Downer (ASX:DOW) share price may only be at start of a capital return cycle

The Downer EDI Limited (ASX: DOW) share price surged to a more than one-year high after announcing a massive share buyback.

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The Downer EDI Limited (ASX: DOW) share price surged to a more than one-year high after announcing a massive share buyback.

This may only mark the start of a multi-year capital return program, according to Morgan Stanley.

The Downer share price jumped 7.3% to $5.71 on Wednesday – making it the top performer on the S&P/ASX 200 Index (Index:^AXJO).

The Kogan.com Ltd (ASX: KGN) share price is in second spot with a 7.1% increase and Cleanaway Waste Management Ltd (ASX: CWY) share price is in third with a 5% gain.

Big capital return boosts the Downer share price

Coming back to Downer, shares in the engineering contractor soared after it said it would undertake an on-market share buyback of up to 70.1 million shares. That's around 10% of its total shares on offer.

A share buyback is one way ASX companies can return capital to shareholders. While it doesn't put cash directly back in shareholders' pockets, the exercise increases earnings per share (EPS) by reducing the total shares on issue.

But don't rule out other capital return initiatives from Downer down the track.

More capital returns ahead for the Downer share price

"In our view, the capital management initiative demonstrates confidence in the underlying business and outlook," said Morgan Stanley.

"If Downer can demonstrate earnings stability, we think it can trade on higher multiples over time. With lower capex post mining and growing earnings, this could be part 1 of a multi-year capital management story."

The broker has an "overweight" (equivalent to "buy") recommendation on the Downer share price. Its 12-month price target on the ASX share is $6.20.

Other capital management options

Other capital return initiatives include things like issuing a special dividend on top of its regular dividend, paying cash back to shareholders as a capital return and doing an off-market share buyback.

Each of these can often have positive tax implications for shareholders.

Morgan Stanley isn't the only broker that issued a bullish note on the Downer share price. Goldman Sachs also reiterated its "buy" call on the shares.

Up to $1bn in available capital

Goldman is forecasting that Downer's proforma gearing will drop to just 16.5%, well below management's target range of 25% to 35%.

"We believe DOW has significant capital return flexibility from the company's ongoing portfolio transformation efforts," said the broker.

"We estimate DOW has A$409-A$1,026mn of balance sheet capacity should the company re-leverage to historical gearing targets post the proposed transactions (if completed)."

Goldman's 12-month price target on the Downer share price is $6 a share.

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Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. owns shares of Kogan.com ltd. The Motley Fool Australia has recommended Kogan.com ltd. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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