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Investors should welcome mining buybacks

Rio and South32's recent investor roadshows focused more on share repurchases than M&A – that's good
December 7, 2017

Share buybacks are back. After commodity price rises, several years of cost-cutting and a chastened approach to capital expenditure, stock repurchases are once again on the agenda for two of London’s largest miners. This week, Rio Tinto (RIO) and South32 (S32) used their annual investor roadshows to explain this approach to capital allocation.

Such transactions are not without their critics. In theory, buybacks offer companies a flexible way to increase their earnings per share, dividends per share, and presumably their share price, without boosting accounting profits. But they can be expensive, suggest that there are no better uses of capital, and are frequently seen as a way for executives to hit bonus-linked financial targets without the hard work of building a business. For resources stocks, buybacks can be hard to time in line with frequently volatile commodity markets.

And yet they appear to be back in vogue. Last month, Rio completed the $575m (£429m) off-market portion of the $2.5bn share buyback programme it launched in September. The remaining funds allotted for the repurchase, which were raised through the sale of Coal & Allied, will be used to buy shares in the market before the end of 2018. This follows an initial $500m buyback programme, later increased to $1.5bn at the company’s 2017 interim results in August.

The approach has been mirrored by South32, which in March announced that in addition to a $192m interim dividend, it would repurchase $500m-worth of shares over a 12-month period. In relative terms the commitment was far larger than Rio’s, and equated to the buyback of 4.5 per cent of the group’s market capitalisation.

In both instances, buybacks look like logical next steps after an intensive period of debt reductions. As for BHP Billiton (BLT), which spun out South32 in 2015, this year’s capital management has so far focused on a $2.5bn bond repurchase programme. Any nerves over stock buybacks could be forgiven. Elliott Management, which earlier this year called for a shake-up of BHP, argues the commodities group has “destroyed” $9bn by buying shares at “inflated market prices”. Despite this, the activist hedge fund suggested off-market buybacks would be a smarter use of capital, a charge that BHP’s revised capital allocation framework appears to have accepted. When the company decides how to deploy excess cash, share buybacks will be considered on an equal footing with acquisitions and additional dividends. Given Rio’s recently completed purchase was made at a 14 per cent discount to the market price, one can understand the attraction.

Glencore (GLEN) sees things differently, and re-iterated in its interim results a preference for cash distributions to buybacks “given inherent volatility in prices”. It hasn’t always been this way. On 20 August 2014, just a day after BHP decided against a cash return to shareholders and with Doctor Copper already pointing to a downturn in commodity prices, Glencore chief executive Ivan Glasenberg announced a $1bn share repurchase.

With hindsight, you can understand the company’s current position. Seventeen months after announcing the deal, with commodity prices on the floor and dividends cut, Glencore stock was down nearly 80 per cent.