Why IT companies are taking share buyback route even as earnings are strong

Under a share buyback issue, a company repurchases its shares from shareholders at a higher price than current market price

Big technology companies such as InfosysTCSWipro and HCL Technologies have in the recent past preferred taking the buyback route meeting 2 purposes of rewarding  shareholders and utilising free cash available.

Latest in the run, Tech Mahindra on February 21, 2019 approved a buyback of Rs 1,956 crore at Rs 950 per share.

Under a share buyback issue, a company repurchases its shares from shareholders at a higher price than current market price.

Experts, who Moneycontrol spoke to, said there could be multiple reasons for IT companies choosing to go for these issues. If firms do not have big capital expenditure plans, the cash gets piled up in their accounts. So, either they use the cash for acquisition or for rewarding shareholders through dividends or share buybacks to maintain return ratios.

“IT companies generate a good amount of free cash every year and in order to maintain healthy return ratios, they keep a generous payout ratio either in the form of dividends or buybacks,” Vineeta Sharma, Head of Research, Narnolia Financial Advisors said.

Normally, an IT company does not have to do major capital expenditure and so there is no prudent reason to hold back cash and earn meager interest income on it, she added.

Astha Jain, Senior Research analyst at Hem Securities also said being cash rich in nature, IT companies are increasingly adopting buyback route. Another reason could be the expectation of global slowdown that in turn affect clients’ budgets.

“Data suggest that based on FY18 balance sheet, 9 out of 10 Nifty IT companies have Quick ratio of more than 2, thus indicating higher liquidity in their balance sheet,” she said.

Hence, share buyback leads the rise in EPS, return on shareholders’ fund ratio of such companies & helps them in commanding greater value for their shares in market indicating effective utilisation of cash available in balance sheet, she added.

Companies also buy back shares when there is a significant erosion in their stock price, but its growth prospects are good. The recent spate of buybacks by PSUs suggest the same.

But that is not the case with most technology companies. In fact, the Nifty IT index rallied 24 percent in last one year, higher than any other sectoral index and 44 percent in last two years backed by US growth and rupee depreciation.

Tax-efficiency

Buyback is a more tax-efficient way compared to other means of rewarding shareholders, like dividend distribution.

“We presume most IT companies are doing a buyback because dividend payment attracts a 15 percent dividend distribution tax and also individuals who receive dividend income in more than Rs 10 lakh pay a dividend tax of 10 percent,” Ajay Jaiswal, President – Strategies & Head of Research at Stewart & Mackertich Wealth Management told Moneycontrol.

Since most public institutions hold relatively good chunk of IT shares, a buyback would also help these institutions to pay higher dividend to the government, he said.

Mohit Jain, IT Analyst at Anand Rathi said: buyback is a more tax-efficient way of giving dividends and there is a general fear in the market that it may not remain so for long.

Outlook for IT companies

“The outlook for Indian IT companies is good as growth in the US remains robust, and depreciation of INR versus USD has further strengthened their margins. However, all IT stocks may not do well. We are positive on Tech Mahindra,” said Ajay Jaiswal.

Q3FY19 performance for major IT companies came in line with the estimates (Q3FY19 revenue ranged between 1 percent QoQ and 6.5 percent QoQ in constant currency term). Some companies like HCL Technologies, L&T Infotech saw strong revenue growth, whereas others saw a furlough impact.

“In our view, positive triggers of FY20 will be 1) continued growth in financial services revenue in North America; 2); large deals participation; (3) capex visibility owing to 5G roll-out; and (4) strategic M&A activities to build capabilities could lend support to FY20E revenue acceleration,” said Vineeta Sharma of Narnolia.In order of preference, our top picks are InfosysHCL Technologies and Tech Mahindra.

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