UK firms pick dividends over buybacks in tough times

Published Sunday, March 09, 2008

By Agencies

Faced with tighter credit conditions and slowing economies, UK companies will be forced to rein in bumper share buybacks in favour of dividend payouts.

US investment bank Morgan Stanley predicts buybacks by UK Plc will fall around 35 per cent to $40.3 billion in 2008 -- the lowest level for four years.

"We have seen massive cash returns to investors over the last few years from both dividends and buybacks," Morgan Stanley UK equity strategist Graham Secker told Reuters.

"Our view will be that over the next 12 months or so, those total cash returns are going to shrink quite significantly."

"A key theme in the market at the moment -- now more than ever -- is that cash is king because financing costs are becoming more prohibitive," Secker said.

For investors in some UK companies, the days of regular share price support from buybacks are already history.

On Thursday, Taylor Wimpey, Britain's biggest housebuilder suspended a $996 million share buyback plan due to tough US and UK housing market conditions.

And energy firm Centrica saw its share price fall, despite posting a 40 per cent increase in profit, after it said share buybacks were not a priority.

And even dividend growth is predicted to slow.

Morgan Stanley said in a recent note that 6 per cent earnings growth and 9 per cent dividend growth forecasts for UK companies in 2008 were far too optimistic.

It sees earnings growth at zero, with downside risks, and dividend growth of about 3 per cent, its lowest since 2001-02.

"You've got earnings going backwards, operational leverage in reverse because of the macro slowdown, couple that with a financial crisis...means that you get...severely restricted cash returns," Secker said.

Gareth Evans, UK equity strategist at UBS, said data from his bank shows current levels of buybacks could not be maintained although for the final quarter of 2007, $16.1 billion of buybacks had been initiated.

STILL PAYING DIVIDENDS

Companies are more hesitant to cut dividends because of the negative implications for their stock price and image, with some raising their payouts despite tougher market conditions.

Barclays and Royal Bank of Scotland, whose shares have been battered as part of a global aversion to financial stocks, both raised their full-year dividend payouts by 10 per cent.

Meanwhile oil group BP last month decided to favour dividends over buybacks and raised its dividend by 31 per cent.

Britain's FTSE 100 index has underperformed its German and French peers throughout a bull run that started in 2003 in terms of price appreciation.

Yet it offers more attractive dividend yields.

According to Reuters data, the FTSE has a dividend yield of 4.3 per cent compared with Germany's DAX, which yields 3.9 per cent and France's CAC with 4.1 per cent.

Morgan Stanley said 2006 saw the biggest return of cash to shareholders, with 40 billion pounds returned via buybacks and 63 billion via dividends -- an all-time high total cash return yield of 6.3 per cent.

But last year, although dividend yields were in line with 2006, buybacks had fallen to $64.4 billion.

"Buybacks are going to tail off but you have to put that in the context that they are already at very high levels," said UBS's Evans.

As conditions tighten, investing in the business will take precedence.

"The corporate sector, first and foremost, needs to look after itself, which means capital investment," said Edward Menashy, economist at Charles Stanley.

"We are coming to the lean spell whereby capital has got to be preserved and not spent willy-nilly."

But some companies are also tightening the dividend and buyback purse strings in order to give themselves the option of buying rivals without needing to borrow.

The flip side is that not doing buybacks could leave companies vulnerable to takeover.

Buybacks act as a good defensive mechanism for companies to shield themselves against hostile takeovers -- as less stock on the market drives up share prices.

Some analysts believe that predicting the demise of cash returns is premature.

"Over a third (of buybacks) is made up of banks and pharmaceuticals, and there are no plans yet to back-track on any of those buyback commitments," said UBS's Evans. (Reuters)

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