Taking A Page Out Of Rolls-Royce’s Playbook

Unilever plc (LON:ULVR) is among a group of companies that could benefit from targeted divestments and buybacks.

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Should Unilever (LSE: ULVR) (NYSE: UL.US), Diageo (LSE: DGE) and Reckitt Benckiser (LSE: RB) speed up divestments? Should they also use proceeds from the sale of assets to buy back more of their own shares? Read on…

The Rolls-Royce Template

On Thursday 19 June, Rolls-Royce (LSE: RR) announced that proceeds from disposals of energy assets would fund a £1bn stock buyback. Rolls-Royce stock shot up 8% on the day and is still more than 1.5% above its close on Wednesday 18 June.

The loss of earnings from the sale of energy assets will reduce Rolls-Royce’s earnings per share, but a lower number of shares outstanding resulting from the buyback will yield the effect that investors had hoped for: no dilution, and no cash is being spent on risky acquisitions.

Companies eager to render their portfolios more efficient by shedding non-core assets may be tempted to re-invest proceeds in shareholder-friendly activity at this economic juncture. Downside risk is apparent and expensive M&A is not the safest way to allocate capital right now.

Unilever

Unilever announced on 19 May a rare £715m stock buyback aimed at simplifying its corporate structure. As a result of a lower share count, its earnings per share will rise by 2%. Three days later, it announced the sale of its pasta sauces business in North America to Mizkan Group for $2.15bn.

These actions have supported Unilever stock in recent weeks but have not been a game-changer, one of the reasons being that the British conglomerate must be more aggressive in its divestment programme. Management acknowledge the problems of their food division, and will likely continue to reduce exposure to an industry faced with high manufacturing costs and pressures on prices. Additional buybacks should not be ruled out if large divestments take place.

Diageo & Reckitt

Diageo could easily divest assets or raise new debt to finance the repurchase of £1bn of its own equity capital. In September 2013, it announced it would buy back up to 10% of its outstanding shares, but only a minimal amount of stock has been acquired so far, according to my estimates. Divestment could help it speed up the process, although there’s no particular need for Diageo to shrink.

Elsewhere, Reckitt spent about £800m in buybacks between 2012 and 2013, and it could spend more if it wanted to diminish significantly the number of its shares outstanding. Management have been cautious, however, and rightly so.

Reckitt stock is trading at all-time highs. If the market turns south, Reckitt may consider a full divestment of its pharma division, rather than a partial spin-out of the unit. Then, proceeds could be channelled into buybacks. A transformational deal, which has been rumoured for some time, would heighten its risk profile.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Alessandro does not own shares in any of the companies mentioned. The Motley Fool owns shares in Unilever.

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