Another Dividend Is Toasted

Reuben is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Cliffs Natural Resources (NYSE: CLF), which mines for iron ore and coal, has been a recent dividend darling. No more -- the company trimmed its distribution by 76% starting in the first quarter of fiscal 2013. And Cliffs isn't the only company that's cut its dividend lately. Here's what investors can learn from some recent dividend cuts.

Cliffs has two divisions, a global commercial group that sells and delivers raw materials and a global operations group that mines them. The company operates iron ore and coal mines in North America and has two iron ore mining complexes in Western Australia. It also owns a 45% economic interest in a coking and thermal coal mine in Queensland, Australia, and is working on a chromite project in Ontario, Canada. It is a notable player in the iron ore space.

The company's dividend hasn't been a model of regularity. In fact, the dividend has been cut before. That should have been one warning sign for investors attracted to the company's high yield. The interesting thing, however, is that Cliffs more than doubled the quarterly dividend in early 2012. That sent a message of strength, but turned into a dividend trap.

The Cut
Here's how the company announced that it would take an axe to its payout: “In light of recent commodity-price volatility, Cliffs is committed to maintaining financial flexibility and supporting an investment-grade profile as it executes Bloom Lake's Phase II expansion. As such, subsequent to quarter end, Cliffs' Board of Directors approved the reduction of the Company's quarterly cash dividend rate by 76% to $0.15 per share.”

The stock fell some 20% on the news.

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CLF data by YCharts

In addition to the cut, the company is set to issue both new common shares and convertible preferred shares. So, not only is the company trimming its dividend, it is also diluting shareholders' current stakes in the company. These are the actions of a company that has problems, not a company that is succeeding. Clearly, the difficult market environment in its core iron ore and coal businesses has taken a toll. So, too, has the company's poor execution in some of its recent expansion efforts.

Nokia (NYSE: NOK)
Another company that cut its dividend recently was Nokia: "To ensure strategic flexibility, the Nokia Board of Directors will propose that no dividend payment will be made for 2012 (EUR 0.20 per share for 2011). Nokia’s Q4 financial performance combined with this dividend proposal further solidifies the company’s strong liquidity position."

Nokia, however, hadn't made a massive dividend increase just months prior to the cut. The unfortunate takeaway from Cliff's is that companies sometimes don't made the best decisions with regard to dividends. Usually, this means holding on to a dividend level longer than it probably should, which is what happened at Nokia and also at Washington REIT, which also recently cut its dividend after years of regular increases.

Nokia and Washington REIT are both likely to be stronger companies for their dividend cuts. Nokia, specifically, still has plenty of cash on hand. However, it wants to ensure that remains the case while it tries to play catch up in the handset business it once dominated. Now, in fact, might be a good time for aggressive investors to look at the shares for their recovery potential since a shoe that many had been expecting to drop finally has. Cliffs, on the other hand, seems to be in worse shape than many believed, highlighted by the stock and preferred issuances.

Pitney Bowes Next?
A more worrisome company to monitor on this front is Pitney Bowes (NYSE: PBI). This company has been hard hit by the Internet because it is so tied to regular mail services. While management is working hard to catch up to the times by bringing out more and more Internet-based services, and trying to create services that transcend both physical delivery and online delivery, there is no question that the company has some problems.

Although Pitney Bowes has an incredibly long history of annual dividend increases, it chose not to increase its dividend at the normal time. This is supposed to give the company's new CEO a chance to review the business, but it's a bad sign for the dividend. While a cut doesn't always come next, it's easier for the a new CEO to make such a move early on in his or her tenure than to admit it is needed later. Avon was in a similar situation before its disbursement was trimmed.

Dividend Cuts
Investors that rely on dividends have to be very careful when selecting stocks to own. Just because a company has a large dividend today, doesn't mean it will have one tomorrow. Cliffs is a sad example of this, and one that stings badly because of the large dividend increase in 2012. To many that move would have seemed like an indication that management was dedicated to protecting the dividend and returning value to shareholders.

A company can only do that for so long while it is struggling, however, which makes watching the underlying business paramount. Nokia and Avon were both struggling before their cuts. Cliffs wasn't performing at the top of its game. Some companies work through problems, however, others don't. For an investor who already owns a company, it might be worth sticking it out. For a conservative investor looking at a stock with an elevated yield, it might be worth looking somewhere else.

Pitney Bowes is a good example of this today. Is it worth getting in the stock now? For conservative investors it clearly is not. Before the cut, Cliffs was also in a difficult situation, though probably not as dire. That said, the company's decision to issue equity should probably dissuade all but the most aggressive from considering a purchase at this point.

What to Take Away
Always watch for companies that are in financially difficult situations that can't be easily solved. Always watch for companies whose situations are worse than that of their competitors. Always watch for dividend increases that don't happen on “schedule.” Always watch for management changes. In addition, always avoid stretching too far for yield, and always diversify broadly.

Lastly, don't feel bad if you get caught in a dividend trap. It happens to almost everyone. Make sure, however, that you learn something from the experience.

ReubenGBrewer owns shares of Washington REIT. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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