An Appraisal of Dividend policy

Of
Meghna Cement Mills Limited (MEGHNACEM)

Course Title: Corporate Finance Course Code: FIN 507 Sec: 01 Session: Fall 2011

PREPARED BY: Md. Mesbah Uddin

Page 1 of 21

Executive Summery

Meghna Cement Mills Ltd is the first manufacturing unit of Bashundhara Group and it is one of the largest cement industries in the country producing nearly 1 million metric tons a year. The Meghna Cement Mills Ltd is an International Standard Organization (ISO 9001: 2008) certified company having accreditation of manufacturing products for both domestic and international markets. The company is listed with both Dhaka and Chittagong Stock Exchanges, the two bourses of the country since 1995 and 1996 respectively. The company markets its product under the registered trade mark "King Brand Cement". It was incorporated on March 1992 as Private Limited Company under the companies Act, 1913 and subsequently on January 1996 Meghna Cement Mills Ltd started their commercial production. The company enlisted with Dhaka Stock Exchange (DSE) in 1995 and Chittagong Stock Exchange (CSE) in 1996 under the trading code MEGHNACEM. The face value of each stock was Tk.100 during enlistment and in 19th September 2010 the company executed the stock split option and following the change of the denomination of shares and market lot, the new face value of the shares of the company became Tk. 10.00 instead of Tk. 100.00 per share, market lot became 100 shares instead of 50 shares and the new adjusted open price of shares was Tk. 280.90 per share. The company has 22500400 outstanding shares of Tk.10 face value in the capital market; it has paid-up capital of Tk. 225 mn and authorized capital Tk. 5000 mn.
Meghna Cement mills Ltd. is a A category share, (i.e. it gives minimum 10% dividend each year), it is also a blue chip script and listed in DSE 20 Share for its national reputation for quality, reliability and the ability to operate profitably in good times and bad times. From the past 10 years dividend payment data it is found that the company follows Regular Dividend Policy since the enlistment in the Stock Market. The board of directors of MEGHNACEM fixes the dividend percentage after reviewing the net income and retained earnings situation of the company. Thus, in the line of operational performance of the company during the year 2010, the board of directors is pleased to recommend for payment of 25% cash dividend on par value of the shares for the year 2010. Their earning per share (EPS) was Tk. 2.23 and price per share was Tk. 400 in December 2010.

Page 2 of 21

CHAPTER-02

DIVIDEND POLICY

Page 3 of 21

2.1 MEGHNA CEMENT MILLS LIMITED (MEGHNACEM)

About MEGHNACEM

The Meghna Cement Mills Limited (MEGHNACEM) was the first undertaking Bashundhara Group in the manufacturing sector. This enterprise produces world-class cement and, as a testimony to this, stands the fact that the concern has been awarded the ISO-9001 certification for sustained quality control effort. The Company markets its cement under the registered trademark of King brand". King Brand Cement is the harvest of industry of its skilled laborers Meghna Cement Mills Ltd uses latest technology. It is BSTI approved. It ensures that these entire things have made Meghna cement to be international standard. It is necessary to beautify the internal environment of Meghna Cement Mills ltd. Authorities of MEGHNACEM import their machineries, which is using for production of cement from China, Germany and Japan. Now the capacity of production of cement in this mill is average 80,000 to 100,000 bags per day (every bag contains 50kg of cement).

MEGHNACEM at a Glance

Trading Code: MEGHNACEM Listing Year: DSE 1995 & CSE 1996 Business Lines Authorized Capital in BDT (mn) Outstanding Capital in BDT (mn) Face Value Market lot Total no. Of Securities Share Sponsor/Director Govt. 52.3 0 Percentage

Market Category: A Cement Manufacturing 5000.0 225.0 10.0 100 22500400 Institute Foreign Public 13.61 0 34.09

Page 4 of 21

2.2 DIVIDEND POLICY

Dividends are cash payments made to stockholders. Decisions about when and how much of earnings should be paid, as dividends are part of the firms dividend policy. Earnings that are paid out as dividends cannot be used by the firm to invest in projects with positive net present valuesthat is, to increase the value of the firm. The dividend policy that maximizes the value of the firm is said to be the optimal dividend policy. i. Dividend Policy and Stock Value - Researchers argue whether there exists an optimal dividend policy. Some academicians argue that a firms dividend policy does not affect the value of a firm (dividend irrelevance theory), while other argues that the dividend policy is an important factor in the determination of a firms value (dividend relevance theory). Investors and Dividend Policy - Investors reactions to changes in dividend policies can be summarized as follows:

ii.

a. Informational content or signaling - There is a belief that managers change dividends (increase or decrease) only when it is necessarythat is, decreases occur only when the firm is facing financial difficulty, while increases occur only when it is expected that the firm can continue to pay higher dividends long into the future. If this is true, then changes in a firms dividend policy provide information to investors, who will react accordingly. For example, investors would consider an increase (decrease) in dividends to be good (bad) news, and thus increase (decrease) the price of the firms stock. b. Clientele effect - Investors might choose a particular stock due to the firms dividend policythat is, some investors prefer dividends and others do not. If such a clientele effect does exist, then we would expect that a firms stock price will change when its dividend policy is changed.

c. Free cash flow hypothesis - If investors truly want managers to maximize the value of the firm, then dividends should be paid only when the firm has no investments with positive net present values. In other words, a firm should pay

Page 5 of 21

dividends only when it has funds that are not needed to invest in positive NPV projectsthat is, only free cash flows should be paid as dividends. If this theory is correct, then we might expect a firms stock price to increase when it decreases dividends to invest in positive NPV projects, and we might expect the stock price to decrease when the firm increases dividends because it no longer has as many positive NPV projects as it did in prior years.

2.3 THEORIES OF DIVIDEND POLICY

2.3.1 The residual theory of dividends A theory that dividend paid by a firm should be the amount left over after all acceptable investment opportunities have been undertaken. This approach includes three steps: Step 1: Determine its optimal level of capital expenditures. Step 2: Using the optimal capital structure proportions, estimate the total amount of equity financing needed to support the expenditures generated in Step 1. Step 3: Because the cost of retained earnings, kr, is less than the cost of new common stock, kn, use of retained earnings to meet the equity requirement determined in Step 2. If retained earnings are inadequate, sell new common stock. If it is in excess of this need, distribute the surplus amount the residual as dividends.

2.3.2 Dividend irrelevance theory According to dividend irrelevance theory which is put forth by Merton H. Miller & Franco Modigliani (M&M) that in a perfect world, the firms value is determined solely by the earnings power and risk of its assets and that the manner in which it splits its earnings stream between dividends and internally retained (and reinvested) funds does not affect this value.

Page 6 of 21

2.3.3 M and Ms theory M and Ms theory shows that in a perfect world, certainty, no taxes, no transaction cost and no other market imperfection. In a perfect world the value of the firm is unaffected by the distribution of dividend. Firms value is determined solely by the earnings power & risks of the assets (investment). In response to studies showing that large dividend changes affect share price. 2.3.4 Bird in- the Hand Theory The belief, in support of dividend relevance theory, that investors see current dividends as less risky than future dividends or capital gains. Stockholders Prefer current dividend. Fundamental to this proposition is their Bird-in -the Hand argument which suggests that investors are risk averse & attach less risk to current as opposite to future dividends or capital gains. A bird in the hand is worth two in the bush. Cash Dividend reduce uncertainty causing earning at a lower rate. Dividend increase, risk decreased, Ks decrease& value of the firms stock increase. Dividend decrease, risk Increased, Ks increase &value of the firms stock decrease.

2.4

FACTORS AFFECTING DIVIDEND POLICY

The firms dividend policy represents a plan of action to be followed whenever the dividend decision is made. Firms develop policies consistent with their goals.
a. Legal Constraints: Earnings limiting the amount of dividends to the sum of the

firms present & past earnings is some times imposed. Dividend may not be greater than most recent and past earnings. Dividend may be greater than most recent earnings. b. Contractual Constraints: Often the firms ability to pay cash dividends is constrained by certain restrictive provisions in a loan agreement. Constraints prohibit the payment of cash dividends until a certain level of earnings has been achieved.

Page 7 of 21

Constraints of dividend protect creditors from losses due to insolvency on the part of the firm.

c. Internal Constraints: The firm's ability to pay cash dividends is generally constrained by the amount of excess cash available rather than level of retained earnings which to charge them. d. Growth Prospects: The firms financial requirements are directly related to the degree of assets expansion that is anticipated. It must evaluate its profitability and risk to develop insight into its ability to raise capital externally. At Growth stage, firm needs more funds and its dividend is minimum. Little or no growth firm may nevertheless periodically need fund to replace or renew assets and dividends are more. New firm has limited sources of fund. Large mature firm needs multiple financing alternatives available. e. Owners Consideration: In establishing a dividend policy, the firms primary concern should be to maximize owner wealth. It is impossible to maximize each owner wealth. The firm must establish a policy that has a favorable effect on the wealth of the majority of owners. There are three considerations: i. Tax status of a firms owners: If the firm has a large percentage of wealthy stockholders who are in high tax bracket, it may decide to pay out a lower percentage of its earning to allow the owner to delay the payment of taxes until they sell the stock. ii. Owners investment opportunities: A firm should not retain funds for investment in projects yielding lower returns than the owners could obtain from external investments of equal risk. iii. Potential dilution of ownership: If a firm pays out a high percentage of earnings, new equity capital will have to rise with common stock. f. Market Consideration: Wealth of the firms owner reflected by the market price of the share. According to dividend relevance theory, Market price of the share is directly influenced by the dividend policy of the firm. Stockholders prefer continuous dividend.

Page 8 of 21

2.5

TYPES OF DIVIDEND POLICIES

There are different types of dividend policies in practice, among these three of the more commonly used dividend policies are described below: a. Constant Payout Ratio dividend policy It indicates that a dividend policy based on the payment of a certain percentage of earnings to owners in each dividend period. The problem with this policy is that if the firms earnings drop or if a loss occurs in a given period, the dividends may be low or even nonexistent.

Dividend payout ratio =

b. Regular Dividend Policy A dividend policy, which based on the payment of fixed dividend in each period. It provides the owners with positive information thereby minimizing their uncertainty.

c. Low regular and Extra Dividend Policy It is a dividend policy based on paying a low regular dividend, supplemented by an additional dividend when earnings are higher than normal in a given period. Advantages of low regular and extra dividend policy: Stable income Confidence

2.6

DIVIDEND REINVESTMENT PLANS

Plans that permit stockholders to have dividend payments automatically reinvested in the firms stock. Dividend reinvestment plans, which are referred to as DRIPs, allow

Page 9 of 21

stockholders to buy additional shares of a firms stock on a pro rata basis using the cash dividend paid by the firm. Often there are little or no brokerage fees involved with DRIPs.

2.7

PAYMENT PROCEDURES

Dividends are usually paid quarterly. The following dates are important when establishing a dividend policy: Declaration date - The date the board of directors states that a dividend will be paid to stockholders. A dividend is not a liability to the firm until it is declared. Holder-of-record date - The date the firm opens its ownership books to determine who will receive dividends. Persons whose names appear in the ownership books after the holder-of-record date, which is also termed, the date of record, but prior to the date the dividend is paid will not receive a dividend payment. Ex-dividend date - Two working days before the holder-of-record date. Ex dividend means without dividend; so, on the ex-dividend date, the stock begins to sell without the right to receive the next dividend payment. In essence, the stock sells without the right to receive the dividend payment because there is not enough time for the names of new stockholders to be registered before the holder-of-record date. Payment date - The date the firm mails the dividend checks.

2.8 STOCK SPLITS AND STOCK DIVIDENDS

Stock splits - An action taken by a firm to change the number of outstanding shares of stock. Many firms believe their stock has an optimal price range within which their stock should trade. If the price of the stock exceeds the price range, then the firm will execute a stock split. If a firm initiates a 2-for-1 stock split, each existing stockholder will receive two shares of stock for each one share he or she now owns. This action should cut the market price of the stock exactly in half. But, there is evidence that shows the price of the stock actually settles above one half the pre-split price.

Page 10 of 21

 Stock dividends - Dividends paid in the form of stock rather than cash. Like stock splits, a stock dividend does not have specific economic value; rather, it increases the total number of shares of stock each stockholder owns. At the same time, the stock price per share decreases because investors have not provided any funds for the additional shares of stock. A firm might use a stock dividend to keep the price of its stock within a particular range.

2.9 DIVIDEND POLICIES AROUND THE WORLD

There is great variation in dividend policies of firms in different parts of the world. In most parts of the world, dividend policies are based on local tax laws. For example, in countries where the tax on capital gains is less than the tax on dividends, firms tend to retain greater amounts of earnings than in countries where the tax companies tend to pay greater amounts of earnings as dividends. Also, in some countries that have few regulations to protect small stockholders.

Page 11 of 21

2.10 AN APPRAISAL OF MEGHNA CEMENT MILLS LTD [MEGHNACEM] DIVIDEND POLICY

To analyze dividend policy it is important to analysis some of the factors those are directly and indirectly influence on the dividend payment of a corporation. To analyze the dividend policy it is important to analyze Net profit after tax, Earning per share, Market price of the share, Dividend payout ration, dividend yields, retained earnings, reinvestment possibilities etc. Bangladesh, being a third world country, does not possess an advanced economy. Here, most of the investors belong to the lower income group who has a greater need for current dividend as thus prefer disbursement of higher cash dividend. In addition: Investors have lack of knowledge of investment & earning potential Many are pension holders or live significantly on the earnings The investors are risk averse The economic condition of the country is not well, going through a recession yielding a higher need for cash dividend Many of them are short-term investors, etc. Therefore, the investors prefer and demand those stocks that yield a higher amount of dividend, resulting in a higher market value for those stocks. To support this amplified need for cash and to maximize the market price as well as market capitalization of the company, most of the firms in Bangladesh follow a policy of dividend which is in favor of a higher dividend. Our analysis of the stock exchange (DSE, CSE) also suggests that the companies that pay higher dividend have relative higher market prices of their shares.

Page 12 of 21

2.11 STOCK SPLIT OF MEGHNACEM

The face value of each stock was Tk.100 during the enlistment and in 19 th September 2010 the company executed the stock split option and following the change of the denomination of shares and market lot, the new face value of the shares of the company became Tk. 10.00 instead of Tk. 100.00 per share, market lot became 100 shares instead of 50 shares and the new adjusted open price of shares was Tk. 280.90 per share. The company has 22500400 outstanding shares of Tk.10 face value in the capital market; it has paid-up capital of Tk. 225 mn and authorized capital Tk. 5000 mn. For our analysis we will consider the face value of Tk.10 and present all data accordingly throughout the report.

2.12 ANALYSIS OF NET PROFIT AFTER TAX OF MEGHNACEM

From the data of Dhaka Stock Exchange and MEGHNACEM itself, the following table has been developed for the Net profit After Tax for Meghna Cement Mills Ltd. Table: Net Profit After Tax
Year Net Profit Tk. (mn) 2001 189.63 2002 86.57 2003 26.02 2004 34.31 2005 75.11 2006 105.10 2007 148.18 2008 23.13 2009 131.99 2010 50.15

To analyze the movement of the net profit, a line chart has been developed. Following line chart is showing the trend of net profit for Meghna Cement Mills Ltd.

Page 13 of 21

From the analysis above we can see that the net profit is suddenly increasing and decreasing as year goes by.

2.13 ANALYSIS OF EARNING PER SHARE (EPS)

From the data of Dhaka Stock Exchange and Meghna Cement Mills Ltd. itself, the following table has been developed for showing the Earning per share (EPS).
Table: Earning Per Share of MCML
Year Earning Per Share (Taka) 2001 8.428 2002 3.847 2003 1.157 2004 1.525 2005 3.338 2006 4.671 2007 6.586 2008 1.028 2009 5.87 2010 2.23

We know that,

From the table above we can see that, the EPS of MEGHNACEM was maximum in 2001 and after that it starts to decline. Again after 2004 it starts to increase again. After getting lots of experience it is possibly that from 2004 MEGHNACEM invested in the new opportunities, as a result EPS increases.

2.14 ANALYSIS OF MARKET PRICE OF THE SHARE

Following table is showing the historical data for share market price of Meghan Cement Mills Ltd. The Data are collected from MEGHNACEM operational and financial data of 20032011 of Meghna Cement Mills Ltd and DSE website. This table can be converted to a line chart to see the growth of the Meghna Cement Mills share price. For homogeneity of data we are considering Tk.10 face value of the share.
Table: Year wise Market Price of MEGHNACEM stock
Year Market price per share (Taka) 2003 27.9 2004 34.775 2005 24.60 2006 27.675 2007 35.225 2008 38.60 2009 128.325 2010 400 2011 135.1

Page 14 of 21

From the table above we can see that the market price of the share is increasing as year pass by. Initially the price was Tk. 27.9 per share (FV of Tk.10). This price later increased to Tk.400 dramatically in 2010. From the line chart we can see the price was very low and the increased the price. Between 2005 and 2006 there may be external pressure like political uncertainty and government interventions. But for their effective operation during 2009 and 2010 the price increased to Tk.400 in December 2010. Todays (November 23, 2011) closing market price of MEGHNACEM is Tk. 135.1.

The dividend policy that followed by the company has an impact on its share price. As the graph shows the share price has an increasing trend. As the company declared 25% dividend per share from 2001-2006 this was more than its EPS so the share price increased and reached to tk. 28. In 2007 and 2009 the dividend 30% and 35% and the price of the stock was higher. It can be observed from the price trend that investors expectation and prediction for the value of the corporation is increasing day by day. So the value of the MEGHNACEM is maximizing. After December 2010 we observed a fall in Bangladesh stock market, hence the current market price does not give the proper valuation of the stock.

2.15 ANALYSIS OF PRICE EARNING RATIO

Price/earning ratio is the most common measure of how expensive a stock is. The P/E ratio is equal to a stock's market capitalization divided by its after-tax earnings over a 12-month period.

Page 15 of 21

A table of year wise price earning ratio of MEGHNACEM is developed from the data of DSE.
Table: Year wise Price Earning Ratio
Year P/E Ratio 2001 3.68 2002 7.26 2003 24.21 2004 20.61 2005 7.64 2006 5.92 2007 5.35 2008 37.55 2009 22.23 2010 155.16

From the chart we can see that the price-earning ratio is fluctuating highly. That means P/E ration is very volatile to determine dividend policy. Besides, the abnormal growth in the P/E ratio indicates the impracticality of unusual price hike before the market crash.

2.16 ANALYSIS OF DIVIDEND VS. DIVIDEND PAY OUT RATIO

Table: Year wise Dividend & Dividend pay out ratio

Year Dividend payout ratio(%) Dividend rate (%) 2001 29.66 25 2002 64.99 25 2003 216.08 25 2004 163.93 25 2005 74.90 25 2006 53.52 25 2007 45.55 30 2008 145.91 15 2009 59.63 35 2010 112.12 25

We know that,

Page 16 of 21

From the line chart above we can see that dividend payout ratio is fluctuating. On the other hand Dividend rate is constant (25%) up to year 2006 and then there is fluctuation in year 2007-2009 and again in the year 2010 the dividend is 25%. Higher dividend payout ratio (more than 100%) indicates higher dividend payment than EPS, i.e. some of the retain earnings were also distributed during those years. On the other hand, dividend payout ratio less than 100% indicates some portion of EPS were kept as retain earning to meet financing requirement.

2.17 Dividend Policy Followed By Meghna Cement Ltd

Table: Financial Data of MCML from 2001-2010
Year EPS (Tk.) P/E ratio Share Price (MKT.) Dividend Payout Ratio (%) 29.66 64.99 216.08 163.93 74.90 53.52 45.55 145.91 59.63 112.12 966.29 96.63 Dividend Cash (%) 25 25 25 25 25 25 30 15 35 25 255 25.5 Bonus Share 0 0 0 0 0 0 0 0 0 0 0 0 Total 25 25 25 25 25 25 30 15 35 25 255 25.5

2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Total Average

8.428 3.847 1.157 1.525 3.338 4.671 6.586 1.028 5.866 2.23 38.676 3.87

3.68 7.26 24.21 20.61 7.64 5.92 5.35 37.55 22.23 155.16 289.61 28.96

31.02 27.93 27.9 34.775 24.6 27.675 35.225 38.6 128.325 400 776.05 77.61

2.18 DISCUSSION

According to the above information it is visible that the company is following regular dividend policy (according to definition as given above). From 2001-2006 the dividend rate is 25%, a constant rate and in year 2007 to 2009 the rate were 30%, 15% and 35% respectively. In year 2010 the dividend was again 25%. So we can say the corporation gives regular dividend. The average EPS of MEGHNACEM for last 10 years is Tk.3.87 and average dividend per share is Tk. 2.55. From this data we can say the firm follows regular dividend policy and its decision is based on dividend irrelevance theory as the firm retains

Page 17 of 21

Tk.1.32 (Tk.3.87- Tk.2.55) per share every year for internal financing and expansion of the company to increase future earning power.

Table: EPS and Dividend per share (Tk.) of MEGHNACEM

Year
EPS (BDT) Dividend per Share (Tk.)

2001
8.428 2.5

2002
3.847 2.5

2003
1.157 2.5

2004
1.525 2.5

2005
3.338 2.5

2006
4.671 2.5

2007
6.586 3.0

2008
1.028 1.5

2009
5.866 3.5

2010
2.23 2.5

The dividend policy that followed by the company has an impact on its share price. As the graph shows the share price has an increasing trend. As the company declared 25% dividend per share from 2003-2004 this was more than its EPS so the share price increased and reached to 347.75tk. But in 2005- 2006 the dividend was lower than its EPS so the share price declined and again increased in 2007 with an increase in dividend after that in 2008 dividend was higher than its EPS so the share price increased and again increased in 2009 with an increase in dividend.

Page 18 of 21

CONCLUSION & REFERENCES

CHAPTER 03

Page 19 of 21

3.1 CONCLUSION
Meghna Cement mills Ltd. [MEGHNACEM] vision is to significantly contribute to the sustainable development and growth of our country towards its journey for a better and prosperous future and its mission is to be the leader in the cement sector of the country by rendering quality products and services through maintaining high standards in business operations and to bring fullest satisfaction to their value shareholders, customers and employees. In the line of operational performance of the company during the year under review, the board of directors is pleased to recommend for payment of 25% cash dividend on par value of the shares for the year 2010. Meghna Cement mills Ltd. is a A category share, (i.e. it gives minimum 10% dividend each year), it is also a blue chip script and listed in DSE 20 Share for its national reputation for quality, reliability and the ability to operate profitably in good times and bad times. From the past 10 years dividend payment data it is found that the company follows Regular Dividend Policy since the enlistment in the Stock Market. The board of directors of MEGHNACEM fixes the dividend percentage after reviewing the net income and retained earnings situation of the company. Thus, in the line of operational performance of the company during the year 2010, the board of directors is pleased to recommend for payment of 25% cash dividend on par value of the shares for the year 2010. Their earning per share (EPS) was Tk. 2.23 and price per share was Tk. 400 in December 2010. The face value of each stock was Tk.100 during enlistment and in 19 th September 2010 the company executed the stock split option and following the change of the denomination of shares and market lot, the new face value of the shares of the company became Tk. 10.00 instead of Tk. 100.00 per share, market lot became 100 shares instead of 50 shares and the new adjusted open price of shares was Tk. 280.90 per share. The company has 22500400 outstanding shares of Tk.10 face value in the capital market; it has paid-up capital of Tk. 225 mn and authorized capital Tk. 5000 mn.

Page 20 of 21

3.2 REFERENCES
1. Principles of Managerial Finance (10th Edition), Lowrence J. Gitman 2. Scott Besely & Eugene F. Brigham, Essentials of Managerial Finance, Thirteenth Edition, Thomson South-Western, Ohio, 2006 3. www.dsebd.org 4. Annual Reports and Accounts of Meghna Cement Mills Ltd. 5. Monthly Review of Dhaka Stock Exchange Ltd. 6. http://www.bashundharagroup.com/mcml/main.html

Page 21 of 21