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The yield illusion

Many high-dividend paying companies will find it hard to sustain their payout

While many stocks at their current market price offer a mouth-watering dividend yield, in reality they are a trap as the financial health of many of these companies are deteriorating. Commodity stocks top the dividend yield table and companies like Cairn India, NMDC, Oil India, Vedanta and others now have a dividend yield in excess of 5%. However considering the recent correction in commodity prices, many of them will have lower operating cash flow and that will impact their ability to sustain last year’s dividend payout.

Take for instance, NMDC which is trading at a tempting over 9% yield. Last year it made a profit of close to ₹4,000 crore and given the high government holding, the entire operating cash was distributed as dividend. In H2FY16 so far, its average realisation has fallen 42% to ₹2,480 per tonne compared with ₹4,274 per tonne last year. Hence, to maintain last year’s dividend, it will have to dip into the existing cash (₹18,500 crore), which the management is holding back to fund its forward integration into steel manufacturing.

Similarly in oil and gas, after the steep correction in the price of crude, the stock price of companies in that sector has been hit. Cairn India, a consistent dividend payer is now trading at a 7.5% dividend yield. In FY15, it paid out ₹2,000 crore as dividend. In the current year, with crude oil now under $30, analysts believe that the company will not be able to make a profit of even ₹2,000 crore.

Cash cushion

Even if it dips into its kitty (₹16,000 crore), Gaurav Dua, head of research, Sharekhan, reminds, "While some them are sitting on cash they cannot distribute dividend from the cash in the books. They can only do so through special dividend for which they will have to seek approval." Meanwhile, upstream oil marketing companies like HPCL and BPCL which are currently trading at a 3% dividend yield seem like a better bet due to the higher profit resulting from zero under-recovery.   

Rakesh Arora, head of research, Macquarie Capital says, "If you are looking for certainty of dividend in the commodities space, Coal India and Hindustan Zinc qualify given that their profit and cash flows are not hit significantly." Despite a lower coal price, Coal India has gained on account of higher volume and better realisation earned through the e-auction of earlier subsidised coal. Last year it paid ₹15,500 crore in dividend. This year, even if the government does not dip into its cash reserve of ₹54,000 crore, an expected FY16 profit of ₹14,500 crore should sustain its current yield of 5.5%.     

NALCO is another PSU that yields 5%. "While Nalco's profit will fall by about 30% this year, at an expected profit of about ₹800 crore, it has enough room to maintain its dividend which was about ₹500 crore last year," says Goutam Chakraborty, who tracks the company at Emkay Global. Nalco also has cash of ₹5,000 crore, which should take care of any dividend shortfall, given the absence of any major capex.

Not bankable

Besides commodities, banking is another sector where investors are sceptical about stocks trading at an attractive dividend yield. Especially, PSU banks like Syndicate, Canara, UCO where the dividend yield is in excess of 5%. "Because of the asset quality issue, banks might have to make higher provision which will impact their profit. Second, most of these banks are yet to be capitalised. It’s quite possible that they might conserve cash rather than distribute," says Swati Kulkarni, who manages the Dividend Yield Fund at UTIMF.

In Q2FY16, Canara Bank’s gross NPA rose by 53% year-on-year basis to ₹14,021 crore and its provisioning was up 49% at ₹1,212 crore. This might continue considering its exposure to stressed sectors like infra, real estate and power. “It is hard to imagine if even a single PSU bank will be able to maintain its dividend payout. The impact of higher provisioning and capital requirement will compel banks to conserve cash,” says Aalok Shah, who tracks the sector at Centrum Broking.

While banks offer less certainty, Rural Electrification Corporation with a yield of 5.5% is better placed for those looking for a dividend play. While its cash flow, too, will be impacted because of the stress at SEBs, the impact on profit is expected to be relatively low. Compared with FY15’s profit of ₹5,200 crore, REC is expected to make a profit of ₹6,000 crore in FY16 which is enough to maintain its FY15 payout of about ₹1,300 crore. 

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