It’s hard to believe that it was more than 10 years ago that Simon Wolfson, more formally Lord Wolfson of Aspley Guise, the chief executive of Next (NXT), explained how the company decides whether to buy back its own shares or issue a special dividend – and it’s remarkable how his rules have stood the test of time.
Buybacks make sense when Next has surplus cash, but what if the company has debt? Next has a cardinal rule that buybacks should be funded from surplus capital, rather than through taking on more loans. Overborrowing could put the company’s credit rating under review; a downgrade would result in it having to pay higher interest rates, and its directors have no intention of risking that. They have maintained its long-term debt at £800mn for most of the past 10 years – there was an upward blip during lockdown, but this was well within its additional borrowing facility of £450mn.
The directors also say that they’ll only buy back shares when the core business is expected to grow in the long term. The surplus cash is what’s left after Next’s bolt-on acquisitions of struggling brands (such as Fatface, Cath Kidston, made.com and Joules) and after taking major stakes in others (eg, Reiss, Gap UK and Victoria’s Secret UK) to add to its online offering. The key priority is to support future growth with capital investments, which include funding for IT, warehouses, systems, stores and its recently launched “Total Platform” that allows other brands to offer ecommerce through Next’s IT, warehousing and distribution infrastructure.
Then comes the regular dividend, the announcement of which is often interpreted as confidence in the sustainability of a company’s performance (or for companies where the results are likely to disappoint the market, that the directors expect the performance to improve). Some companies have a target – perhaps between half and two-thirds earnings per share (EPS), depending on the maturity of the business. Others work around a relationship with the cash generated per share. Like them, Next aims to increase the regular dividend every year in line with EPS, but it’s kept relatively low to leave room for buybacks – the yield at Next tends to be 3 per cent or less. In a way, this is self-balancing: a rising EPS tends to push up the share price in step with the dividend. The exception was in 2020, when both EPS and the share price fell due to store closures during lockdowns. Dividends and buybacks were suspended until the situation stabilised.
What to do with the residual cash is a question of judgment, and so also a governance issue. Some companies accumulate cash; others pay down debt. Next returns it to shareholders. For a company to buy its own shares, a shareholder resolution is needed. Some argue that where EPS is a performance condition, buybacks can be an underhand way of triggering higher executive bonuses or payouts on share awards. Next’s directors don’t contest this. Instead, they argue that buybacks ought to be included in their calculation because, for years, their company’s buybacks have been a consistent ingredient in their drive to deliver shareholder value.
Once brokers begin to buy back a company’s shares, the directors tend to leave them to it, partly because for much of the time, board members know price-sensitive information. Brokers could use their discretion, but they’d be criticised if they held back and then had to buy at a higher price because of market rises, so for some companies, they seem to buy at whatever the price until all the allocated amount is spent.
This was where the Next 2013 annual report seemed to break new ground, for it showed how a limit order could be defined. Wolfson talked about the “Equivalent Rate of Return”, which compares the extent to which buybacks will increase the EPS (and so in theory, the share price) with the expected return on equity. This is then used to determine the share price above which share buybacks fail to enhance earnings sufficiently to make them worthwhile. If the share price goes higher than this, the directors prefer to pay a special dividend.
In many ways, Next has been a victim of its own success. The share price soared from 39p in 1999 to 239p in 2012. During the same period, the number of its shares in issue more than halved. Since then, there have been buybacks in some years and special dividends in others. The issued shares have shrunk by a further quarter and now cost over £80 each. At that price, according to its own criteria, buybacks have once again become at best marginal.
The Wolfson policy is not intended to guide others, but potential investors could have done worse than to have bought Next shares when the company did. For existing shareholders, the recent price rise is a nice problem to have. They might be in for a special dividend this year.
