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The core principal of Event-Driven trading is that corporate events can be catalysts for change.
In today’s passive driven markets, Companies can no longer rely on active market participants to close the gap between intrinsic and market valuations
That is where buybacks come into play. Let’s dive in…
A stock buyback, also known as a share repurchase, is a corporate action where a company buys back its own shares from the marketplace. This process reduces the number of outstanding shares in the market. When a company decides to buy back shares, it uses its own cash reserves to purchase the shares either on the open market or through a direct offer to its shareholders. The repurchased shares are either held in the company’s treasury to be reissued later or retired completely, which permanently reduces the total number of shares outstanding.
The effect of a stock buyback is multi-fold. First, it can increase the value of remaining shares because there are fewer shares available. Second, buybacks are often perceived as a sign that the company’s leadership believes its stock is undervalued, sending a positive signal to the market. Additionally, buybacks can be a tax-efficient way to return money to shareholders, as they might be more favorable than dividends from a tax perspective. However, stock buybacks can also be controversial, especially if they’re seen as a means for companies to inflate share prices artificially or if they’re executed in lieu of investing in business growth.
Stock buybacks can serve as a significant catalyst for stocks in industries perceived as left for dead by the market. When a company decides to repurchase its own shares, it often signals to the market that the company’s management believes the stock is undervalued. This gives investor confidence and suggests that the company has a positive outlook on its future and is willing to invest in itself. This vote of confidence can be particularly impactful in reviving investor interest in sectors that are overlooked or considered obsolete, prompting a reevaluation of the stock’s true value.
Industries that have been left for dead by the market often make compelling investment opportunities because of structural changes to supply, demand, and the competitive landscape. However, one of the biggest arguments against investing in these industries is that there is no “catalyst” -yea they’re cheap but they’re cheap for a reason. The market views the current performance as unsustainable, and the company will eventually revert back to the performance it experienced in the down market. This logic is often times flawed. Industry consolidation during a bear market often results in fewer competitors, allowing the remaining companies to have increased market share and greater pricing power. This consolidation can lead to a more favorable competitive landscape, where the surviving firms are stronger and better positioned to capitalize on market opportunities. Additionally, bear markets can lead to the permanent destruction of supply as weaker companies exit the market or reduce their capacity. This reduction in supply can be particularly significant if the industry has faced prolonged challenges, leading to a more balanced supply-demand dynamic. Stock buybacks can serve as a critical tool for companies to deliver shareholder value while the stock is depressed because the broader market hasn’t recognized the paradigm shift in the company or industry.
Stock buybacks also directly impact the financial metrics of a company, which in turn can lead to a re-rating of the stock. By reducing the number of shares outstanding, EPS and other related metrics are mechanically improved, making the stock appear more attractive from a valuation standpoint. This can be especially beneficial for companies in struggling industries, as improved financial ratios can make them stand out among their peers. Additionally, the reduction in the supply of shares available in the market can create upward pressure on the stock price, as fewer shares available for trading can lead to a scarcity premium. This combination of improved financial metrics and reduced share supply can be a powerful catalyst for stocks in industries that have been largely written off by the market.
Stock buybacks are a more tax-efficient way of returning value to shareholders than dividends because of the different tax treatments of capital gains and dividend income. When a company does a buyback, it repurchases its own shares from the market, often leading to an appreciation in the value of the remaining shares and the increase in share value comes via capital gains. In most jurisdictions, capital gains are taxed at a lower rate compared to dividend income. Furthermore, capital gains are only realized when the investor decides to sell their shares, providing a level of control over the timing of the tax event. In contrast, dividends are typically taxed as ordinary income in the year they are received, often at a higher rate than capital gains. This immediate tax liability reduces the net income that investors receive from their investments.
When analyzing a company that has implemented a stock buyback program, a critical factor to consider is the trend in its outstanding share count. A primary objective of such programs is to reduce the number of shares in circulation, thereby increasing the value of remaining shares and signaling confidence in the company’s future prospects. However, this strategy can be undermined if the outstanding share count remains stable or, worse, increases. This situation can occur due to share-based compensation schemes, where new shares are issued to employees or executives, offsetting the reduction achieved through buybacks. An increase in outstanding shares despite buybacks can dilute shareholder value and may indicate that the buyback program is not effectively achieving its intended purpose. Therefore, a thorough examination of the trend in the outstanding share count is essential to assess the true impact of a buyback program.
Another important aspect to consider is how the buyback is financed. Ideally, stock buybacks should be funded from excess free cash flow, which indicates that the company is generating sufficient income to reinvest in its own stock without compromising its financial stability or growth prospects. If a company is resorting to debt to finance its buybacks, it raises concerns about financial prudence and long-term sustainability. Using debt for stock repurchases can lead to increased financial leverage and interest obligations, potentially undermining the company’s financial health.
Alpha Metallurgical Resources presents a compelling case study of how significant value can be created for shareholders through strategic share repurchases, especially in industries that are generally perceived as “Left for Dead”. Emerging from its second bankruptcy in 2021, the company was trading at a low singled digit PE, indicative of the market’s lack of confidence in its sector. It was during this period of undervaluation and industry skepticism that Alpha Metallurgical Resources decided to initiate a share buyback program in Q2 2022. This move was a bold signal to the market considering metallurgical coal had been out of favor for nearly a decade, suffering from prolonged periods of poor performance. The industry’s unpopularity had a lingering effect on the company’s valuation, as evidenced by its continued low PE ratio even in the face of growing earnings and the ongoing buyback program.
The company’s persistent approach to share repurchases proved to be the right approach to creating shareholder value. Initially setting out with a $150 million share repurchase authorization, Alpha Metallurgical Resources didn’t hesitate to aggressively increase this amount to $1.5 billion in multiple increments. This action signaled a strong confidence in the company’s future and a commitment to enhancing shareholder value. The results of this strategy were remarkable – the stock has increased approximately 500% since the initial $150m authorization. This dramatic increase is a testament to the power of well-timed and sizable share buybacks in reviving investor interest and reinvigorating the market value of a company, particularly in an industry that many had written off. AMR’s story highlights the potential for companies in overlooked sectors to leverage financial strategies like share repurchases to alter market perceptions and significantly boost shareholder returns.
Kuppy’s Event Driven Monitor (“KEDM”) is not a financial or investment advisor and the information contained in this publication is not intended to constitute legal, accounting, or text advice or individually-tailored investment advice and is not designed to meet your personal financial situation. The investments discussed in this publication may not be suitable for you. You are required to conduct your own due diligence, analyses, draw your own conclusions, and make your own investment decisions. Any areas concerning legal, accounting, or tax advice or individually-tailored investment advice should be referred to your lawyers, accountants, tax advisors, investment advisers, or other professionals registered or otherwise authorized to provide such advice. KEDM makes no recommendations whatsoever regarding buying, selling, or holding a specified security, a class of securities, or the securities of a class of issuers, and all commentary is for educational purposes only. The investment examples noted are intended to provide and example of the events and data KEDM flags each week and is not representative of typical returns generated by each event or any future returns.
