Published in AFR by Sarah Turner – AFR 5/11/18 (Original Source Link Here)

Selected Australian companies are set to buy back more of their shares, fund managers said, as legendary US investor Warren Buffett joined the share buyback bandwagon.

Mining giants BHP and Rio Tinto have already said they will return capital to Australian shareholders, with BHP announcing a $14.7 billion combination of buybacks and special dividends, while Rio Tinto will undertake a $US1.9 billion ($2.6 billion) off-market buyback.

The capital return plans unveiled by the mining giants in the past few months follow a wave of buybacks from American companies.

Mr Buffett is somewhat late to the American buyback party, telling shareholders on the weekend that his investment firm Berkshire Hathaway would buy back its own shares for the first time since 2012.

“The world was awash with liquidity after the global financial crisis. It was very cheap to borrow money, so there have been a lot of buybacks in the last few years,” Tribeca Investment Partners portfolio manager Jun Bei Liu said.

The benefit of buying back shares for companies, along with returning capital to shareholders, is that it reduces the number of shares in circulation and can lift earnings and share prices.

The tide started to turn for American corporate buybacks earlier this year as interest rates moved higher for companies that had already taken on substantial amounts of debt to buy back their stock.

“The US is so far ahead of us in terms of scale in buybacks, but that’s starting to run its course as interest rates rise,” Katana Asset Management portfolio manager Romano Sala Tenna said.

Buying back shares is an arm of the capital allocation story for companies. Other ways to allocate capital include investing in organic growth, engaging in mergers and acquisitions and paying dividends.

The type of capital allocation that a company leans toward is in some ways a function of a firm’s national operating culture, Mr Sala Tenna said.

In the US they have traditionally paid lower dividends. The model has been about capital growth and shareholders are accustomed to receiving more capital growth, the fund manager said.

But in Australia “we haven’t been as keen on buybacks”, he said. That’s partly because Australian interest rates didn’t fall as far as US interest rates after the global financial crisis and also because Australia’s tax regime favours dividend payouts, Mr Sala Tenna noted.Advertisement

“Because we have fully franked dividends here, it’s more attractive for shareholders to receive dividends than for companies to undertake a share buyback,” he said.

Still, that could be set to change, he said, noting that the election of a Labor government next year could alter the outlook for dividend payments given the opposition’s focus on the current dividend franking regime. “We might see changes [to buybacks] if the franking regime is less attractive.”

The fund manager also noted that some Australian companies were already buying back their shares, including insurance firm QBE, fund manager Janus Henderson and miner South32, which are companies in which Katana has shareholdings.

These companies are “old world” companies that can trade on low multiples compared to the rest of the market. They have repaired their balance sheets but operate in a low-growth environment, he noted.

“I think we are going to see more. Old world companies are in a low-growth environment and investors are now more accepting of disciplined capital management.”

Mature Australian businesses are buying back shares, agreed Ms Liu at Tribeca. “I think when companies go down the route of buybacks they don’t have any other route for using capital.”

She noted that the miners had been returning capital to shareholders as higher commodity prices had helped these firms pay off their debt quickly and they were sitting on cash balances with strong balance sheets.

“Increasing numbers will be doing buybacks,” she said. “Their earnings are so cyclical. If China stopped buying iron ore then their fortunes could turn around quickly.”

For other sectors of the market, the fund manager said mergers and acquisitions will likely dominate as shareholders in growth companies, for example, would not be likely to reward the engineered earnings growth from buybacks when these firms could be achieving earnings growth by other means.


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