The curious case of a 35 per cent dividend-yielding company

With the market reaching a new all-time high, we looked at high dividend-paying companies and found an interesting case.

Amid the challenge of identifying value in the current market, two companies, Hindustan Zinc and Vedanta, exhibited astonishing dividend yields of 15 per cent and 35 per cent, respectively, while trading at low prices (price-earnings ratios, i.e., P/E below 20).

Intriguingly, Hindustan Zinc is a subsidiary of Vedanta .

This got us curious. We decided to understand why the market had not yet adjusted for these remarkable dividend yields. Our exploration sought to unveil the underlying dynamics at play in these stocks.

The origins of high dividend yields
The promoter group of Vedanta had mounting debt obligations of approximately $10 billion, which were maturing soon. To address this, the London-based promoter group utilised its Indian assets as a financial resource to meet these obligations.

However, this was not the only route taken by the company to meet these obligations.

The Anil Aggarwal-led company also attempted to delist Vedanta at Rs 87.25 in 2020. With a 50 per cent stake then, this move was touted to simplify the corporate structure and merge the Indian-listed Vedanta with the London-based entity. However, the attempt failed as LIC, a major shareholder with a 6 per cent stake, demanded Rs 320 per share.

Undeterred, Aggarwal pursued an alternative by purchasing shares from the open market, ultimately elevating the shareholding to 70 per cent. After this substantial increase in shareholding in early 2021, the significant dividend payouts commenced.

With such a substantial ownership stake, most of the high dividends payouts returned to the company.

Exploring other alternatives for funds
With the commodity rally losing momentum and reserves depleted, Vedanta is now opting for alternatives to dividend payments. These include escalating brand fee payouts (increased from 0.75 to 2 per cent of revenue in FY21), extending inter-corporate borrowings, demerging Indian entities, and attempting cross-selling group assets within the entities at premium valuations.

The promoters have also initiated the sale of some shares acquired during 2020-21.

Additionally, Hindustan Zinc's dividend distribution has gradually decreased in frequency and magnitude.

All these attempts are aimed at generating additional funds.

Conclusion
While distributing dividends from free cash flows is a positive sign, Vedanta's aggressive dividend strategy transformed Hindustan Zinc from a net cash to a net debt company.

While the apparent high dividend yield may seem advantageous for shareholders, it becomes evident that the primary intent of the promoters was to capture all company dividends rather than rewarding the broader shareholder base. Despite the perception that the problem may have subsided, the promoter company still grapples with a substantial $6.4 billion net debt.

Furthermore, negotiations with bondholders, including concessions, illustrate the company's efforts to extend deadlines. In the absence of support from commodity prices and a perceived end to the era of high dividends, the outlook for these Indian-listed entities appears bleak.

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