The SA equities market is, no doubt, challenged. Global and local sentiment has depressed JSE-listed equity valuations and market sentiment is not particularly optimistic.
It is no wonder foreign investor interest in the local stock market is low. However, the same cannot be said for local fund managers’ interest in offshore markets. The changes made to Regulation 28 of the Pension Funds Act caused an increase in the allowed percentage of pension funds allocated to offshore (excluding Africa) assets, from 30% to 45%. In response, the last 18 months have seen a sell-down of SA assets.
Using the MSCI SA 12-month forward price earnings multiple as a gauge of valuation, the current SA equity multiple of 9.4x is trading at discounts of about 13% and 27% to its five and 10-year averages, respectively.
Yet despite the low valuation multiples, the resilience and agility of SA corporates has led to robust earnings and cash-flow generation in certain sectors, leaving those companies with excess capital. Effective capital allocation is always critical, and executives need to consider how best to allocate it in a way that benefits the company and its growth ambitions, as well as the shareholders.
Capital can be deployed within the business to fund operational expansion or for M&A to grow the business inorganically. Current economic conditions however, limit the opportunity for either. The other option is to return excess capital to those who have invested in the company, whether as lenders or shareholders. If it can be done without compromising the company’s gearing level, capital can be returned to shareholders via dividends or share repurchases.
Confidence in executive management teams is underscored by a transparent, consistent strategy. As such, investors prefer a company with a well-understood, consistent dividend payout ratio. That tends to rule out a material change to dividend policy as companies will want to avoid creating expectations of a higher payout ratio in future. Special dividends remain an option that signal to the market a “one-off” distribution but even these, if paid regularly, can create an expectation.
Fundamental value
A share repurchase allows the company to repurchase its own shares in the open market. Going this route gives the company the ability to increase shareholder value while providing a positive signal to the market and supporting the share price. These are all important considerations for shareholders in markets as challenging as these.
Regarding share repurchases, in assessing whether it would create value for shareholders, the company can perform an analysis of its fundamental value, cash flows, return on invested capital, cost of capital and earnings per share to reach an informed decision. A repurchase only creates value if the company can buy back its shares in the market at a discount to its fundamental value. Fundamental value is not the same as a company’s listed market value, which is more a function of supply and demand market dynamics.
RMB has performed an analysis of the top 100 companies on the JSE by market capitalisation, as at June 30, to understand the extent of share repurchases in the SA market over the past 12 months. The data shows that share repurchases have become an increasingly popular tool to enhance shareholder value in a market in which equity valuations have declined materially.
Of the 100 companies analysed, 90 companies included special resolutions in their most recent AGM seeking shareholder approval to repurchase shares. Shareholders in 88 of these companies saw the requisite number of votes cast (75% or more) in favour of the special resolutions for the repurchase to be authorised. Not only were the resolutions passed, the average approval vote obtained for each share repurchase resolution was about 94%. This demonstrates shareholders’ support for share repurchases as a mechanism to allocate excess capital.
Public disclosure
Of the companies analysed, 31 proposed a share repurchase of 5% or less, 37 companies proposed a repurchase of 10% and 20 companies proposed a repurchase of greater than 10%. A total 74 companies proposed a maximum repurchase price of a 5% premium to the five-day volume-weighted average price (VWAP), with the remainder receiving approval for a maximum repurchase price of a 10% premium to the five-day VWAP.
The JSE requires that share repurchases must be announced to the market when an aggregate 3% of the shares in issue have been repurchased and every subsequent 3% thereafter. As share repurchases below this threshold do not require public disclosure, they may go unnoticed in the market. Of the 100 companies analysed, 25 showed an overall net reduction in their total shares outstanding over the past 18 months (per Refinitiv market data), indicating the potential presence of share repurchases in these companies.
The overall repurchase period will vary and depends on the amount being repurchased, the pricing parameters approved and the overall liquidity of the company’s shares. Another important consideration is that share repurchases reduce the number of shares held by investors, reducing the shares that are available to trade in the market. This reduces the company’s free-float and may negatively affect the liquidity of its shares.
There is much uncertainty ahead as SA continues to navigate various macroeconomic headwinds and equity valuations remain depressed. Companies will continue to seek alternatives to protect and grow value for shareholders. Share repurchases offer a valuable tool for companies to allocate excess capital and we expect the trend of repurchases to continue in the pursuit of shareholder value.
To quote Warren Buffett on share repurchases: “If you do it at the right price, there’s nothing better than buying in your own business.”
Sinclair is Head: Equity Capital Markets and Rowson Equity Capital Markets Senior Transactor at Rand Merchant Bank.
