I have written about how the impact on the market from the COVID-19 crisis is a good time to build your dividend portfolio in order to secure stocks that have gone down in price but have also seen their annual dividend yields go up. See here.
We can look back at some data now that we have a few months of this crisis in the rear-view mirror. The S&P 500 declined more than 30% between February 21st and March 23rd. Due to the drop in stock prices the S&P 500 dividend yield grew from 1.9% at month-end in February to 2.3% at month-end in March. The index’s yield has since dropped back to 2.0% at the end of April as the market has staged a pretty impressive rally. No one knows if it will last or if we will get a retest of the lows as unemployment and loan defaults pile-up or if we get a second wave of the virus or some failures on the vaccine trials.
If the market does not retest the lows has the opportunity to get quality dividend stocks at low prices and higher yields passed you by already? Not necessarily because much of the rally has been driven by big technology. There are still stocks generating impressive dividend yields relative to their historical averages. The last several months have introduced many more opportunities in specific securities. There are still dozens of companies in the S&P 500 index that are generating average annual dividend yields in excess of 5%. Many of these stocks are still selling at depressed levels and they are typically in some of the more challenged sectors – energy, financials, and real estate.
Now, we have to be careful with these sectors and some of these companies are likely to cut their dividends or have significant going concern issues if they are over-leveraged. So far this year, fifteen S&P 500 companies have reduced their dividends and another 29 companies in the index have suspended their dividends. If you were relying on dividends from these companies for passive income then your passive income for the next year or two is going to take a hit. Also, if you bought a stock as a dividend stock that has subsequently cut or suspended its dividend then you need to re-evaluate whether you still want to own the stock. Things are never easy.
So what is a person to do? Part of the answer is take a look at the recent earnings call transcripts of dividend companies you own or are thinking about purchasing. Get a general sense on how the company is performing and perform a word search on key words such as “dividend” or “distribution” and “balance sheet.” Take a look at what the company is saying about its dividend and financial strength – this will help you determine the safety of a current dividend being paid by the company.
Look at These Three Things when Evaluating a Dividend
I look at three things when thinking about a company’s dividend strength:
- Is the company committed to paying the dividend? A lot of companies are either reaffirming or distancing themselves from their dividends. For example, Realty Income is a real estate company that calls itself the Monthly Dividend Company. Its business is under some duress but it will do whatever it can to protect its dividend and its brand. This is the first step to determining if a dividend is safe. Other companies, like Disney, have suspending their dividends because they likely view dividends as less critical to their overall value proposition to investors.
- Does the company’s operating cash flow still cover the dividend or is the dividend being paid using other sources of cash? If the dividend is not supported by operating cash flow for a prolonged period of time then at some point there will need to be a dividend cut or suspension. Look at the a company’s payout ratio (the more it is below 100% the better in terms of being able to pay a sustained dividend at current levels) and free cash flow (the actual cash it can use to pay things like dividends and debt).
- Does the company have a solid balance sheet? I basically look at whether the company (i) has cash and other sources of liquidity to pay the dividend if its operating cash flow cannot pay for the dividend for a few quarters and (ii) does it have a manageable level of debt with no significant debt payments due in 2020.
Finally, companies that are committed to the dividend but going through really tough times may cut the dividend until things get better. A lot of strong dividend companies cut dividends during the 2008 financial crisis but re-instated those dividends within 12 months. It is worth looking at what a company did from 2008-2011 regarding its dividend if you are worried about a dividend cut or suspension.
So, the rest of this article will show you the language I paid attention to regarding dividends when I reviewed earnings information for companies I hold in my portfolio. I spent about 8-10 hours reading and listening to earnings updates. Based on this review I have broken my larger holdings that pay dividends into rock solid, pretty good, and at-risk dividends. It has definitely helped me refine the companies I want to invest in over the next few quarters, especially if their prices remain depressed. I suggest you do the same for any stocks that you plan to have as part of your passive income strategy.
One final note – if you can read financial information this is why picking solid companies is way better than index fund investing. With index funds, or even sector-ETFs, you get the best-in-class stock along with the garbage companies that might have some real issues if there balance sheets suck. See here.
Rock Solid Dividends
Apple – Apple sends signal of strength through its dividends and share repurchases
“Apple’s board of directors has declared a cash dividend of $0.82 per share of the Company’s common stock, an increase of 6 percent. The dividend is payable on May 14, 2020 to shareholders of record as of the close of business on May 11, 2020. The board of directors has also authorized an increase of $50 billion to the existing share repurchase program.”
Abbvie – Allergan transaction is expected to keep the dividend strong and growing.
The Allergan deal “provides significant additional earnings in the period following the loss of HUMIRA exclusivity, and the transaction provides enhanced cash flow to support a strong and growing dividend while rapidly paying down debt and continuing to invest in our innovative pipeline through increased R&D funding and the acquisition of mid to late stage assets.”
Microsoft – Dividends from this juggernaut remains safe because COVID-19 has had no negative impact on earnings.
This says it all, “COVID-19 had minimal net impact on the total company revenue” with revenues up 40% from last year.
Verizon – Strong balance sheet and cash flow will support the dividend which is number #2 in priorities after making sure we keep the lights on!
“Free cash flow for the quarter was $3.6 billion, which was up 26.2% year-over-year and continues to fund our dividend.
“Yeah. First of all, I think we talked about where we stand on the balance sheet and the great work the team has done with the balance sheet, not only in the last couple of years, but also in the first quarter. We feel that we’re in a very good position with our balance sheet and that can be seen that we both increased our capex this quarter as well as major acquisition of BlueJeans. We have our capital allocation priorities very clear for us; number one is the business; number two is the shareholders (through a dividend); three is the debt reduction; and number four is buybacks.
And we feel that we’re in a really good situation to continue to put our Board in the right position to serve our shareholders with dividends, but as we said on the Investor Day, when it comes to buybacks, that’s probably unlikely happening this year, given the situation. But all other priorities, we are definitely in a very good position to serve at this moment.”
Pretty Good Dividends Safety
Archer Daniels Midland – Ample liquidity to support dividend for foreseeable future.
“In future quarter ends, you should expect us to carry significantly lower cash balances as we now have the other liquidity facilities in place. We also had $5.6 billion of readily marketable inventories, which, if needed, we could sell very quickly and turn into cash. When taken together, we feel confident that we will be able to comfortably weather any prolonged downside economic scenarios and continue funding all of our financial and capital spending obligations, including dividends, in the foreseeable future.”
AT&T – The Company remains very committed to the dividend and has the ability to pay it, okay? So stop asking.
“So here’s what we’ve done and what you can expect. As you know, we’ve suspended share retirements. We have a strong cash position, a strong balance sheet, and our core businesses are solid and generating good cash flow. We are sizing our operations to reflect the new economic activity level and we’re leaning into our cost and efficiency initiatives. As a result, you should expect the following: We will continue investing in our critical growth areas like 5G, broadband, and HBO Max. We remain committed to our dividend. In fact, we finished last year with our dividend as a percent of free cash flow a little over 50%, and even with the current economic crisis, we expect the payout ratio in 2020 to be in the 60s and we’re targeting the low-end of that range, which is a very comfortable level for us. And last, we’ll continue to pay down debt and maintain high-quality credit metrics.”
Management reiterated their commitment to paying the dividend at least four times during analyst questions.
Bank of America – Low payout ratio should keep dividend in place even in an adverse situation.
“In terms of the dividend, we kept the dividend payout ratio below 30% of the sort of normalized earnings level and we did it for a reason that we – one of our operating principles is we want to maintain a dividend. And given what we know we’ve done twice the dividend this quarter, $0.40 versus a $0.18 payout ratio and we expect that to continue. And that shows you the 100 plus basis points – 130 basis points of excess capital. We’ve tested it lots of ways as you might expect.”
Cardinal Health – Another solid dividend declared on solid earnings.
“Third quarter GAAP operating earnings increased 30% to $562 million. Non-GAAP operating earnings increased 8% to $719 million. GAAP diluted earnings per share (EPS) increased 20% to $1.19, while non-GAAP diluted EPS increased 2% to $1.62.”
“Now let me shift gears and discuss capital allocation. We remain committed to a disciplined and balanced capital allocation approach that prioritizes reinvesting in the business, maintaining a strong balance sheet, and returning cash to shareholders in the form of a dividend.“
“With respect to the dividend, our Board of Directors recently approved a 1% increase. Finally, going forward, we will continue to evaluate M&A and share repurchases. But in the near term, our other capital allocation priorities take precedence. To close, we are focused on supporting the healthcare system now and into the future. We play a critical role in helping our customers combat many of the challenges this pandemic has presented. Simultaneously, we are maintaining a strategic focus on positioning ourselves for the future.”
Chevron – Number 1 priority is to protect the dividend and the company has taken actions to back it up.
“Our decision to suspend the repurchase program, lower costs and flex capital down will reduce the pull on our balance sheet…. All our actions are consistent with our long-standing financial priorities, and number one is to protect the dividend, which we know is vital to our shareholders.”
“We’re protecting the dividend because we’re set up to do so, and we’ve made it a priority. As Pierre said, we enter with balance sheet strength that is second to none, an advantaged portfolio with a low breakeven, capital discipline that’s part of our DNA. We’ve demonstrated it through the way we’re managing capital spending, our discipline on transactions. And we’ve got capital flexibility. And all of this is because we’re committed to the dividend. And you can see that while we do lean on the balance sheet to fund the capital program over this period of time, we can support the dividend comfortably and still remain in a very healthy position, and we’ve set ourselves up to do so.”
Enterprise Partners – Current distribution level seems safe for now; future distribution growth will be reviewed on a quarterly basis.
“We define payout ratio as the sum of cash distributions and buybacks as a percent of cash flow from operations. Our payout ratio was approximately 56% for the first quarter of 2020 cash flow from operations. In January, we provided guidance that we expected to increase our distribution related to the first quarter of 2020 by $0.025 to $0.4475 per unit.
Given the economic sudden stop and uncertainty related to coronavirus, we thought it was prudent to hold our distribution flat at $0.4450. It will be paid on May 12. This distribution represents a 1.7% increase when compared with the same quarter of 2019. Given the current macroeconomic backdrop, we will be deliberate and our board will evaluate our distribution growth quarterly in 2020.”
Equity Residential – Rent collections steady, the balance sheet is in good shape, and very little debt coming due in 2020.
“Finally, a few highlights on our balance sheet. We ended the first quarter with an incredibly strong net debt to normalized EBITDA of 4.9 times and nearly $1.8 billion in liquidity under our revolving credit facility. Subsequent to quarter end, we improved this already strong position by closing on a very attractively priced 2.6% or $195 million 10-year GSE loan and by closing on the sale of an asset in the San Francisco Bay Area. With these steps, we sit here today with over 84% of our total NOI unencumbered, about $150 million in commercial paper outstanding and readily available liquidity of over $2.2 billion under our revolving credit facility, which does not mature until 2024. This liquidity is more than sufficient to address our modest level of anticipated development spend, minimal debt maturities in 2020 and to address our next significant debt maturity, which isn’t until December of 2021. Our balance sheet is in excellent condition to weather the storm and take advantage of opportunities should they present themselves.”
Realty Income Corp – It took this company 25 years to become a Dividend Aristocrat and they are not going to give up that title without a fight.
“In summary, our balance sheet is in great shape, and we continue to have low leverage, strong coverage metrics and ample liquidity. In March, we increased the dividend for the 106th time in our company’s history. We have increased our dividend every year since the company’s listing in 1994, growing the dividend at a compound average annual rate of approximately 4.5%. And we are proud to be one of only three REITs in the S&P 500 Dividend Aristocrats Index for having increased our dividend every year for the last 26 consecutive years. As we navigate through the current state of economic volatility and uncertainty, we believe a strong financial position is paramount. The time line for economic uncertainty remains unclear, but we believe we are well positioned with significant financial flexibility. Further, we believe we are well positioned to capitalize on opportunities going forward once we receive additional clarity regarding the current crisis.”
And from Q&A with analysists:
“So I have a couple of quick questions. One is many of the other questioners asked a lot of my questions, so that was really good. But I guess I’m thinking of just from a more long-term perspective as it relates to your dividend, which is kind of your brand in terms of the from the retail perspective. I guess, fundamentally, how safe is this dividend? And how much pressure is there on you and your organization to continue to meet the criteria to be a dividend aristocrat? I’m thinking because and the reason I’m asking is because when I look at these what percentage over 11% of your top 20 tenants by revenue being restaurants or casual dining, gyms and theaters, my perspective is that these things aren’t going to come back for a long time, like you said.
And even when the restrictions are lifted, from a government perspective, there’s very I see more bankruptcies coming from these theaters and restaurants. And as you said, maybe not as much from gyms, but the overhead and capital structure of these institutions seem very weak, if you have to go for three or four or six months without any revenue anyway. So that’s sort of a fundamental question. Would you guys borrow money or would you need to borrow money to continue to pay that dividend? That’s sort of my first question.”
President and Chief Executive Officer
“We have 20% of room within our business model to help support the dividends that we have in place. Yes, it is our brand. We are the monthly dividend company. It is very much part and parcel of how we operate our business. It is our mission. And so this is one of those tools that we certainly have available to us to manage liquidity but one that we feel, at least given the lay of the land today and despite all of the things that you’ve laid out, we do not need to pull on.”
“And part of that goes back to the liquidity strength that we have to be able to withstand disruptions, even medium-term disruptions, and still be able to maintain a profile of the business that continues to be very strong and continues to support the dividend. As you know, we were added to the Dividend Aristocrats earlier this year. It took us 25 years to get there and we don’t want to lose that.”
Wells Fargo – We have a strong balance sheet and the government won’t let us use it so our high dividend yield makes sense! We will keep paying it if we can and we feel good about it based on the stress tests we have run on our assets.
Well, listen, I think certainly, the dividends are certainly important for all of those that own the stock, and ultimately those that wind up benefiting from stock ownership or for individuals in one way or another, whether it’s direct holdings or whether it’s pension plans and things like that. And so, I think the income stream that people come to rely on, especially, in times like this is important, but there has to be an underlying ability for companies to be able to pay. And so, to the extent that they have that ability to pay, I certainly think it’s the right thing to do for the reason today that I just said.
We have strong capital ratios. We do all the stress test and whatnot that John referred to and determine our ability to return capital in this severely stressed environment. Also remind you that for us, we are slightly different than others because of the balance sheet cap. So our balance sheet cap does limit our ability to deploy capitally — to deploy capital internally. And so, based on that, that’s why we sit here and look at and say that we think the dividends certainly that we’re paying makes sense. But as I alluded in my prior comments, we don’t know what the future looks like. Based upon the assumptions that we’ve laid out in these very stressed environments, we do feel good about it, but ultimately, the timing and the pace of the recovery is going to determine earnings capacity for everyone to be able to continue to support the level of dividends.
At-Risk but Committed to Dividends
Simon Property Group – Unprecedented times for this best-in-class retail REIT but it is heading into this war with a best-in-class balance sheet that provides over $8 billion of liquidity. The company intends to pay a cash dividend in June.
“Let me turn to the dividend. The Board will declare a second quarter dividend before the end of June and that dividend will be paid in cash. We expect to pay out at least 100% of our taxable income in 2020 in cash. As a point of reference, there have been over 175 public companies who have either suspended or reduced their common stock dividend by 50% or more. We will not be one of those companies.”
Energy Transfer – First quarter cash covered latest distribution but probably not as well positioned as EPD.
“Distributable Cash Flow attributable to partners, as adjusted, for the three months ended March 31, 2020 was $1.42 billion, a decrease of $177 million compared to the three months ended March 31, 2019, primarily due to the decrease in Adjusted EBITDA. Distribution coverage ratio for the three months ended March 31, 2020 was 1.72x, yielding excess coverage of $594 million of Distributable Cash Flow attributable to partners in excess of distributions.”
Exxon – We value the dividend (said with a little less conviction and a little more wiggle room than Chevron). Plus, we know the share price is screwed if we cut the dividend.
We remain committed to our capital allocation priorities: investing in industry advantage projects that grow cash flow in support of reliable, growing dividend and strong balance sheet. Obviously in this environment, it’s critical to strike the right balance across these priorities and to remain flexible to market developments, including an eventual recovery. And of course, do all of this while keeping our people and communities safe, protecting the environment and delivering the products that societies rely on.
Good morning, team. Thank you. Thanks for taking the question. Darren, I guess the first question is around capital allocation and dividend sustainability. We saw one of your peers reduce their dividend in light of the macro environment. Just want to get your views on the right level of distribution, how you think about dividend growth and how you think about that in terms of prioritization around capital allocation.
Chairman and Chief Executive Officer Response:
“I think as I said in my prepared remarks and I have repeated in some of our press release, the priorities in the capital allocation scheme that we’ve got have not changed with what we’re seeing here in the short term. And again, it kind of comes back to a large business that has depleting assets. You’ve got to continue to invest in industry advantaged accretive projects if you’re going to sustain a strong foundation to support the business going forward, a successful business, to support a growing and reliable dividend and to maintain a strong balance sheet. So, the projects investments are critical foundation to the long-term health of the business.
And then, obviously if you look at our shareholder base, about 70% of them are retail or long-term investors that look for our dividend and see that as an important source of stability in their income. And so we have a strong commitment to that and then finally making sure that we have a balance sheet to manage the volatility that we see in the ups and downs of the price cycles. Obviously, we’re in a pretty big dip here, which is outside of the normal price cycle volatility. But I think we’re demonstrating that the balance sheet is handling that through this time frame. So that priority remains the same.
And then I think the question — and I talked about this is on the Investor Day — is how you balance across those priorities in the short term. And so today as we to face these very short-term challenging market headwinds, we are making sure that we’re maintaining that dividend and continuing to advance the projects with the expectation that you will see a recovery, that revenues will rise, more cash will come in, which will allow us to continue to invest in those projects, and so that we’re not making a trade-off on the medium to long term, but one in a short term based on the needs of a lot of our investment base. And I would just tell you that we will continue to strike that balance as we go forward. If this market evolves and we see changes in a recovery that’s slower than what we even anticipated, recognized and been pretty conservative in our outlook, we’ll have to step back and look to see if we need to make any further adjustments there.
But my view is, if you don’t have those investments, you’re not providing the foundation to support that dividend. A lot of the projects that we’ve been putting in place, the capital we’ve been spending over the last couple of years, those projects are going to come online and start contributing cash. So I think we’re going to begin to see here in the next year or so a lot of the benefits associated with the investments we have been making, and that will contribute to the cash and provide the basis to support the dividend.”
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