Woolworths sneaks in a buyback

If you're a Woolworths shareholder, you'll have recently received a 'Buyback Booklet'. So let's get down to brass tacks: is it worth participating?

As usual buybacks are complicated. But unless you're on a low marginal tax rate, you can probably ignore it*. It's most attractive to shareholders on a 0% marginal tax rate - such as a super fund in pension mode - but might be of some benefit to those who pay up to 21%.

If that's you, keep reading.

Essentially, Woolworths is offering certain shareholders - those on low marginal tax rates - the opportunity to receive more in cash proceeds via the buyback than if they were to sell their shares on the market. Participation is however entirely voluntary.

Even if you hadn't thought of selling your Woolworths shares any time soon, it might still be worthwhile selling some via the buyback. After completion you can buy them back on market.

Speaking frankly

Off-market buybacks work mainly because a significant portion of the proceeds is paid as a fully franked dividend. The franking credits attached to the dividend are currently useful to low rate taxpayers, who receive a refund via their tax return.

However, if the ability to obtain refunds for franking credits is removed - as Labor is proposing if it wins the 18 May election - buybacks will become less attractive overall. Woolworths is sensibly sneaking one in before the rules change.

As the example in the table on page 14 of the Buyback Booklet shows, a shareholder on a 0% marginal tax rate could receive almost $5.00 a share more by participating in the buyback rather than selling on market. If you're a low marginal rate taxpayer, and were looking to sell some of your Woolworths shares anyway, it's likely the buyback will be the best method to do so.

However, what you will receive depends on your own tax situation. Woolworths has provided a tax calculator online at www.woolworthsgroup.com.au/buyback if you want to input your personal tax details.

So is Woolworths undertaking the buyback to spread a little love to hard-done-by retirees?

Love me tender

Not entirely. The advantage for the company is that participating shareholders must tender their shares to the company in a range of a 10-14% discount to the market price (determined as the volume-weighted average price for the five days to 24 May). Past buybacks have shown that it's a waste of time tendering at any other price than the maximum discount (that is, 14%).

If you're wondering why you'd sell your shares to the company at a 14% discount to the market price, remember that - for low rate taxpayers - the franking credit benefit more than offsets the price discount.

So the franking credits mean it's an attractive deal for participating shareholders, and the price discount means the buyback is a good thing for the company. But they're not the only winners, because even non-participating shareholders benefit as well.

The reason is that Woolworths' shares on issue will reduce by about 5% following the buyback. As a result earnings per share will increase. With supermarket companies having trouble eking out growth at the moment, it's positive for Woolworths' remaining shareholders (even if the growth is somewhat artificial).

None of this changes our Woolworths recommendation. We were already aware that the company would receive $1.7bn for its petrol business, and that it would likely use the funds to buy back shares, so the higher earnings per share have already been factored into the share price.

In the absence of the buyback it's likely the share price would have fallen given the disappointing news that's been emanating from the supermarket sector in recent months.

How to participate

So let's assume you're a low rate taxpayer who has worked out it will be advantageous to participate. We'll also assume you intend to repurchase on market any shares you sell into the buyback.

If you own 180 shares or fewer you must tender all your shares into the buyback. Otherwise you can tender more shares if you want, subject to a minimum of 180 shares.

On the offer form in the Buyback Booklet we suggest you tender all your shares at the 'Final Offer Price' (Box B). The reality is that, if it's worth you participating, getting too cute with different prices or discounts is likely to result in you missing out.

Buybacks are typically popular among low tax rate shareholders, so it's possible not all the shares you tender into the buyback will be sold. Once the company advises how many shares have been bought from you, you can repurchase the shares on market. Be aware that some of the value you realise will come later: when you receive a refund of the franking credits in your 2019 tax return.

Remember that you can of course choose to do nothing. In fact that's the sensible option if you're not a low marginal rate taxpayer. As a continuing Woolworths shareholder you'll benefit anyway from the expected increase in earnings per share.

Woolworths remains the highest quality supermarket operator - as the sale of its petrol business for a decent price shows. We're some way from an upgrade, though, especially given a few storm clouds in the sector, and our recommendation remains HOLD.

*We're company analysts rather than taxation advisers, so you should speak to your taxation adviser to make a final decision on whether to participate.

Note: Our Model Income Portfolio owns shares in Woolworths.

Note: The Intelligent Investor Equity Income Portfolio owns shares in Woolworths.