Problem of plenty

As long as institutional investors remain silent, cash-rich companies will continue to give hefty dividends

Even as the Indian economy is poised for an explosive growth, with opportunities beckoning to expand market share, more and more companies are declaring dividends for the year ending March 2010. This follows a difficult financial year 2008-09, when the developed economies faced recession and the emerging markets a slowdown as financial markets melted on credit crunch. In the last decade, HUL and Nestle stood out from the rest for their bumper dividends. Now it is the turn of Hero Honda Motors to distribute surplus cash to the shareholders. The Anglo-Dutch conglomerate issued one bonus debenture of Rs 6 each per Re 1 share in 2002. It also paid a special dividend of Rs 2.76 per Re 1 share. Initially, it was to distribute about Rs 135 crore after the dividend distribution tax, which was abolished in the subsequent budget. As a result, it disbursed Rs 608 crore as special dividend from the profit & loss account. The Swiss food maker declared a second interim dividend of Rs 14.50 per equity share of Rs 10 and approved distribution of special dividend of Rs 7.50 per equity share after paying dividend distribution tax in October 2008. Its dipped into the share premium account to withdraw Rs 43.24 crore and returned Rs 43.08 crore that was transferred to its general reserve between 1981 and 1996, which was in excess of the 10% profit of the company. The world’s largest two-wheeler maker by volumes will pay 4,000% interim dividend of Rs 80 on each share of Rs 2 face value, which is the highest payout in percentage by an Indian company to date. Like HUL, the handout could have been more if there were no dividend distribution tax.

Five things stand out in the rush to distribute dividends over the last decade. The first is the ambivalence of the government on taxing dividends. Earlier, companies paying dividend as well as the shareholders were taxed. Later, on the realisation that levying dividend distribution tax implied double taxation as the amount is distributed from after tax profit, only the shareholders were taxed. Now, it is once again back to the earlier position of taxing the corpus set aside for distribution by companies, with the recipients getting a tax-free ride. The new Direct Tax Code to be implemented next fiscal has proposed taxing all income without differentiating the source and period of holding as per the personal tax rate. This implies reverting back to the double-taxation regime unless the dividend-distribution tax is abolished. The second trend is that large payouts are being resorted to by consumer durables and non-durables companies despite pressure from intensifying competition, HUL, Nestle and Hero Honda are sitting on huge cash. Yet all three cannot afford to remain complacent as rivals get bolder. The third strain is cost control. HUL learnt the lesson the hard way after facing labour problems at its Mumbai plant late 80s. It was among the first Indian companies to geographically spread out its manufacturing facilities so that supplies would not get disrupted due to bottlenecks at one plant. This also cuts down on the expense in transporting raw materials and finished products. Eventually, the fashion of developing dedicated suppliers or outsourcing certain processes gained ground even before the word became a lexicon in the financial markets for cost cutting.

Another common feature is that all the three are have foreign equity, though the Indian promoter and the foreign collaborator hold an equal stake in Hero Honda. Besides, all the three are dominant players in their segments. Most of the times, they enjoyed the first-mover advantage. Being a monopoly till Bajaj Auto revved up and Hero Honda had the pricing advantage as motorcycles gained acceptance with the economy opening up and bringing more people into the job stream, and on improving road infrastructure. A young population also contributed to its success. Yet the company, which symbolizes the aspiration of India’s youth, could not think of any other use of its cash. Hero Honda could very soon find itself in a similar situation that confronts HUL and Nestle: saturation of the urban market and a high volume low margin rural market. HUL and Nestle are wooing this segement by launching low-priced sachets, Hero Honda, in contrast, would have to keep on churning higher-end replacement models to grow. The market’s obsession with dividend yield could be another reason for the race to outdo competitors in making huge payouts. As long as institutional investors prefer to remain silent and do not question companies on deployment of their cash in more productive avenues, the trend to please the market with high dividend will continue. Till that time, investors can make merry as the sun shines.

State of the health

Recession or recovery, drought or normal monsoon, India has to live with inflation

The certificate of health given to the Indian economy by Standard & Poor’s was the trigger the market was waiting for to spring back into action. What were tentative moves, influenced by the woes of the European economy and the still weak US economy, into the trading ring after the presentation of the Union Budget 2010-11 have become bolder forays. The budget represents an opportunity to the government to translate its vision into concrete ground level action. Yet, the scope is restricted, mindful of the fiscal imbalance that could be the spin-off of going overboard: inflation, drying of investment, and decline in revenue. In India, along with the budget, foreign investors also watch policies on foreign direct and portfolio investment. Achieving a semblance of stability in managing conflicting interests is considered a feat that needs to be acknowledged. Political stability, efforts to pull back fiscal deficit, important reforms to be initiated in direct and indirect tax codes, restoration of foreign capital inflow, a range-bound currency, kicking off of PSU divestment and 3G spectrum auction, and hints of opening the financial services sector probably satisfied S&P that India is on the right course of inclusive growth. The market has responded to the rating agency’s approval with vigor, unmindful of the rising inflation and indications that the Reserve Bank of India may have to clamp down on money supply sooner than later. A few days after S&P upgraded India’s rating, the RBI raised the repo and the reverse repo rates at which it lends and borrows short-term funds. The central bank’s hesitant moves arise from the crossroads facing Indian markets.

On one side is the promising growth story set to take the markets to new heights. On the other is the accompanying inflation, fuelled by external and internal factors. Earlier, crude oil was a major contributor. The irony is that despite consumption growing manifold on the expansion of the automobile, aviation and petroleum-based product sectors, rise in prices of oil is being absorbed by the economy much better than when the economy was closed. This is despite the government subsidising the usage of petroleum products by urban and rural poor. The answer lies in the increasing prosperity of rural areas, stemming from the minimum support prices for food grains. It is a vicious circle: government supports prices during scanty rainfall to help farmers and also during bumper crop to put a floor to declining prices. The resultant demand from rural areas spurs companies to compete for capital as well as for commodities and capital goods to undertake expansion. Consequently, India is faced with a perpetual problem of inflation as surplus cash finds its way to automobiles, consumer goods and real estate, while infrastructure sectors have to scramble to raise funds. The spin-off is pressure on interest rates. Higher interest rates strengthen the rupee. The monetary authority, therefore, is always in conflict with market forces to tame money supply without capping growth. The banking sector captures the dilemma of the policy makers of meeting liquidity requirement without creating asset bubbles.

Emerging sectors like telecom and aviation are as likely to ground India’s flight as can credit crunch in the infrastructure sectors. Frequent changes in rules and delays in taking decisions have been a bane of the telecom sector just as restrictive guidelines on foreign investment and volatility in aviation turbine fuel have been for the aviation sector. It is important that the two poster boys of reforms remain in good health. The aviation sector is only now emerging from the cutthroat competition even as the telecom sector is in the midst of a shakeout. Transparent allocation of 3G spectrum is vital for its healthy growth just as easing the crushing taxes on ATF. The government’s procrastination and opaqueness in the initial round of bids when mobile telephony was introduced, stemmed partly from the desperation to bridge fiscal deficit, ballooning from subsidisation of the festiliser and petroleum product sectors. Implementation of the Kirit Parikh Committee report on the deregulation of the petroleum sector will temper the need to take recourse to other channels like telecom auctions with stiffling norms and high-priced divestment to make up for the diversion of resources to socially sensitive sectors. But for these compulsions, there would not have been the need to experiment with the French auction method in the sale of shares of NTPC and REC with unsatisfactory results or stiff rules so as to perpetuate by default the control over the telecom market of the top three to four players by virtue of bagging 3G spectrum for all circles.