Capital management adds value if well executed

Nanjing Night Net

CAPITAL management is much talked about among Australian companies but rarely executed with much panache. Properly used, capital management can create tremendous value for shareholders.CSL Limited (CSL)

THE joys of a big health company being able to borrow at 4 per cent have created a beneficial cycle for CSL. The company recently announced a $900 million buyback of its stock, making it the fifth buyback the company has undertaken in recent years.

At the end of last year, CSL organised about $1.5 billion in debt with the combination of a private issue in the US and a new facility with its bankers. Analysts assume the money has been borrowed at an average of about 4 per cent. If this is the case, the company, in theory, can buy its own stock up to a price-earnings multiple (P/E) of about 25 times. It sounds incredible, but that is the case.

At $46.60 a share, CSL is trading on a historical P/E of about 25 times and a prospective P/E on 2013 earnings of closer to 21 times. If the company buys the whole $900 million worth of stock in the next 12 months, it will purchase about 6 per cent of all shares traded. If we assume it will need to pay $50 a share over the year, it will buy 18 million shares at an average P/E of about 23 times. This is pushing the limit, but analysts point out that with earnings projected to grow strongly in 2014, it will be earnings-per-share accretive in that year – two years from now.

While CSL’s buyback announcements support the share price, there is a strong argument the company should ditch its buyback and issue shares for an acquisition or give the excess cash back to shareholders, even though dividends would be unfranked. For investors, they should be concerned if CSL continued to buy shares above the $50 market, because it requires earnings to grow strongly into the medium term. That is always a dangerous assumption.Devine Limited (DVN)

AT THE other end of the scale to CSL is Queensland-based property group Devine. Like most companies that rely on property for its earnings, Devine has fallen on hard times. More recently, though, the company’s share price has spiked from a low of 53�0�4 in August to 71�0�4 this week, with investors a little more excited about the story in a lower interest rate environment.

Devine’s earnings were clobbered in 2012 because of the benign activity in all forms of property in the Queensland and Victorian markets, and the share price has fallen to about 35 per cent of the group’s stated asset backing. Ideally, Devine would jump in and start buying its own shares, just like fellow Queensland group Sunland has done recently. Every share Devine would buy at this level would increase its net asset backing.

Unfortunately for Devine, its balance sheet, with gearing sitting around 30 per cent, is not in a position to buy back its shares and pay a dividend at the same time. If, however, the board believes the carrying value of its assets, the company should seriously consider putting the company up for sale to realise the value. Another approach is to sell some of its assets for near book value and use the funds raised to buy back shares.

If there are no buyers for the overall company, Devine, with 14,500 land lots, is a great leveraged play into a recovery of the Queensland and Victorian property markets in 2014. Over the fullness of time the share price could easily double even if asset value is written down 20 per cent from current levels.Bendigo and Adelaide Bank (BEN)

HISTORY tells us that it is dangerous to own banks in the November to February period because they generally underperform the broader market. However, for those obsessed with franked dividends, it might pay to have a closer look at Bendigo Bank. The company had its annual meeting earlier this week and despite talking about a tough environment there was no downgrade forthcoming.

There is a lot to dislike about Bendigo, with its paltry 9 per cent return on equity and a hefty cost-to-income ratio of 59 per cent topping the list. If you can overcome these sickly numbers, it might be worth switching into the stock once Westpac, NAB and ANZ go ex-dividend in November.