Kingfisher looks off colour as buybacks fail to support the share price

DIY specialist Kingfisher is having to reply on self-help plans and cost-cutting to meet analysts’ forecasts for the year to January, as a disappointing second-quarter trading update reveals a further deterioration in like-for-like sales growth.
17 August 2017

The shares slipped 5% in early trading, taking the stock to the bottom of the FTSE 100.

“It is still relatively early days for the five-year turnaround programme outlined by chief executive Véronique Laury in January 2016 and investors should resist the temptation to be too hasty in their judgement of the plan,” says AJ Bell Investment Director Russ Mould.

“The second half should be a good test, however, of the progress being made, once Kingfisher irons out its product availability problems, especially as France’s economy seems to be finally showing some positive momentum.”

Kingfisher announced a 1.9% drop in like-for-like sales on a constant currency basis, the second consecutive quarter of annual decline.

Source: Company accounts

France was again weak, as like-for-like sales in constant currency terms at the Castorama and Brico Dépôt operations fell by 3.8% year-on-year.

At least that represented a lesser decline than those seen in the prior two quarters. The most unwelcome news was a 1% like-for-like drop in the UK, where Screwfix performed strongly (to vindicate the plan to expand the brand’s physical footprint to complement is website) and B&Q did poorly.

Véronique Laury attributed some of B&Q’s woes to the unreliable British weather although the boss was again forced to acknowledge some product availability issues across the group as Kingfisher looks to move toward supplying unified products rather than regionally-adapted ones. The good news is that availability is now said to be “approaching normal levels,” so this will make the second half of good test of this particular part of the turnaround plan.

Buyback blues

Investors initially enthusiastically welcomed the ONE Kingfisher plan which had two key thrusts:

  1. First, generate a £500 million profit uplift over five years, through higher operational efficiency across the brands, cutting costs and improving its digital offering

  2. Second, an additional £600 million in capital returns above and beyond regular dividend payments over the next three years

Dogged by concerns over underlying trading, the shares have now slumped to their lowest level since late 2014 and they have done so even as Kingfisher has spent £368 million of the planned £600 million buyback.

 Source: Thomson Reuters Datastream

The failure of this largesse to support the shares raises further questions over whether buybacks are a good value of creating long-term value for investors or not.

There are four strong arguments in favour of buybacks.

  1. If a company is generating surplus cash it can return it to shareholders and let them decide what to do with it, rather than splurge it on an unnecessary acquisition or capacity increases. This is a particularly acute issue at the moment when record-low interest rates means that firms are not gaining a decent return on any cash holdings.

  2. Buybacks can work for individuals depending on their tax situation, and whether they prefer to be taxed on a capital gain (buyback) or dividend (income).

  3. Anyone who elects to retain their shares will a firm buys back stock will have an enhanced stake in the company and thus be entitled to a bigger share of future dividends (assuming there are any).

  4. They can also suggest that a management team feels a company’s shares are undervalued, so any move to buy back stock can be seen as a vote of confidence in the firm’s near and long-term trading prospects.

However, there are four strong arguments against buybacks too:

  1. History shows companies have a habit of buying stock back during bull markets (when their stocks tends to be more expensive) and not doing so during bear ones (when their stock tends to be much cheaper). For example, buybacks in the US peaked in 2007 and collapsed in 2008 and 2009 only to accelerate again in 2011 and 2012 and speed up further in 2015 and 2016.

  2. This in turn exposes investors to the risk management teams are buying high rather than low could therefore question whether executives are sufficiently objective when they sanction a buyback to show the market they feel their stock is undervalued. Kingfisher has bought back shares over last 18 months irrespective of the price or valuation attributed to the stock.

  3. A buyback could be used to boost earnings per share figures by reducing the share count at limited cost. This could be used to trigger management bonuses or stock options while doing little to boost the long-term competitive position of the company or improve its operational and financial performance.

  4. There is also the risk that firms buyback stock using debt, potentially weakening their balance sheets and competitive position in the long term (although the same danger lurks with dividends). This does not look to be the case with Kingfisher, at least.

It may therefore be worth heeding the words of master investor Warren Buffett from his 2012 letter to shareholders in his Berkshire Hathaway investment vehicle.

“Charlie [Munger] and I favour repurchases when two conditions are met: first, a company has ample funds to take care of the operational liquidity and needs of its business; second, its stock is selling at a material discount to the company's intrinsic business value, conservatively calculated.”

As such investors should not take a buyback as being good news at face value.

The should analyse the source of the money used to carry it out (internally generated cash flow or debt) and whether the company is applying any valuation discipline to the levels at which it is prepared to buy back stock or not.

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