More share buybacks on the way as companies swap equity for debt

Rio Tinto, the Anglo-Australian mining group, yesterday joined a growing band of companies seeking to buy back their own shares when it said it would seek authority from shareholders to buy in 10 per cent of its share capital. Peter Thal Larsen finds that institutional investors see no end to the trend of companies swapping equity for debt.

Rio Tinto, whose shares have taken a hammering in recent months as a result of the Asian crisis and falling metals prices, said share prices were a good use of the company's cash.

"Buying back shares, particularly in current market conditions, should achieve earnings per share improvement for the shareholders and enhance the underlying value of those shares which remain outstanding," said Robert Wilson, chairman of Rio Tinto plc, the group's UK arm.

Analysts said that given uncertain market conditions, the company was better off buying in shares than investing in new mines. A 10 per cent share buy-back would cost the company over pounds 1bn. But with an annual cash flow of pounds 2bn and a gearing ratio of 26 per cent, experts reckon Rio Tinto can afford it.

Shares in Rio Tinto Limited, the group's Australian arm, rose 8 per cent to A$18.30, while shares in Rio Tinto plc finished the day up 15.5p at 713p.

Peter Davy, an analyst with investment bank Societe Generale Strauss Turnbull, pointed out that Rio Tinto would not necessarily use the authority to buy back shares. "All they are doing is making sure they have the full set of tools available to get their balance sheet in order," he said.

Nevertheless, the fact that Rio Tinto is considering the move points to the growing fashion of companies distributing their spare cash to shareholders. In the past 18 months, British firms have handed back more than pounds 10bn in the form of share buybacks and special dividends. Recent converts to the trend include Bass, the hotels and brewing group, and electronics giant GEC.

But there is much more to come. NatWest Markets, the investment bank, reckons that share buybacks alone will reach pounds 7bn this year, up from pounds 3bn in 1997.

Underlying this trend is the belief that increased levels of debt will reduce a company's overall cost of capital. Since investors demand double- digit returns from shares, companies have to produce those returns from investments funded by equity. Debt, however, costs no more than the company pays in interest. With corporate borrowing rates at historically low levels, debt has become much more attractive.

Giving cash to shareholders is also seen as safer than pouring money into risky investments or acquisitions. "Buying back shares is like taking over a company where you know exactly what you're buying and you're not paying a premium," says one leading fund manager.

He points to utilities, insurance companies and the former building societies as obvious candidates to distribute spare cash. Other favourites include Associated British Foods, the food group which has accumulated a huge cash mountain, British Telecom and Marks & Spencer.

The trend towards share buybacks has been accelerated by recent tax changes. In the past, pension fund investors had a preference for equity because dividends came with a tax credit. When Gordon Brown, the Chancellor, abolished the tax credit in July, however, shares immediately became less attractive.

Mark Tinker, equity strategist with UBS, the investment bank, says British companies currently carry less debt on their balance sheets than businesses in the US and continental Europe.

He calculates that if UK debt levels rise to the same level as the rest of the world, British companies would be able to return pounds 100bn.

Generally, institutional investors encourage the trend. "When companies are generating free cash flow we are happy to see them buying in shares," says Mark Critchley, head of balanced funds at Gartmore, the fund management group.

"But we wouldn't expect a company to do it if it was at the expense of long-term investment in the business."

Nevertheless, other fund managers sound a note of caution about firms overstretching their balance sheets. "Incurring debt may involve putting a company's destiny in the hands of its bankers," says one. "Bankers aren't the shareholders' friends."

Outlook, this page

Start your day with The Independent, sign up for daily news emails
ebooksA year of political gossip, levity and intrigue from the sharpest pen in Westminster
Latest stories from i100
Have you tried new the Independent Digital Edition apps?
Independent Dating

By clicking 'Search' you
are agreeing to our
Terms of Use.

iJobs Job Widget
iJobs Money & Business

Selby Jennings: VP/SVP Credit Quant- NY- Investment Bank

Not specified: Selby Jennings: VP/SVP Credit Quant Top tier investment bank i...

Selby Jennings: Quantitative Research | Equity | New York

Not specified: Selby Jennings: Quantitative Research | Global Equity | New Yor...

Selby Jennings: SVP Model Validation

Not specified: Selby Jennings: SVP Model Validation This top tiered investment...

Selby Jennings: Oil Operations

Highly Competitive: Selby Jennings: Our client, a leading European Oil trading...

Day In a Page

A timely reminder of the bloody anniversary we all forgot

A timely reminder of the bloody anniversary we all forgot

Who remembers that this week we enter the 150th anniversary year of the end of the American Civil War, asks Robert Fisk
Homeless Veterans appeal: Former soldiers pay their respects to a friend who also served

Homeless Veterans appeal

Former soldiers pay their respects to a friend who also served
Downfall of Dustin 'Screech' Diamond, the 'Saved By The Bell' star charged with bar stabbing

Scarred by the bell

The downfall of the TV star charged with bar stabbing
Why 2014 was a year of technological let-downs

Why 2014 was a year of technological let-downs

Security breaches and overhyped start-ups dominated a year in which very little changed (save the size of your phone)
Cuba's golf revolution: But will the revolutionary nation take 'bourgeois' game to its heart?

Will revolutionary Cuba take 'bourgeois' golf to its heart?

Fidel Castro ridiculed the game – but now investment in leisure resort projects is welcome
The Locked Room Mysteries: As a new collection of the genre’s best is published, its editor Otto Penzler explains the rules of engagement

The Locked Room Mysteries

As a new collection of the genre’s best is published, its editor explains the rules of engagement
Amy Adams on playing painter Margaret Keane in Tim Burton's Big Eyes

How I made myself Keane

Amy Adams hadn’t wanted to take the role of artist Margaret Keane, because she’d had enough of playing victims. But then she had a daughter, and saw the painter in a new light
Ed Richards: Parting view of Ofcom chief. . . we hate jokes on the disabled

Parting view of Ofcom chief... we hate jokes on the disabled

Bad language once got TV viewers irate, inciting calls to broadcasting switchboards. But now there is a worse offender, says retiring head of the media watchdog, Ed Richards
A look back at fashion in 2014: Wear in review

Wear in review

A look back at fashion in 2014
Ian Herbert: My 10 hopes for sport in 2015. Might just one of them happen?

Ian Herbert: My 10 hopes for sport in 2015

Might just one of them happen?
War with Isis: The West needs more than a White Knight

The West needs more than a White Knight

Despite billions spent on weapons, the US has not been able to counter Isis's gruesome tactics, says Patrick Cockburn
Return to Helmand: Private Davey Graham recalls the day he was shot by the Taliban

'The day I was shot by the Taliban'

Private Davey Graham was shot five times during an ambush in 2007 - it was the first, controversial photograph to show the dangers our soldiers faced in Helmand province
Revealed: the best and worst airlines for delays

Revealed: the best and worst airlines for delays

Many flyers are failing to claim compensation to which they are entitled, a new survey has found
The stories that defined 2014: From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions

The stories that defined 2014

From the Scottish independence referendum to the Ice Bucket Challenge, our writers voice their opinions
Stoke-on-Trent becomes first British city to be classified as 'disaster resilient' by the United Nations

Disaster looming? Now you know where to head...

Which British city has become the first to be awarded special 'resilience' status by the UN?