Tesco - Publication of circular relating to a special dividend and share consolidation etc

[BBLSP1]

I guess, at least when I have my HYP hat on, that I am focussed on income. Being very much a ‘green grocer shop’ economist, my view is that the purpose of a business is to make a profit. That profit is given to me, a part owner of the business, in the form of dividends. As per Adam Smith, and keeping within the Laws of the land, the profit arises from a public good, so I can sleep happily at night.

[Arborbridge]

I guess, at least when I have my HYP hat on, that I am focussed on income. Being very much a ‘green grocer shop’ economist, my view is that the purpose of a business is to make a profit. That profit is given to me, a part owner of the business, in the form of dividends. As per Adam Smith, and keeping within the Laws of the land, the profit arises from a public good, so I can sleep happily at night.

But the Directors (rightly in my view) have to look after the company future, not just the present dividend. They may believe it in the best long term interest to change direction even at the cost of reducing dividends for a while, with the long term aim of increasing profits.

With my cynic's hat on, there may be cases where such changes are urged on (perhaps sunbonsciously) because those in powerful positions make a huge lump of dosh by doing so....

[Arborbridge]

What do you consider to be your target top-up yield?

TJH

I have a nominal lower limit of 90% of my running yield. The latter is 4.59%, giving around 4.1% buying yield as my minmum in normal circumstances. That places PHP just on the minimum and Tesco just below it.
Normal circumstances recognises that this is just a guideline for me and I might buy something below that if it looks appealing - such as ULVR when the yield is as good as it gets for that company.

Generally, I wouldn't stray far from my lower target, indeed I'd prefer much higher otherwise what would be the point of HYP compared with an IT?

Arb.

[Dod101]

The dividend per (remaining) share should not change too much; that is one of the points of reducing the number of shares in issue. It depends of course how much the businesses sold were contributing compared to the business remaining within the company. The dividends produced by the business remaining within Tesco have to be spread around fewer shares than before.

Dod

[scrumpyjack]

One factor that will help earnings in future is that paying £2.5bn into the pension scheme reduces the need for future payments into the scheme which would otherwise be a drag on earnings.

[Arborbridge]

I doubt any of us could be really sure of the effect on the dividend, but we are in the usual position of havign to trust the management - or not.
From this discussion so far, I'm by no means sure that there is a case for buying more or not buying more. Personally, unless there is a clear case for "queue jumping" or taking a speculative punt I would treat my top-ups in the usual way, based on HYPTUSS.

I could probably agree that this ought to make the company more resilient since I doubt they would have sold of a big chunk unless they thought it was causing problems, or reducing performance overall. But none of us really know, do we?

Arb.

[dealtn]

One factor that will help earnings in future is that paying £2.5bn into the pension scheme reduces the need for future payments into the scheme which would otherwise be a drag on earnings.

Well that would depend on the return on those "investments".

Investing £2.5bn into the pension scheme and buying gilts earning 0.1% vs investing £2.5bn into the business with a return of >0.1% and discounting the cash flows under either alternative gives a different answer to yours as to which is a drag on company (and ultimately shareholder) earnings.

[daveh]

The dividend per (remaining) share should not change too much; that is one of the points of reducing the number of shares in issue. It depends of course how much the businesses sold were contributing compared to the business remaining within the company. The dividends produced by the business remaining within Tesco have to be spread around fewer shares than before.

Dod

According to the initial RNS from Tesco the Asian business's were contributing £200 -300m operating profit per year over the last two years and profit was falling. The proceeds of the sale (£8.2b) was 12.5x EBITA which sounds like a fair value (as a Tesco shareholder I'd prefer if the buyers had overpaid). For comparison last years results for the group (not including the Asian Business as far as I can see) showed an operating profit of £1,033m

RNS with details off Asian Business
https://www.investegate.co.uk/tesco-plc ... 00064046F/

[Gengulphus]

This post repeats some stuff that has been said in others' posts since I started writing it yesterday (and then got distracted by other stuff, mainly a major upgrade of my internet connection), but I think also offers some extra thoughts. Disentangling the two looks like too much hard work, so I'll post it as it is, with apologies for the repetition:

As ever, I'm left wondering what the benefit of this is to ordinary shareholders and why so much effort should be put into such an operation. It all seems a vacuus waste of time, but is somehow promoted to us as a "benefit".
How can a forced sale on my holding in Tesco which I then need to buy back (if I want to maintain my holding) be a benefit to me? It costs the company and me cash, but what do we get in return?

We get a company whose earnings per share are not being diluted by holding a large amount of near-unproductive cash, or by having invested that cash in something that isn't very productive of earnings. (If the directors think that they can invest the cash in something that is very productive of earnings, it's generally highly likely that they'll do so rather than return cash to shareholders!)

Or looked at another way, having sold off a substantial part of their business operations which presumably were making a substantial contribution to the company's earnings, Tesco has quite a lot less in the way of earnings to fund its dividends. Unless it can replace those lost earnings using the proceeds of the sale (and the fact that they're returning cash indicates that the directors feel they can't do so), they need to cut their total dividend payout. There are basically two ways to cut a company's total dividend payout: either cut the number of shares in issue, or cut the dividend per share. I.e. this way of looking at it is that we're getting the absence of a dividend cut when the sale of Tesco's Thailand and Malaysia operations would otherwise probably have forced one.

Of course, there are other ways of using the cash to cut the number of shares in issue besides special dividends accompanied by share consolidations - for example, market buybacks or tender offers. Each has its advantages and disadvantages in terms of costs (tender offers are probably the worst on that, due to the need to get individual responses from shareholders), speed (market buybacks are the worst on that if the amount of cash involved is at all large), shareholder annoyance (special+consolidation annoys shareholders like you, but market buybacks have been known to attract "p***ing the cash against the wall" type comments), etc. So company directors who need to return cash because they can't find something suitably productive to invest it in are basically certain to attract criticism of one type or another whichever decision they make...

In any case, the practical decisions for HYPers to make about what Tesco is doing are things like what to do with the special dividend cash (with paying tax on it being an important input to that decision if their Tesco holding isn't tax-sheltered) and how to treat it in their own portfolio-tracking (assuming they're not so Doris-like that they don't do any portfolio-tracking!). Directors' decisions about whether Tesco returns cash (and if so, how) aren't among them - those decisions are part of the backdrop against which HYPers make the decisions they can, just as e.g. market prices are part of that backdrop.

There is of course a rather more indirect way in which such directors' decisions can affect HYPers' practical decisions: if a HYPer chooses to try to assess the quality of a company's directors' decisions for themselves as part of deciding whether to buy (or sell) the company's shares for their HYP, assessing such decisions about what to do with surplus cash will be part of that. But when doing that, it is important to assess them against alternative decisions that are actually available to them, not just against vaguely-described alternatives. E.g. such a vaguely-described alternative is "invest the surplus cash in the company's existing operations" - it needs to be sharpened up into something like "invest the surplus cash in a new factory producing their best-selling product X" or "invest the surplus cash into trying to take on the incumbents in market Y, where the company doesn't currently compete". Once that sharpening up is done, often problems will emerge, such as that producing more of product X will simply result in the market for it being oversupplied rather than meeting currently-unmet demand, or that the chances of successfully breaking into market Y are very low due to the incumbents' dominant position.

Incidentally and for what it's worth, I don't personally try to assess the quality of directors' decisions - I don't feel competent to do so, nor in possession of anything like enough facts, nor willing to put in the time and effort needed to work out what the alternative decisions are that the directors could make in sufficient detail to assess them properly. What I do instead is try to assess how well their major decisions are aligned with my investment goals. If a company really made a habit of paying special dividends accompanied by share consolidations, I would probably downgrade my assessment of it as a constituent of my HYP considerably, due to that habit of theirs not being very compatible with my "doesn't give me much trouble" investment goal for my HYP. But the only company I know of with such a habit is Intercontinental Hotels, and they are neither in my HYP nor a plausible new share for it (on the much simpler grounds of low yield), so such a downgrade is currently moot.

Gengulphus

[dealtn]

The dividend per (remaining) share should not change too much; that is one of the points of reducing the number of shares in issue. It depends of course how much the businesses sold were contributing compared to the business remaining within the company. The dividends produced by the business remaining within Tesco have to be spread around fewer shares than before.

Dod

According to the initial RNS from Tesco the Asian business's were contributing £200 -300m operating profit per year over the last two years and profit was falling. The proceeds of the sale (£8.2b) was 12.5x EBITA which sounds like a fair value (as a Tesco shareholder I'd prefer if the buyers had overpaid). For comparison last years results for the group (not including the Asian Business as far as I can see) showed an operating profit of £1,033m

RNS with details off Asian Business
https://www.investegate.co.uk/tesco-plc ... 00064046F/

From that RNS

"Consideration for the Disposal represents an enterprise value of $10.6 billion (equivalent to £8.2 billion) on a cash and debt free basis, implying an EV/EBITDA multiple of 12.5x"

So that 12.5x multiple, using £8.2bio, gives an EBITDA of £656mio. (This is for the period Mar18-Feb19).

The EBITDA of the Group for that period, on that basis, looks to have been £3,503mio and an EV of £24.863bio (from Google not my own calculations).

If correct, subtracting the Tesco Asia businesses, gives the residual EBITDA £2,847mio and EV £16.663bio alternately expressed as EV/EBITDA multiple of 5.8x

That suggests selling off the higher rated business, keeping the lower rated. It would depend on what type of investor you were, and what strategy you pursue, to determine you contentment, or otherwise at the decision.

Were it me I would view Tesco as a portfolio of 2 shares, 1 of which had been sold for cash. I would be facing 2 decisions. Am I happy holding the remaining share in such a portfolio? What will I do with the cash?

(I should have been asking 2 questions before the divestment decision too. Am I happy holding both shares, but it would have presented a potential issue if I had concluded I only wanted to hold 1 of the 2).

Most of which is irrelevant to HYP, of course. Holders (here at least) simply ignore the transaction, take the special dividend, continue to hold (rump) Tesco, and reinvest the cash in the best alternative. (Or perhaps even stricter but unrealistic, as a "Doris" do nothing with the cash).

[Gengulphus]

The company has made a sale of part of its business and is returning the cash to you. Your % ownership of all the remaining parts of the business are the same. You don't need to "buy back" anything to retain your holding in (the remains of) the company.

You don't need to 'buy back' anything to retain your percentage holding. You do need to to prevent the capital value of your holding falling abruptly (*), and to prevent the subsequent dividends you receive from falling by about 21.1% if Tesco holds its dividend, or falling by more than the dividend cut if Tesco cuts its dividend, or falling rather than rising if Tesco raises its dividend by less than about 26.7%, or rising by a lot less than the dividend is raised by if Tesco raises its dividend by more than that.

As a HYPer, I value those three aspects of my holdings in the order dividends first, capital value second, and percentage holding last by a long way - indeed, I struggle to see any value to me in my percentage holding, given that percentage holding figures are mainly relevant to company control issues and my percentage holdings in every one of my HYP companies are totally negligible in company control terms.

(*) Or to be precise, to reverse that abrupt fall, since the fall happens when the shares are consolidated and you don't receive the dividend cash to do the 'buy back' with until a few weeks later.

Gengulphus

[dealtn]

The company has made a sale of part of its business and is returning the cash to you. Your % ownership of all the remaining parts of the business are the same. You don't need to "buy back" anything to retain your holding in (the remains of) the company.

You don't need to 'buy back' anything to retain your percentage holding. You do need to to prevent the capital value of your holding falling abruptly (*), and to prevent the subsequent dividends you receive from falling by about 21.1% if Tesco holds its dividend, or falling by more than the dividend cut if Tesco cuts its dividend, or falling rather than rising if Tesco raises its dividend by less than about 26.7%, or rising by a lot less than the dividend is raised by if Tesco raises its dividend by more than that.

As a HYPer, I value those three aspects of my holdings in the order dividends first, capital value second, and percentage holding last by a long way - indeed, I struggle to see any value to me in my percentage holding, given that percentage holding figures are mainly relevant to company control issues and my percentage holdings in every one of my HYP companies are totally negligible in company control terms.

(*) Or to be precise, to reverse that abrupt fall, since the fall happens when the shares are consolidated and you don't receive the dividend cash to do the 'buy back' with until a few weeks later.

Gengulphus

Yes all true.

If you do as you say you will be increasing your holdings in the original, and remaining parts of the company, and you, or indeed anyone might be happy with that investment choice. Alternatively someone could invest that (returned) cash in an alternative investment.

I think what is (possibly, although possibly not by you) being misunderstood here is the "back" in "buy back". The residual parts of (your) Tesco holding were never sold, and hence there is no need to buy them "back". What you are describing is of course a legitimate investment choice, but you are buying "more" not buying "back" (residual) Tesco exposure.

[Gengulphus]

If you do as you say you will be increasing your holdings in the original, and remaining parts of the company, and you, or indeed anyone might be happy with that investment choice. Alternatively someone could invest that (returned) cash in an alternative investment.

I think what is (possibly, although possibly not by you) being misunderstood here is the "back" in "buy back". The residual parts of (your) Tesco holding were never sold, and hence there is no need to buy them "back". What you are describing is of course a legitimate investment choice, but you are buying "more" not buying "back" (residual) Tesco exposure.

Agreed to all of that. The 'forced sale' is not actually a forced sale, but its effects on a HYPer's holdings (both of Tesco shares and of cash) are pretty much the same as those of a forced sale would be. The 'buy back' is not actually buying back shares lost to the 'forced sale', but its effects on a HYPer's holdings are pretty much the same as those of really buying back following a real forced sale would be. That's the point of the quotes around the phrases - to indicate that they're not pedantically accurate, but for many practical purposes (*) they can be treated as accurate.

And yes, someone could instead invest in an alternative investment, and the "needs" being discussed are what needs to be done to achieve particular goals rather than absolute needs. And I was guilty of leaving certain aspects of those goals implied rather than actually stated - with those implied aspects added in square brackets, what I meant was:

You don't need to 'buy back' anything to retain your percentage holding [of Tesco]. You do need to to prevent the capital value of your holding [of Tesco] falling abruptly (*), and to prevent the subsequent dividends you receive [from Tesco] from falling ...

I wasn't trying to say that HYPers need to have those goals (nor even to suggest that they ought to have them), just what they need to do if they have those goals and want to achieve them. FWIW, if Tesco were in my HYP (which it isn't) I would regard my holding's capital value and anticipated future dividends as having fallen due to the 'forced sale' being something akin to what pyad calls "market trading", resulting in a reinvestment decision needing to be made - and the fact that my percentage holding of Tesco had remained the same as of no relevance to that reinvestment decision.

(*) Not all practical purposes - tax being a notable exception if not tax-sheltered.

Gengulphus

[scrumpyjack]

One factor that will help earnings in future is that paying £2.5bn into the pension scheme reduces the need for future payments into the scheme which would otherwise be a drag on earnings.

Well that would depend on the return on those "investments".

Investing £2.5bn into the pension scheme and buying gilts earning 0.1% vs investing £2.5bn into the business with a return of >0.1% and discounting the cash flows under either alternative gives a different answer to yours as to which is a drag on company (and ultimately shareholder) earnings.

Well yes but...

Realistically they had no choice but to put £2.5bn to clear the pension deficit. These days politically the first use of any large cash inflow to a company has to be to plug the pension deficit, as Whitbread did when they sold Costa. Having done so, one 'benefit' is that there will not be a £250m annual charge to the P&L to reduce the deficit. So the question of whether a better return could be obtained by doing something else with the money doesn't really arise

[daveh]

From that RNS

"Consideration for the Disposal represents an enterprise value of $10.6 billion (equivalent to £8.2 billion) on a cash and debt free basis, implying an EV/EBITDA multiple of 12.5x"

So that 12.5x multiple, using £8.2bio, gives an EBITDA of £656mio. (This is for the period Mar18-Feb19).

The EBITDA of the Group for that period, on that basis, looks to have been £3,503mio and an EV of £24.863bio (from Google not my own calculations).

If correct, subtracting the Tesco Asia businesses, gives the residual EBITDA £2,847mio and EV £16.663bio alternately expressed as EV/EBITDA multiple of 5.8x

That suggests selling off the higher rated business, keeping the lower rated. It would depend on what type of investor you were, and what strategy you pursue, to determine you contentment, or otherwise at the decision.

Were it me I would view Tesco as a portfolio of 2 shares, 1 of which had been sold for cash. I would be facing 2 decisions. Am I happy holding the remaining share in such a portfolio? What will I do with the cash?

(I should have been asking 2 questions before the divestment decision too. Am I happy holding both shares, but it would have presented a potential issue if I had concluded I only wanted to hold 1 of the 2).

Most of which is irrelevant to HYP, of course. Holders (here at least) simply ignore the transaction, take the special dividend, continue to hold (rump) Tesco, and reinvest the cash in the best alternative. (Or perhaps even stricter but unrealistic, as a "Doris" do nothing with the cash).

Or you could look at it as that the rump of the company is under valued and is worth holding or even reinvesting the special into, as the share price may be re-rated if that under valuation is recognised by the market. Or am I misinterpreting the figures?

[monabri]

One factor that will help earnings in future is that paying £2.5bn into the pension scheme reduces the need for future payments into the scheme which would otherwise be a drag on earnings.

That might well be a significant (good) move going forward as you say. I don't have up to date info on Tesco but they were contributing ballpark £270 million per year to the pension fund against a deficit of £3230million. I wouldn't be surprised if pressure were to be applied on companies to close pension deficits (at the expense of dividends).

[Dod101]

One factor that will help earnings in future is that paying £2.5bn into the pension scheme reduces the need for future payments into the scheme which would otherwise be a drag on earnings.

That might well be a significant (good) move going forward as you say. I don't have up to date info on Tesco but they were contributing ballpark £270 million per year to the pension fund against a deficit of £3230million. I wouldn't be surprised if pressure were to be applied on companies to close pension deficits (at the expense of dividends).

That is what scrumpyjack said in hos latest post above )more or less; he mentioned £250 million) so that will be saved if the £2.5 billion plugs the gap.

Dod

[monabri]

One factor that will help earnings in future is that paying £2.5bn into the pension scheme reduces the need for future payments into the scheme which would otherwise be a drag on earnings.

That might well be a significant (good) move going forward as you say. I don't have up to date info on Tesco but they were contributing ballpark £270 million per year to the pension fund against a deficit of £3230million. I wouldn't be surprised if pressure were to be applied on companies to close pension deficits (at the expense of dividends).

That is what scrumpyjack said in hos latest post above )more or less; he mentioned £250 million) so that will be saved if the £2.5 billion plugs the gap.

Dod

I was also adding an angle where politics might rear it's head and demand that companies shore up their pension schemes and not feed the "fat cat" investors their dividends in preference (maybe as a fall out from the Carillion investigation where the pension fund was left in the lurch). I was also flagging up the (significant) extent that a payment of £2.5b would make on plugging the deficit.

I don't own shares in Tesco and have no plans to neither!

[Dod101]

We are in the same camp then as I do not own any either.

Dod

[dealtn]

From that RNS

"Consideration for the Disposal represents an enterprise value of $10.6 billion (equivalent to £8.2 billion) on a cash and debt free basis, implying an EV/EBITDA multiple of 12.5x"

So that 12.5x multiple, using £8.2bio, gives an EBITDA of £656mio. (This is for the period Mar18-Feb19).

The EBITDA of the Group for that period, on that basis, looks to have been £3,503mio and an EV of £24.863bio (from Google not my own calculations).

If correct, subtracting the Tesco Asia businesses, gives the residual EBITDA £2,847mio and EV £16.663bio alternately expressed as EV/EBITDA multiple of 5.8x

That suggests selling off the higher rated business, keeping the lower rated. It would depend on what type of investor you were, and what strategy you pursue, to determine you contentment, or otherwise at the decision.

Were it me I would view Tesco as a portfolio of 2 shares, 1 of which had been sold for cash. I would be facing 2 decisions. Am I happy holding the remaining share in such a portfolio? What will I do with the cash?

(I should have been asking 2 questions before the divestment decision too. Am I happy holding both shares, but it would have presented a potential issue if I had concluded I only wanted to hold 1 of the 2).

Most of which is irrelevant to HYP, of course. Holders (here at least) simply ignore the transaction, take the special dividend, continue to hold (rump) Tesco, and reinvest the cash in the best alternative. (Or perhaps even stricter but unrealistic, as a "Doris" do nothing with the cash).

Or you could look at it as that the rump of the company is under valued and is worth holding or even reinvesting the special into, as the share price may be re-rated if that under valuation is recognised by the market. Or am I misinterpreting the figures?

Absolutely. Just about the only reason I can see for investing in Tesco.

But "here" is HYP-P and investing for market revaluation, and the capital gains is anathema (or at least very much a secondary concern).

A thread about such on Share Ideas would be more appropriate.