As investors, we like to see companies with strong dividends that increase over time. However, on occasion, companies are forced to cut their dividend due to a lack of cash flow, too high of a payout ratio, or even because of government regulators in the case of the banking industry.
We asked three of our analysts which stocks may cut their dividends in the near future, and here is what they had to say.
George Budwell: Pfizer (NYSE:PFE) is a favorite name among income investors for a variety of reasons, including its long history of consecutive quarterly payments, strong cash flows, and the fact that it has raised its dividend about once a year for the past five years (in absolute terms). In fact, if history serves as any guide, Pfizer should up its dividend yet again within the next quarter or two.
That said, I think there is good reason to believe that Pfizer is about to cut its dividend, not increase it. Veteran Pfizer investors will recall the $68 billion merger with Wyeth in 2009 that led to the company's first major dividend reduction in decades. When the dust settled, this megamerger caused the world's largest drugmaker to slash its quarterly payout in half, from $0.32 to $0.16 a share. Given that Pfizer has signaled another mega deal is likely via its failed pursuit of AstraZeneca, and it can no longer access its foreign cash reserves to execute a deal without a heavy tax liability, I think the die has been cast for a marked dividend reduction.
Leo Sun: PDL Biopharma (NASDAQ:PDLI) pays a forward annual dividend of 7.7%, making it the highest yielding stock in the healthcare sector. PDL acquired a portfolio of royalties and patent assets over the past few years to generate a steady stream of revenue and profits.
But there are several red flags ahead. First off, PDL's free cash flow over the past 12 months comes in at $28.7 million, yet it paid out $93.2 million in dividends. FCF was weighed down by several deals, including the $240.5 million purchase of DepoMed's royalty streams for diabetes and other drugs last October, and a $70 million financing deal with Durata Therapeutics last November. PDL needed those deals to diversify its top line beyond its "Queen" patents for humanized antibody technology, which account for a large portion of its top line. The last of the Queen patents were expected to expire at the end of 2014, but a settlement with Roche's (NASDAQOTH: RHHBY) Genentech in February allows PDL to recognize revenue from several Queen patents through 2016.
The problem with PDL Biopharma is its future beyond 2016. As PDL makes more deals to diversify its pipeline, its dividend payouts could remain higher than its FCF, leading to a big dividend cut.
Jordan Wathen: It seems unfathomable that Fifth Street Finance (NASDAQ:FSC) could be headed for a dividend cut. After all, the company only recently increased its dividend in July, partially reversing a dividend cut from December.
Fifth Street Finance has been one of the hardest hit by falling middle market loan yields. The company's origination platform, which is built on the back of private equity buyouts, is prone to more competitive pressures than its rivals. Last quarter, yields on its investments fell from 11.4% to 10.8% year over year.
Furthermore, the company's asset manager, Fifth Street Asset Management (NASDAQ:FSAM) recently went public, which may put new pressure on Fifth Street Finance to grow. Growth can be good for BDCs, but with yields down, adding new loans at lower interest rates only weakens its ability to pay its current dividend. The company earned just $0.25 per share in net investment income last quarter, $0.05 per share less than its current dividend payout.
That's a steep difference to make up, made only more difficult by the conflicts between the external manager and Fifth Street Finance. I wouldn't put much faith in Fifth Street Finance's current dividend over the long term.