Ind-Ra: Debt Funding of Dividends to Reduce by A Third to INR58 billion

India Ratings and Research (Ind-Ra) estimates that the funding of corporate dividends by external borrowings is on a declining trend because of improving profitability. The debt component of dividend funding is likely to reduce to around INR58 billion each year during FY17-FY18 from the average INR90 billion observed between FY14-FY16. Ind-Ra's sectoral projections, which are a combination of its own forecasts and Bloomberg estimates for various sectors, point towards a continued improvement in the profitability in FY17 and FY18. However, this is under the assumption that debt reduction remains minimal and continues to get refinanced.

Category A companies (entities having free cash flow to the firm (FCFF)> dividends), which had followed a growth strategy between FY10-FY13, have moved towards a higher dividend payout strategy. The absolute dividend of these companies grew at a faster rate of 21% (CAGR) during FY10-FY16 in relation to the 6% CAGR observed in FCFF. These corporates have resorted to higher payout on the back of steady cash accruals coupled with limited incremental revenue visibility thus limiting further capex. Ind-Ra expects the pace of dividend payout to pick up in FY18 for Category A companies, averaging 40% payout compared to the 23% witnessed during FY10-FY16.

Ind-Ra observes that the dividends paid by Category C companies (entities whose dividends are 100% debt-funded) increased at an 11% CAGR between FY10-FY16. This is a measure possibly taken by the companies to recoup market cap - which has increased 2% despite negative FCFF since 2012. Similarly, Category B companies (entities whose dividends partly debt-funded) witnessed a 5 % CAGR increase in absolute dividends despite a negative 21% CAGR in FCFF. This appears to have aided the market cap to increase by 4%.

Ind-Ra believes that market value of few weak corporates has remained unchanged despite a sharp deterioration in their credit profiles over the years. Ind-Ra believes that the market value of these corporates may not be reflecting the true picture unless it is cyclical, and hence may be overpriced. Banks and financial institutions, therefore, need to be cautious in pricing their products that are linked to the market value of such corporates.

According to Ind-Ra's analysis, capital-intensive sectors have hitherto accounted for 73% of the debt-funded dividends paid by Indian corporates between FY10-FY16 and the trend is likely to continue in FY17-FY18. While the composition of such companies in the auto, telecom, infrastructure, power, and real estate sectors is likely to increase to 77% by FY18 from 42% during FY10-FY16, the likely improved profitability of metals and mining sector, as reflected in 9MFY17 financials, could lead to a significant decline in the debt-funded dividends to 1.4% by FY18 from 44% in FY16.

The quantum of the dividends paid in FY16 for each of the 65 dividend-paying companies (accounting for close to 89% of total dividend paid) increased with an increase in promoter shareholding, despite a fall in the profitability.

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