When investors are evaluating dividend stocks, the criteria include whether the dividend is likely to be paid for years to come and the dividend growth potential.
While some dividend-paying stalwarts may look like attractively priced opportunities, it always pays to do some homework to make sure a company's circumstances can continue to support the dividend. Sometimes companies make missteps that threaten the ability to pay a dividend, much less help it grow.
1. Macy's: Can a department store really adapt to changing retail channels?
Macy's, the iconic American department store chain, currently pays a juicy 11% dividend. On Feb. 25, it turned in holiday quarter report that included earnings-per-share of $2.12, versus EPS expectations of $1.96, an 8.1% upside surprise. But the company has been struggling, and the stock price has fallen 49% in the past year as investors registered skepticism about the company's cost-cutting plan.
The 161-year-old retailer announced 125 store closings earlier in February due to dropping sales as mall traffic has dramatically decreased. It is also cutting 2,000 jobs.
Consumers are increasingly turning to online shopping and discount retailers like T.J. Maxx and Marshalls, both owned by TJX Companies. To compete, Macy's has invested heavily in its off-price Backstage business, operated as a store-within-a-store at existing Macy's. The company is also accelerating its online strategies to compete with companies like Amazon, which have siphoned business from Macy's through online sales for years.
The dropping share price reflects investors' concerns over expenses and timeframes for Macy's turnaround plans to bear fruit. Additionally, novel coronavirus fears have led to new concerns over sales at tourist-based stores, and possibly affected sales at other Macy's locations.
In Nov. 2019, Morgan Stanley retail analyst Kimberly Greenberger said: "With Macy's stock declining 50% in the last year, its dividend yield has nearly doubled to 10% -- a clear indication the market views it as unsustainable. We expect Macy's may need to cut its dividend in the next two years if it's unable to stabilize cash flow."
In summary, this company's dividend is in trouble if its plans don't proceed on schedule or if unexpected bumps in the road appear. If you are buying for the dividend, this is one stock to avoid. There are safer companies with attractive dividends available.
2. Kraft Heinz: Consumers' taste for healthy and organic upend a business
Kraft Heinz currently pays an attractive dividend of 6.4%, but its business has been challenged in the past few years.
The downward turning point for Kraft Heinz was in 2015 when an agreement was struck for Berkshire Hathaway and 3G Capital Partners to own just over half of Kraft Heinz, while the rest remained publicly traded. After that, 3G forced a zero-based budgeting and cost-cutting strategy on the company, while trying simultaneously to expand the company.
Bernardo Hees, a 3G Capital partner, was named Kraft Heinz CEO, to lead the cost-cutting while attempting to grow the company. The aggressive cost-cutting drained the business of talent, as experienced managers left for other jobs. It also crippled innovation, as R&D budgets were slashed. As a result, efforts to increase organic sales failed as management was pushed to introduce product line extensions that offered nothing new, and actually cannibalized sales.
Investors became critical of the heavy focus on cutting costs, shrinking sales, and lack of brand investment. In April 2019, Miguel Patricio replaced Bernardo Hees as CEO. Company objectives changed to aligning products with customer needs while doing more marketing of the bigger brands.
But questions arise around these objectives. Without recent innovations, do Kraft Heinz products really meet customers' needs? With concerns about rising obesity, consumer preferences have shifted to healthier foods, fresher ingredients, and organic origins. The Kraft Heinz product lineup does not reflect those preferences, relying heavily on processed foods. And increased marketing of brands that don't meet customer expectations won't increase sales; it only wastes resources.
In February 2019, Kraft Heinz surprised Wall Street with a $15 billion writedown of its Kraft and Oscar Mayer brands. In August the company announced a $500 million writedown on the value of several other poorly performing brands, including Velveeta, Maxwell House, and Miracle Whip.
Creating healthy new product choices and getting them to market is a slow and expensive journey. Kraft Heinz cut its dividend in 2019 and may have to do it again in 2020.
On Feb. 4, Credit Suisse analyst Robert Moskow said: "We expect a step-down in EBITDA in 2020 of $200 million just from divestitures and incentive compensation alone. If so, we do not see how the company can achieve the rating agencies' targets unless it cuts its dividend."
On Feb. 14, Fitch Ratings downgraded Kraft Heinz debt to junk status due to leverage concerns.
Kraft Heinz is another company that isn't safe enough to count on its dividend staying steady, much less growing. Until the company achieves a true turnaround, consumer staples investors should look elsewhere.