A High-Yield Strategy

The narrowing gap between bond and dividend yields makes a compelling case for investment in high dividend yield stocks

If you are a serious investor in the stock markets, perhaps you would never care to buy a stock just because it pays a good dividend. Your prime consideration would be a hefty capital appreciation. This makes sense.

Especially in this age of great volatility where in a single day stocks gain or lose more than what bond investments deliver in a year. But soon you may have to change your perspective.

The professionals in the market say that there is a compelling case for investing in stocks which yield good dividends now. For a number of savvy investors, high dividend yielding stocks qualify as the best buys today.

So much so that Birla Sunlife Mutual Fund even launched a special fund focused on investing in high dividend yielding stocks a month back called the Birla Dividend Yield plus.

The argument goes like this: the spread between bond yields and dividend yields is becoming narrower, making high dividend yielding stocks look more attractive. Currently, the dividend yield on the BSE Sensex is 2.18 per cent while the yield on one-year government bonds is 6.11 per cent, a gap of just 3.93 per cent. In 1996, the gap between dividend yield on Sensex stocks and the State Bank of India's 1-year deposit rates was around nine per cent.

Besides, the Kelkar Committee has recommended that dividend tax should be done away with. "This will further enhance the attractiveness of dividend yielding stocks on a post-tax basis as returns will be even higher," says S Naren, director and chief operating officer, HDFC Securities. Currently, dividends are taxable in the hands of the investor at the applicable personal income tax rate. And if past experience is any indication, high dividend paying stocks could witness a re-rating if dividends are made tax-free in this Budget. The 1998 Budget announcement to make dividends tax-free in the hands of shareholders triggered large-scale buying in high dividend paying companies, resulting in good near-term price appreciation.

Besides, many high dividend yielding stocks are not really bad as they are often perceived to be. There are fundamentally strong companies which offer dividend yields in the range of 7-14 per cent and leave enough scope for steady capital appreciation. These make a compelling case for investment.

For retail investors, these are better alternatives to debt funds where the returns are tapering off, say fund managers. The recent fall in gilt prices has resulted in a decline in the net asset values of debt funds. In the past one month to date, debt funds have lost 1.87 per cent. Going forward, there is little likelihood of any major capital appreciation and interest rates will at best remain stable, they add. Says Paras Adenwala, fund manger of the newly launched High Dividend Yield Fund, Birla Sunlife Mutual Fund: "There are good alternatives for investors in debt funds looking for stable returns over the medium-term."

Another logic going in favour of these stocks is that in a bearish market, when stocks fail to perform, regular dividends can provide stable returns to investors. "High dividend yielding stocks are not glamorous, but they can provide steady returns, especially in times of a lull in the stock market," says Arun Kejriwal, a Mumbai-based stockbroker.

Quite a few high dividend paying stocks have already run up in the past few weeks. Notably, some public sector stocks have gained momentum, thanks to high dividend expectations. In the last two years, the government has benefited immensely from exceptionally high dividend pay-outs by cash-rich PSUs. Market sources suggest that the government may look at dividends from PSUs as a key revenue source in the future as well, especially when the government falls short of disinvestment targets.

S Naren

Director & chief operating officer, HDFC SecuritiesM

Great Eastern Shipping Company

Latest price: Rs 35.15

Dividend yield: 10.67 per cent

GE Shipping is one of the most sought after stocks as a dividend play. Last fiscal, the company declared a dividend of Rs 4. This year, it could announce a dividend of Rs 3.5 per share. At the current market price of Rs 35, the scrip is trading on a multiple of 2.9 times its annualised earnings for the first nine months of fiscal 2003 and at an estimated yield of 10.67 per cent.

GE Shipping is the largest private sector shipping company in the country. Present in both wet and dry bulk transportation, it is also involved with offshore oilfield services. The company's financial performance is dependent on internationally determined sea freight rates. The key driver for dry bulk freight rates is world trade growth while that of wet bulk is oil production by OPEC.

Although freight rates were weak in the second quarter of fiscal 2003, the company managed to lift its bottomline through operating efficiencies and lower interest and depreciation costs. However, in the third quarter, profits were lower on a year-on-year basis since the company's performance in the same period the previous year was quite strong. But with the Venezuela strike and threat of war keeping oil prices firm, freight rates have jumped over the past month-and-a-half. The company believes that this rise in freight rates is likely to hold through the fourth quarter.

With the government making efforts to reduce dependence on crude imports, exploration and production are receiving a fresh impetus. Over the past three years, the government has introduced three rounds of bidding under the new exploration and licensing policy (NELP). With focus on fresh exploration and increased production, demand and rates for rigs are likely to increase.

With firm freight rates and optimistic outlook for oilfield services, G E Shipping's financial performance should improve in the near term.

BPCL

Latest price: Rs 209.25

Dividend yield: Rs 5.26 per cent

Considering the sharp turn in fortunes, BPCL is likely to match last year's dividend figure. For the last fiscal the company declared a dividend of Rs 11 per share -- a payout of 38.8 per cent. Based on the current market price, the stock offers an attractive yield of 5.3 per cent.

The company's recent performance has been encouraging and its management indicated last month that they would encourage growth in petro-product consumption going forward. Its fourth quarter has started on a strong note with two upward revisions in retail prices of petrol and diesel during the first half of January 2003. Though the fourth quarter could be volatile as the Middle East situation remains fluid, a resolution to the impasse will result in cooling petroleum prices and reflect on the financials. Our earnings estimate for the full of this fiscal year is Rs 35. At Rs 209, the stock is trading attractively at six times the fiscal 2003 earnings estimate, which is closer to the pre-marketing deregulation forward price-earnings band of 3-5 times earnings. Post-marketing deregulation, the price-earnings band should settle between 5-7 times earnings, which means the stock is trading at the lower end of the spectrum.

Tata Chemicals

Latest price: Rs 58.40

Dividend yield: 8.56 per cent

The company owns and operates the largest and most integrated inorganic chemical complex in Gujarat. It operates salt works, spread over 60 square kilometres and is capable of generating over two million tonnes of solar salt, the basic raw material for almost all the 27 basic chemicals that it produces. It is from here that the company pioneered the production and marketing of vacuum-evaporated, iodised salt, which goes under the top-selling Tata Salt brand name. Beginning with a soda-ash capacity of 80 tonnes per day (tpd), the chemical complex has grown into a vast operation, making 2400 tpd of soda ash, 1000 tpd of vacuum-evaporated salt and 33 other products.

On the financial side, Tata Chemicals has gone in for a debt restructuring exercise using a two-pronged approach - progressive reduction in the quantum of debt and in the interest profile of debt. In fiscal 2002, the benefits of debt restructuring were visible. Debt was reduced by over Rs 470 crore to Rs 1550 crore despite a variable profitability environment. As a result, interest cost was down by 32 per cent from Rs 160 crore in fiscal 2001 to Rs 110 crore in fiscal 2002. Also, the company has seen continuous reduction in interest cost over the last four years