IiAS: Dividend and buy-back study 2020
60 companies can incrementally return almost Rs. 886 billionto shareholders
Cash hoarding continues to plague the Indian corporate sector. In our fifth annual study on companies that can pay more, IiAS estimates, based on FY19 financials, that 60 of the S&P BSE 500 companies can, conservatively, return Rs.886 bn of surplus cash to their shareholders; which is just about one-third of their aggregate on-balance-sheet cash on 31 March 2019.
Over the years, IiAS has been rallying against cash hoarding in Indian companies and asking boards to critically reevaluate their capital allocation policy. Our consistent advocacy even led to SEBI asking the top 500[1] companies to publish a dividend distribution policy, in the hope that this will compel boards to think about the use of surplus cash[2]. While several boards have taken a hard look at the need for cash conservation, there is room for more to be done.
IiAS study, based on FY19 financials, concludes that 60 of the S&P BSE 500 companies can incrementally distribute Rs. 886 bn to their shareholders. Key conclusions of the study are:
Of the 60 companies, just five companies aggregate over 50% of the total incremental distributable cash of Rs. 886 billion (Exhibit 1).
Of our list of 60 companies, almost one-third are MNCs.
The excess cash, if distributed by these 60 companies, translates to a median dividend yield to 3.8%, significantly higher than the current 1.1%. There are six companies where the excess cash translates into an additional dividend yield of more than 15%. These are listed in Exhibit 3.
The 60 companies can return a median of 52% of their total cash to shareholders. There are ten companies that can distribute over 75% of their 31 March 2019 on-balance-sheet cash (Exhibit 4).
Exhibit 1: Five companies alone can distribute over Rs. 463 bn
Exhibit 2: MNC companies (Top 10) likely to pay higher dividends from FY21 onwards, due to abolition of DDT
The consolidated PAT for these 60 companies increased by 13.4% over FY18, while the profit after tax for the BSE 500 companies in aggregate increased by 0.3%. While the 60 companies have outperformed the index (based on profitability), almost half of these companies reported a decline in the FY19 return on equity (ROE), compared to the previous year: this should compel their boards to review capital allocation and return some of the excess cash to shareholders.
This year the number of companies with excess cash reduced from 75 to 60, while the absolute quantum of excess cash dropped from Rs.1,081 bn to Rs. 886 bn this year. Profitable companies with surplus cash reported lower free cash flows in FY19 - a result of slower operating cash flows coupled with increase in capital expenditure, especially by state-owned enterprises.
Exhibit 3: Companies where the excess cash translates into an additional dividend yield of more than 15%
Exhibit 4: Companies that can distribute over 75% of their 31 March 2019 on-balance-sheet cash
The Finance Bill 2020 proposes to remove the Dividend Distribution Tax (DDT) and dividends henceforth will be taxable in the hands of shareholders. While the proposed amendment may work out beneficial for certain retail shareholder in the lower tax brackets, the effective tax rate can be as high as 42.7% for individuals with income of over Rs. 5.0 cr. On the other hand, companies will bear buyback tax of 20% (effective rate of 23.3%), which was introduced in the Finance Act 2019, if they decide to return surplus cash through the buyback route.
Exhibit 5: The impact of IiAS 2019 study (which was based on FY18 financial statements)
IiAS believes companies strategy on whether to choose buyback or dividend as a route to return cash to shareholders will likely depend upon the ownership structure. The abolition of DDT augurs well for MNCs, as the foreign parent entity can claim credit for the corporate taxes paid in India on dividends in their home jurisdictions. On the other hand, family-owned companies may accelerate dividends before the next fiscal, to escape paying dividend taxes in personal capacities. Even so, IiAS believes companies’ dividend policy must not be driven by personal taxation requirements of controlling shareholders – instead, it must be driven by thoughtful capital allocation policies that result in predictability of corporate behavior.
While we recognize that companies need to maintain liquidity for organic and inorganic growth, the question is how much cash is reasonable to hold. Excess cash on the books has led some companies to make risky acquisitions. In another case, the excess cash was encumbered, which investors did not realize until the company defaulted on debt. Therefore, returning cash to shareholders is a testimony of the quality of a company’s earnings and will result in more efficient use of capital.
Footnotes:
[1]: SEBI regulations mandate the top 500 companies by market capitalization to articulate a dividend distribution policy
[2]: All references to cash and/or cash balances includes cash and bank balances, cash equivalents, and liquid investments.
[3]: There is a civil suit filed by ITC Limited against IiAS and two of its employees, in the Calcutta High Court, alleging defamation in relation to its 2017 AGM voting advisory and a report issued by IiAS on succession planning at ITC. ITC has claimed purported damages aggregating Rs. 10bn. The suit is being contested by IiAS and its two employees and is presently pending before the court.
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