The Next Dividend Blowup?

By Chad Henage - August 9, 2012 | Tickers: DDR, GRT, NNN, SPG | 0 Comments

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Usually when investors hear that a company is a dividend aristocrat they assume that the stock would be a good long-term hold. In theory, a company doesn't increase its dividend for 25 straight years in a row without some type of stability in its operations. However, I've now looked at several new dividend aristocrats that were added this year and they don't exhibit the same type of stability that more well-known names do. The latest example is a company named, National Retail Properties (NYSE: NNN). 

This company is a REIT that acquires, manages, and develops retail properties. As you might imagine, in the last several years this has been a difficult business. Analysts seem to believe that this difficulty will continue. Consider that of the four different companies I looked at, none have a growth rate of better than 6.6%, and you can see that investors would not buy the shares strictly for growth in earnings. Like most REITs, investors primarily are looking for dividend yield as their reason for acquiring the shares. Before we get to National Retail Properties, let's look at how this company compares to a few other REITs in its industry:

As you can see, none of these companies has the huge yields of REITs that operate in the mortgage industry. Instead, these are companies managing malls, shopping centers, and outlets over the long haul. What's interesting is that there seems to be a direct correlation between a company's growth and lower dividend yield. For instance, both DDR and Simon Property Group have similar growth rates and yet both pay lower dividends. On the opposite end of the spectrum is National Retail, which has the lowest growth rate yet pays the highest yield. There are also significant differences in each company's ability to pay dividends. In DDR's case, the company has a 53.10% free cash flow payout ratio, and in three of the last four quarters has paid down its debt. By contrast, Glimcher Realty has been cash flow negative in two of the last three years, and has issued between $100 million and $256 million in new shares annually to cover this shortfall. Simon Property falls somewhere in the middle, as its average free cash flow payout ratio of the last three years is around 55%, but this number has risen to over 81% as of last year. Unfortunately for investors in National Retail, the company has taken its cue from Glimcher Realty by issuing new shares and even debt to afford their dividend.

Over the last four years, National Retail has issued new shares every year to deal with the company's inability to generate enough cash to cover their dividend payments. For instance, in 2008 the company was free cash flow negative by over $55 million. To cover the over $116 million in dividends, they issued $128 million worth of new shares. In 2011, the company had negative cash flow of over $500 million and issued over $500 million in stock as well as almost $200 million in new debt. While it's true that a REIT may issue debt or shares to assist the company in acquiring new properties, a consistent pattern of negative free cash flow could at some point place the dividend in jeopardy.

You can see this issue beginning to play out by looking at the company's dividend increases over the last few years.

Prior to the year 2009, the company's average dividend increase exceeded 5%. Since then, the largest increase was actually declared in 2012, with an increase of 2.6%. Given the company's issues with covering its cash flow needs, it's not surprising that the rate of dividend increase has been cut almost in half in the last few years. The question for investors is, what happens next?

There are two possibilities for the company going forward. First, the company curtails its spending and gets its cash flow issues under control. If this occurs, dividend increases stay in the low single digits, but the yield is at least protected. The second possibility is that the company's cash flow issues continue and the dividend has to be altered for the company to continue operating. While National Retail Properties' dividend yield looks attractive at over 5.3%, the company's cash flow issues are too consistent to ignore. With analysts calling for just 3.3% growth in earnings over the next few years, there doesn't appear to be a transformative event that allows the company to suddenly become free cash flow positive on a consistent basis. Until the company can prove that it doesn't have to issue shares to meet its cash needs, I would avoid the stock.

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