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 dividend being given by banks and financial sector is the main reason why investors are altering their portfolio to other growing sectors like hydropower. So far hydropower companies are able to provide handsome returns.

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

However, the share prices in Nepal largely depends upon the dividend it provides to its 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 thinks that its own growth opportunities are better, it should keep the profits and reinvest them into the business. In my opinion, this should be the case for hydropower companies in Nepal.

What hydropower companies in Nepal are doing?

There is no compulsory provisioning policy for hydropower companies. They can distribute all the profits to shareholders if they want to. And this is the path 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. And when it comes to developing new projects, they simply issue right shares at par value. This will certainly please the 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 be zero value after 30 years, if hydropower companies do not think seriously about their dividend policy. Technically speaking, the project has to be handed over to government after 30 years since hydropower projects in Nepal are constructed under BOOT basis. If the developers do not develop another project during this 30 years time and keep on distributing cash dividend just to please the 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 do hold multiple hydropower licenses. Without any shadow of doubt, no hydropower companies in Nepal have intention to develop only one project during entire life time. The only concern here is, how will they construct new projects? Are they going to finance new projects by issuing right shares at par value or from their reserves by tightening the dividend policy?

Analysis

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

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

Increasing number of shares means declining EPS. The following tables show 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 above table indicates that the 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 long term which will ultimately increase the share price. 

Conclusion

Paying dividend, especially huge cash dividend, can be costly in the long term. When it comes to developing new projects, the hydropower companies first of all should try to construct the project from its own reserve. 

Developing project by issuing right shares is not a healthy way of maximizing the wealth. By nature, return in hydropower companies is fixed and adding unnecessary equity burden is not the right way. 

I understand dividend policy of the company depends on many things but my analysis is another dimension to show how hydropower companies can be more profitable.