Undervalued UK companies have taken matters into their own hands by buying back shares this year, according to Russ Mould, investment director at AJ Bell.
Domestic stocks have been unloved for some time, with Brexit, a lack of technology stocks and the global pandemic all putting overseas off from buying UK companies.
However, the largest names appear to be taking a proactive approach to their share prices, with FTSE 100 firms planning to buy back up to £26.9bn in shares this year.
HSBC, BP and Ashtead made bumper profits in 2023 and announced multi-billion dollar share buyback schemes. This puts the sector on track to match 2022’s record cumulative buybacks of £55.8bn.
“The total is £110.4bn, equivalent to 5.2% of the FTSE 100’s current total market capitalisation of £2.1trn,” said Mould.
“That is competitive when compared to the Bank of England base rate or the yields available on UK government bonds, although the danger remains that buyback plans are revised and dividend forecasts prove over-optimistic, should a recession or another unexpected development strike.”
Indeed, he warned that this “cash return bonanza” could reverse just as easily, depending on the direction of the global economy in the second half of the year.
This was the case in 2020, for example, when companies scrapped plans to buy back £10.3bn more as the pandemic spread, lockdowns were imposed and the world plunged into a recession.
“Buybacks are particularly subject to revision, as there is far less stigma when a management team quietly parks a programme compared to when a boardroom has to sanction a dividend cut,” said Mould.
But the risks don’t stop there and not everyone is happy with the announcements, in particular in relation to BP.
“Investors still seem a bit disappointed with BP’s forward guidance for buybacks and dividends for the rest of 2023, given how first-quarter cash flow was not quite so copious as before, thanks to lower fossil fuel prices and increased capital investment,” said the director.
“Even so, BP’s announcement cements the oil and gas sector’s position at the top of the buyback charts, as ranked by industrial sector. This will doubtless make environmental campaigners despair, but it also may also mean their pleas for further windfall taxes resonate with politicians and the wider public alike, especially if oil or gas prices start to rally again.”
Buybacks by company and sector
Source: AJ Bell; Company accounts. *Announced to date
Another reason for cynicism is that buybacks tend to be pro-cyclical. Buyback activity reached its high in 2006-07, as spirits were running most strongly just before the financial crisis swept the world, noted Mould.
“More than £60bn in buybacks across those two years did nothing to support share prices in 2007-09 and buybacks slowed to just £3bn in 2009 by the time the crisis was passing, and equity markets had collapsed and thus become much cheaper.”
The same happened in 2018 and the FTSE 100 topped out that year too.
“Management teams’ record of buying high rather than low may give some investors pause for thought as to whether buybacks are a potential contrarian indicator,” said Mould.
“BP’s own track record here is not great. Its last major buyback spree of 2005-07 ran slap into the financial crisis and a collapse in the oil price from $147 to $35 by late 2008, while 2014’s buyback was followed by a two-year drop in the price of crude from over $100 a barrel all the way down to $28.”
BP share buybacks
Source: AJ Bell, Company accounts, Refinitiv data. *2022 announcements to date
Buyback programmes could also be used “to massage earnings per share figures” by reducing the share count at limited cost to then trigger management bonuses or stock options through “some near-term financial engineering”, said Mould, who also warned about the risk of achieving this through debt and potentially weakening balance sheets.
On the other hand, his arguments in favour of buybacks included returning money to shareholders by increasing the share price, therefore letting them decide what to do with it rather than “splurge it on an unnecessary acquisition or capacity increases”.
It also gives investors an enhanced stake in the company, who will thus be entitled to a bigger share of future dividends (assuming there are any).
Finally, “buybacks can also suggest that a management team feels a company’s shares are undervalued, so any move to buy back stock can be seen as a vote of confidence in the firm’s near and long-term trading prospects,” he concluded.