Are buybacks becoming a boon?

Only 5 in 11 cash-rich firms were successful in driving better returns.

While there are proponents both for and against the use of share buybacks, DBS Vickers Securities believes that in times of macro uncertainty, where companies have funds beyond current working capital and investment needs, buybacks - if executed properly, could provide some support for share price as they send positive signals about companies being undervalued.

This month, the research house screened for SGX-listed small mid-cap companies (SMC) of market capitalisation between US$20m (S$28.4m) and US$1b (S$1.42b) with active share repurchase mandates and fulfill certain criteria such as profitable over the last 12 months; repurchased >0.3% of current market cap over the last 12 months; and cash resources (either internally-generated or through access to loan facilities) are in excess of curent reinvestment needs.

When screening for companies with active buyback programmes, DBS Vickers Securities found that the majority of the companies that have engaged in buybacks over the last 12 months are in net cash positions.

The research house believes this is mostly due to the current volatile market environment, which limits corporations’ access to profitable investment opportunities and shifts focus to their ability to stay nimble.

"Share buybacks could then be attractive as they provide companies with a fairly low-risk approach to utilising their excess cash," it said.

DBS Vickers Securities found that debt-financed share buybacks are generally less effective..

"Theoretically, the use of debt for share repurchases could help unlock value, i.e. when the company is able to lower its WACC in the process. With the exception of Poh Tiong Choon Logistics, which rallied in August 2016 on news that the group’s major shareholders were seeking a strategic review relating to their shares in the company, our preliminary findings based on the criteria set out above suggest that oftentimes (Lum Chang, Tiong Seng, Falcon Energy and Karin Technology), debt-financed buybacks have been seen as generally less effective in supporting share price," it said.

Evidence is relatively mixed for cash-rich companies, meanwhile.

According to DBS Vickers Securities, of the 11 net-cash companies in its screen, only five – Powermatic Data, PEC Ltd, LHN Ltd, Telechoice International and Valuetronics – appear to have greater success in supporting share price (represented by the change in price from the beginning of the respective companies’ share buyback mandate in 2015 to 17 November’s close), while the remaining half saw declines of between 3% and 39% over the period.

"We think the mixed performance among the net-cash companies was mainly driven by company/industry-specific factors, such as iFAST, whose operations are vulnerable to market sentiment and saw four consecutive weak quarters between 3Q15 and 2Q16, before delivering an improved quarter in 3Q16," it said.

DBS Vickers Securities cautions that overpaying for shares can destroy value. It notes that while there is no clear metric for determining the right price that companies should pay, it opines that prudent buybacks conducted at the lower end of companies’ historical price range could provide a better signal that stocks are undervalued, while instilling investor confidence in management’s commitment towards delivering value.

It also observed that with the exception of Lum Chang Holdings, the buyback programmes of companies which had a record of stable dividends tend to be more effective.