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The ‘quasi-dividend’ of a buy-back programme

Financial Times: The ‘quasi-dividend’ of a buy-back programme

“So why has there been such commiseration when companies such as Royal Dutch/Shell… cast a veil of uncertainty over their share repurchase programmes?”: “This month, shareholders have been disappointed by the impact a $45bn (£25bn) capital spending programme over the next three years will have on Shell’s buy-back programme.”

By Henry Tricks

Published: October 2

According to a joke doing the rounds in the City, dividends are like marriage and share buy-backs are like affairs, requiring no long-term commitment.

So why has there been such commiseration when companies such as Royal Dutch/Shell, Barclays and Boots cast a veil of uncertainty over their share repurchase programmes?

The answer, according to Rolf Elgeti, strategist at ABN Amro, is that investors are viewing buy-backs as “quasi-dividends” instead of the flexible way of returning cash to shareholders they are meant to be.

“We have been seeing a shift here since the beginning of this year where more and more investors have incorporated share buy-backs into their dividend yield forecasts,” he said. “It may be that playing around with the buy-back programme will come to have the same potential impact as a dividend cut.”

This month, shareholders have been disappointed by the impact a $45bn (£25bn) capital spending programme over the next three years will have on Shell’s buy-back programme. When Barclays announced it was in talks to buy South Africa’s Absa, it indicated it might be forced to suspend its buy-back programme if it makes a cash purchase. Meanwhile, Boots has left open the possibility of suspending the second tranche of its £700m share repurchase programme.

Bankers and analysts say it is perfectly legitimate for companies to adjust their buy-back programmes if they can increase returns by investing the money in improving the business rather than handing it back to shareholders. The trouble comes when companies use the cash for misadventures, or shareholders lack the confidence that management will spend their surplus cash wisely. However, shareholders should not become complacent, they say.

“The market has got used to a continuous stream of buy-backs but it has to recognise buy-backs are driven by management’s view of what constitutes genuine surplus,” warns a senior London investment banker. “They should not be counted on.”

According to Graham Secker, of Morgan Stanley, share buy-backs are running at a record rate of £14bn this year, equating to what he calls a “buy-back yield” of 1.2 per cent. Adding this to UK companies’ dividend yield of 3.4 per cent provides a combined yield of 4.6 per cent – slightly lower than the return on 10-year gilts.

That combined yield, he says, is at a nine-year high.

It is easy to exaggerate the inherent value of buy-backs. According to analysts, in the UK there are few meaningful tax advantages to buy-backs over dividends.

JP Morgan notes that share repurchases do not create value unless the cash payment is big enough to permanently increase leverage, or if the stock is undervalued and subsequently re-rates. Sometimes, share repurchases signal a lack of management vision. There is little evidence to prove over the long-term that buy-backs provide a lasting boost to shareholder returns.

However, in times of uncertainty, it is heartening for shareholders to know that management believes its own growth story. Moreover, buy-backs enhance earnings per share, even if that is merely cosmetic.

That, perhaps, is why managers are in love with them. But buy-backs, like love, are a fickle thing.

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