DIVIDEND PAYMENTS THROUGH BORROWED MONEY

Aggressive dividend payouts by top 500 companies has seen 419 of them together borrowing around Rs 20,000 crore, while paying around Rs 1.2 trillion (Rs 1.2 lakh crore) in FY'14, according to India Ratings. "Several BSE 500 corporates, excluding banks and financial services companies, adopted an aggressive dividend payment strategy in FY'14, despite a reduction in their net profit. "We expect 419 of these corporates to have paid an aggregate dividend of Rs 1-1.2 trillion in the fiscal and availed aggregate debt of Rs 18,000-20,000 crore for the same," as per the data collated by the rating agency. The agency estimates 419 corporates availed Rs 19,180 crore of debt in FY'14 to fund the aggregate dividend payment of Rs 1,04,900 crore. The trend of dividend payment behaviour over FY'09-FY'13 suggests that in most instances cash flow from operations was adequate and instances of debt requirement declined steadily from FY'11-FY'13. "However, the total quantum of debt needed rose sharply in FY'13 (after declining in FY'12) due to an increase in dividend payments and a reduction in net profit. As many as 37 public sector units among the 419 corporates paid aggregate dividend of Rs 45,060 crore in FY'13, and of these, eight of them had to borrow Rs 12,890 crore to make the payments. However, considering the sovereign linkage of these companies, their credit profiles are unlikely to be impacted, it added. But more worrisome may be the case of 12 private corporates with high leverage (above 5 times) which could have borrowed an estimated Rs 2,770 crore to pay dividends. Lenders have to watch out for corporates whose cash flow from operations (CFO) is negative or have CFO below the amount of divided paid, while PAT may be positive. In some of these cases, dividend payments could be financed by debt, even when financial leverage is high. As such, some loan documents have covenants with respect to dividend payments, but they usually require the borrower to inform or seek approval from bankers before paying dividends. Decision triggers are usually accounting profit, balance sheet net-worth or debt/equity ratio. Under the new Companies Act, a corporate can pay dividend out of its current or past accounting profit, in essence out of net income. However, it is possible that while a corporate can generate positive net profit, its CFO may be negative due to high working capital requirements to support revenue and EBITDA profits. In such cases, a company paying dividend higher than its CFO is likely to tap its cash reserves, investments and non-recurring income. If this is insufficient, the company would effectively rely on debt to finance dividends. Reliance on cash reserves or debt to partly or fully fund dividend payments has a negative impact on net leverage (adjusted debt net of cash dividend/EBITDA) and the overall credit profile, it added.