Why Vedanta's upcoming dividend is no cause for celebration

Vedanta has sent a response to the following article. We have appended it to this page.

Profits may fluctuate, but dividends won't. That's an unspoken vow of Vedanta to its shareholders. True to form, the dividend aristocrat will consider an interim dividend, the fourth this financial year, on October 8, 2024. Investors are delighted. The stock is up nearly 7 per cent in two days since the announcement on September 25, 2024.

In the last two years, Vedanta shelled out Rs 48,531 crore in dividends against its free cash flow of Rs 38,508 crore. So naturally, it's been depleting its cash reserves to make these payments. They have nearly halved to Rs 30,137 crore over FY22-24.

Buzzkill alert: using cash reserves to give dividends is nothing out of the ordinary. Large, stable businesses almost always do. But for Vedanta, this is no good news.

A cash cow, but for promoters

Vedanta's dividend payments are less a cause of celebration and more of concern for two reasons:

1. The money is actually being routed to its UK parent Vedanta Resources as dividend, given it's the largest shareholder in the Indian miner, with a stake of 56 per cent. So, more than half the dividend payouts get bankrolled to the parent to help lessen the massive debt of $9.7 billion (around Rs 81,000 crore) that it took on a few years back.

2. Vedanta itself is saddled with a large debt pile and has significant capex to fulfil. Its dividend payment spree is diminishing its ability to stay afloat and keep growth plans on track.

Cracking the numbers

Simply put, Vedanta is biting off more than it can chew. Let's first take note of its expected profit kitty. It is optimistic about delivering annual EBITDA (earnings before interest, taxes, depreciation, and amortisation) of Rs 50,000 crore driven by buoyant metal prices. This works out to be Rs 1.5 lakh crore in the next three years.

Now, let's take a look at its obligations.

• There is a capex plan of Rs 67,000 crore in place for the next three to four years.
  
• Add to this the debt dues. The parent company's long-term debt worth Rs 25,000 crore matures in three years. So, Vedanta will have to pay a nearly Rs 50,000 crore dividend over this period to fulfil the parent's debt obligation. Remember, half the dividends go to the parent.
  
• Vedanta's own debt of Rs 50,000 crore will also mature at the same time. These are only principal payments.

All the above adds to cash outflows of around Rs 1.7 lakh crore over the next three years, amounting to a shortfall of around Rs 20,000 crore.

To sum it up

Even if we ignore the cyclicality of its commodity business, which makes achieving the projected EBITDA uncertain, Vedanta doesn't have enough money to pay for its capex and deleveraging efforts.

So, it either has to lower its planned capex, slowing growth. Or continue trying to arrange capital from other sources. Like it did recently through a QIP issue and a stake sale in subsidiary Hindustan Zinc. Either way, the growth trajectory will be muted—something that investors should keep in mind, given they have propped up the stock over two times in just a year.

Disclaimer: This is not a stock recommendation. Investors should do their own due diligence before making any investment decision.

Also read: Is it possible for Vodafone Idea to ring in profits?

The following is a response we have received from Vedanta:

At Vedanta Limited, our priority has always been to deliver consistent value to our shareholders. Our dividend policy reflects this commitment. The decision to consider an interim dividend on October 8, 2024, exemplifies our focus on providing steady returns, even in fluctuating market conditions. The positive market response, with the stock gaining 89 per cent in the last six months, underscores investor confidence in our business and its long-term value creation proposition.

1. The article references the use of cash reserves for dividend payments, but it is important to clarify that dividends, growth, and capex have co-existed harmoniously at Vedanta. Over the last eight quarters, our financial performance has demonstrated that we can simultaneously support dividends and invest in growth. Utilizing cash reserves for dividends is a common practice among large, stable businesses like ours, reflecting prudent capital allocation, rather than straining financial health.

2. Vedanta has invested substantially in both brownfield and greenfield expansions, with a total growth capex of $3.3 billion over the last three years. This demonstrates our commitment to long-term value creation through strategic capital allocation. Recent acquisitions, such as Nicomet and FACOR, along with new power plants like Athena Power and Meenakshi Power, have strengthened our portfolio. Additionally, acquisitions of iron ore mines, including the Barbil and Bicholim mines, and critical mineral blocks such as the Cudnem Iron Ore block and Nickel mineral blocks, further secure our raw material needs and position us for sustained growth.

3. Our operational performance continues on an upward trajectory, thanks to the sustained and structural initiatives we've undertaken over the last couple of years. This is evidenced by a 47 per cent YoY growth in EBITDA for Q1 FY25.

4. Vedanta's commitment to financial discipline is further reflected in the aggressive deleveraging efforts at parent company, Vedanta Resources Limited (VRL). VRL reduced its debt by $3.7 billion over the last two years up to FY24, with an additional $0.6 billion deleveraged in Q1 FY25 through strategic initiatives, including dilution of promoter shares and a successful liability management exercise. Brand fees also serve as a significant source of funding at the parent level, alongside dividends.

5. Our dividend payouts to Vedanta Resources form part of a holistic liquidity management approach, which also includes cash flows from operations, brand fees, and strategic stake dilutions--not solely dividends. This ensures that Vedanta Resources has sufficient liquidity to meet its obligations, while Vedanta Limited's operational stability remains unaffected.

6. Investor confidence is evident in our recent $1 billion Qualified Institutional Placement (QIP) and Hindustan Zinc Ltd (HZL) Offer For Sale, both of which contributed to our strengthened financial position. These achievements speak to the trust our investors have in our strategic vision and performance.

7. Although commodity price cyclicality poses short-term challenges to profitability predictability, Vedanta remains well-positioned for long-term value creation. Our proactive capital management approach, alongside strategic acquisitions and growth capex, ensures that we are on track to meet both our capex and debt obligations without compromising growth.

8. Our efforts have not gone unnoticed. ICRA recently upgraded Vedanta Limited's long-term credit rating from AA- to AA, further confirming the strength and stability of our financial standing. In addition, S&P Global Ratings upgraded Vedanta Resources Ltd from 'CCC+' to 'B', highlighting our improved capital structure and liquidity.

9. Our proposed demerger, planned to be a simple vertical split, will also enable value unlocking and attracting big-ticket investment into the expansion and growth of each of its demerged businesses. By further simplifying our corporate structure, the demerger will create sector-focused independent businesses providing investment opportunities to Indian and global investors, including sovereign wealth funds and strategic investors.

Vedanta Limited's equity valuation has surged nearly 2x this calendar year, driven by strong operational performance, rising commodity prices, and growing investor confidence. This growth reflects the market's recognition of our strategic initiatives, including ongoing capex, deleveraging, and liability management. Our ability to deliver sustainable returns to shareholders is a core tenet of our approach.

Looking ahead, we are committed to maintaining this momentum with an ambitious target to deliver $10 billion in EBITDA and invest $8 billion in growth capex over the coming years.