How high dividend yield can be a trap

Dividend yields north of 6 per cent for state-owned power financiers Rural Electrification Corp. (REC) and Power Finance Corp (PFC) drew investors over the past one year. But after the recent bout of broader market corrections, the two stocks are not finding enough takers — even at 10 per cent dividend yields and price-to-book multiples of 0.6.More than 80 per cent of their outstanding loans were given to publicsector companies, and investors did not factor in defaults on such advances. But the Street is now concerned that most of the remaining loans given to the private sector may turn into non-performing assets (NPA). It is 15 per cent in case of REC and 18 per cent in case of PFC. This 15 per cent seems small, but it is almost equal to the net worth of these companies.65990237 For REC, outstanding loans to the private sector amount to Rs 33,000 crore and its net worth is Rs 35,000 crore. In case of PFC, net worth is Rs 37,500 crore and outstanding loans to the private sector Rs 51,700 crore. Out of this, the management has already declared loans worth Rs 25,500 crore as stressed, and Rs 5,300 crore worth of loans as revival envisaged. Together, these account for 83 per cent of the total net worth of PFC.The Street is also concerned about weak loan demand from public sector power companies. High growth from this segment that accounts for four-fifths of the loan books can offset private-sector NPAs over a period. But finances of the state discoms continue to worsen. Various reports suggest that UDAY (Ujwal Discom Assurance Yojana) Scheme launched in 2015 has not been able to turn around the discoms. In such a situation, revival for loan demand appears unlikely in the near term.Furthermore, a government proposal to sell its 65 per cent stake in REC to PFC can also put the high dividend payouts at risk. Both companies have been consistently paying high dividends for the past five years. But the same cannot be said for the coming years. Another state-backed power financier, PTC Financial Services, paid Rs 1.5 a share as dividend in FY2017: The payout fell to 20 paise a share in 2018.

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