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India Inc’s growing disconnect between profits and dividends

Here’s a poser for the founders and the top management at Infosys: Had the information technology major been more generous in distributing its surplus cash over the years to its shareholders, would the promoters have had less incentive to sell their holdings to fund their post-retirement pursuit? Two days ago, the company’s four founders sold around 18 million shares to leading to a sharp fall in its share price. The founders together raised around Rs 6,500 crore from their share sale.

Infosys was sitting on cash & equivalents worth Rs 28,144 crore at the end of March 2014 which was equivalent to 62.6% of the company’s assets at the end of last fiscal — the highest among all top five IT majors. Had Infosys distributed the cash pile through special dividends, the promoters would have had more cash in hand to play with.

In the last five years ending March this year, Infosys has distributed nearly a third of its net profit as equity dividend. The corresponding ratio for TCS is 40% during the period and would rise further if its payout in the first quarter of current fiscal is taken in account. The company has distributed nearly all of its profits in the first half as mix of regular and special dividend.

Chart-1 : India Inc dividend pay-out ratio and profitability
Year End  RoE* (RHS) Pay-Out Ratio Cash to Assets
  (%) (%) (%)
FY09 15.7 23.8 17.8
FY10 17.5 24.5 18.7
FY11 17.8 22.7 16.1
FY12 15.3 26.4 14.6
FY13 14.4 30.3 14.6
FY14 13.8 34.2 14.5

Elsewhere in India Inc, the link between profits and dividend pay-out has weakened in recent years. In last five years, the dividend pay-out by BSE 200 companies excluding bank & financials, grew at a compounded annual rate (CAGR) of 20.5%, growing much faster than 12.1% compounded growth in net profit during the period.

This growing disconnect between profits and dividends is what may have prompted Sebi to propose a dividend policy for listed companies. Currently shareholders don’t have visibility of dividend income from their equity holdings even if their company provide earnings visibility. Having a dividend policy will discourage both cash hoarders and as well those who borrow to maintain pay-out ratio.

Companies in general stepped up their payout ratio (proportion of current year net profit distributed as equity dividend) in response to decline in growth and profitability. In FY14, companies paid out over a third of their net profit (34.2%) as dividends against 23.8% in FY09 and 22.7% in FY11. During the same period, return on equity for the sample declined to 13.8% in FY14 from 15.7% in FY09 and a high of 17.8% in FY11. (See chart)

  Ten Biggest Cash Hoarders  
Company RoE Pay-Out Ratio Cash in Assets Cash & Equiv
  (%) (%) (%) (Rs Crore)
Engineers India 30.9 55.1 99.4 2531.47
GlaxoSmith C H L 31.5 43.1 95.0 1838.78
Glaxosmit Pharma 26.3 72.5 91.1 2041.58
Oracle Fin.Serv. 16.6 0.0 75.2 6672.61
Coal India 35.6 52.1 68.6 54780.17
Hind. Zinc 20.9 14.7 62.9 23557.93
Infosys 25.8 33.0 62.6 28144
NMDC 26.4 32.2 62.1 18657.23
Bajaj Auto 50.6 39.4 60.0 6255.9
Hero Motocorp 53.0 72.6 59.9 3569.85
         
Source: Capitaline, Compiled by BS Research Bureau  

Companies in cash rich sectors industries such as consumer goods, IT services and pharma have been accumulating cash balances; whole those struggling with slow growth and poor profitability such as construction & infra, capital goods and power companies stepped-up pay-out to maintain some parity with their past dividends.

In all, 158 non-bank & financials companies cumulatively distributed Rs 1,01,767.2 crore as equity dividend last fiscal, up by 24%, a faster pace than 9.4% growth in net profits a year ago.

The mismatch was highlighted by India Ratings, local arm of Fitch Ratings which suggested that 57 companies borrowed as much as $ 3.5 billion (Rs 21,000 crore) in 2012-13 to pay dividends, indicating increased in indebtedness (or debt to equity ratio) while paying out to shareholders. The report did not give out the name of the companies.

However as Infosys suggests, reverse is also true. Some of India’s most cash rich and profitable companies are accumulating cash at a faster clip. For 18 out of 158 non-financial BSE 200 companies’ cash & equivalents on their books accounted for more than half of their assets. And as many seven companies reported cash to asset ratio of 75% or higher last fiscal.

Some of India Inc’s biggest cash hoarders include Coal India, Infosys, Hero MotoCorp, Bajaj, Auto, Oracle Financial Services, Hindustan Zinc, Crisil, GSK Consumer Healthcare, GSK Pharma, NMDC, Bharat Electronics and Hindustan Unilever among others. In others words, these companies’ cash & equivalents exceeded their cumulative investment in plant & equipment and other physical assets (adjusted for accumulated depreciation). (see table)

“In IT industry strategies can change so the cash acts as a cushion and war chest for them. Whereas in the capital intensive industries assets stay longer on the books so if companies are comfortable with their leverage ratio they get generous with dividend distribution,” says  Shriram Subramanian, managing director at proxy advisory firm InGovern  

In all 43 companies reported cash to assets ratio of 30% and higher last year.  Analysts find this wasteful as cash balances earn much less than what companies earn from investment in their core businesses. This dilutes companies’ overall return on equity and weighs on its valuation besides diverting managerial resources on cash management.

“The difference in companies’ dividend pay out strategy is quite natural as they operate in different environments,” says Amit Tandon, co founder of proxy advisory firm Institutional Investor Advisory Services.  “This is why we believe that companies should be up front about their strategy as shareholders need to know this,” he says.

For the entire sample, cash represented 14.5% of company’s assets on average at the end of FY14.

At the end of March this year, the companies in our sample were sitting on cash & equivalents worth Rs 6.6 lakh crore or around $ 107 billion dollars. The cash pile was up 17% in in FY14 over previous year and it has expanded at a CAGR of 13.44% beating net profit growth of 12.1% during the period.

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