Rudi's View | Mar 25 2015
This story features COMPUTERSHARE LIMITED, and other companies. For more info SHARE ANALYSIS: CPU
In this week’s Weekly Insights:
– Buy Capital Management
– The Fed’s Volatility Conundrum
– Are We Too Bullish On USD?
– Rudi On TV
– Rudi On Tour
Buy Capital Management
By Rudi Filapek-Vandyck, Editor FNArena
Companies that buy in their own equities outperform stocks that do not buy in their own equities. The same logic applies to companies that announce special dividends, or any other form of capital management.
There is enough research available from the USA to support the opening statement in today’s Weekly Insights, which is why since sometime in 2014 this weekly piece of market analysis carries an (incomplete) overview of companies that have announced (or are about to announce) capital management initiatives.
Australian companies have been rather conservative in offering additional rewards to shareholder in the post-GFC era, certainly when compared with their peers in the US. But things are picking up and there are quite a few analysts and market observers around who expect to see more M&A, more spin-offs, more special dividends and more share buy-backs by corporate Australia as 2015 unfolds.
This should be good news for Computershare ((CPU)), as this is the sort of corporate activity the company’s business model thrives upon, but also for traders and investors who are willing to piggyback on such corporate announcements. Some of the best performers in the share market, such as CSL, Ansell and Amcor, have repeatedly reduced their equity in years past, further supporting the thesis that buy backs are good for shareholder returns.
Now analysts at Macquarie have done the hard yakka, analysing corporate buy-backs in Australia since 1994. We no longer have to rely on overseas research, or on anecdotal market observations, to support and value board initiatives to enhance shareholder benefits. Now we have local data to support the thesis that policies aimed at delivering more rewards to shareholders work. In most cases, that is.
Expensive Works Better
Before we move into the nitty gritty of Macquarie’s research, let’s spend some extra time first on what I regard two key observations from the report:
– capital management does not always translate into outperformance, but it does in the overwhelming majority of cases
– it works particularly well for companies trading on high multiples who buy in their own shares; better for them than for companies that are “cheap”
The first observation is partially interlinked with the fact that capital management needs to have a serious impact in order to have a noticeable effect. Buying back 0.5% of outstanding capital is not going to move the dial. Buying back 5% or 10% does. One other personal observation is that sometimes capital management, like a one-off extra dividend, serves a defensive purpose at times when a company is going through turmoil or has no clear growth avenues. I find that in such cases the impact is smaller, no doubt because the uncertainty that remains dilutes the positive from the extra shareholder reward.
Think back at those dreadful years at Telstra ((TLS)) when the board kept its promise to guarantee shareholders a 28c in dividends each year, and even took on extra debt to guarantee the promise, but the share price kept on falling each year. In recent times, Telstra is one of the strongest performers in the share market, now offering steadily growing profits, cash flows, dividends and a share buy-back on top.
Conclusion number two will surprise many. It contradicts those experts who complain when companies announce buy-backs when share prices are flying high, as opposed to when they are “cheap”. The latter position is always described as the better decision because it signals the board believes the shares are undervalued. Who buys in when their shares are expensive?
Don’t believe the reasoning, because it is dead wrong. It is but one of widely approved theses that sound logical, but don’t stand up in real life. And Macquarie research has just added one more piece of evidence that the opposite is true. High multiple stocks -think CSL, Ansell, Amcor and, yes, even Telstra- trade on high multiples because they are in demand. In high demand. These stocks offer growth, solidity, consistency and long odds of failure, and adding capital management on top simply makes their investment case even more attractive.
What I find fascinating is that this, again, flies in the face of everyone who feels comfortable buying “cheap” stocks while ignoring high multiple stocks, because the latter are supposedly more “expensive”. See also my Weekly Insights from last week: “The False Comfort Of Cheap Versus Expensive”.
Capital Management Equals Outperformance – The Stats
Time to throw in some data and stats to illustrate why investors should pay attention:
– A simple strategy of buying the top 20% of stocks by Net Buyback Yield would have returned investors 10.9% per annum compared to the equal weighted ASX200 return of 6.5% per annum since 1994 (excess return of 4.4% per annum over twenty years)
– The average excess return of stocks on announcement day is 1.55% with 63% of firms outperforming the market
– The average excess return vis-a-vis the market for the month following the buy back announcement is 1.0%
– The average excess return over 12 months is 3.4% and over 24 months it is 9.1%
A few facts that stand out from the research:
– Large cap firms are more likely to undertake buy-backs and when they do, the returns are better than in small caps
– Companies with low dividends and no franking attached to the dividends perform more strongly post buy-back announcement than high yielding stocks with fully franked dividends (probably because the first category trades on “growth” and the second on “yield”)
– Companies announcing large buy backs (>10% of equity) see positive short-term reactions however stocks with more moderately sized buy-backs perform better over the longer term
– Markets react positively to special dividends with an average excess return of 2.4% in the two weeks prior to the ex-date
– Companies with non-franked dividends have seen significantly positive returns following a share buy back, 19.2% average excess return after 24 months, with a hit rate of 61%
– Portfolios built around companies returning capital outperform the broader market
Below is the chart that illustrates all of the above in comparison with high yield stocks and the ASX200. High yield stocks, as we all know, have significantly outperformed the broader share market since 2009. But don’t be fooled by hyperventilating commentators with a short memory. The chart below clearly shows this was equally the case pre-2007 as well.
However, superior returns have been delivered by companies buying in their own shares. Within this group, high PE multiple stocks have outperformed stocks on lower PE multiples.
Share Buy Backs – Who’s Doing It?
Below is an incomplete overview of companies buying in their own shares this year. We very much appreciate all contributions and suggestions at email@example.com
– Amcor ((AMC))
– Boral ((BLD))
– CSL ((CSL))
– DWS Ltd ((DWS))
– Fairfax ((FXJ))
– Fiducian ((FID))
– Finbar Group ((FRI))
– GDI Property Group ((GDI))
– Logicamms ((LCM))
– Nine Entertainment ((NEC))
– Orica ((ORI))
– Pro Medicus ((PME))
– Rio Tinto ((RIO))
– Seven Group ((SVW))
Wants to buy in own stock (but still awaiting shareholders approval): Intrepid Mines ((IAU))
How about we start broadening our list to all forms of capital management, including extra dividends and spin-offs? Your contribution is highly appreciated at firstname.lastname@example.org
Note: Premier Investments ((PMV)) reported a solid financial performance on Monday, withstanding the trend for retailers to disappoint, and surprised with a special 9c dividend on top of 21c in interim pay-out. The shares rose more than 11% on the day in response.
The Fed’s Volatility Conundrum
Central bankers like stability and predictability, they do not like volatility. There’s more weight behind that sentence than you realise.
While just about every commentator and their dog have an opinion about the US labour market and US economic data this year, credit analysts at Deutsche Bank have shone a light on something that has remained completely absent from any predictions or comments on the outlook for US interest rates and bond yields: volatility.
Central bankers at the FOMC don’t like volatility. They don’t like to stir things up when things are hyper and volatile. And said Deutsche Bank analysts have the historical data to prove it.
Enter: the chart below. What you see is volatility measured across three key assets -equities, FX and yield instruments- shown via the blue line on the chart.
History shows a clear and direct relationship between Fed actions and market volatility, points out Deutsche Bank. The green arrows show the Fed loosening when volatility is high and tightening only when volatility is low.
The chart also clearly shows that Fed tightening is followed by increased volatility, which might explain as to why the Fed doesn’t like to start in a volatile environment to begin with. This does, however, clearly explain the current conundrum for FOMC members and as to why they’d want to act slowly and cautiously.
It does become a dilemma though in the face of the Fed’s determination to lift interest rates ahead of the next requirement to stimulate the US economy. What if volatility spikes every time the next decision time draws nearer? Or does this merely imply that quick successive actions of tightening -the ultimate bogeyman for financial assets- simply cannot be on the cards?
Are We Too Bullish On USD?
We are all USD bulls in 2015. Judging by recent FX updates by the likes of CBA and ANZ Bank, there simply is no end in sight for predictions of stronger USD/weaker euro and weaker AUD by year-end and, in fact, for the next two years. But none of this means the majority view is also going to turn out the correct view.
Need I remind everyone that in 2013 the general view was that bonds were on their way out and equities were shining as the only remaining viable alternative? Bonds did well in 2014. The world had to wait until 2015 for bonds to start accumulating losses and only because, as it turns out, expectations had run too hot for potential policy changes at the Fed.
Which is why the latest “Currency Special” by HSBC should attract everyone’s attention. Faced with just about everyone being bullish on the greenback, analysts at HSBC have decided it’s time to go the other way. The USD bull run, in their view, has now largely run its course. What we are witnessing now is the final stage of a bull trend that is about to reverse, says HSBC.
Factors that make the team at HSBC believe we are at the beginning of the end of the bull run for USD:
– Recent data developments (see also my Weekly Insights last week)
– US tolerance for USD strength has its limits
– Positioning / USD bullishness has become all-pervasive
– USD does not perform once Fed has actually pulled the trigger
Here is some of the reasoning from the report: “There is obviously scope for one last spike higher, as is often the case in the later phase of big bear or bull market moves, which sucks all participants into the narrative. So convinced become the participants that any rational arguments fall on deaf ears and forecasters start coming out with ever more extreme views. But it is time to start looking the other way as this last spike is likely to be reversed swiftly. When the world seems to be revising EUR-USD expectations ever lower, we are moving the opposite way. Our forecast for year-end 2016 is now 1.10 compared to 1.05 previously, and we believe the rate will move to 1.20 during 2017.
“Clearly there are events such as EUR break-up or JPY debasement which could lead to destructive dollar strength. But these are very much tail risks and we believe it would be a mistake to be drawn into the forecasting fashion of relentless dollar dominance. Markets are so caught up in the price action they are ignoring anything that suggests the move might end. The feeling in the market is that we are in the middle of a sustained USD rally whereas we would argue this is, in fact, the beginning of the end of the bull run.”
One of the flipsides of the HSBC view is, of course, that were the USD to reverse course, keeping AUD stronger for longer, we may well see the RBA more in action than is currently accounted for.
To be continued (and to be watched closely).
Rudi On TV
– on Wednesday, Sky Business, 5.30-6pm, Market Moves
– on Thursday, Sky Business, noon-12.45pm, Lunch Money
– on Thursday, Sky Business, 7-8pm, Switzer
– on Friday, Sky Business, 8-9pm, Your Money, Your Call. Bonds versus Equities
Rudi On Tour
I have accepted invitations to present:
– May 19, ATAA Canberra
– August 2-5, AIA National Conference, Surfers Paradise Marriott Resort and Spa, Queensland
(This story was written on Monday, 23 March 2015. It was published on the day in the form of an email to paying subscribers at FNArena).
(Do note that, in line with all my analyses, appearances and presentations, all of the above names and calculations are provided for educational purposes only. Investors should always consult with their licensed investment advisor first, before making any decisions. All views are mine and not by association FNArena’s – see disclaimer on the website)
THE AUD AND THE AUSTRALIAN SHARE MARKET
This eBooklet published in July 2013 forms part of FNArena’s bonus package for a paid subscription (excluding one month subscriptions).
My previous eBooklet (see below) is also still included.
MAKE RISK YOUR FRIEND – ALL-WEATHER PERFORMERS
Odd as it may seem, but today’s share market is NOT only about dividend yield. Post-2008, less risky, reliable performers among industrials have significantly outperformed and my market research over the past six years has been focused on identifying which stocks, and why, are part of the chosen few; the All-Weather Performers.
The original eBooklet was released in early 2013, followed by a more recent general update in December 2014.
Making Risk Your Friend. Finding All-Weather Performers, in both eBooklet versions, is included in FNArena’s free bonus package for a paid subscription (excluding one month subscription).
If you haven’t received your copy as yet, send an email to email@example.com
For paying subscribers only: we have an excel sheet overview with share price as at the end of February available. Just send an email to the address above if you are interested.
For more info SHARE ANALYSIS: AMC - AMCOR PLC
For more info SHARE ANALYSIS: BLD - BORAL LIMITED
For more info SHARE ANALYSIS: CPU - COMPUTERSHARE LIMITED
For more info SHARE ANALYSIS: CSL - CSL LIMITED
For more info SHARE ANALYSIS: DWS - DWS LIMITED
For more info SHARE ANALYSIS: FID - FIDUCIAN GROUP LIMITED
For more info SHARE ANALYSIS: FRI - FINBAR GROUP LIMITED
For more info SHARE ANALYSIS: GDI - GDI PROPERTY GROUP
For more info SHARE ANALYSIS: LCM - LOGICAMMS LIMITED
For more info SHARE ANALYSIS: NEC - NINE ENTERTAINMENT CO. HOLDINGS LIMITED
For more info SHARE ANALYSIS: ORI - ORICA LIMITED
For more info SHARE ANALYSIS: PME - PRO MEDICUS LIMITED
For more info SHARE ANALYSIS: PMV - PREMIER INVESTMENTS LIMITED
For more info SHARE ANALYSIS: RIO - RIO TINTO LIMITED
For more info SHARE ANALYSIS: SVW - SEVEN GROUP HOLDINGS LIMITED
For more info SHARE ANALYSIS: TLS - TELSTRA CORPORATION LIMITED