Share buybacks: welcome payments in a suspect currency
European companies are buying their own shares in spades. They earmarked $350bn for the purpose in 2022, equivalent to 2.4 per cent of their market value, according to analysis by Bernstein, a wealth manager. Stock repurchases reached £55.5bn in the UK market last year, according to AJ Bell. Shell and BP alone accounted for £22bn. Lloyds, NatWest and Barclays contributed £5.5bn to the buyback pot.
Investors usually see bumper buybacks as supporting stock prices. But they may not be the bullish signal they appear.
The positive case for buybacks is that they return cash to shareholders on top of ordinary dividends while at the same time delivering growth.
The growth in question is only in earnings per share. By retiring stock, the company ensures the pie of future income is divided among a smaller number of diners. The pie will usually be a little smaller too. Company debt and interest costs typically rise. But borrowings are cheaper than equity and interest is tax deductible, so the whole exercise is usually described as “EPS accretive”. If earnings multiples do not change, that should increase the market value of the remaining shares – giving shareholders the benefit of the cash distribution without the immediate tax burden created by dividends.
Bulls argue buybacks are a bit like capital expenditure, with the company choosing to invest in its own assets — implying that executives think the stock is cheap.
That is as may be. But there is a downside to buybacks, too. Lex is a confirmed curmudgeon on the subject, while recognising that many investors love them.
Buybacks are the flakier cousin of dividends. They tend to reflect exceptional — rather than sustainable — profits. They are also a poor substitute for viable investment in corporate expansion. A company may be able to keep increasing profits by investing in new products and services, getting better at it the bigger it gets. Once it has retired all its shares, the EPS accretion game is over.
To top things off, executives have a self-serving bias in favour of buybacks. They typically receive share bonuses for achievements that include steadily-rising EPS.
Take all of that together and — rather than a way of signalling confidence — buybacks can indicate unsustainable profits and a dearth of investment opportunities.
That, at least, is one way to read the buyback spree oil majors are on. High oil and gas prices mean they are making bumper profits. Reinvesting these in value-added energy projects is easier said than done. The cost of capital for oil and gas has risen, as investors fret that fossil fuels will be edged out by the energy transition. And deploying heaps of money in renewables is also difficult. It takes time for companies to build their capabilities.
Hiking dividends is an option — and indeed, oil companies have done that too. But commodity prices rise and fall, whereas dividends should be stable or growing.
The flexibility, in this case, comes courtesy of the buyback. This, Bernstein argues, is a tool that will come in handy over and over again as investment opportunities dwindle further and supply constraints bolster oil and gas prices. While that provides welcome cheques for investors, it is hardly a resounding show of faith in the sector’s long-term prospects.
He’s a Schu-in
Incoming Unilever chief executive Hein Schumacher — most recently head of a Dutch dairy co-operative — hardly ranks as a household brand. But the ex-Unilever executive has the approval of activist Nelson Peltz, who has agitated for change at the UK-listed consumer goods company.
Schumacher, who takes the helm in July after current boss Alan Jope retires, will inherit an underperforming company. Shareholders interpreted Jope’s abortive attempt to buy the consumer products division of GSK as an attempt to create a smokescreen.
Unilever has delivered volume and product mix growth of 1.8 per cent a year on average since 2003, compared with Nestlé’s 3 per cent, according to analysis by Jefferies.
That gap has widened significantly since the first quarter of 2020. The shares have reflected Unilever’s lacklustre performance. Total shareholder return over Jope’s nearly four years to the end of 2022 has been 14 per cent, versus the sector at 40 per cent.
Unilever trades at a significant discount to its peers. Its 17 times 2023 earnings compares poorly with Nestlé on 22 times. US home and personal care rival Procter & Gamble earns a punchier 23 times forward earnings multiple.
An easy win for Schumacher would come courtesy of more marketing spending, begun by Jope. An ill-conceived profit margin target — now ditched — led to a fall in Unilever’s brand investment as a percentage of sales since 2016.
Sluggish volumes may also be a reflection of Unilever’s sometimes underwhelming food brands. Unilever has begun tweaking its portfolio by selling its €6.8bn spreads business in 2018 and its tea unit in 2021. A rumoured $3bn sale of its US ice-cream business should follow.
Schumacher — a dyed-in-the-wool food executive, once at Heinz Foods — should know what to keep and what to cull. Ideally, he should be able to recycle capital raised from divestments into faster-growing markets and products.
Unilever’s brands command plenty of loyalty. It managed to lift prices by 12.5 per cent in the third quarter with only a limited impact on volumes. The group’s emerging markets exposure — which accounts for 60 per cent of sales — could get a boost from improving economic prospects and a weakening dollar. Unilever should close its valuation gap with peers if Schumacher lives up to his promising CV.
A line has been added since publication concerning the tax treatment of buybacks and dividends.
Lex Populi is an FT Money column from Lex, the FT’s daily commentary service on global capital. Lex Populi aims to offer fresh insights to seasoned private investors while demystifying financial analysis for newcomers. Lexfeedback
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