The Dividend That Looks Affordable Until You Check the Cash
Padma Foods plc reports net profit after tax of BDT 18 crore on revenue of BDT 240 crore. It has 6 crore shares outstanding trading at BDT 42. The board is under pressure from a large family shareholder to raise the dividend from BDT 1.50 to BDT 2.50 per share. Capital expenditure planned for next year is BDT 22 crore, of which BDT 6 crore is maintenance. Depreciation was BDT 9 crore. Working capital is expected to absorb BDT 3 crore as volumes grow. The company has BDT 4 crore cash and undrawn facilities of BDT 10 crore, but the loan covenant caps net debt to EBITDA at 2.5x; current EBITDA is BDT 30 crore and net debt is BDT 55 crore. The finance director says the payout is 'covered by earnings'; the independent director asks whether it is covered by cash.
1. Assess the proposed dividend against free cash flow to equity and the covenant, showing your figures.
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Earnings coverage is not the test. At BDT 2.50 per share on 6 crore shares, the dividend is BDT 15 crore, a payout ratio of 83% of PAT. That looks 'covered' but says nothing about cash.
Free cash flow to equity.
- Net profit: BDT 18 crore
- Add back depreciation: +BDT 9 crore
- Less total capex: −BDT 22 crore
- Less working capital absorption: −BDT 3 crore
- FCFE ≈ BDT 2 crore
So the dividend of BDT 15 crore exceeds FCFE by BDT 13 crore. The shortfall must be funded from the BDT 4 crore cash balance and drawings on the BDT 10 crore facility - i.e. new debt.
Covenant test. Net debt would rise from BDT 55 crore to about BDT 68 crore (BDT 13 crore funded plus the BDT 4 crore cash used). Net debt/EBITDA becomes 68 ÷ 30 ≈ 2.27x, still under 2.5x but with only about BDT 7 crore of headroom - roughly BDT 2.3 crore of EBITDA cushion. Any earnings miss or capex overrun breaches the covenant.
Conclusion. The FD's 'covered by earnings' claim is arithmetically true and financially misleading. The dividend is funded by borrowing, which is defensible only if the capex is genuinely value-creating and temporary. Here the growth capex of BDT 16 crore is the swing factor: if it can be phased, the dividend is affordable; if not, the board is borrowing to pay shareholders, which transfers value from lenders to shareholders and will be priced at the next refinancing.
2. The family shareholder argues that a higher dividend signals confidence and will support the share price. Evaluate this using the numbers given.
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What the market is currently pricing. At BDT 42 with earnings per share of BDT 3.00 (18 ÷ 6), the P/E is 14x. The current dividend of BDT 1.50 gives a yield of 3.6% and a payout of 50%. The proposed BDT 2.50 gives a yield of 6.0% and a payout of 83%.
The signalling argument. Dividend signalling works when a payout increase conveys private information about sustainable future earnings. It backfires when the market can see the payout is debt-funded. Analysts will compute FCFE of about BDT 2 crore against a BDT 15 crore distribution and read the increase as a sign of weak investment opportunities or of controlling-shareholder extraction, not confidence. The empirical pattern is that unsustainable payout increases are followed by cuts, and cuts are punished more severely than the original increase was rewarded.
The clientele problem. Raising the yield to 6% attracts income investors who will sell violently if the dividend is later cut to fund capex. The company locks itself into a payout it cannot maintain, and the resulting volatility raises the cost of equity - the opposite of the intended effect.
A better structure. If the family wants a signal, a smaller increase to BDT 1.80–2.00 (payout 60–67%, cost BDT 10.8–12 crore) plus a clear statement that growth capex is being funded from the facilities would signal confidence without borrowing to distribute. Alternatively, a scrip or buyback option gives the family liquidity without draining cash. The board should ask what the family actually needs - cash or a higher share price - because the two are not served by the same instrument.