More UK companies could be tempted to adopt share buyback programmes like their US counterparts as a way of returning cash to shareholders as dividend growth looks set to be anaemic after the coronavirus pandemic.
The UK has a long history of rewarding loyal shareholders through consistent dividend payments. But this has been turned on its head during the coronavirus pandemic with high flying dividend payers including the UK banks HSBC, RBS and Lloyds, all agreeing to delay or cancel shareholder pay outs.
Royal Dutch Shell, the FTSE 100’s largest dividend payer in 2019, cut its dividend for the first time since the second world war last week.
So far this month Johnson Service Group, which sells premium linens to hotels and catering companies, and materials and paper products provider James Cropper have announced cuts, bringing the total of dividends scrubbed to £25.9bn across 310 firms.
By contrast, 27 UK companies have halted share buyback programmes worth £10.3bn since the Covid crisis, according to data from AJ Bell. But after factoring in partially completed repurchases the total amount halted was half this amount at £5.6bn.
Will take time before UK dividends return to 2019 levels
AJ Bell investment director Russ Mould says it could take a while before dividend levels recover to their 2018 high of £86bn or nearer to £93bn if you include special dividends.
“It is possible that the massive fright caused by the viral outbreak persuades company management teams to scrub theories of efficient balance sheets and the primacy of return on equity and focus instead on cash,” he says.
“Just like any private individual listening to their financial adviser, their first step is to build a cash buffer and then sit on it, so that six to 12 months’ operational and capital expenses can be met whatever the circumstances.
“Managers breathe more easily but shareholders get lower profits, lower returns on equity and less dividend growth, perhaps with the result that dividends do not return to 2019’s levels for some time.”
Growth in income funds and DC pension pots leads to ‘over-distribution’ of dividends
Lazard Asset Management head of UK equities Alan Custis thinks coming out of Covid UK plcs will take the opportunity to rebase dividend payments downward and rebuild dividend cover, which could prompt more companies to consider share buybacks.
Too many UK companies have got themselves into a position where they have been “over-distributing”, he explained during a recent webinar featuring fellow UK equity managers Richard Buxton (pictured) and Gervais Williams.
“And I think part of this has been driven by the growth of income funds and the fact that more and more people have to be responsible for their own pension arrangements with the growth of defined contribution pensions.”
Companies that can still offer shareholders a dividend will become a hot commodity, said Custis.
“I think that the market will cluster into some of those more staple type names that we think will continue to have the wherewithal to pay dividends.”
See also: Terry Smith trashes Investment Association over equity income decision
UK companies have begun to get the ‘buyback bug’
In recent years the UK has begun to get the “buyback bug,” says Mould, albeit to a lesser extent than companies in the US.
FTSE 100 companies gave back £135.9bn more to shareholders through buybacks than they raised for them between 2010 and 2019, according to data from Bloomberg. Over half of this, or £74.6bn, was from the repurchase of shares in the last three years.
Over the period Shell was the biggest purchaser, buying back around £25.5bn of its shares, including £10bn in 2019 on top of £11.6bn worth of dividends.
It was followed by miners Rio Tinto and BHP which bought £17.9bn and £17.6bn worth of shares respectively, while Dove soap maker Unilever snapped up £13.2bn of its own shares.
“Theories of efficient balance sheets were clearly catching on here, encouraged by the arrival of activist investors, record-low interest rates that penalised management teams for holding cash and potentially boardroom bonus schemes that were triggered by metrics such as earnings per share, which buybacks could flatter,” says Mould.
Dividends won’t disappear
Evenlode Global Income manager Ben Peters expects boards will continue to utilise buybacks as a way of returning capital after Covid.
But he adds: “Dividends are used as a signal of confidence in a company’s prospects though, so I don’t expect them to disappear completely from the picture.”
Peters says he doesn’t have a preference for companies that use buybacks versus dividend payments.
“Our approach aims to balance the delivery of income today with growth in income in the future, delivering good risk-adjusted total returns over the long term as a result,” he says.
“If a combination of dividends and buybacks is used by a company, and that means that they can appropriately invest in their own operations for the future through a broad range of economic situations, then we’re pretty happy.”
‘Profits are privatised, losses are socialised’
Buxton, Merian Global Investor’s head of UK equities, spoke critically of share buybacks, which in recent years have been increasingly financed with debt.
“It’s crystal clear that if the US airlines have delivered $45bn of share buybacks in recent years and then go cap in hand for a $50bn bailout, that profits are privatised and losses are socialised,” he said during the webinar.
Mould points out that share buybacks were illegal in the US between 1934 and 1982 on the grounds they represented stock price manipulation.
“It will be interesting to see if the bail-outs offered to US airlines and Boeing’s frantic scramble for cash turn investors against buybacks, given the lavish programmes these firms had run for much of the last 10 years.”
Buxton said he was concerned by the number of companies that had continued to “juice up” equity returns through debt, seemingly not learning anything from the global financial crisis.
“We’ve talked to management teams for years about the fact that we don’t get comfortable with too much debt. And they go, ‘Well, what are you Brits like? Why are you so wimpish?’
“I do think boards at the very least, if not the government themselves, needs to think about in a world where economic activity could stop overnight is do we really want to have an efficient balance sheet, or do we want to have a prudent balance sheet?”
See also: Richard Buxton lays into regulators for pushing dividend cuts
Post-Covid Buxton thinks there will still be some large cap stocks that can offer dividend growth. “But I’m very grateful I’m not trying to run a very large income fund because I think that is going to be problematic,” he added.
