[fm]: 5 Stocks at Risk of Dividend Cuts in 2016

Energy companies are especially vulnerable, but four of our picks come from outside of that troubled sector. 

 

When investors think of dividends, they often think “safety.” Checks that arrive like clockwork come to mind. But a recent round of dividend cuts has given some income-seekers a rude awakening. Among the rudest: Kinder Morgan (symbol KMI), the energy pipeline giant, slashed its dividend 75% in early December, cutting the quarterly payout from 51 cents a share to 12.5 cents. A day later, Freeport McMoRan (FCX), a copper and gold producer with an ill-timed expansion into oil and gas production in 2013, suspended its dividend. 

 

Dividend cuts are still rare. Through mid December, 337 companies in Standard & Poor’s 500-stock index increased their payouts this year. But the average increase is running at 13%, below the 18% average increase in 2014 and 20% in 2013. And 15 companies in the S&P decreased their dividends, while three, including the aforementioned Freeport, suspended them altogether, up from just eight cuts and no suspensions in 2014. Companies in the struggling energy sector cut dividends by $6.2 billion. For context, consider that from 2010 through 2014, cuts in the energy sector totaled $1.3 billion.

 

How to spot a risky dividend

Ironically, an indication that a cut is imminent is a spiking yield, which is a stock’s annual dividend rate divided by its share price. What’s “high” in terms of yield depends on the industry; 4% for a utility stock is fine, but it invites skepticism in a faster-growing tech company or a more-economy-sensitive industrial company, for instance. But if a stock that usually yields 4% all of a sudden yields 6%, and the cause of that burgeoning yield is a falling share price, it could be an indication that Wall Street doesn’t believe that the dividend is sustainable and that a reduction is in the offing.

It’s best to be on the lookout for warning signs of a dividend cut early on, because by the time it’s finally announced, much of the damage to a stock has already been done. Keep a close eye on a stock’s payout ratio, or the amount of a company’s earnings paid out in dividends. The average payout ratio for S&P 500 stocks is currently 37%. Again, what constitutes a high ratio depends on the business. Tobacco stocks can pay out the majority of their earnings in dividends because a long-term decline in demand for their product means they’re not spending a lot on factories and equipment, yet the business remains profitable and generates tons of cash.

But in general, anything above 70% to 75% should raise eyebrows—or at least initiate some research. Get to know the company’s cash flow situation. While earnings can be subject to various adjustments, a positive free cash flow means a company has invested what it needs to maintain its business and has money left over to spend on dividends.

Look at how much debt the company is carrying and whether it needs to tap capital markets to meet its commitments. Companies forced to choose between protecting their credit rating and protecting their dividend will cut the payout every time. “That’s what forced the situation for Kinder,” says Josh Peters, a stock strategist and editor of Morningstar Dividend Investor.

Stocks whose dividends might be in jeopardy

Whose dividend is next on the chopping block? Reality Shares Advisors, a sponsor of exchange-traded funds, ranks dividend-paying stocks based on historic dividend trends, cash flow, earnings, buybacks and other data, with an eye toward determining the prospects for dividend hikes or cuts. Stocks with the company’s lowest rating have about a 40% chance of cutting their dividends within the next 12 months.

Whether a dividend cut is a reason to sell depends on why you own the stock in the first place. What a bargain-hunter sees as a smart fiscal move to deal with a temporary setback could be a deal-killer for an income investor. But we think the five stocks below, many of which land in Reality Shares’ bottom two dividend buckets, merit watching. Share prices and yields are as of December 28.

Mattel (MAT; price, $27.47; yield, 5.5%)

Mattel’s payout ratio for the 12 months that ended September 30 was a whopping 171%. Analysts’ estimates for both dividends and earnings imply a 145% payout ratio for the 2015 calendar year and 114% for 2016. Meanwhile, cash on Mattel’s balance sheet has steadily declined from $1.3 billion at the end of 2012 to $290 million at the end of the third quarter of 2015. The company’s toy lineup is in desperate need of a hit. “Depending on how Mattel did this holiday season, 2016 may see the introduction of ‘Dividend Cutter Barbie,’” quip the analysts at Reality Shares.

By: Anne Kates Smith. 



Review: Emerging Market Formulations & Research Unit, Flagship Records.
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