Dividend stocks are suitable for most investors, generally providing low volatility and income in the form of dividends. There is no reason why you should not like or not have dividend stocks in your portfolio, even if you’re more interested in day trading or investing for the short term.
Dividend aristocrats are a unique set of stocks that have provided dividends for many years, and many have also increased their dividends over that time.
But what happens when some dividend stocks may decide to implement a dividend rate cut? And why is an imminent dividend cut so important?
Reasons for a Dividend Cut to Watch For
In general, dividend cuts are a negative sign for any stock. The first reason is that a dividend cut signals a weakening financial position, which could make the company less attractive to investors.
The weakening financial position may be due to declining earnings, increasing debt levels or a dramatic fall of the free cash flow. For a company to pay dividends, it needs profits and positive free cash flow. A triple threat of increasing debt, declining profitability and even worse, negative free cash flow, equals a very large red flag.
At the same time, a dividend cut lowers the intrinsic value of the stock and harms its valuation. So it may lead to selling pressure or even worse, turn the stock out of favor. Imagine a stock with a dividend yield of 8% cutting its yield in half. Certainly, those investors who bought the stock for its dividend would reconsider their positions.
Another reason for a dividend cut may be an unsustainably high payout ratio. The payout ratio is the percentage of dividends compared to the net earnings. For example, if a stock has earnings per share of $10 and it has a dividend of $8 per share then it has a payout ratio of 80%, which would be seen as way too high and a likely candidate for further dividend cuts.
A decline in revenues, and therefore earnings, is one of the most important factors that may signal a future dividend cut, especially if combined with high debt levels. Here are three stocks that may be at risk of a dividend cut in 2021.
3 Stocks With a Likely Dividend Rate Cut
- International Consolidated Airlines Group, S.A. (OTCMKTS:ICAGY)
- PPL Corporation (NYSE:PPL)
- Icahn Enterprises L.P. (NASDAQ:IEP)
For our list today, we used the Yahoo! Finance stock screener to look for stocks with (1) a forward dividend yield greater than 5%, (2) a net income margin less than 0%, (3) a debt to equity ratio greater than 2 and (4) an average 3-month volume greater than 200,000. The average volume is very important as we want to have a lot of liquidity available in order to move in and out of stock positions quickly when need be.
Dividend Stocks Ripe for a Rate Cut: International Consolidated Airlines Group, S.A (ICAGY)
Sector: Industrials
Industry: Airlines
Forward Dividend & Yield: $1.31 (23.09%)
Stock price as of June 7, 2021: $5.64
The Covid-19 crisis has been terrible for airline stocks and International Consolidated Airlines Group was no exception. Global and domestic travel collapsed, and most airlines had to ground their fleets due to lack of demand and restrictions such as economic lockdowns and even border closings.
International Consolidated Airlines Group S.A had revenue of $22.38 billion in 2019 but sales of just $6.99 billion in 2020, a decline of 68.74%. The net income of $1.5 billion in 2019 turned to a huge loss of $6.15 billion in 2020, a decline of 509.03%. Free cash flow of $471.13 in 2019 million turned to negative free cash flow of $4.65 billion in 2020. A massive decline of 1,087.79%.
The D/E ratio in 2019 was 1.81 and skyrocketed to 10.28 in 2020. The very high forward dividend yield of 23.09% simply looks unsustainable. With a 5-year average growth of negative 19.34%, things look dim for this incredible dividend yield.
PPL Corporation (PPL)
Sector: Utilities
Industry: Regulated Electric Utility
Forward Dividend & Yield: $1.66 (5.72%)
Stock price as of June 7, 2021: $29.09
Utility stocks are considered to be mature stocks, defensive during economic downturns and offering decent dividend yields. They could be also characterized as safer compared to other stocks given their low beta (they are less volatile). Yet PPL stock has some important underlying problems.
First quarter earnings for 2021 weren’t good, as the company reported a net loss: “first-quarter reported a net loss (GAAP) of $2.39 per share, reflecting a $2.65 per share net loss from discontinued operations associated with the U.K. utility business.”
What I especially dislike is that revenue has been declining for the past two consecutive years. In 2019 revenue reported was $7.77 billion (-0.21% compared to 2018) and in 2020 revenue was $7.61 billion (-2.09% compared to 2019).
These numbers may look small, but net income growth has declined more than revenue. That isn’t an optimistic scenario. In 2019 there was net income reported of $1.75 billion (-4.38% compared to 2018) and in 2020 net income reported was $1.47 billion (-15.87% compared to 2019).
What’s very interesting and quite alarming is the fact that this company has had negative free cash flow for the past five years, yet managed a payout ratio of 82.4% in 2020, the highest for the past five fiscal years.
What about the debt level? Things are not positive here, as both short-term and long-term debt are at their highest level in the past five years. With increased interest expenses and a history of negative free cash flows, this sky-high dividend yield is at severe risk.
Icahn Enterprises L.P (IEP)
Sector: Industrials
Industry: Conglomerates
Forward Dividend & Yield: $8.00 (13.81%)
Stock price as of June 1, 2021: $55.17
IEP stock completely defies modern economic theory and I would not be surprised if they slashed their dividend rate not just gradually, but drastically.
To start, 2020 was a very bad year for IEP stock with revenue reported at $6.67 billion, down 40.57% compared to 2019. Then operating income or EBIT after Unusual Expense has been negative for the past two consecutive years. In 2019 operating income after the unusual expense was -$1.41 billion, and in 2020 -$1.86 billion. A company should at least have positive income from its core operations to be able to pay dividends. This has not been the case for IEP stock for 2019 and 2020.
But it wasn’t just that 2020 was a bad year. Over the past five years, the last time the company had positive net income was back in 2018, with a reported figure of $319 million. And even worse, as of 2018 net income had been declining for the past three consecutive years; then in 2019 and 2020 the company reported net losses.
With a negative net income, it is almost 100% guaranteed that free cash flow will be negative too. And this is the case for IEP stock, with negative free cash flow in both 2019 and 2020. The financials do not inspire, to say the least.
The D/E ratio was 1.12 in 2018, increasing to 1.50 in 2019 and 2.38 in 2020. Yet despite these very poor financial results, the dividend has steadily increased. In 2016 the dividend was $6.00 per share, in 2018 it went up to $7.00 per share and in 2019 and 2020 it stabilized at $8.00 per share.
Is this dividend sustainable? Given the 5-year trend in financials, I don’t see how it could be. The most recent mix of debt, net loss, and negative free cash flow suggest that a dividend cut is very likely.
On the date of publication, Stavros Georgiadis, CFA did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
Stavros Georgiadis is a CFA charter holder, an Equity Research Analyst, and an Economist. He focuses on U.S. stocks and has his own stock market blog at thestockmarketontheinternet.com/. He has written in the past various articles for other publications and can be reached on Twitter and on LinkedIn.