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Digital-Only Market Wrap: Did Telstra do the right thing in undertaking a share buyback last year?

February 21, 2017
in Expert Advice
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Telstra conducted a $1.5 bn share buyback last year to return capital to shareholders. But share buybacks can mean mixed results for the company’s share price and sometimes the timing of announcements can be critical.

Off-market buybacks can significantly increase the volatility in a company’s share price, which isn’t good if the share price has been weak, as this increases the risk of a further decline. Often the price will fall below the final offer price.

The main reason for this is the company will generally propose the offer price at a discount to the market price. Why would anyone be willing to hand over their shares below market?

The sweetener for shareholders in this instance was the combination of a fully franked dividend of 15.5 cents per share, and the return being comprised of capital and a fully franked dividend. Depending on your tax situation, the franking credits can be attractive.

But following the release of the official offer in August 2016, TLS fell by around 16 per cent to a low of $4.70 in November 2016. And, given the potential for the share price to fall significantly in a buyback, the timing can be very important, particularly if the shares are already in decline.

However, this week TLS announced forecast guidance would be cut. The shares have been sold down swiftly. My analysis indicates that if TLS trades below $4.70 the probability increases for a further fall to between $4.10 and $4.40.

What do we expect in the market?

The All Ordinaries Index (XAO) rose strongly this week to recover most of the decline in January. At the time of writing the market was trading back above 5850 points.

The market appears quite bullish. I have been waiting for a euphoric rise and I still don’t believe we are there yet.

Part of the reason for the rise is likely to be improved results during the US reporting season, and generally better than expected results in Australia. More than 70% of companies have reported and a high percentage demonstrated profits are up relative to last year. Given this, the XAO is likely to continue to rise.

If you hold shares in the market, it is important to plan for potential downside, while hoping the market will head up from here.

Dale Gillham is the Chief Analyst at Wealth Within

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