Tomorrow’s payout

Locking funds in dividend-yield stocks could result in missed opportunities to ride on capital appreciation during a bull run

By Mohan Sule

A slowdown is a suitable time to revisit many conventional theories that drive the market. Many times, themes that seemed logical for the market to assign higher discounting during a bull phase go out of fashion during a downturn. Companies unveiling capital expenditure plans are greeted with enthusiasm by investors as these symbolize confidence about future. Capacity expansion is expected to result in higher output. The spurt in the top line is assumed to pull up the bottom line, too. Turn the page, and fall in capacity utilization haunts shareholders. The squeeze in cash-flow not only affects equity ratios but also the ability to service the debt taken up for organic or inorganic growth. Suzlon Energy typifies the incredible rise and fall of companies accompanying the cycles of the market. At the other end is Wockhardt, which is enjoying a second lease of life following the promoters’ relentless cost-cutting initiatives. The lesson is what is good for a company during a market upturn may prove to be its undoing during a bear phase. Take another favorite investment path propounded when the market has caught the cold: scoop dividend-paying companies as they offer comfort during a period when scope for capital appreciation is limited. Besides, the steady steam of income is tax-free. There are two major pitfalls involved with this strategy. The yield decreases if investors, anticipating a dividend, flock to the counter. Those who go by past record to enter a stock may have to wait till the end of the quarter or fiscal year to pluck the dividend. Second, there is no guarantee that these companies would be able to maintain their operating profit as they are present in mature markets, where gaining share can come at the expense of margin. This is what happened to FMCG companies in the last fiscal.

The absence of expansion and diversification limits the attraction of dividend payers during an upturn. Such companies are in the danger of becoming relics. Apple, the most valuable company in the world, announced its intention to pay dividend for the first time and buy back shares in March 2012. Coming soon after the death of its charismatic founder, the market took the move as an indication that the growth machine had run out of innovative products to launch rather than the company’s desire to return some of the cash pile lying idle. Many big FMCG companies outsource chunks of the manufacturing process to retain flexibility during demand push and slump. The suppliers have to sacrifice on margin as their high-volume clients drive a hard bargain. So there is a strange scenario of big manufacturers accumulating cash to pay dividends while the ancillaries face pricing pressure from the end users as well as rising cost of raw materials. In the process, the smaller units may not be in a position to pay dividends. To ensure that investors get a fair deal, companies in safe-haven sectors should invest in their raw material and intermediate suppliers in sectors such as paper and packing, plastic products, glass, printing, and even metals on one hand and in the distribution chain of wholesalers and retailers on the other. This would ensure that satellite producers benefit from the dividend distribution of their large shareholders, who in turn benefit from the growth prospects of their smaller-size suppliers as the capital infusion would enable to update their technology as well as ensure attention and guidance from their shareholders-cum-customers.

Not only investors, even government loves dividend payers. It collects 16.22% dividend distribution tax, an important source of revenue when dwindling volumes and share prices cause a dent in the securities transaction tax and, importantly, tax on corporate profit. This should be small comfort when capital-intensive companies are unable to service their debt and the queue for debt restructuring lengthens. For a country talking of reaping the demographic dividend of more than half the population below 25 years of age, better to have a universe of companies providing employment opportunities and thus creating a consumer class rather a smallish segment distributing dividends. Supporters of dividends argue that the dividend income is a welcome flow of cash in the hands of investors to splurge on consumption. On the contrary, during uncertain times, investors prefer to lock up cash in debt instruments that offer the security of capital protection and high interest rates due to the strain on liquidity despite inefficient post-tax returns. For companies, repaying debt is much more constraining than raising resources through equity issuance. Time perhaps for government, companies and investors to re-look at the issue of dividends to ensure that the cash utilization is efficient and productive.

Mohan Sule

Puzzling obsession

The fall in demand for gold is the best lesson for the finance minister to stop directing banks on how to conduct their business

By Mohan Sule

In the end, the government did nothing to discourage its consumption. Nor was there any patriotic fervor behind users’ waning interest. Rather high prices contributed to the fall in demand for gold by 20% in India in the June 2012 quarter over a year ago. Continuation of this trend could have a beneficial impact on the country’s current account deficit, easing the pressure on the rupee and, thus, interest rates. The reversal demonstrates how market forces are the best levelers rather than artificial efforts to suppress prices or discourage usage. Taken together with the low tariffs in the telecom services space, it should embolden the government to free prices of natural gas, power, coal, and fuel. This could be the signal for the market to break out rather than cosmetic tinkering with the minimum retail subscription for IPOs, which was recently raised by Sebi to attract serious investors and ensure allotment. This is despite increasing the cap for this category of investors to Rs 2 lakh from Rs one lakh producing no noticeable surge in participation by the small investors. Small investors’ disinterest stems from issuers pricing their offerings richly, leaving little scope for post listing appreciation. Inability to get allotment is due to the large portion (65%) allocated to institutional investors. Prohibiting big-ticket investors from withdrawing their bids would make them choosy and increase the selling expenses of issuers, and prompt them to opt for private placement, preferential allotment or tap the cheap overseas markets.

The flattening of gold consumption should also be a lesson for the finance minister from interfering with companies’ administrative affairs. P Chidambaram has suggested that banks reduce their interest rates on loans for consumer durables and automobiles. According to his reckoning, the resultant demand-push would accelerate GDP growth. As the largest shareholder of PSU banks, the government does have a right to opine on operational matters of state enterprises. So are funds with exposure to listed entities entitled to oppose any move that would hurt minority shareholders’ interest. The brawl between the largest institutional investor in Coal India and the Centre over capping prices of coal is still fresh. Second, the finance minister’s advice amounts to abutting into the Reserve Bank of India’s job of carefully weighing growth and inflation indicators to determine the credit policy. It is perhaps the outcome of the government’s frustration at the central bank’s stubbornness over easing interest rates. Unwittingly, the advisory indicates that the lawmakers believe that the monetary authority has the finger on the trigger for economic growth, unwilling to concede that they too have some responsibility for the slowdown. The bump that the equity markets around the world are receiving at the prospect of a third round of quantitative easing by the US Federal Reserve could have also encouraged the finance minister to think that lower interest rates could move the wheels of the economy. But the demand unleashed by soft lending rates will be temporary and could release inflationary pressures. Consumer durables manufacturers can produce more if raw materials and finished goods can be transported quickly and there is adequate power to run their facilities. A transparent and uniform tax structure will enable them to buy inputs and price their goods efficiently. There is no dearth of capital. The obstacle is the inability of the government to implement policies that would facilitate this environment.

It is time policy makers give up their obsession with interest rates. Heating up of prices is a characteristic of a growing economy and so also high interest rates. It would be surprising if they were not. Instead of trying to choke up inflation by tightening and increasing the cost of money supply, it would be interesting to examine the factors influencing inflation. The two biggest contributors in recent time have been crude and food items. The flow of both is beyond government’s control. Availability of oil depends on the growth of global economy and tensions in the producing regions. Food grains’ output is dependent on monsoon. The predictable response to surging oil prices is to ramp up interest rates in a vain bid to suppress consumption. The collateral damage is increase in the capex cost of companies as investors flee from equities to debt. The minimum support price is hiked to incentivise farmers to grow more and also to ensure that they do not suffer in case of glut. In the process the share of food items in the wholesale price index goes up. This means using interest rates to counter rising prices can prove counterproductive for a growing economy. Instead allowing the market to even out demand-supply, as demonstrated by gold, would ensure flow of investment in the right direction and at the same time keep prices in check.

Mohan Sule