Are These Dividends Safe?

Rupert 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 the biggest U.S. iron ore producer, fell the most in more than three years after cutting its quarterly dividend by 76 percent and announcing a share sale to repay debt.'

'Cliffs reduced the payout to 15 cents a share, the Cleveland-based company said in a statement after the close of trading yesterday. That erases the increase made in March, when Cliffs raised the dividend to 62.5 cents from 28 cents'

Source: Bloomberg

This is the kind of announcement that dividend investors fear. Before Cliffs announced this cut, the share was yielding 7.5%, a yield far above the market average. Now, the stock yields just 2%, below the market average.

The problem is it's hard to spot when dividend cuts like this will happen. You see, Cliffs raised its dividend earlier this year, making investors believe the dividend was strong, well covered and there was plenty of good news to come. However, a detailed analysis of the company's cash flows reveals a different story.

In the second, third and fourth quarters of 2012, Cliffs spent $89 million a quarter on its new higher dividend of 62.5 cents a share. Cliffs was spending this cash on dividends even though the company had a negative free cash flow of around -$200 million, which meant that Cliffs had to either borrow the money, issue shares or dig into is cash reserve to fund the dividend.

With Cliffs' failure still fresh in investors' minds what is the situation of other high yielding companies in the S&P 500, can they sustain their dividends?

Two Harbors (NYSE: TWO)

Market cap

$3.74B

P/E ratio

11.24

EPS

$1.13

Dividend

$1.70

Div. yield

17.3%

At first glance it would appear as if Two Harbors cannot sustain its dividend. Two Harbors paid out $1.70 in dividends only EPS of $1.13.

$US

03/01/2012

06/01/2012

09/01/2012

12/01/2012

Average

EPS

0.28

0.11

0.10

0.64

0.3

Dividend

0.40

0.40

0.36

0.55

0.4

Cover from EPS

0.7

0.3

0.3

1.2

0.6

Indeed, on a quarterly basis the only periods where Two Harbors has been able to sufficiently cover its dividend from earnings was in the last quarter of 2012. During all three previous quarters the dividend was almost double EPS.

$US Millions

12/01/2011

03/01/2012

06/01/2012

09/01/2012

Net Operating Cash Flow

63

36

49

78

Net Investing Cash Flow

583

-2532

-1810

-4040

 

 

 

 

 

Cash Dividends Paid

56

56

86

87

Change in Capital Stock

0.1

692

55

790

Issuance/(Reduction) of Debt, Net

(640)

2030

3780

3600

 Net Financing Cash Flow

-696

2670

1710

4300

 

 

 

 

 

Net Change In Cash

-50

185

-50

336

Free Cash Flow

7

-20

-109

-128

Two Harbors' is an mREIT; therefore the company's cash flows look a lot different to the rest of the group. While other companies have to balance net operating cash flow with net investing cash flows, mREITs do not as they are constantly re-shuffling their mortgage backed assets and loans. In addition, the company will issue a lot of debt to finance its purchase of mortgage backed securities. However, this debt is usually re-purchase agreements, which are mostly risk free

So, with that in mind does Two Harbors have room to pay its dividend? Well in contrast to the rest of the group, I will analyze Two Harbors' dividend based on the company's net operating cash flow only.

It appears Two Harbors cannot afford its dividend from its net operating cash flow. Consistently, the company has paid out more in dividends than it has received in operating cash flow from its operations, meaning the company has needed to issue stock or debt in order to finance its dividend payouts. I'm afraid Two Harbors does not survive this dividend test.

AstraZeneca (NYSE: AZN)

Market cap

$56.83B

P/E ratio

9.15

EPS

$4.99

Dividend

$2.85

Div. yield

6.32%

From this quick overview, it appears AstraZeneca is able to cover its dividend from EPS. Astra paid out dividends of $2.85 during 2012 on EPS of $4.99.

$US

03/01/2012

06/01/2012

09/01/2012

12/01/2012

Average

EPS

0.81

0.8

0.77

0.76

0.79

Dividend

1.95

0

0.9

0

0.71

Cover from EPS

0.4

0.0

0.9

0.0

1.1

However, on a quarterly basis the company is not able to cover its dividend. That said, taking into account the average figures across the year, shown at the end of the table it would appear that on a yearly basis AstraZeneca is able to cover its payout at least once from earnings.

$US Millions

03/01/2012

06/01/2012

09/01/2012

12/01/2012

Net Operating Cash Flow

1540

2791

4100

6948

Net Investing Cash Flow

593

1353

-1345

-1859

 

 

 

 

 

Cash Dividends Paid

-2505

-2505

-3665

-3665

Change in Capital Stock

-912

-2505

-2273

-2206

Issuance/(Reduction) of Debt, Net

(34)

(62)

1492

917

 Net Financing Cash Flow

-3438

-4156

-4398

-4923

 

 

 

 

 

Net Change In Cash

-1291

-20

-1633

162

Free Cash Flow

-657

719

17.2

1600

AstraZeneca's net cash flow leaves plenty of room for dividend payments after the deduction of investing cash flows.

The company was buying back stock during 2012 and it looks like this put pressure on cash flows. Indeed, in the third quarter of 2012, AstraZeneca had to issue $2.5 billion of debt to fund part of its buybacks. However, AstraZeneca has announced that it will not continue its buyback program into 2013, which will reduce the pressure on the company's cash flows.

Still, excluding the effect of stock buybacks dividends remained well covered and the company actually had a positive free cash flow for the last three quarters of 2012. 

AstraZeneca passes this dividend test now it has stopped buying back stock.

Windstream  (NASDAQ: WIN)

Market cap

$5.26B

P/E ratio

28.84

EPS

$0.31

Dividend

$1

Div. yield

11.20%

With a yield of 11.2% it appears that Winstream is not able to cover its dividend from EPS. The company paid out $1 in dividends during 2012 on earnings of only $0.31.

$US

12/01/2011

03/01/2012

06/01/2012

09/01/2012

Average

EPS

-0.03

0.11

0.09

0.09

0.07

Dividend

0.25

0.25

0.25

0.25

0.25

Cover from EPS

-0.1

0.4

0.4

0.4

0.3

Windstream's inability to be able to cover its dividend is highlighted further in its quarterly figures. On a quarterly basis the company has not been able to cover its dividend from EPS for the past twelve months. For the past four quarters the company has an average quarterly dividend cover of only 0.30.

$US Millions

12/01/2011

03/01/2012

06/01/2012

09/01/2012

Net Operating Cash Flow

309

438

398

407

Net Investing Cash Flow

-126

-176

-288

-343

 

 

 

 

 

Cash Dividends Paid

-129

-147

-147

-147

Change in Capital Stock

0

0

0

0

Issuance/(Reduction) of Debt, Net

135

(272)

15.3

148

 Net Financing Cash Flow

9.3

-426

-137

13

 

 

 

 

 

Net Change In Cash

193

-163

-27

77.3

Free Cash Flow

-25

54

-51

-79

Despite the fact that Windstream's EPS are not sufficient to cover dividends, the company's cash flows tell a slightly different story. If the investing cash flow is deducted from the operating cash flow, the company has plenty of cash left over to pay its dividend. Furthermore, in the first quarter of 2012, the company had enough free cash to buy back some debt.

However, despite the good performance in the first quarter of 2012, the company fell behind in the third quarter and was forced to issue debt to sustain the dividend.

Overall, Windstream is on a knife edge and I do not believe the current dividend is sustainable.

Pitney Bowes (NYSE: PBI)

Market cap

$2.70B

P/E ratio

6.12

EPS

$2.22

Dividend

$1.52

Div. yield

11.05%

At a first glance it appears that Pitney is easily able to cover its dividend form EPS. The company paid out a dividend of $1.52 on EPS of $2.22 during 2012.

$US

03/01/2012

06/01/2012

09/01/2012

12/01/2012

Average

EPS

0.79

0.5

0.38

0.55

0.56

Dividend

0.38

0.38

0.38

0.38

0.38

Cover from EPS

2.1

1.3

1.0

1.4

1.5

On a quarterly basis, Pitney has been able to cover its dividend consistently every quarter, which gives the company the best record of coverage in the group. The dividend has been covered by earnings at least once in every quarter resulting in an average 5-yr dividend cover of one-and-a-half times.

$US Millions

12/01/2011

03/01/2012

06/01/2012

09/01/2012

Net Operating Cash Flow

170

96

274

70

Net Investing Cash Flow

52

-4

-11

-81

 

 

 

 

 

Cash Dividends Paid

-74

-75

-75

-75

Change in Capital Stock

102

2

2

3

Issuance/(Reduction) of Debt, Net

0

28

(578)

0

 Net Financing Cash Flow

-81

-45

-660

-73

 

 

 

 

 

Net Change In Cash

141

59

-415

-75

Free Cash Flow

63

-29

160

-45

Before the cash flows are considered, I must say that I believe Pitney operates within a dying industry and therefore even though dividends are well covered now, the company's revenues are in terminal decline and future dividends should not be taken for granted.

That said, Pitney has been able to cover its dividends well from cash flow over the last four quarters. In addition, the company has a good cash balance so any short falls can be easily covered. Indeed the company used this cash balance to repay debt in the second quarter of 2012.

Pitney passes this test now but I believe future dividends will come under pressure.

Overall

So, out of these 4 contenders only two, AstraZeneca and Pitney Bowes pass the dividend test. That said, I believe Pitney's dividend could come under pressure soon as the company grapples with falling revenues and declining sales.

Out of these four stocks, AstraZeneca is the only company that I believe will be able to sustain its dividend.

Data Source: Motley Fool CAPS, MarketWatch

 


RupertHargreav has no position in any stocks mentioned. 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!

blog comments powered by Disqus

Compare Brokers

Fool Disclosure