Nandini Home Textiles: Dividend Versus Covenant
Nandini Home Textiles Ltd has 6 crore shares and PAT of ₹36 crore, giving EPS of ₹6. It has followed a 40% dividend payout, but its stated policy is a residual dividend based on a target debt-equity ratio of 1:2. It has identified a ₹50 crore capex programme for next year. Cash and equivalents are ₹18 crore, of which ₹10 crore is needed as minimum operating cash. The term loan covenant restricts dividend payout to 30% of PAT until the loan is repaid at the end of next year. A large institutional investor has told the board it will vote against the directors if the payout is cut, while the promoter family relies on dividends for personal liquidity. The CFO is comparing three options: (i) pay 40% and fund the capex with additional debt; (ii) pay 30% and use the remaining cash and debt; (iii) maintain 40% and defer ₹12 crore of capex by one year. Deferring the capex is expected to cost ₹2.5 crore of lost contribution and delay ₹6 crore of annual EBITDA improvement by a year.
1. Compute the dividend per share under a strict residual policy at the target debt-equity ratio of 1:2. Compare it with the 40% payout and the 30% covenant cap.
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Capex ₹50 crore. At D/E 1:2, debt = 50 × 1/3 = ₹16.67 crore; equity = ₹33.33 crore. PAT ₹36 crore. Residual equity available for dividend = 36 − 33.33 = ₹2.67 crore. DPS = 2.67/6 = ₹0.445; payout = 2.67/36 = 7.4%. The historical 40% payout would be ₹14.4 crore (DPS ₹2.40), far above the residual amount and above the 30% covenant cap of ₹10.8 crore (DPS ₹1.80). A strict residual policy therefore implies a severe cut, but the covenant sets a ceiling, not a floor. The board cannot pay 40% without a waiver.
2. Evaluate the three options using the cash and covenant constraints. Show the funding arithmetic.
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Surplus cash above the ₹10 crore minimum is ₹8 crore.
(i) 40% payout = ₹14.4 crore; retained = ₹21.6 crore; with ₹8 crore cash, ₹29.6 crore is available against a ₹33.33 crore equity need; the ₹3.73 crore shortfall must be extra debt, taking project debt to ₹20.4 crore and D/E to 0.61. Also, 40% > 30% covenant → breach.
(ii) 30% payout = ₹10.8 crore; retained = ₹25.2 crore; plus ₹8 crore cash = ₹33.2 crore, almost exactly the ₹33.33 crore equity need (rounding). Debt stays at ₹16.67 crore, D/E ≈ 0.5, and the 30% covenant is met. Only a tiny ₹0.13 crore gap remains.
(iii) 40% payout plus deferring ₹12 crore capex: the covenant is still breached unless waived. If waived, capex falls to ₹38 crore, equity need is ₹25.33 crore, and retained earnings plus cash of ₹29.6 crore cover it; but the delay costs ₹2.5 crore plus one year's lost ₹6 crore EBITDA, about ₹5.36 crore PV at 12%, total ~₹7.9 crore.
3. Recommend an option and explain how the CFO should handle the institutional investor and the promoter family.
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Recommend option (ii): pay 30% (DPS ₹1.80), stay within the covenant, use ₹8 crore of surplus cash and retained earnings, and fund the balance ₹16.67 crore with debt at the target ratio. This preserves the capex timetable and avoids the ~₹7.9 crore cost of delay. The institutional investor should be told that 40% would breach the term-loan covenant and could trigger acceleration; a 30% payout plus a clear commitment to revert to 40% after the loan is repaid is a credible compromise. The promoter family's liquidity need should be addressed separately-perhaps a modest additional dividend next year or a planned share sale-not by breaching the covenant. If the investor still objects, the board can seek a one-year waiver, but it should not assume it will be granted. Document the liquidity buffer and the post-repayment dividend policy.