There have been several buybacks during the August reporting season. It is important for investors to understand what it means to their portfolio, and the reasons buybacks have been so prevalent recently.
A Look at ASX Share Buybacks
A combination of strong balance sheets and share market volatility seems to have led to several share buyback announcements in the most recent reporting season. Names such as Whitehaven Coal (WHC), Nine Entertainment (NEC), The A2 Milk Company (A2M), Qantas Airways (QAN) and McMillan Shakespeare (MMS) are just a few of the companies that announced plans to conduct share buybacks.
Share buybacks are when a company offers to re-purchase some of its shares on issue from its shareholders. They're a form of capital management, a way to distribute surplus capital, consolidate ownership and boost shareholder returns.
They're typically done when a company believes its shares are undervalued, providing a way to effectively invest in itself and support the share price. On the other hand, it can sometimes be a tactic when a company sees limited growth opportunities to deploy excess equity capital.
By conducting a buyback and reducing the number of shares on issue, each remaining share will represent a greater share of company earnings, resulting in a higher per-share value. This acts to improve company financial ratios. With fewer shares on issue, earnings per share (EPS) will be lifted, thus improving metrics such as price/earnings ratios which may improve the company's appeal to new investors.
Share buybacks can be performed one of two ways, either "on-market" or "off-market".
On-market share buybacks involve a company buying its own shares on the ASX in the ordinary course of trading. Those shares are then cancelled, reducing the number of shares on issue.
One company that recently announced an on-market buyback was Qantas (QAN). The airline plans to undertake an on-market share buyback of up to $400 million. CEO Alan Joyce explained that the faster-than-expected post-pandemic rebound in travel has allowed for the share buyback, despite the company reporting its third consecutive annual loss. The market welcomed the announcement, with the Qantas share price surging by 10% on the news.
All else being equal, shareholders may be best placed to hold their shares until the buyback has been completed, as the buyback should positively impact the share price.
Companies can choose to conduct off-market share buybacks as a way to divert franking credits on their balance sheets to the investors that value them most, namely low-tax retiree investors. Off-market buybacks are entirely optional and conducted by a tender process. Investors are invited to opt-in by completing an application form nominating how many shares they wish to sell up to an advised maximum.
After announcing strong profits for FY22, McMillan Shakespeare Limited (MMS) said on Monday that it intends to buyback up to 10% of its ordinary shares off-market. Companies can offer a buyback without shareholders' approval if they purchase less than 10% of shares on issue. For more than 10%, shareholders will have the opportunity to vote on the matter. McMillan Shakespeare intends to buyback $86 million worth of shares based on an illustrative share price of $12.95, which was a 14% discount to the volume-weighted average MMS share price over the five prior days. This 14% is the maximum discount to market allowed by the ATO for off-market buybacks.
Now you may be wondering why anyone would opt to sell their shares back to the company for 14% less than they could get by selling their shares on-market? Simply put, it comes down to franking. In deciding whether to participate, shareholders must consider their tax situation since buybacks consist of a capital component, dividend, and franking components. Only certain shareholders benefit from available franking credits, such as those with shares held in a tax-free super pension or those on a very low income. On the other hand, such buybacks won't necessarily be profitable for earners in exceptionally high tax brackets or foreign investors. That's because they pay income tax on the total value of the fully franked dividend and the franking credits attached. Alternatively, if investors hold onto the shares, they may benefit from increased earnings on a per-share basis once the buyback is completed.
As for McMillan Shakespeare, it has advised that fully franked dividends for tax purposes will be a significant component of the buyback proceeds, so they will provide different benefits to shareholders depending on their particular tax situation. Depending on your circumstances, buybacks can provide a greater after-tax return than selling your shares on-market without incurring brokerage fees.
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TAMIM Asset Management provides general information to help you understand our investment approach. Any financial information we provide is not advice, has not considered your personal circumstances and may not be suitable for you.