An ASX company sometimes buys back its own shares, as a way to return capital to investors.
Such actions are not necessarily received well, according to Allan Gray portfolio manager Dr Suhas Nayak.
“Some argue that it shows a lack of growth options,” he posted on Livewire.
“Others say that it is financial engineering, especially if those companies are borrowing a lot to enable the buyback.”
However, executed well, buybacks can provide tremendous benefits to shareholders.
Nayak said that Australian tax rules rightly favoured franked dividends, but businesses like Metcash Limited (ASX: MTS) and Sims Ltd (ASX: SGM) have returned capital effectively to investors this year.
With this in mind, Nayak named 4 ASX shares that could see buybacks in 2022.
But why wouldn’t these companies put that money into a “hot investment” such as green energy, lithium or cloud software?
“It is inevitable that ‘hot’ investments are overpriced and companies will pay up for that privilege, or that returns will disappoint,” said Nayak.
“It would be far better to see companies exercise good judgement and patience by slowly chipping away at their own shares, especially as the market is giving them an opportunity to buy those shares so cheaply.”
G8 has nothing else to do with its money
According to Nayak, earnings have not yet fully recovered but the business is now in a net cash position and the share price is below its peers.
“With limited value-accretive investment opportunities, the company’s best course of action may well be to return cash to shareholders via a buy-back, while also improving underlying operations of their existing centres,” he said.
“That is certainly something we would like to see.”
G8 shares are down more than 6% for the year so far and closed Friday at $1.105.
Demand for Monash IVF is far better than expected
Fertility services provider Monash IVF Group Ltd (ASX: MVF) also raised significant funds last year.
But its business has “dramatically increased” during the pandemic, according to Nayak, meaning it’s seeing more activity now than in the pre-COVID era.
“With the benefit of hindsight, the capital raising was not required and it is unlikely that inorganic opportunities are priced anywhere near as [attractive] as its own share price.”
Nayak said that for Monash IVF, it’s “time to reward shareholders”.
“Money raised has now clearly been shown to be far in excess of requirements and could be put to good use through a share buyback.”
The Monash IVF share price is up 17% in 2021, closing Friday at 92.5 cents.
An ‘intentionally capital-light’ growth plan
Only a couple of years ago, Incitec Pivot Ltd (ASX: IPL) was struggling due to the drought in Australia.
But it’s now thriving with much higher prices for its products, such as fertilisers and explosives chemicals.
The Melbourne company paid down its debts after a 2020 capital raising.
Incitec now has “a growth plan that is intentionally capital-light”, according to Nayak.
“With a low franking credit balance, a strong balance sheet, healthy cash flows and an adjusted share price that is still well below pre-COVID levels, we believe the company should institute a buyback program.”
Incitec shares closed Friday at $3.08, which is up more than 35% for the year.
Buyback could cash in on a pile of franking credits
Rising oil prices haven’t really helped Woodside Petroleum Limited (ASX: WPL) investors, with its shares down 3% this year to close Friday at $22.
According to Nayak, higher commodity prices will result in “strong cash flows” inside the business.
“This, together with the sell-down of Pluto T2 (the new LNG train Woodside is building to process the Scarborough resource), the enlarged earnings base that will come with the BHP Group Ltd (ASX: BHP) petroleum merger, and only one large growth project (Scarborough) getting off the ground means the company will soon find itself under-geared.”
But the biggest reason why Nayak thinks a buyback could be coming is Woodside has a financial ace up its sleeve.
“What really pushes us over the line on a share buyback is the potential to unlock an asset currently valued at zero by most: a US$1.8 billion-and-growing pile of franking credits.”
An off-market equal-access buyback would allow the company to purchase the shares at up to a 14% discount for the good of all shareholders, said Nayak.