Royal Dutch Shell management must have a brighter outlook than most corporations. Equities are falling and many expect oil companies to be most affected by the fall in demand for oil and the falling price of crude. But in a rare sign of confidence, Shell management continues its program of buying back shares. On Friday it bought 465,000 “B” Shares* at a price of 1538.14 pence per share.
Share buybacks are when a company buys and then cancels its own shares either through a tender offer or on the markets. Buybacks reduce the total dividend payout, reduce the risk of a takeover and increase earnings per share (EPS), but they give the impression that a firm has more cash than it can comfortably invest. It may also imply that management has run out of better ways to increase EPS.
The dividend payout is an interesting aspect. Normally, companies with high dividend payouts provide the highest return, not just because of the dividend but because of increased investor confidence in future growth. High dividend payouts imply a bull market, this London Times article states that between 1997 and 2007, companies which increased dividend payouts gave a 12.7% return per year. Companies with buyback plans returned just 8.2%.
The only years in which buyback companies provided higher returns were 1997, 2001 and 2002. What do those years have in common with 2008? An intense bear market.
When the bear market ends, Shell will have a strong balance sheet with which to borrow debt at a cheaper rate. This debt will have lower tax payments and the cost of interest may be less than the cost of dividends.
Usually money spent on buybacks means less money spent on research and development or asset investment. But a buyback can be considered an investment in the company’s future financial stability. Depending on future performance and the markets, It will be interesting to find out which is the case for Shell.
*RDS has two classes of shares: ‘A’ and ‘B’. Unlike tracking shares which are responsible for different divisions of a company, Shell’s dual stock system exists only to provide dividends in different currencies. When Royal Dutch, a Dutch company, merged with British Shell, RD shareholders were issued class A shares in Royal Dutch Shell, which pay dividends in Euros and Shell shareholders were issued class B shares, paying dividends in Sterling.
