Buyback: A Lever to shore up valuation

BL Research Bureau Given their high operational cash flows and relatively limited scope for capital investments, large Indian FMCG companies have constantly explored new options to return cash surplus to shareholders over the past few years.

Hindustan Unilever’s (HUL) bonus debenture programme and Marico’s bonus preference share offer, Nestle India’s special dividend and Colgate Palmolive India’s proposal to reduce its share capital are attempts of large FMCG companies to reduce the surplus cash . FMCG companies often enjoy high return on equity ratios (many in excess of 100 per cent) and thus have substantial cash coffers, which are usually deployed in treasury operations.

Given the conservative investment policies followed by most of them, the treasury operations often generate returns that are much lower than core operations.

Buyback scheme is largely a strategy to improve the overall return parameters for investors . Hindustan Unilever’s proposal this week to consider share buyback should be seen in this light.
In HUL’s case, it is quite clear that the buyback is also being used as a tool by the company to signal that its stock, in its view, is under-valued.

Sluggish financial performance over the past two quarters has led to the stock trading below its all-time high, with valuations that hover below long-term averages.
How will the buyback impact investors in the HUL stock?

Well, if it is routed through open market purchases, it may provide support to the stock price against any further downside.

If it is the tender offer route, the pricing of the offer may determine the upside.
However, investors should note that only a certain proportion of the tendered shares may be accepted in that case.

But a successful buyback will reduce HUL’s equity base and thus improveits earnings per share.
It may also peg up the parent’s stake in the Indian company.

The stock closed at 194 at BSE on Friday.