Dividend policy to make hydropower projects more profitable.

Investors, unlike previous years, are gradually shifting their focus towards the hydropower sector, as it has become more lucrative in terms of dividends compared to banks and financial institutions.

According to experts, the decreasing dividends being given by banks and the financial sector is the main reason why investors are altering their portfolios to other growing sectors like hydropower. So far, hydropower companies have been able to provide handsome returns.

The main challenge for any hydropower company is to construct the project. Once it is constructed, it will provide a steady income, and the project becomes a “cash cow.”

However, share prices in Nepal largely depend upon the dividends provided to shareholders. This is a unique phenomenon that exists in Nepal. Companies that provide regular dividends tend to have higher share prices.

But in reality, companies that do not pay dividends are not necessarily without profits. If a company believes that its own growth opportunities are better, it should retain the profits and reinvest them into the business. In my opinion, this should be the case for hydropower companies in Nepal.

What are hydropower companies in Nepal doing?

There is no compulsory provisioning policy for hydropower companies as of now. They can distribute all their profits to shareholders if they choose to. This is the path most hydropower companies are following.

The general trend in Nepal, at the moment, is to distribute all the profits to shareholders without maintaining any kind of reserves. When it comes to developing new projects, they simply issue right shares. This certainly pleases shareholders in the short term but may have a negative impact in the long run.

What will be the impact?

Some experts claim that the equity invested in hydropower projects will have zero value after 30 years if hydropower companies do not seriously reconsider their dividend policy. Technically speaking, the project has to be handed over to the government after 30 years, since hydropower projects in Nepal are constructed under the BOOT (Build, Own, Operate, Transfer) model. If the developers do not develop another project within this 30-year period and continue distributing cash dividends just to please investors, then the initial investment may turn to zero. This is a valid argument. But in reality, this is not practical.

Almost all hydropower companies in Nepal hold multiple hydropower licenses because hydropower project is a product which has a definite life, whereas the company that holds the license has a perpetual life. 

Without any doubt, no hydropower company in Nepal intends to develop only one project during its entire lifetime. The only concern here is: how will they construct new projects? Will they finance new projects by issuing right share or from their reserves by tightening the dividend policy?

Analysis

I did an analysis by creating a financial model of a 5 MW project to understand the optimum dividend policy for hydropower companies. In this model, I included all the practical parameters applicable to Nepalese hydropower. This is what I found:

By the end of the fifth year from the Commercial Operation Date (COD), the project will have sufficient equity to develop another 5 MW project, assuming the company does not pay any dividends. In other words, a hydropower project will have enough money to construct another project of the same size every five years.

An increasing number of shares means declining EPS. The following table shows the EPS, share price, and P/E ratio of hydropower companies in Nepal:

Hydro Companies	Last audited EPS	Expected EPS	Share Price	P/E
Butwal Power	24		859	35.8
Chilime	55.23		2,736	49.5
Arun Valley	18		531	29.5
Ridi		22.67	703	31.0

The table indicates that share prices have a direct relationship with EPS. Maintaining reserves by tightening the dividend policy and investing in future projects will certainly raise the EPS in the long term, which will ultimately increase the share price.

Conclusion

Paying dividends — especially large cash dividends — can be costly in the long term. When it comes to developing new projects, hydropower companies should first try to construct the project from their own reserves.

Developing projects by issuing right shares is not a healthy way of maximizing shareholder wealth. By nature, returns in hydropower are fixed, and adding unnecessary equity burdens is not the right approach.

I understand that a company’s dividend policy depends on many factors, but my analysis provides another perspective on how hydropower companies in Nepal can be more profitable.