are not necessarily negative for credit; in at least one case the company will use proceeds to reduce debt.
Some capital allocation trends remain more concerning; we continue to monitor areas of potential overinvestment. We highlight that utility companies could face high funding needs as they invest in the energy transition, though we believe management teams remain committed to retaining IG credit ratings. Utilities trying to avoid issuing more debt may either increase their hybrid issuance or engage in minority interest sales or outright divestitures.
Lastly, we note that share buybacks have once again been increasing as managements feel more confident. However, a potential new tax on share buybacks in the US may lead companies to return capital to shareholders through variable dividends instead. From a credit point of view, buybacks are not a positive development, but are preferable to dividends because they are more flexible.
