For dividend investors, high yields are like a flame is to a moth -- often too hard to resist, even if you might end up getting burned. As a case in point, HanesBrands' (HBI -7.72%) 9.8% yield, as presented recently by some major online quote services, is ephemeral at best. Here's why this fat dividend isn't real and why conservative dividend investors need to do some homework before buying a stock.
Attractive figure
An S&P 500 Index ETF will provide investors with a yield of around 1.65% today. The average consumer staples stock, using the iShares US Consumer Staples ETF as a proxy, has a dividend yield of around 2.15%. So the huge yield apparently on offer from HanesBrands is quite attractive, relatively speaking. That yield is also near its highest levels over the past decade, so it is seemingly attractive historically speaking, as well.
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In many ways, it looks like HanesBrands is worth a deep dive for income-focused investors. Doing some research is always a good thing, but what you find here will lead dividend investors to pass right on by.
The biggest problem is really to be found on the company's balance sheet. HanesBrands' debt-to-equity ratio, a measure of leverage, sits at around 9.7 times. That's high for just about any company. It's also high relative to other clothing manufacturers. For example, VF Corp (VFC -3.00%) has a debt-to-equity ratio of roughly 2 times, which is still a bit elevated, while PVH (PVH -1.99%) has a very reasonable 0.5 times debt-to-equity ratio.
To be fair, HanesBrands isn't in a death spiral. It is still covering its interest costs, highlighted by a times-interest-earned ratio of 3.2 times. This metric looks at trailing 12-month interest expenses relative to trailing 12-month earnings before interest and taxes. A number above 1 means the company is covering its interest costs, with higher numbers better than lower ones. HanesBrands has breathing room, but VF Corp and PVH have times-interest-earned ratios of 5.7 and 4.7, respectively. They have much more leeway for adversity.
Simply put, the hefty dividend yield on offer from HanesBrands is resting on a fairly weak foundation -- which is why it was just too good to last.
A bad end to the year
HanesBrands reported fourth-quarter 2022 earnings on Feb. 2. One of the key bullet points was that the company "(t)akes proactive steps to strengthen balance sheet and increase financial flexibility. Updates capital allocation strategy to focus use of all free cash flow on debt reduction." More on that cash flow statement in a second.
The reported adjusted earnings in Q4 was $0.07 per share. That's versus a Q4 dividend of $0.15 per share. One way to assess the safety of a dividend is to look at the payout ratio, which takes the dividend and divides it by earnings. When the dividend is larger than earnings, the number rises over 100% and signals that the dividend could be at risk.
To be fair, dividends don't come out of earnings -- they come out of cash flow. In fact, the cash flow statement is where dividends show up as a line item. The only reason you may find them on the earnings statement is because management is adding the figure as a courtesy to investors.
So, even a company that's losing money can keep paying a dividend if it wants to (often using debt to fund the payment). But when that company says that "all free cash flow" is being put toward debt reduction, well, the very next line is likely to highlight the elimination of the dividend. That's exactly what happened on Feb. 2 with HanesBrands: "The HanesBrands Board of Directors eliminated the Company's quarterly cash dividend as HanesBrands shifts its capital allocation strategy..."
The real takeaway
Online data services haven't caught up to the dividend cut announcement. They may not for a little while, so the yield listed just isn't real. And you'd only find that out if you dug in, just a little, and read the company's most recent earnings update. That said, the weak balance sheet and risk of a dividend cut have been evident for quite some time, so this outcome is hardly a shock.
Still, for dividend investors, the real lesson here is that you can't simply accept what you see online as fact. You need to go to the source and do your homework. If you don't, you might end up buying for a reason that no longer exists.
