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1. INTRODUCTION ITC was incorporated on August 24, 1910 under the name Imperial Tobacco Company of India Limited.

Later on because of its multi business portfolio, the company was rechristened ITC Ltd. in 2001. Its turnover is US $ 4.75 billion. It ranks third in pre-tax profit among India's private sector corporations. ITC initially started with the Cigarettes and Leaf Tobacco business, went into Hotels, Paperboards, Packaging and Agri-Exports, and is gaining market share in its nascent businesses of Packaged Foods & Confectionery, Branded Apparel and Greeting Cards. ITC is also gaining a strong hold in the Information Technology sector with its subsidiary ITC Infotech India Ltd. 2. OBJECTIVES OF STUDY The following are the objectives of Study: 1. To analyze the Current Dividend Policy of ITC 2. To evaluate the Prospects of future dividend policy. 3. To compare ITCs dividend policy with its peers. 3. ANALYSIS Company Performance: Notwithstanding turbulent market conditions, ITC Ltd. delivered a steady performance with Gross Turnover at Rs.23144 crores reflecting a growth of 8.4% over the previous year. This performance was achieved despite the unprecedented increase in excise duties on non-filter cigarettes, coming close on the heels of the un-paralleled levy of VAT on cigarettes in the preceding year. The decline in hotel revenues in the wake of the economic slowdown and the unfortunate terror strikes in Mumbai, the continuing impact of high commodity prices and store rentals, brand building costs of the new Personal Care portfolio and the significant investments in augmenting the distribution infrastructure and systems combined to exert intense pressure on profitability during the year.

1. Current Dividend Policy Analysis: a. Dividend History: Bonus Issue and Stock Split in 2006 In 2006, ITC declared a bonus issue in the ratio of one share for every two equity shares of Rs. 10 each and it also split the face value of shares from Rs. 10 to Re. 1. The share split benefited all eligible employees of the company and its subsidiaries who have been granted stock options (under the ESOP scheme).

The market was expecting the bonus and stock split and prices were already on a high in anticipation. So the announcements did not kick off a major rally, instead the scrip fell by Rs 3.10 or 0.20 per cent on the National Stock Exchange. The stock split increased trading volume on the bourses, as the shares became more affordable to retail investors. The expanded equity base helped the company to raise debt to fund its ambitious expansion plan. Whenever a consistent dividend-paying company announces a bonus issue, it means the management is signaling a better future performance. This also means the company will continue to pay dividends in the same proportion though the number of shares has increased. This implies better returns for them in the long run.

The following table shows the Dividend per share trend along the years 2005 to 2009: Year Dividend (in Crore Rs.) Mar 09 1,396.53 Mar 08 1,319.01 Mar 07 1,166.29 Mar 06 995.12 Mar 05 773.25 Mar 05

3.7 3.5 3.1 2.65 31 (10 Rs) 3.1 (1 Rs) Gradual increase of Dividend Decreased dividend after Split and Bonus The increase % in dividend is at (3.7 3.5)/ 3.5 %, i.e., 0.057% the last year Payout Ratio: Though the dividend per share is increasing (as shown in the above table,) the company is tending to decrease its dividend payout ratio, signifying a lesser ratio of the Profit being given as dividends, year after year Dividend Payout Ratio (Cash Profit): Mar 09 Mar 08 Mar 07 42.84 43.36 44.54 Decrease of Dividend Payout Ratio Mar 06 Mar 05 44.19 35.25 Increase of Dividend Payout Ratio

B. Analysis of the Current Dividend Policy:

A. Full Information Models-The Tax Factor


Under capital asset pricing theory, investors offer a lower price for the shares because of the future tax liability of the dividend payment. Sales Taxation in tobacco sector (affects the total sales) The tax measures have become harsher in 2007, with an increase of 6% in excise and an additional 12.5% in VAT, bringing the total effective tax to about 20%. ITC

Group has taken price hikes as high as 20% on some brands. The overall industry declines have been lower than expected, reflecting consumer resilience to price rises.

Thus the sales revenues have been unaffected because of the high margins.
(2009 has seen a further hike of 10% in specific rate on cigarettes which had a marginally negative impact on companies like ITC and Godfrey Philips.) Corporate Dividend Tax Excise reduction on semi-mechanized and mechanized matches production and corporate tax reduction to 30% from 35% was a welcome relief for ITC.

Thus the cost of dividend payout will decrease, encouraging the company to pay out dividends.
B. Models of Information Asymmetries 1. Signaling: The mitigation of the information asymmetries between managers and owners via unexpected changes in dividend policy is the cornerstone of dividend signaling models. The Shareholders profile can be predicted using the volume of stock trading: The Stock trading volume on Jan 22 2010 of ITC ltd is 935,893, enlisting them in a group A most traded company, but placing them extremely low from the market maximum of 31,730,307 trading volume of Cals Refineries Ltd., which implies that their shareholders profiles are skewed towards being risk averse and will be motivated by dividend, taking up positive signals.

ITCs shares are largely held by banks, mutual funds and foreign shareholders which imply that they are heavily dependent on other people instead of their promoters and thus, they have to make sure that they keep their shareholders happy by giving them huge dividends. 2. Agency costs: Agency cost theory uses dividend policy to better align the interests of shareholders and corporate managers. The ESOPs of ITC in the past 3 years are: 1,295,580(2007) + 2, 83,840 (2008) + 33, 96,970(2009) of Ordinary Shares of Rs 1 each. Since ITC has a sizeable employee stock option, dividends would ensure the confirmation of alignment of shareholders and mangers interest and signal better trust

3. The free cash flow hypothesis. The free cash flow hypothesis is an ad hoc combination of the signaling and agency costs paradigms; the payment of dividends can decrease the level of funds available for perquisite consumption by corporate managers. The current cash and cash equivalent: 1,032.39 crores Liquidity ratio - Current ratio is given as follows: Mar 09 1.44 Mar 07 Mar 06 Mar 05 1.37 1.27 1.04 Increase of Current ratio The company is inclined towards increasing current ratios and maintaining cash balances. They manage to achieve this increase even with a constant increase in dividend %. This is because of the following trend: The adjusted EPS has had a continuous increase over time, below: Mar 08 1.39

Adjusted EPS (Rs.) Mar 09 Mar 08 Mar 07 8.43 7.87 7.08 Gradual increase of EPS over the time period Mar 06 Mar 05 Mar 05 6.02 68.32 (10 Rs) 6.832 (1 Rs) Split and Bonus decreased the EPS

2. Evaluate the future dividend policy


Residual theory The Leverage Ratio, Fixed assets turn over ratio of ITC is as follows: Mar 09 Mar 08 Mar 07 1.44 1.59 1.75 Decrease of Fixed assets turnover ratio Mar 06 Mar 05 1.59 1.33 Increased Fixed assets turnover ratio after Split and Bonus The decreasing fixed asset ratio shows the increased investments and Capital expenditure. Thus, the residual theories have high significance in deciding the dividends. Current Dividend policy acc to Residual theory 2009 Retained earnings: 2,358.14 Crores Net cash used in investment activities: 1260.74 crores Residual Amount: 1097.4 crores

Cash/ Cash equivalents available for dividend payout = residual amount: 1097.4 crores Actual Dividend paid: 1,396.53 Implies that the company finances the Dividend pay/ investments through Loan Funds (secured + insecure) Loan Funds of the following years are: 2008 12,215.98 2009 13,857.54 Net increase in Loan Funds: 1641.56 crores From the Debt/ equity ratios of the years 2005 to 2009, Companys Debt equity ratio, has been a constant 0.01. Further increase in Long term borrowing might vary this ratio.

Future Dividend policy acc to Residual theory The following calculation will provide an analysis of Debt equity ratio after an increase of 0.06% in dividend.

Calculation of 2010 Capital Expenditure


Year Net cash used in Investing activity 2005 1438.95 2006 175.31 2007 1082.78 2008 1736.78 2009 1260.74 2010 1500.4 Through linear projection method, (with liner trend equation, y = 120.5x + 777.4) the Capital expenditure of 2010 is forecasted.

Calculation of 2010 Retained Earnings


Year 2005 2006 2007 2008 2009 2010 Retained Earnings 1696.27 1712.06 1897.53 2224.45 2358.14 2527.6

Through linear projection method, (with linear trend equation, y = 183.6x + 1426) the Retained Earnings of 2010 is forecasted. Cash Available for Dividend = Projected retained earnings Capital Expenditure = 1027.2 crores. (Ref: http://www.moneycontrol.com/stocks/stock_market)
The Board of Directors recommended a dividend of Rs. 3.70 per Ordinary share of Re.1/each (Previous year: Rs.3.50 per share). This will entail a total cash outflow of Rs. 1634 crores, comprising proposed dividend of Rs. 1397 crores and income tax on the proposed dividend of Rs. 237 crores

Evaluating this recommendation, - The financing from the Long term Loans required will be: 1634 crores 1027.2 crores = 606.8 crores - Since the current debt equity ratio is Low, (0.01) and the company has been constantly increasing the long term debts - Financing 606.8 crores from long term debt is a viable option (less than the previous years borrowing of 1641.56 crores.) The borrowing should be controlled in the longer run, since, once the company has achieved the ideal debt- equity ratio, and still over shoots it, it will lose the share holders confidence and credit ratings.

3. Compare ITCs dividend policy with its peers.


As 47% of the ITCs income and 52% of the profits are contributed by the tobacco sector of the company, the dividend policy of the company can be compared with those of other tobacco companies such as Godfrey Phillip India Ltd. and VST Industries Ltd. a. Godfrey Phillips India Ltd. It belongs to the BSE B group of companies and has been paying dividends since 10% in 1998. In 2009, it announced a dividend of Rs. 17 per share. According to the data of past few years, the company has not undergone any stock splits or had any bonus share issues. The company has been providing a more or less constant annual dividend (average increase being 2.7%).

Dividend Policy and selected financial statements Year 2005 2006 2007 2008 2009 Dividend % 250 250 250 225 220 Equity Dividend (crores) 22.88 23.40 26.00 26.00 26.00 2009 1,119.84 28.03 61.70 2008 888.04 19.77 21.47 2007 773.36 19.07 7.95 2006 671.76 18.37 2.67 2005 687.33 16.55 6.47

Value (in crores) Operating income Depreciation Capital work-in-progress

b. VST Industries Ltd. It belongs to the BSE B group of companies and has been paying dividends since 10% in 1998. It went for a bonus issue in the ratio of 3:5 in 1991. In 2009, it announced an excellent dividend of Rs.30 per share. The company has not undergone any stock splits. It has adopted a dividend policy where dividends continue to increase per year at an average rate of 28%.

Dividend Policy and selected financial statements Year 2005 2006 2007 2008 2009 Dividend % 300 200 200 125 125 Equity Dividend (Crores) 19.3 19.3 30.88 30.88 46.33 2009 371.06 15.82 5.42 2008 338.90 13.72 2.87 2007 332.83 11.48 2.25 2006 312.45 10.24 0.96 2005 307.91 9.51 0.75

Value (in crores) Operating income Depreciation Capital work-in-progress

Comparison of companies on the basis of following features Value(in 2009) Current ratio PE ratio Dividend payout ratio EPS (in crores) Operating profit per share Godfrey Phillips VST 1.64 18.77 27.92 81.57 150.81 ITC Ltd. 0.68 12.77 87.66 34.01 53.59 1.44 28.24 50.06 8.65 13.04

The PE ratio of ITC is the highest which implies that ITC commands a share price higher than what is prevalent amongst its competitors. Furthermore a 50.06 dividend payout ratio showcases the confidence that the shareholders have in ITC. Thus its apparent that ITC is not overly dependent on the dividend it provides for maintaining its market image. Following a stock split in 2006, ITC had an EPS of 6.02. The EPS then showed an upward trend to 8.65 which implies that ITC has been making good profits during its on-going expansion phase. All 3 companies provide steadily increasing dividends to shareholders.

References 1. As cited in information given at www.itcportal.com 2. As cited at www.money.rediff.com/companies 3. Facts obtained from http://en.wikipedia.org/wiki/ITC_Limited 4. Article on http://www.indiainbusiness.nic.in/business-news 5. As cited at www.godfreyphillips.com 6. As cited at www.vsthyd.com