European companies are buying their own shares in spades. They set aside $350 billion for that purpose in 2022, equivalent to 2.4 percent of their market value, according to an analysis by wealth manager Bernstein. Share buybacks 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 pot.
Investors typically view bumper buybacks as supporting stock prices. But it may not be the bullish signal they appear to be.
The positive case for buybacks is that they return cash to shareholders beyond common dividends, while also delivering growth.
The growth in question is only in earnings per share. By divesting shares, the company ensures that the future revenue pie is shared among a smaller number of eaters. The pie will usually be a bit smaller as well. The company’s debt and interest costs usually increase. However, loans are cheaper than equity and interest is tax-deductible, so the whole exercise is usually described as “incremental EPS”.
Bulls argue that buybacks are somewhat like capital expenditures, with the company choosing to invest in its own assets — implying that executives believe the stock is cheap.
This is as it may be. But there is also a downside to acquisitions. Lex is a confirmed chaser in the matter, while recognizing that many investors love them.
Buybacks are the more obvious cousin of dividends. They tend to reflect exceptional — rather than sustainable — earnings. They are also a poor substitute for sustainable investment in corporate expansion. A company may be able to continue to grow profits by investing in new products and services, improving it as it grows. Once it retires all its shares, the EPS growth game is over.
Additionally, executives have a self-serving pro-acquisition bias. They typically receive stock bonuses for achievements that include consistently increasing EPS.
Take all this together and – rather than a way of signaling confidence – takeovers can indicate unsustainable profits and a lack of investment opportunities.
That, at least, is one way to read the ongoing oil buying spree. High oil and gas prices mean they are making big profits. Reinvesting them in value-added energy projects is easier said than done. The cost of capital for oil and gas has risen as investors worry that fossil fuels will be wiped out by the energy transition. And deploying piles of money in renewables is also difficult. It takes time for companies to develop their capabilities.
Increasing dividends is an option – and indeed, oil companies have done so as well. But commodity prices rise and fall, while dividends should be flat or rising.
Flexibility, in this case, comes courtesy of repurchase. This, Bernstein argues, is a tool that will come in handy again and again as investment opportunities shrink further and supply constraints bolster oil and gas prices. While this provides welcome checks for investors, it’s hardly a resounding sign of faith in the industry’s long-term prospects.
It’s Schu-in
Unilever’s incoming chief executive Hein Schumacher – most recently head of a Dutch dairy cooperative – hardly ranks as a household name. But the former Unilever executive has the endorsement of activist Nelson Peltz, who has pushed for change at the UK-listed consumer goods company.
Schumacher, who takes over in July following the retirement of current boss Alan Jopp, will inherit an underperforming company. Shareholders interpreted Jope’s failed attempt to buy GSK’s consumer products division as an attempt to create a smokescreen.
Unilever has seen volume and product mix growth of 1.8 percent a year on average since 2003, compared with Nestlé’s 3 percent, according to a Jefferies analysis.
This gap has widened significantly since the first quarter of 2020. Shares reflect Unilever’s underperformance. Total shareholder return over Jope’s nearly four years to the end of 2022 was 14 percent, against the industry at 40 percent.
Unilever trades at a significant discount to its peers. Its 17x 2023 earnings compares poorly with Nestlé at 22x. US home and personal care rival Procter & Gamble earns more at 23 times earnings.
An easy win for Schumacher would come thanks to more marketing spending, initiated by Jope. A misguided profit margin target — now abandoned — led to a decline in investment in Unilever’s brand as a percentage of sales since 2016.
Sluggish volumes may also reflect Unilever’s sometimes underwhelming food brands. Unilever has begun reshaping its portfolio by selling its spreads business for €6.8bn in 2018 and its tea unit in 2021. It will be followed by a rumored $3bn sale of its US ice cream business.
Schumacher—a dyed-in-the-wool food executive once at Heinz Foods—should know what to keep and what to remove. Ideally, it should be able to recycle capital raised from divestitures into faster growing markets and products.
Unilever’s brands exude plenty of credibility. It managed to raise prices by 12.5% in the third quarter with only a limited impact on volumes. The group’s exposure to emerging markets – which accounts for 60 percent of sales – could be boosted by an improving economic outlook and a weaker dollar. Unilever should close its valuation gap with its peers if Schumacher lives up to his promising resume.
Lex Populi is an FT Money column from Lex, the FT’s daily commentary service on global capital. Lex Populi aims to bring new insights to seasoned retail investors while demystifying financial analysis for newcomers. Lexfeedback@ft.com