Roundtable Discussion; The Future of Mineral Sands. Watch the video here.
"There are many PIs, including bb contributors here, who did not invest in GKP based on detailed/or even any DCF analysis."
Neither did I. I bought because I naively thought the shares would outperform the oil price. I maybe boobed: the oil price has outperformed GKP in terms of CAGR. I have't taken into account TSR because I don't know how I'll be taxed on the dividends. I get that many 'shareholders' are just interested in passing their shares on for more than they paid regardless of share price sensitive events, and that they haven't the slightest interest in understanding their investment or holding the BoD to account.
Putup, you spend a considerable amount of your posts ****ging off DCFs (you can’t admit that the value of the cash lost to the company doing a buyback is greater than the face value of the cash actually spent on the buyback), asserting moral superiority because the accounting treatment of buybacks agrees with your twaddle that buybacks are just an alternative way of distributing retained earnings: they are in the accounting sense, yet you must like DCFs because you say you’ve done loads in your life, yet you won’t allow the cash leaving the company to include the discounted value of its associated future profit stream. Hmm.
I repeat my own understanding of Terry Smith’s views: the incremental DCF value added by the purchase of each share for cancellation must be not be less than the DCF value per share of the cash being lost. Otherwise, value is being destroyed.
I also repeat Terry Smith’s view “One of the most important facts that is continually overlooked is share buybacks only create value if the shares repurchased are trading below intrinsic value and there is no better use for the cash which would generate a higher return.”
Intrinsic value, as you know, is fair value or DCF value.
Finally, GKP trades on a price to book of 1.3x and has an ROCE of 26.24%. So if you bought shares back for cancellation at today’s price, 1.3 x book price, you would, at the margin, be redeploying capital to earn only 20.2.%. In that case, why not redeploy the cash to earn 26.24% at 1 x book value (not do a buyback)?
There are some extremely self-serving reasons why companies do buybacks (often to trigger shed loads of free shares being issued to directors, and buy-backs, if I’ve understood them right, can be value-destructive for us, even if eps rise as a result, which is a strange paradox, if true), and our Chairman (or his ghost writer, Celicourt) has already told us a load of *******s about the last buyback being value-accretive – I don’t know if this is because he doesn’t understand them fully himself or if he was flat-out lying. Sh*t, if the Lex column writer gets it wrong, why should our Chairman understand them – he’s an oil man.
P.S. I wasn’t inviting you to participate on ADVFN, just to look at an image I posted of an equation that would need to hold true if your twaddle about buybacks just being another means of returning capital were true: as I’ve said, it’s slightly more complicated than that, and Warren Buffet, Phil Oakley and Terry Smith also seem to think so.
“Nobull. I've done literally thousands of DCFs over the last 35 years. Smart cookies those fellows at Lex.”
So you will know the amount expended on the buyback is less than the DCF value of the cash that is lost to the company.
While the cash leaving the balance sheet (the accounting treatment) is the same as the amount spent on the buyback, the true loss of the value of the cash to the company is more than the cash expended on the buyback.
The cash on the balance sheet has an associated profit stream of its own, albeit one that is subjective and that is yet to materialise, but in DCF terms, that associated profit stream attached to that cash, whether it’s ascribed a DCF value on the assumption it will compound at the available ‘instant access cash deposit’ interest rate or compound at the IRR on funds used to expand the business is neither here nor there.
Accountants are there to please bond investors, not equity investors, so they follow the prudence concept of not assuming a profit stream will arise from that cash in the future, so they don’t, and indeed aren’t allowed to, put the DCF value of the profit stream associated with the cash on the balance sheet, but it has a value, and it has been lost to the company, even if the accounts don’t show it.
That lost value therefore has to be replaced with an as good or better investment, the purchase of the company’s own shares. If those shares are purchased at the wrong price (above the DCF value per share, a.k.a .fair or intrinsic value, before the buyback was done) value will be destroyed, because the incremental DCF value added by the purchase of each share for cancellation is less than the DCF value of the cash being lost . That’s my understanding of what Buffet, Terry Smith and Phil Oakley are all saying. I agree that the Lex column writers are smart people but like you, they, can, on very rare occasions, get things wrong.
My understanding of your argument is that the DCF value per share before the buyback must be the same as the DCF value per share after the buyback, all other things such as the discount rate used remaining the same. If this doesn’t make sense, then I would have to prove your argument is false by algebra. I prefer to remain in agreement with Buffet, Terry Smith and Phil Oakley on this one.
Terry Smith widsom on buybacks:
3. Investors and commentators should use return on equity to
analyse the effect of share buybacks rather than movements
in earnings per share
4. Share buybacks need to be viewed with more than average
skepticism when done by companies whose management
are incentivised by growth in Earnings Per Share
(Do our LTIPs and VCPs make eps growth one of the performance criteria for our BoD to pick up a shed load of free shares?). This might be the true reason for the buybacks.
What to do?
We [FundSmith] would suggest the following conclusions from all this:
• Share buybacks are not sufficiently understood by company
investors and commentators, and maybe by company
managements (although some of them may understand
them perfectly well but not be using them to create value
or anyone other than themselves)
• Share buybacks only create value if the shares repurchased
are trading below intrinsic value and there is no better use for
the cash which would generate a higher return
• Current accounting for share buybacks conceals their
true effect
• Most share buybacks now destroy value for remaining
shareholders
"They neither create nor destroy value. The simply distribute cash. (Do the DCF exercise.)"
Agree to differ then. I am never going to agree with you on this. That said even the FT Lex column has made the same mistake as you have. The FT Lex column said on 8th January 2010 "The way in which cash is returned to shareholders is irrelevant", the same crap you are spouting, and the FT ought to know better.
It is highly relevant how cash is returned. There are various articles in Investors Chronicle on the buybacks done by Rightmove plc and by Next Group, all analysed by Phil Oakley. I have posted an image for you to look at on ADVFN from Terry Smith's publication "Share buy backs - friend or foe", Post No. 651956 . You are the one who needs to read it, not me have to prove that numerator (DCF value of a company after the cash has left) and denominator (no. of shares in issue after a buyback) has to be equal to the same equivalent fraction using the numbers for the numerator and denominator that represented the situation prior to the buyback. How hard is it for you to grasp that? Don't be a plank - we are not calculating Planck's constant here! There is no reason why the numerator and denominator have to remain in lockstep after the buy back compared to the situation before.
"What you don't get to do is to come back 3 years later and blame management "
Agreed. I haven't. I have stated in other posts that the BoD could not have foreseen the oil price crash and the pandemic (I do not blame them for buying at the wrong price). Also the person I advised to buy in April 2020 benefited, and now me, as I inherit the shares, from getting in at a lower share price than they otherwise would have. It took me a while to realise that, but my big bug bear is our chairman calling the buyback value-accretive at the time he did when it plainly wasn't: it wasn't for the existing shareholders at the time, but it was for new investors like my relative. I am glad you now agree that buybacks destroy value when executed above fair value and that there is more to buybacks than just seeing them as returns of excess capital.
Straycat, hi
"Applying that rationale (albeit twenty odd years later), what do you think Jaap Huijskes’ motives were when he initiated the 2019 buyback?"
I have no idea. I think it is a good question to ask at the AGM. I don’t have an adequate understanding of the VCP, the LTIP and the DBP (not read them). Nor do I know what the amount of stock out on loan was during this period. I would want to be sure our BoD was not trying to lift the share price to trigger the satisfaction of a particular director’s performance criteria (share price appreciation is often one of the performance criteria?) to deliver a shed load of free shares for themselves. In short, whether it was totally self-serving or not.
“His motives, as Chairman of GKP, are an issue of real concern to me.”
They are to me too. I am not against buybacks but I want to be sure they are done below fair value and that they are done for right motives.
" if the market price is above the company’s estimated fair value, what is the incentive of being a holder whether they are doing buybacks, dividends or nothing?"
None. Logically, you should sell. But in the real world, some investors will have CGT problems that inhibit them from selling out all at once. I suppose occasionally there might be exceptions where a bidder might pay more than fair value simply because they expect to get economies of scale that change the fair value of what they are buying, and some people may hold on in the hope of such a bid arising, and shares trading at above fair value might indicate the market thinks some corporate event is going to change the FMV . I don't know. Not enough investment experience in these matters.
"Let me know when you've actually worked through the example I suggested"
No need. You are behaving like a child in a school science experiment insisting Darwin's theory of evolution is all wrong. You simply refuse to accept the concept that buybacks can be value destructive or value accretive (or neither as you insist they always are) and that they are just a return of excess capital. You haven't grasped that it is more complicated than that. How do you explain Buffet's comments on share buybacks if they never destroy or create value and are just a return of excess capital?
Buffett on buybacks
“ Nevertheless, it appears to us that many
companies now making repurchases are
overpaying departing shareholders at the
expense of those who stay. In defence of
those companies, I would say that it is
natural for CEOs to be optimistic about
their own businesses. They also know
a whole lot more about them than I do.
However, I can’t help but feel that too
often today’s repurchases are dictated by
management’s desire to “show confidence”
or be in fashion rather than by a desire
to enhance per-share value.”
Warren Buffett
Berkshire Hathaway 1999 Annual Report
PS The value of the profit stream associated with excess cash on the balance sheet in any DCF calculation should maybe not be the interest rate at which it is currently earning but the rate it would earn if it was re-invested in the business, if higher, as the loss of cash has an opportunity cost. You do not get it, do you?
Take comfort, Terry Smith, Phil Oakley and Warren Buffet all disagree with you. It is sad that our chairman, like you, doesn't understand buybacks either, otherwise he wouldn't have claimed they were value-accretive at the time he did.
"Doesn't matter to the DCF how many shares were bought back. "
A DCF, as you know very well, can be done at the company level or at the per share level. There will be a change at the per share level when shares are cancelled. The DCF value of *the company* changes when is a loss of cash (the loss of the income stream associated with that cash) (the numerator). In a DCF value per share, the magnitude of the denominator, the number of shares, falls. You seem to be insisting both numerator and denominator fall in proportion to one another so that value is never created or destroyed. How realistic is that? It may happen sometimes, but I don't think Warren Buffet, Terry Smith or Phil Oakley agree with you that it always has to be like that.
TM, hi. We can all have our own view on what fair value is (as long as its backed up with a DCF calculation based on reasonable assumptions). The point is to get the company to state what they think the DCF value is so that they are not free to just buy back shares when it suits them rather than us. Sure, we might want to disagree with any discount rate or long term oil price they use, but it would be a start.
For example, MP Evans publishes a DCF valuation of its plantation assets, using an independent valuer, once a year in its annual report, using a pre tax 16% discount rate and a $600 long term palm oil price, IIRC, which generates a £12.65 a share valuation. The same company is putting buybacks back on the AGM agenda, after having been defeated in previous year by an acquisitive shareholder who maybe wanted to accumulate more shares without competition from the company. Buybacks against some standard such as a fair value calculation limit their misuse. JMV.
"The only reason they're not doing buybacks is because key shareholders want to take money off the table and at least recover their initial investment."
That may be.
But it is still right never to do buybacks above fair value. It is you who doesn't get it.
If excess cash is on the balance sheet and a company decides to return it through buybacks then the DCF value of the income stream associated with that cash needs to be less than incremental DCF value associated with having fewer shares in issue.
"Why did GKP buy 20m if they only actually needed 2m? And why did it take them twelve months and a shareholder revolt cancel them?"
That's a great question to ask at this AGM. Maybe they were trying to keep the share price high to achieve particular performance criteria, not that buybacks are likely to be very effective at doing that when more powerful forces are at work lowering future earnings expectations or are pricing in greater uncertainty surrounding the achievement of those earnings.
By law, the BoD should be forced to publish a DCF calculation showing the discount rate used, the anticipated cash flows, the long term oil price used and then have their heads chopped off if they do any buybacks above the fair value thus calculated. JMV.
"I think Straycat refers to ... not allowing those treasury shares to be used to feather their own respective nests, and at a time when goals were not met?"
Thanks Solafire.
"I notice that the HR director will receive a further whopping amount of shares"
Now I get what IC means when it referred to "corporate governance issues" in one of its GKP write-ups, albeit before that announcement.
"Whatever the Co does the F/Y nos will be one of the more interesting REA has
reported for many a year..." Agreed.
Not stupid to sell out - nobody could have foreseen the huge rise in the price of CPO and coal, and nor could they have foreseen the Ukraine invasion and the anticipated disruption to sunflower oil production. The only clue maybe was a comment in one of the annual reports that CPO had been trading below its 10 year average for some time. ATB.
"The treasury shares (19m of 20m purchased) were cancelled because without that action neither Jaap Huijskes nor Jon Ferrier could have commanded the required 80% shareholder approval threshold for re-election at the 2020 AGM."
I thought shares held in Treasury carry no vote. This is why they are deducted from the no. of shares in issue when computing the percentages various stakeholders own. As far as voting is concerned it makes no difference whether shares are held in Treasury or are cancelled, surely?