A dividend cut is usually awful news for investors. No one wants to be collecting less dividend income. And it's a sign that the business isn't doing particularly well. However, if investors have already been waiting for a dividend cut for some time because they see that the company is struggling and that the payout is unsustainable, a reduction in the dividend may not be all bad.
Walgreens Boots Alliance (WBA 0.57%) recently announced a significant dividend cut, resulting in its future payout being reduced to nearly half of what it was. It sounds awful, but here's why this seismic reduction in the payout may turn out to be a long-term good thing for the pharmacy retailer's shareholders.
Walgreens wasn't going to be able to keep that dividend going for long
The new dividend for Walgreens investors will be $0.25 per share every quarter. That's a 48% reduction from the $0.48-per-share quarterly payment it was making last year. Investors will now collect $1 per share every year, putting the yield at 4% based on current share prices, which is still far higher than the S&P 500 average of 1.5%. While Walgreens could have tried to keep last year's payout going, it was simply unsustainable.
Over the trailing 12 months, the company's diluted per-share earnings totaled $0.66. Its free cash flow over the past year was a negative $529 million. An argument can be made that even the new dividend may not be safe from further cuts based on those numbers. Walgreens, is, however, working at slashing costs to improve its financials.
Ultimately, a reduction to the dividend looked inevitable for the company given its current challenges. The hope for investors is that as Walgreens' healthcare business grows and it continues to lower its costs, the new dividend will start to look safe again.
The decision is a sign of the company's path forward
By making the move to cut the dividend, new CEO Tim Wentworth is showing that Walgreens is serious about improving its cash flow and prioritizing the sustainability of its operations. It is also signaling that it won't allow the company's dividend growth streak (which was getting close to 50 years) to get in the way of that. In the end, the business needs to be in good financial shape. Paying a high dividend should not take precedence over that.
In recent years, Walgreens has been investing billions into the rollout of primary care clinics at its locations. Freeing up cash flow from the dividend will allow the company to allocate more resources to that initiative. Annually, Walgreens spends about $1.7 billion on its dividend payments.
There may be more cost reductions necessary and a further dividend cut may still be possible, but the good news for investors is that the new CEO is making the moves necessary to improve the company's operations. While Walgreens' business isn't in a great place today, it could be much stronger in the future thanks to management taking vital steps toward strengthening its financials and facilitating its growth.
Is Walgreens stock a buy?
Walgreens cutting its dividend shows the company is serious about considering all available options in an effort to improve its financials and overall stability. But it's by no means the only move the business needs to make for this to be a tenable investment. The pharmacy retail giant is still struggling to post a profit, and there's a lot of work to be done, particularly as it grows its healthcare business.
While reducing the dividend is a good and necessary move, it's still too early for investors to consider investing in Walgreens. Plenty of risk remains here, and if you're looking for a significant and safe payout, you're better off considering other dividend stocks instead.
