Here we go again with one of my favorite contrarian topics: Buckle up, the dividend butcher is sharpening his axe once more! Four prestigious dividend stocks once deemed safe havens are poised to slash their generosity to ribbons. With worsening fundamentals, overstretched balance sheets and drying cash flows in a challenging environment, these firms will likely need to trim the fat from their dividends in the not-too-distant future.
Summary and key takeaways from today’s Weekly
– Long series of either uninterrupted or even frequently raised dividends are often strong arguments for less experienced investors to almost blindly invest into a stock.
– However, when there’s not other way out, dividends will always be cut to save a company.
– My four discussed cases are likely to call the butcher soon.
My long-time readers will instantly know that this is one of my most often discussed topics, if not the most frequent: writing about upcoming dividend cuts.
I like to dig deep into companies’ financials, particularly in uncovering dangers within the finances of prestigious, renowned companies with long series of uninterrupted dividends, ideally dividend aristocrats and kings (I absolutely dislike these titles, as they’re useless, focusing solely on the past).
That’s why I wanted to create another list with candidates that you should have on your radar. The more so, if your primary strategy is dividend investing.
While many backward-looking investors will likely disagree and point to long track records, in recent years, I’ve correctly predicted several dividend cuts, not sparing prestigious names like 3M (ISIN: US88579Y1010, Ticker: MMM), Intel (ISIN: US4581401001, Ticker: INTC), W.P. Carey (ISIN: US92936U1097, Ticker: WPC) or Walgreens Boots Alliance (ISIN: US9314271084, Ticker: WBA).
You can find some of my calls here, here, here, here and here.
The funny thing is that with a bit of effort, many payout slashes can be anticipated well in advance. There are certain red flags that cannot or should not be ignored. This does not work every time as some companies decide to muddle through by taking on more debt just to keep the series intact. But this can only last for so long.
Today, I am presenting four new candidates with excessive debt loads, where sustaining the dividends – which consume most or even all available free cash flow — is more a burden than a sign of strength.
Don’t be surprised if the butcher comes!
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Shink, shink – the axe is honed for a dividend slash
Of my four candidates, three are from the US while one is from Europe.
We do not have the same dividend culture here. For full disclosure, I am not a dividend investor, but I have made certain observations over the years. In many instances, dividends are paid in relation to the previous year’s earnings. If earnings are lower, the subsequent dividend will be lower, too. This is especially the case here in Germany.
This does not mean that we do not have companies that at least keep or even raise their payouts every year without cuts in between. But there are much less uninterrupted series and expectations are different, also partly attributed to a different payout pattern.
While in the US most companies pay a quarterly dividend, in Europe it is often biannually or even only once a year after the meeting of shareholders. This often results in a first-half-heavy dividend schedule, as most companies’ fiscal years end with the calendar year, with shareholder meetings occurring in the first half, too.
Die-hard dividend investors prefer a more smoothed out payment schedule, though.
Key exceptions are the European energy supermajors and the two big British tobacco companies – all following a quarterly dividend structure.
Let’s now have a look at a European company, an American company that has been paying a dividend for more than 100 years, a dividend aristocrat (25+ consecutive raises) and even a dividend king (50+ consecutive raises) where it should not be surprising if they axe their payouts to preserve cash.
My top contender from Europe is Pernod Ricard (ISIN: FR0000120693, Ticker: RI).
The French spirits powerhouse has seen its stock drop over 50% from the peak. This is insofar very painful as the entire industry for long has been seen (and partly still is) as a high-quality and recession-resistant, defensive sector.
If they only knew…
Seeing a stock that is perceived to be defensive and of high-quality to be cut in half in a relatively short period of just two years is certainly tough to swallow on its own. But if you have massive sectorial headwinds, shifting consumer behavior (either to more affordable offerings or drinking less at all) and on top worsening economic conditions mixed up with a toxic valuation, the result is not that surprising anymore.
For me, this chart looks like it’s sipped one Mumm too much — stumbling drunk and unable to keep standing — not healthy…
However, despite the strong fall from grace, I do not think a dividend cut is priced in.
That would be the nail in the coffin, likely sending the stock further south. If a company is not only not growing anymore, but struggling to keep results even flat, the dynamic has clearly shifted.
While a record-high 5% dividend yield sounds intoxicating and without checking the numbers many will likely assume it to be safe, this couldn’t be further from the truth. In fact, Pernod Ricard slowly has squeezed out the maximum possible. If the family-run and -owned business (biggest shareholder) has the company’s financial health and long-term well-being as the top goal, then it needs to slash the payout.
Below, we can see that sales growth has topped out.
The same applies to gross and operating margins:
The recent results weren’t helpful either.
While they claim to be working on improving margins and having fallen victim to certain negative effects regarding timing and working capital shifts, these seem to be more desperate excuses and of minor importance. I am even surprised they didn’t blame the weather.
The big picture is telling a different, but very clear story.
Here’s the development of net debt (only until 30 June 2024, the latest number is even a billion higher at 12 billion EUR)…
… operating and free cash flow…
… and the total dividend payout:
The overall trends are debt up, cash flows have peaked and turned down while the dividend payment has continued to balloon to now 1.250 bn. EUR.
The latest figures for operating and free cash flow on a rolling twelve-month basis (per year end 2024 due to bi-annual full reporting) are 1.8 billion EUR and 1.1 billion EUR.
There’s already a deficit of a good 150 mn. EUR between free cash flow and dividend payout. This won’t break them the neck as the company has 1.9 bn. EUR in cash on the balance sheet. They could try to wait this one out, but the business has serious issues and it wouldn’t be wise to do so just to keep the payment up.
By the way, this wouldn’t be the first cut. In 2009 (recession-resistant anyone?) and 2020 the dividend was lowered.
I find it also funny that on their own website in the dividend section, the dividend history starts only from 2010, i.e. after the previous cut.
Next up, a company that traces back to 1897, when it was founded by Herbert Henry Dow in Midland, Michigan as the Dow Chemicals Company.
The company has retained this name throughout its history, until it underwent a significant merger with DuPont in 2017, first forming DowDuPont, which later in 2019 split into three separate companies, including the current Dow Inc. (ISIN: US2605571031, Ticker: DOW).
The idea of the merger and subsequent split was to reduce competition put together complementary businesses to increase their scale and then to separate again those parts that are too different to stay together (e.g. electronics, water, chemicals, agri chemicals).
Today, Dow Inc. is a materials science company that develops and manufactures a wide range of chemicals, plastics, and advanced materials for industries like packaging, infrastructure, mobility, and consumer care. Its key products include polyethylene, polyurethanes, silicones, coatings and specialty chemicals.
The Dow Chemicals Company has paid uninterrupted dividends since 1912, a period of a respectful 113 years.
However, its dividend history includes a significant cut in 2009, the first in its 97-year dividend history at that time.
I am pretty sure this will not remain the last one.
Dow is a highly cyclical business. Currently most chemicals companies are on a painful downswing. Let’s again look at the key charts.
Starting with sales since Dow is a standalone company again. The current phenomenon as discussed in the last call is that despite higher volumes, sales are falling as margins are eroding.
Here are the gross and operating margins, reaching record lows for this period:
These are again figures until year-end 2024. Since then sales and especially margins are down more. It is not helpful that at the same time net debt is on the rise again (although there are no significant maturities until 2027)…
… due to less cash on the balance sheet (2.4 bn. USD at year-end 2024 and only 1.4 bn. USD per last count – the latter is not in the chart, it would be the lowest of all bars):
While Pernod Ricard is also in a downswing, it is unlikely they’ll burn any cash. I am not so sure with Dow, as low chemicals prices can pull the business down strongly. It is not uncommon for cyclicals to generate losses and burn cash when times are hard.
Here is how operating and free cash flow have been doing.
Almost needless to say that free cash flow is now double as negative (–676 mn. USD last twelve months vs. –354 mn. USD at year-end 2024).
Frankly, operating cash flow took a hit due to unfavorable working capital movements. Without that, free cash flow would have been positive. But I don’t care about “would”. However, this drag was among others due to higher inventories, signaling a weak business environment.
Cash cannot be drawn down forever. Speaking of cash, how much does the current dividend (constantly 0.70 USD per quarter since 2019) cost the company?
Almost 2 billion USD a year. The payout shrank a bit over time due to buybacks.
As the capital intensive business cannot cut investments entirely, the capital needs are very high. Here’s again a chart showing this time operating cash flow against Capex and the dividend.
While in the past, this equation had a clear positive result with the blue bar (cash flow) being much higher than the other two combined, using the latest numbers the company is spending 5.2 bn. USD a year. Even if we adjust cash flow for the negative working capital, the result is only 3.8 bn. USD over the last twelve months.
Management has started with cost cutting program, targeting 1 bn. USD in lower costs. From one-time proceeds from a legal win and several asset sales, management is expecting a short-term cash infusion of 6 bn. USD which creates some breathing room for now. Capex was announced to be reduced to 2.5 bn. USD.
But Capex plus the dividend will still cost 4.5 bn. USD. Even if cost savings kick in, I do not see that the gap between cash flow and Capex plus dividends can be closed.
In April, the company has yet again declared a 0.70 USD per share quarterly dividend. The economic situation hasn’t improved (outlook does not foresee an improvement, either). Dow will be able to keep up the payment for a few more quarters thanks to the described cash infusion. But this is not a healthy setup.
Which leads us to number three, dividend aristocrat Albemarle (ISIN: US0126531013, Ticker: ALB). The company is a global leader in specialty chemicals, known for producing lithium compounds for electric vehicle batteries, bromine-based fire safety solutions, and catalysts for petroleum refining.
But it is primarily known as the world’s largest lithium producing company.
Albemarle has lithium assets in the US (Nevada and North Carolina), Australia and Chile. Their largest lithium mine is the Greenbushes Lithium Mine in Western Australia, where they hold a 49% interest and which is known for having one of the highest ore reserve grades of any hard rock lithium mine globally.
The lithium market has experienced what I was afraid would be coming and thus entirely bypassed this sector when the party was in full swing: over-exaggerated demand assumptions and at the same time aggressive over-investments which led to a painful oversupply. Never should the investment thesis in the commodities sector be based solely on exuberant demand growth forecasts.
Accordingly, the lithium price chart looks the following:
And that’s why Albemarle’s chart looks exactly like this (down 80% from its high):
For more than 30 years, according to the chart below since 1994, Albemarle has been constantly raising its dividend, year after year. That’s why it is today a dividend aristocrat with at least 25 consecutive raises.
This is the more so remarkable, as this is a commodities company.
And yes, no cuts during the financial crisis of 2008–2009. That’s quite an achievement.
But slowly it starts to look like the end is near. The business suffered from an oversupplied market and demand that has been growing slower than initially expected. Basically the same what happened to oil after 2014.
Sales took a meaningful hit. That is not a surprise.
Margins nosedived either and operating earnings turned negative.
To be fair, the loss was mainly the result of a hefty one-time asset write down of a billion USD. That’s why I am only noticing from a broad perspective the declining margins, but focus on cash flows for my main assessment.
We can see on the next chart that operating cash flow is still positive (orange line). However, free cash flow (violet bars) has been deeply negative over the last two years, which isn’t great – and it’s adjusted for the asset write-down.
Operating cash flow was still strongly positive as the company sold off a big chunk of its inventory, thus it benefitted from a positive working capital movement.
Without this one-off, operating cash flow would have been meaningfully lower, likely strongly negative, too. Below you can see a massive bar up, representing the change in inventories, in this case lower inventories contributing positively to cash flows as they were sold and exchanged for cash.
I am saying this as nothing fundamental has changed in the sector for the better, yet.
The only thing is that first higher-cost mines are being closed or at least production curtailed. The companies are trying to cut costs and preserve cash.
But the price of lithium hasn’t reacted positively as of yet which is concerning. Here’s the one-year chart:
Coming now to the dividend. Albemarle currently pays out 311 mn. USD.
And you will have noticed below a massive bump, i.e. higher payout which I am going to explain in just a second.
As seen above, but also again on the following chart, we can see that free cash flow is deeply negative. So what did Albemarle do to finance the dividend?
They raised cash by issuing a preferred stock which is something in between a stock and a bond. What matters here is that is has a preferred dividend attached to it, i.e. first the preferred stock gets paid and only then the common equity.
Net debt with 2.2 bn. USD is already substantial, thus more debt would have been playing with fire in a cyclical downswing.
The preferred stock is the reason for the massive bump in the total payout we have seen above. Thus, the bottom line is, Albemarle already has substantial debt, deeply negative free cash flow and questionable operating cash flow, the price of lithium continues to drift lower and the company issued a preferred share to raise cash, but which increases the to-be-paid dividend.
While the company will likely be able to cut some costs, this is a race against time. To keep their dividend aristocrat status, they would need to even hike the dividend soon. The last four quarterly payments were all stable.
Not a good situation to be in…
Save the best for last: Dividend king PepsiCo (ISIN: US7134481081, Ticker: PEP).
I know that many people do not want to believe it and for some, even their eyes might be popping when seeing this. Pepsi has a series of 52 consecutive dividend increases to defend. The last hike is even relatively fresh from early-May, i.e. not even a full month ago.
From my perspective, It will be a tough fight!
It sounds unbelievable, but I have good arguments.
First of all and following the order from previous cases, sales and sales growth. The top line (blue) seems to have peaked for now, as indicated by the falling growth dynamic (black). Sales grew only by 0.4% year over year.
Over there last twelve months, the figure has turned even negative.
Pepsi hiked prices too much and sacrificed volumes for an overall negative result (see my extensive discussion of Pepsi here).
In the same token, while gross margins are relatively stable, this is not the case with operating margins. Still strong enough and on a multi-year high. But below the highs a decade ago.
What I absolutely do not like to see is strong sales growth, while free cash flow has stayed basically flat. Sales are up about 50%, while FCF over a decade did nothing.
Here’s free cash flow again. Where’s the growth?
We can find growth in the total dividend payout, as Pepsi has been raising its dividend frequently. However, what sounds like a generous management for shareholders, is rather slowly a sign to be concerned.
First, the development of the total dividend payout.
The dividend cost the company 7.2 bn. USD annually per year-end 2024.
After the recent raise by 5%, the payout grows to 7.5–7.6 bn. USD. Unfortunately, this consumes the entire free cash flow. This chart shows that this was already the case at yer-end.
It should not be surprising that buybacks have become less and less.
Now we have a 5% higher dividend, while the business operationally has challenges, showing no growth. To make it clear, I do not expect a cut to be imminent. But the financial flexibility has narrowed noticeably.
With a high debt load, as shown on the next chart, this setup is a bit tight-knit.
Net debt has grown to 40 bn. USD. Compared to a free cash flow before the dividend (~7.2 bn. USD), this is already substantial leverage with more than 5x.
Having in mind that more than the entire FCF goes for the dividend and the direction of interest rates not being as clear as many envision publicly (rising government bond yields are NOT supportive for lower interest rates), I recommend to be cautious.
I am convinced that management will try to muddle through for as along as possible. But being a dividend king is not a guarantee that the dividend won’t be ever cut. Just ask 3M shareholders.
Please be cautious with these obscure dividend titles!
Conclusion
Long series of either uninterrupted or even frequently raised dividends are often strong arguments for less experienced investors to almost blindly invest into a stock.
However, when there’s not other way out, dividends will always be cut to save a company.
My four discussed cases are likely to call the butcher soon.
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