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3 Companies That Could Slash Their Dividends

By Motley Fool Staff - Jan 19, 2015 at 8:38AM

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Income investors need to watch out for what's around the corner for these three dividend-paying stocks.


Source: Images Money.

Income investors have relied on dividend-paying stocks recently in order to get the high yields they need to make ends meet, especially with low rates on other types of income-producing investments. Yet dividend stocks aren't invulnerable to pressures that can result in their having to reduce their payouts to shareholders, and when that happens, share prices can plunge, leaving investors burned twice.

To help you identify stocks with some danger for dividend investors, three Motley Fool contributors picked companies that they believe could slash their dividends in the near future. Their views certainly aren't a guarantee that dividend cuts will occur, but they nevertheless believe that some danger signs warrant a closer look from current shareholders or those considering buying company shares.

Jeremy Bowman (American Eagle): Teen apparel retailers had a terrible 2014. Shifting tastes toward so-called fast-fashion retailers hammered stocks like Aeropostale, Abercrombie & Fitch, and American Apparel, all of which fell at least 20% in the last year. Of the group of struggling mall staples, American Eagle (AEO 7.06%) may have fared the best as the stock has bounced back from lows last summer and is now essentially flat over the last year, thanks to a better-than-expected holiday sales report.

Those improvements are relative to a terrible performance last year, however, as same-store sales for the holiday period beat expectations but still fell by 2%, worse than the 7% slide the year before. 

Those sliding comparable sales make its 3.6% dividend yield increasingly precarious. American Eagle pays out $0.50 per share to investors each year, but the company is projected to earn just $0.59 per share this year, making its payout ratio 85%, or 85% of its profits go to paying dividends. Generally, 80% is considered the limit for ensuring that a dividend is safe.

On a free cash flow basis -- a better way of measuring dividend safety since those payments must come from cash -- the numbers are more worrisome. In 2013, the company had negative free cash flow of $70 million, but paid out $72 million in dividends. Over the last four quarters, free cash flow has been essentially flat, but the company has paid out $96 million in dividends. This pattern is not sustainable.

The saving grace for investors may be the retailer's cash hoard, which, at $280 million as of November, is enough to fund dividends at current levels for about another three years, but doing so without an improvement in the underlying business would be irresponsible. Management is probably loath to cut the dividend, and analysts expect increased profits this year, but if that doesn't happen the dividend could soon take a hit. This is a company in the midst of a turnaround and the underlying health of the business is more important than quarterly payouts to investors.

Dan Caplinger (Family Dollar): One stock that's almost certain to disappoint dividend investors this year is Family Dollar (FDO.DL). As the only one of the major dollar-store discount retailers to pay a dividend, Family Dollar's 1.6% yield will disappear if shareholders accept Dollar Tree's (DLTR 1.38%) $8.5 billion acquisition bid to buy out the company. Under the terms of the deal, Dollar Tree will pay Family Dollar shareholders $59.60 in cash for every share they own, as well as roughly $14.90 in Dollar Tree stock.

Source: Family Dollar.

With a vote scheduled for Jan. 22, the Dollar Tree deal isn't a sure thing, especially since two previous meetings scheduled to produce a decision have delayed taking a vote. But in all likelihood, any rejection of the Dollar Tree bid would come with the expectation that Family Dollar would accept rival Dollar General's (DG 1.52%) unsolicited bid for $78.50 in cash.

Even if Family Dollar's deal with Dollar Tree goes through, nowhere in Dollar Tree's press release about the acquisition offer does it mention any plans for the merged company to start paying a dividend. Of course, Family Dollar shareholders will have the right to take their cash and invest it in other income-producing stocks. But for those who want to stay invested in the deep-discount dollar-store retail space, the most viable investment option for income investors is likely to disappear once a deal is approved.

Bob Ciura (CTC Media): On the surface, small-cap independent media company CTC Media's (CTCM.DL) 14% dividend yield is tantalizing for income investors. However, the company is at high risk of a significant dividend cut, with two huge factors putting its dividend in jeopardy. First, the company is set to distribute more in dividends than it generates in underlying profits in 2015. Second, CTC Media is located in Russia, making it highly exposed to the collapsing Russian economy.  

Source: Wikimedia Commons, courtesy Bernt Rostad.

CTC reported a 16% decline in diluted earnings per share in the past three quarters combined, year over year, as revenue declined 8% due to weakening content sales in several markets, including Ukraine. Earnings suffered mightily from the devaluation of the Russian ruble, a major consequence of the collapsing Russian economy due to crashing oil prices, economic sanctions, and a weak European economy.

CTC's earnings are now dangerously close to not covering its dividends. Over the first three quarters of the year, dividends totaled $0.525 per share, but earnings clocked in at just $0.57 per share. Should CTC's fundamentals deteriorate further, it may have to cut its dividend.

For the full year, CTC management expects a 30% operating profit margin, which would be a decline from last quarter and is a troubling signal. This implies that earnings may continue falling, which puts its dividend in the cross-hairs. This fear is evident in CTC's stock price, which has fallen 56% over the past six months. At a 14% yield, the market is now pricing in the possibility of a dividend cut, and investors should do the same.

Bob Ciura has no position in any stocks mentioned. Dan Caplinger has no position in any stocks mentioned. Jeremy Bowman has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Family Dollar Stores Inc. Stock Quote
Family Dollar Stores Inc.
FDO.DL
American Eagle Outfitters, Inc. Stock Quote
American Eagle Outfitters, Inc.
AEO
$13.80 (7.06%) $0.91
CTC Media, Inc Stock Quote
CTC Media, Inc
CTCM.DL
Dollar Tree, Inc. Stock Quote
Dollar Tree, Inc.
DLTR
$168.22 (1.38%) $2.29
Dollar General Corporation Stock Quote
Dollar General Corporation
DG
$256.78 (1.52%) $3.84

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