European de-equitisation comes of age

For the first time in at least 20 years, European companies are buying back their shares at a faster clip than even US companies, according to Bernstein. Welcome to the big leagues.

Last year, Europe-based companies announced that they would repurchase shares worth about $350bn, up from $218bn. That amounts to a record 2.4 per cent of their total stock market capitalisation.

In the US the dollar value is still much higher — at $835bn in 2022 — but that is down from a peak of about $1tn in 2018, and is only equal to 2.2 per cent of their market cap, according to Bernstein. Here’s that expressed in terms of a buyback yield.

Of course, these are only announced buyback programmes. In reality, companies don’t always repurchase the full amount they tout. But given how stock prices fell in 2022 it seems likely that these programmes will be completed (and may in some cases be added to).

The main contributors are European banks and energy companies, but continental companies as a whole are generating more free cash flow — and in fact currently boast a higher FCF yield than US companies — allowing them to be more generous with shareholders.

Dividends have historically been the favoured way of chucking cash back to investors in Europe, but it’s never a good look to have to cut them. With a recession possibly looming many executives probably think it makes more sense to use buybacks, which can be dialled up and down more tactically.

Bernstein reckons the surge is also driven by lower European equity valuations and a reluctance to sit on a lot of cash at a time of high inflation, and argue it is a positive sign:

… One potential reason why European buyback activity has increased relative to the US could be linked to relative valuations. Europe usually trades on a lower forward earnings multiple than the US with an average 12-month forward PE discount of 13% over the last 30 years. However, in recent years the discount has grown and Europe is now 23% cheaper than the US. Intuitively, one would expect company management to be more likely to sanction buyback programmes if they consider that their stock to be cheap and that current multiples do not adequately reflect the underlying intrinsic value of the company. Lower valuations, all other things being equal, should therefore lead to greater use of buybacks.

We think that this catch up with the US on the use of buybacks to return capital to investors is, on the whole, a positive for regions outside the US. Buybacks tend to be beneficial for a number of reasons. They act as a signal to investors that corporate managements consider their stock to be undervalued. In addition, they also have accretive effects on future earnings, dividends and free cashflow per share streams which can be given a boost as the number of outstanding shares gets smaller. Moreover, at the aggregate level, a higher portion of buyback activity should be supportive of equity prices at the margin as it represents an additional source of demand for equity combined with a reduction in the supply of equity as shares are bought back and canceled. Furthermore, if we are entering a period of structurally higher inflation then investors may begin to increasingly favour companies that payout excess capital to them rather than leave it sitting on the balance sheet to be eroded by inflation.

Still, given how much opprobrium buybacks attract in the US, it will be interesting to see what European politicians — who have even hotter takes on what companies should be doing with their money — will make of this trend should it continue.