Companies at Risk of Cutting Dividends in 2024

Investors have a deep affection for dividends. The joy they experience when dividends are paid and increased is unmatched. Conversely, the disappointment and dissatisfaction they feel when dividends are reduced are immense.

However, it is an inevitable reality that several significant companies will cut their dividends in 2024. Research conducted by consulting firm McKinsey indicates that apart from financial crises, approximately 1% to 2% of all dividend payers cut their dividends each year – equating to seven or eight large companies. The crucial task is to identify these companies and exercise caution until the payout is reduced. It is at this moment that an opportunity arises.

Determining which companies are on the verge of cutting their dividends is no easy feat. Nevertheless, Wolfe Research strategist Chris Senyek highlights three warning signs to watch out for. First, high yields may appear appealing, but they often indicate underlying issues within a company. Excessive debt results in a significant portion of cash being allocated to interest expenses rather than being returned to shareholders. Furthermore, companies that distribute a substantial amount of free cash flow lack a buffer to withstand adverse business conditions, particularly during a recession.

Consumer-discretionary companies currently cause Senyek the most concern. This apprehension is well-founded as even the National Retail Federation predicts a challenging year for consumers in 2024, following a robust 2023. “Tighter credit conditions along with higher borrowing costs continue to be in place now…and employment reports confirm that the labor market expansion is slowing,” stated economist Jack Kleinhenz in the organization’s 2024 outlook.

Senyek has identified eight companies that meet his criteria for concerning metrics – these are companies he believes are at risk of cutting their dividends this year. The companies include Vail Resorts, a skiing giant; Hasbro, a toy maker; Whirlpool, an appliance manufacturer; Wendy’s and Cracker Barrel Old Country Store, operators of restaurants; Leggett & Platt, a home-goods maker; LCI Industries, an RV parts supplier; and Kohl’s, a retailer.

Dividend Payers Face Challenges Ahead

As dividend payouts soar, some investors are raising concerns about the sustainability of these high levels. A recent analysis reveals that certain companies in the S&P 500 index are projected to pay out nearly 100% of their estimated 2024 free cash flow as dividends, a significantly higher payout ratio compared to the average dividend payer. While companies can temporarily pay out more than their generated cash flow, this leaves little room for error.

Complicating matters further is the burden of large debt loads. The average dividend payer in the S&P 500 has a debt to EBITDA ratio of 2.2, which is considered manageable. However, the specific companies highlighted in the analysis have an average ratio of 4.2, indicating a higher level of leverage. Additionally, these companies boast an average dividend yield of 6%, more than double the 2.5% yield of the average dividend payer in the S&P 500.

It is important to note that there is no guarantee that these dividends will be reduced. The eight companies mentioned in the analysis did not respond to requests for comment on this matter. Nonetheless, it is prudent to remain vigilant and proactive. Historical data reveals that the stock market tends to factor in a dividend cut approximately one year before it actually happens. Interestingly, the eight consumer-discretionary stocks in question have already experienced a decline of around 20% over the past 12 months, consistently underperforming the broader S&P 500. Only one of these stocks, LCI, has managed to achieve a modest gain of 5% during this period.

While a dividend cut may seem discouraging, it can also create opportunities for investors. For instance, consider the case of Intel, whose stock price dropped by 40% in the year leading up to its dividend reduction in February 2023. However, since then, Intel shares have rebounded by approximately 80%. The analysis suggests that the stocks of companies that eventually reduce their dividends tend to underperform the market by approximately 17 percentage points in the year preceding the cut. However, performance starts to improve around three months after the cut, with these stocks then outperforming the market by approximately five percentage points after one year.

In light of these findings, it is wise to exercise patience when it comes to dividend cuts.

Sources: Bloomberg, FactSet, Wolfe Research

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