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I would be curious as to you view of companies with a very high debt level to shareholder's equity that incur debt to repurchase shares instead. It seems to have worked wonders with Autozone (AZO) and homebuilder NVR (NVR), less so with Ryan's Steakhouse (RYAN).

My reply to this question is that the situation should be looked at on a case-by-case basis. From a purist standpoint, I would prefer that a soundly managed corporation with high cash flow refrain from paying common share dividends if the excess cash available, therein, is utilized to repurchase shares. In addition, this type of company could consider incurring added debt to purchase shares.

By using excess cash flow and incurring some additional debt to repurchase shares, Homebuilder NVR is a textbook example of what enlightened management can do for the shareholder. Between 1996 and the year 2004, NVR reduced its common shares outstanding in half, from 13.6 Million to 6.3 Million. At year end December 31, 2004, NVR's common shares were selling for $769 versus an average price of $10, back in1996. It should be noted that even now, NVR's total debt is only 33% of the company's total capitalization.

Another company you cited which is much more highly leveraged than NVR, is Autozone, Inc. Between 1998 and year end 2000, AZO's common shares declined to 79.6 Million from 152 Million. During this same time span, AZO's long-term debt soared to almost $1.9 Billion from $545 Million. The company's debt, which is entirely long-term, now totals 92% of AZO's capitalization. Within this timeline, AZO's share earnings more than quadrupled (from $1.48 to $6.56), and the stock has tripled in value.

At this juncture, if an NVR and AZO investor asked me if they should still hold these stocks, my answer would be, yes.

In closing, one interesting company with an exceedingly high debt level is Regal Entertainment (RGC-NYSE). In early 2003, when Regal was selling for $18, the company declared a special dividend totaling over $5 per share. The stock then immediately rose to $23. RGC borrowed $700 million in order to fund the dividend. Under the IRS tax code, if a corporation has no retained earnings and utilizes borrowed funds to pay a dividend, the pay out is considered to be a non-taxable distribution to shareholders.

Incredibly, in the second quarter of 2004, RGC declared another extraordinary dividend of $5 per share. Again, RGC incurred mostly added debt to finance the distribution. Also, in 2004, RGC doubled the rate of its regular annual dividend from 60¢ to $1.20. For the year 2004, 87.5% of RGC's dividend, or about $5.80, was a non-taxable distribution.

One key question would be, Should an investor purchase RGC at its current price of about $19? The answer has to be, no, because as of December 31, 2004, RGC's debt totaled 95% of capital and equity amounted to only 4% of capital. But an investor who purchased the stock at $23 in 2003, now has an adjusted price of only $11, after deducting all of the dividends they received during the past two years. So the punch line is, Such an investor is now receiving an annual return of almost l1%, mostly tax free. Therefore, on a yield basis, RGC is a good hold.

An interesting side note concerning RGC was the attempt by the Louisiana State Pension Fund to legally block RGC from paying the $5 special dividend last year. The pension plan claimed that RGC was managing the company in a reckless fashion by incurring so much added debt to fund the pay out. A court ruled against the Fund on the grounds that it is within the purview of a corporation to decide its dividend policy. After the ruling, RGC told Louisiana State Pension plan that they should sell their RGC holdings if they disagree with RGC's dividend policy.

Thornton Oglove
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