‘Not Willing To Commit To Targeted Payout Ratio': Expert On Why Indian Companies Are Hoarding Cash

The pandemic saw companies conserving cash by lowering dividend payouts. The cash reserves in the US soared from $1.6 trillion in 2000 to approximately $5.8 trillion. This trend is true for India as well with companies increasingly holding significant amounts of cash. 

Proxy firm Institutional Investor Advisory Services (IiAS) in their IiAS Dividend and Buyback Study 2023 found that based on 2021-22 financials and adjusted for announced acquisitions and capital expenditure in 2022-23, some 45 BSE 500 companies can return almost Rs 69,000 crore or more to their shareholders, or almost 41% of their balance sheet cash for the fiscal year-end. 

According to the study, Tata Consultancy, Siemens, ITC, Hero Motorcorp and Sun TV Network collectively hold an excess cash balance of Rs 37,800 crore. This accounts for 47 percent of their total cash.

"While companies have been returning more cash to shareholders (through dividends and buybacks) in FY22, cash balances continue to build up for corporate India," IiAS said in a note.

There could be various reasons behind this including lack of sufficient investment or expansion opportunities, or an unprecedented profit run in recent years. 

Why are companies sitting on so much cash? And should they give it out? To know more about the reasons why companies are not deploying cash and what the investors can expect, founder of The Core and financial journalist Govindraj Ethiraj spoke to Hetal Dalal, president and chief operating officer of IiAS. 

"Investors need to engage rather than demand, and try to understand the rationale for this excess cash on the balance sheet," Dalal said. 

Here are the edited excerpts from the interview.

What are the reasons behind the cash reserves on balance sheets, and what options did companies have to address this situation?

One of the biggest concerns of capital markets in India specifically is hoarding of cash. Maintaining cash is something that companies must do as it is needed for working capital, capex, and as COVID has taught us, for uncertainties. But the question we always ask is how much cash is enough? Which is why, our study aims to conservatively estimate the quantum of excess cash that companies have on their balance sheets. And whether these can therefore be paid out to shareholders in terms of dividends or buybacks. 

While we've done our estimates, it is for the boards to decide whether the excess cash is distributable or would they actually want to save it for potential capex or for unforeseen circumstances. But our view is that the board should explain the need to have excess cash. 

For example, given the uncertainty around COVID in 2020, it was important for companies to conserve cash, which some companies did. As vaccines came in, there was greater visibility of recovery and companies started paying out dividends and buybacks. So there was a lot of cash that actually then started exiting and going back to the shareholders. 

During the Covid years, there was a need to distribute cash for shareholders and MNCs actually paid out more than most of the other companies. There's also been a performance dip because of Covid. Therefore, cash accumulation itself has been slightly more limited, because of which the number has come down a little bit in the current study(IiAS Dividend and Buyback Study).

If many of these companies are, proportionately more than others, sitting on more cash, what are the key drivers of the cash accumulation analysis?

Our analysis is not industry specific, although there are certain industries which tend to generate a little bit more cash than others. The way we look at it is by taking the top 500 companies that account for about 90% of market cap. Financial services are then removed from this list, because these are companies which use cash as raw materials. This is why, saying that banks have excess cash or NBFCs(Non-Banking Financial Company) are hoarding excess cash has limited validity. 

Next, we looked at the quantum of cash that companies typically need to conserve and narrow it down to how much of the cash is distributable. Within the remaining companies, we look at the companies that have cash which we consider to be excess. 

This is determined by looking at past track record of capital expense including average capex of the past three years or five years, expected capex, working capital, and also the total debt repayment. Let's say you minus the debt repayment from the cash, adjust for contingent liabilities, and cap that entire number at 50% of net worth. Because if a company pays out a dividend, obviously, the net worth is going to be impacted and the company cannot pay out the entire thing as dividend. Lastly, we also manually adjust the number for the announcements that companies have made in terms of acquisitions, or other projects. 

What is the single biggest reason why companies are not deploying cash?

This is driven by two things, one is the speed at which the company is generating cash and the other is the ability of the board to decide on capital allocation. IT companies generate cash significantly faster than most of the other companies like manufacturing. SEBI came out with a regulation stating that companies need to have a dividend policy. But the reality is that a lot of companies are still not willing to commit to the targeted payout ratio. 

A lot of dividend policies don't carry a targeted payout ratio. However, some of them do. Companies like Infosys or Bajaj Auto have taken it a step further to look at dividend, not just simply as a payout ratio, but as a function of free cash flows, as a function of the total quantum of cash that they have on the balance sheet. For the boards which are becoming more thoughtful about capital allocation have got a formula and a process by which they're going to decide how much dividend are they going to pay out?

Going forward, as an adviser, are you going to push your investor groups, or institutional investors to in turn put pressure on companies to return capital?

The idea of putting out a report of this nature is to create more awareness around some of these issues. While we've done this entire estimate of the excess cash on the balance sheet, it is finally for boards to decide or at least communicate to their investors on why they are maintaining this high level of liquidity. If they have legitimate reasons for maintaining the high level of liquidity, then it is fine. But if it's just the ability to think through whether or not the company needs it, then they should definitely look at paying it out. 

So, investors need to engage rather than demand, and try to understand the rationale for this excess cash on the balance sheet. 

How do you see this in contrast to what's happening with large companies internationally like NYSE and Nasdaq?

There are market peculiarities but dividend tends to be more company specific. That's something we've seen in the Indian context as well, for both industry and the nature of management specific companies. There are companies listed globally also, which don't actually have very high dividend payouts, because they fundamentally believe it gets built into the stock price. Therefore, dividend is not something they're going to be focused on as long as there's capital appreciation. 

There are companies which will pay out higher dividends, equally in the global market. But by and large, we're trying to drive the market towards more considered and thoughtful capital allocation policy is what we're trying to drive the market towards. It is not necessarily demanding that more dividends have to be paid out, but pushing audit committees to be a little bit more thoughtful on whether you really need that much cash. Are you not better off giving it to investors?

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