The decision by Hindustan Unilever Ltd (HUL) to buy back shares may appear mysterious. The consumer products company is faced with rising competition in the Indian market and is fighting a battle to regain market share and volume growth in a few key categories. While that may seem an occasion to conserve money, what gives HUL confidence is the mountain of cash it generates.
In fiscal 2010, HUL’s cash generated from operations was Rs3,420 crore, compared with Rs2,025 crore in the previous year (15-month accounting period). A large part of this is due to better working capital management. Its balance sheet as of March 2010 had around Rs1,900 crore in cash and around Rs1,260 crore in investments, a large proportion of which will be liquid. It will be cash-rich, even after paying dividends of Rs1,656 crore (including tax).
HUL has budgeted Rs630 crore for the buy-back, a figure dictated by regulation, capping the amount at 25% of the equity capital and free reserves. It will buy shares from the market, paying up to Rs280 a share. In reality, it may pay a lower price, as the current price is Rs250. Moreover, it has a long fight ahead of it, which may affect its financial performance and valuation as a result. If its price remains subdued, HUL can buy back more shares at a lower price. In its previous buy-back, announced in 2007, it bought back shares at an average price of Rs207 against the capped price of Rs230.
Photograph by Prashanth Vishwanathan / Bloomberg; graphic by Naveen Kumar Saini / Mint
How will the buy-back help HUL? A stronger balance sheet can become a problem too, as the excess capital earns lower returns than the core business. That is, if the business earns a return of say 15%, capital deployed in safe fixed income instruments may not earn more than 6-7%. That depresses the overall returns as a result. By returning this cash, HUL can lower its balance sheet size by a bit. In addition, its equity capital will fall by around 1% and its earnings per share will increase, providing a buffer against lower profit growth.
The buy-back will also shore up Unilever Plc’s shareholding in the company. HUL had outstanding stock options of 4.76 million as of March 2009. Between then and March 2010, HUL’s equity capital increased by 1.8 million shares and Unilever’s stake has come down by 2 basis points. If more options are exercised (likely as they are making a profit at current prices), then Unilever’s stake may fall further. One basis point is one-hundredth of a percentage point. Assuming the buy-back is done at Rs250, Unilever’s stake will go up to a comfortable 53.2%.