Warren Buffet, in his 2011 letter to shareholders, laid out the two conditions he believes when present should compel management to undertake share buybacks: ‘First, a company must have ample funds to take care of its business, and second, its stock is selling at a material discount’.
Given DBS’s position as Singapore’s largest local bank by deposits, the first test for liquidity is easily met. More importantly, given the recent crash in its stock price, the second and harder-to-satisfy test for valuation is also met.
Check out this historical chart of share buybacks conducted by DBS:
Source: SGX filings
DBS management significantly increased the size of share buybacks since the stock collapsed in late February 2020. They have cumulatively spent S$431 million on share buybacks in one month between 26 February and 23 March. This amount is significantly more than that in any of each of the previous four years.
In terms of the number of shares, 21.4 million shares were bought back in during the one-month period, representing close to 1% of the total number of shares outstanding. This is 75% more than the number of shares bought back in 2018 (and 42% more than in 2018 by value).
What does the huge buyback signal?
The management believes that its shares are undervalued.
Benefits to share buybacks:
- Value investment play. When a company buys back its own shares below its intrinsic value, it is a good use of cash. When the price eventually recovers, the shares can be reissued at a gain to both the company and shareholders.
- Increase share ownership for long term investors. If you are an existing shareholder of DBS and do not plan to sell, your ownership in the company will increase post-buyback. To give a simple illustration, assuming you own one share in a company with 10 shares and the company buys back five shares, your ownership of the company increases to 20% from 10%. In addition, your increased ownership will reward you with a larger share of future dividends.
The share buyback, if anything, is a massive vote of confidence by management in the inherent strength of DBS’s business. This is a business that demonstrates strong profitability and capitalization, and has grown from strength to strength especially in leading the industry through its digitalisation efforts.
At the same time, to put things in perspective, one must consider the risks to DBS. These are my top concerns:
- Non-performing loans. How has the loan book performed in recent weeks? I will be most concerned with the loans to SMEs, retail mortgage, and the oil & gas sector. Given the economic slowdown, rising unemployment, and the collapse in oil prices, what is the bank’s strategy for dealing with non-performing loans?
- Profitability. Does the bank plan to announce mortgage/loan repayment holidays for borrowers in financial difficulty? If there is a steep collapse in interest income for the bank, how does it plan to manage profitability on other fronts? Will there be a cut to dividends?
- U.S. dollar liquidity. What is DBS’s exposure to U.S. dollar credit commitments and what is the bank’s strategy for funding it? Given that liquidity/cashflow is the topmost concern for companies today, how much more unfunded U.S. dollar credit lines does DBS have which it has to commit to? Consequently, what is DBS’s U.S. dollar funding strategy and how much more is it expected to cost in today’s market?
The fifth perspective
Even the spectre of a deep economic recession and a significant hit to its underlying business has not deterred DBS management from aggressively repurchasing its stock. If you take similar perspectives as DBS’s management, then this is a positive signal. At the same time, the economic lockdown due to COVID-19 will impact businesses everywhere and it’s important to understand the risks and exposure a bank like DBS has.