Dividends or buybacks? It’s a hotly debated question proponents of each capital allocation decision are quick to defend, but so far in 2016, there’s no doubt which is performing better.
With yield difficult to come by in a low-interest-rate environment, it’s only natural that the iShares Select Dividend ETF (DVY) would attract investors.
DVY tracks the Dow Jones U.S. Select Dividend Index (PDF), a group of 100 companies that have consistently provided relatively high dividend yields over the long haul. It’s up 8.1% year-to-date through April 8.
On the buyback front, we’ve got the PowerShare Buyback Achievers Fund (ETF) (PKW), which tracks the Nasdaq U.S. BuyBack Achievers Index, a group of 233 stocks, all of which have repurchased at least 5% of their stock over the trailing 12 months. It’s down 1.2% year-to-date, which is much worse than DVY but a percent better than the Nasdaq itself.
Dividends beat buybacks. For now, at least. But if you believe in both, National-Oilwell Varco, Inc. (NOV) stock, despite its Monday morning announcement that it is cutting its dividend by 89%, is all you need in the long-term.
Here’s why.
Good Job Buying Back NOV Stock
There aren’t many firms that do a good job in this area — evidence suggests buybacks actually destroy value, not create it — National-Oilwell Varco is a rare exception.
NOV stock closed 2013 trading at an adjusted (dividends) price of $66.27. Then came the oil implosion. It closed 2015 at $33 on an adjusted basis, a 50% decline in its stock price over 24 months. Long-term owners of NOV stock have certainly paid the price — on paper.
So, you can either believe that oil is permanently broken and NOV stock is a complete write-off or support the idea that sub-$40 prices aren’t going to last forever. It’s one of the two. Of course, they’ve said the same thing about interest rates.
I can’t say anything about the former, but I can speak to the latter. If the current state of oil prices is only temporary, it’s safe to say that the intrinsic value of NOV stock is higher than $29.11, its April 8 closing price.
What does this have to do with stock buybacks?
NOV management repurchased 55.6 million of its shares in 2014 and 2015 at an average cost of $54.32. On an adjusted basis, that’s about $45. Clearly, it feels the intrinsic value of NOV stock is higher than that.
Why?
Because it doubled down in 2015, buying back 44 million or 79% of the shares repurchased over the past two years. With its stock dropping 46% in 2015, there would be no better a time to invest its free cash in its own stock rather than equipment that was just going to sit idle. That’s capital allocation 101.
In two years’ of trading, NOV stock traded as high as $86.55 ($70.97 adjusted for dividends) in September 2014, and as low as $32.89 in December 2015. The average between the high and low — $51.93 on an adjusted basis, almost $7 more than what National-Oilwell paid for its stock.
Take some time and do this exercise for some of the other companies held by PKW and you’ll see this achievement is rare.
The last time NOV stock traded this low was June 2010. At that time, it chose to use its free cash to make acquisitions. It was still growing. Another wise allocation of capital. Then it switched gears and used debt, rather than cash, to make 17 acquisitions worth $2.9 billion in 2012 alone. A third example of capital allocation smarts.
Which brings us to the present. Where to next? That’s up in the air.
Bottom Line on National-Oilwell
National-Oilwell CEO Clay Williams is on record wanting to make acquisitions with $2.1 billion in cash and $3.6 billion undrawn on its loan revolver, but won’t pull the trigger unless it makes sense from a capital allocation standpoint.
However, NOV might have tipped its hand Monday stating in its press release, “Reducing our dividend will allow us to preserve capital to invest in future growth opportunities and enhance the core capabilities our customers will need when industry activity increases.”
That tells me acquisitions are definitely back on the table.
Any short-term hit NOV stock takes as a result of its dividend cut is a buying opportunity in my opinion, because history has shown it doesn’t take capital allocation lightly.
NOV stock was worth owning last week. It will be worth owning next week, too. When the business returns, as will a higher dividend.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.
