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
Seth Rollins cashes in his Money in the Bank contract to win the WWE World Heavyweight Championship
WWERollins win the WWE World Heavyweight title in one of the greatest WrestleMania's ever seen
Arts and Entertainment
Louis Theroux: By Reason of Insanity takes him behind the bars again
tvBy Reason of Insanity, TV review
Arts and Entertainment
Cassetteboy's latest video is called Emperor's New Clothes rap
videoThe political parody genius duo strike again with new video
Arts and Entertainment
tvPoldark, TV review
ebooksA special investigation by Andy McSmith
  • Get to the point
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

Recruitment Genius: Retirement Coordinator - Financial Services

Negotiable: Recruitment Genius: To provide a prompt, friendly and efficient se...

Recruitment Genius: Annuities / Pensions Administrator

Negotiable: Recruitment Genius: You will be the first point of contact for all...

Ashdown Group: HR, Payroll & Benefits Officer - Altrincham - up to £24,000.

£18000 - £24000 per annum + benefits: Ashdown Group: HR, Payroll & Benefits Of...

Ashdown Group: Learning and Development Programme Manager

£35000 - £38000 per annum + benefits : Ashdown Group: A highly successful, int...

Day In a Page

No postcode? No vote

Floating voters

How living on a houseboat meant I didn't officially 'exist'
Louis Theroux's affable Englishman routine begins to wear thin

By Reason of Insanity

Louis Theroux's affable Englishman routine begins to wear thin
Power dressing is back – but no shoulderpads!

Power dressing is back

But banish all thoughts of Eighties shoulderpads
Spanish stone-age cave paintings 'under threat' after being re-opened to the public

Spanish stone-age cave paintings in Altamira 'under threat'

Caves were re-opened to the public
'I was the bookies’ favourite to be first to leave the Cabinet'

Vince Cable interview

'I was the bookies’ favourite to be first to leave the Cabinet'
Election 2015: How many of the Government's coalition agreement promises have been kept?

Promises, promises

But how many coalition agreement pledges have been kept?
The Gaza fisherman who built his own reef - and was shot dead there by an Israeli gunboat

The death of a Gaza fisherman

He built his own reef, and was fatally shot there by an Israeli gunboat
Saudi Arabia's airstrikes in Yemen are fuelling the Gulf's fire

Saudi airstrikes are fuelling the Gulf's fire

Arab intervention in Yemen risks entrenching Sunni-Shia divide and handing a victory to Isis, says Patrick Cockburn
Zayn Malik's departure from One Direction shows the perils of fame in the age of social media

The only direction Zayn could go

We wince at the anguish of One Direction's fans, but Malik's departure shows the perils of fame in the age of social media
Young Magician of the Year 2015: Meet the schoolgirl from Newcastle who has her heart set on being the competition's first female winner

Spells like teen spirit

A 16-year-old from Newcastle has set her heart on being the first female to win Young Magician of the Year. Jonathan Owen meets her
Jonathan Anderson: If fashion is a cycle, this young man knows just how to ride it

If fashion is a cycle, this young man knows just how to ride it

British designer Jonathan Anderson is putting his stamp on venerable house Loewe
Number plates scheme could provide a licence to offend in the land of the free

Licence to offend in the land of the free

Cash-strapped states have hit on a way of making money out of drivers that may be in collision with the First Amendment, says Rupert Cornwell
From farm to fork: Meet the Cornish fishermen, vegetable-growers and butchers causing a stir in London's top restaurants

From farm to fork in Cornwall

One man is bringing together Cornwall's most accomplished growers, fishermen and butchers with London's best chefs to put the finest, freshest produce on the plates of some of the country’s best restaurants
Robert Parker interview: The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes

Robert Parker interview

The world's top wine critic on tasting 10,000 bottles a year, absurd drinking notes and New World wannabes
Don't believe the stereotype - or should you?

Don't believe the stereotype - or should you?

We exaggerate regional traits and turn them into jokes - and those on the receiving end are in on it too, says DJ Taylor