Britannia's unique approach to rewarding shareholders

Britannia Industries has employed a relatively rare strategy to reward its shareholders by issuing bonus debentures. Before we explain what it means for investors and the company, let's recap what debentures are.

What are debentures
Debentures are debt instruments issued by companies to borrow money. In simple terms, if you purchase a debenture, the company is loaning money from you. Like every loan, you earn an interest over the period of the loan, and the company returns you the principal amount after the debt matures.

What are bonus debentures
Companies reward their shareholders by distributing a portion of their earnings in the form of dividends. Bonus debentures offer an alternative route to distribute earnings among shareholders. Here, the company is transferring a portion of its reserves (part of net worth) to its shareholders in the form of a loan. So, in effect, a part of the net worth becomes a liability (debt). The shareholders earn interest on these debentures.

These debentures are issued to shareholders on a proportional basis (proportional to their shareholding). Moreover, these debentures are also listed on exchanges. So, shareholders have the choice to sell them before maturity.

The Britannia way
Britannia has issued non-convertible debentures worth Rs 1,419 in the last five years. The debentures have been issued in the ratio of 1:1, which means one debenture for every equity share held by the shareholder.

In 2019, the board approved the issue worth Rs 721 crore carrying an interest of 8 per cent per annum and in 2021, issuance of Rs 698 crore has been approved. The interest rate is yet to be announced.

What are the implications of issuing it?

• A higher ROE: As the company is turning a portion of its equity into debentures, it is inadvertently boosting its ROE. However, this has also increased its debt-to-equity ratio.
• Unlike dividends, turning unused capital into debentures allows the company to retain the capital for capex and refinancing.

A word of caution
While debentures indeed are a way to reward shareholders, it does come with their risks. With dividends, companies have a choice, meaning the management can choose to withhold dividends if it feels it will hurt the overall financial health of a company. However, if a company has issued bonus debentures, it has to keep paying interest to shareholders, regardless of its financial health.

Suggested read: Are your stocks financially healthy?

This article was originally published on June 13, 2023.