1100 13th Street, NW, Suite 1000Washington, DC 20005202.887.6400Toll-free: 800.544.0155
All Contents © 2020The Kiplinger Washington Editors
By Will Ashworth, Contributing Writer
| March 5, 2020
The Dow Jones Industrial Average hit an all-time high of 29,551.42 on Feb. 12. Investors continued to pile into stocks despite excessive valuations and global fears of the coronavirus – an outbreak that has already made SARS relatively tame by comparison.
The worst, investors thought, was over. The number of new cases had plateaued. Then news surfaced Feb. 24 that cases of coronavirus were surging outside China. The Dow lost 14% of its value over the next five days of trading, closing at 25.409.36. The Dow has continued to log massive price swings since then.
Volatility is back, and investors seeking shelter from this storm might be interested in owning dividend stocks to ride it out. That's a good idea, but remember: Dividend-paying companies are not all the same.
The DIVCON system from exchange-traded fund provider Reality Shares is helpful in an environment like this when quality is essential. DIVCON's methodology uses a five-tier rating to provide a snapshot of companies' dividend health, where DIVCON 5 indicates the highest probability for a dividend increase, and DIVCON 1 the highest probability for a dividend cut. And within each of these ratings is a composite score determined by cash flow, earnings, stock buybacks and other vital factors.
If dividend safety is your focus, you want to own DIVCON 5 stocks because they are the crème de la crème of dividend safety – and more likely to keep the dividend increases. The lower the score, the more cautious you should be.
Here are seven dividend stocks to sell or stay away from based on low DIVCON ratings over the past couple of months. While the fundamentals behind the scores are hardly death sentences, these stocks are best avoided or sold so you can put your money to work in more resilient opportunities.
Data is as of March 4. Dividend yields are calculated by annualizing the most recent payout and dividing by the share price.
Market value: $2.0 billion
Dividend yield: 8.3%
DIVCON rating: 1
DIVCON score: 28.0
International Game Technology (IGT, $9.61) has been flashing warning signs that DIVCON has been picking up for some time. Among them, the manufacturer of casino gaming systems has generated negative free cash flow (FCR) for years. (Companies use free cash flow to pay their dividends.)
When we last covered IGT, DIVCON also noted the company's Altman Z-score:
"Altman Z uses five factors to measure a company's credit strength; a score of 3 or above means a low/negligible probability of bankruptcy, 2.99 to 1.81 means a moderate probability and any score of 1.8 or below indicates an elevated likelihood. (For context, the median score among the largest dividend payers is 3.9.)"
At the time, IGT had an Altman Z-score of 1.61, and it has since improved a little to 1.86 – though that score is hardly reassuring.
More troubling if you're looking for sustainable dividend stocks is the fact that through the first nine months of its 2019 fiscal year, International Game Technology paid out $258 million in dividends – more than the $250 million in net income it made through Q3 2019.
Free cash flow has been improving, though. For the first nine months of fiscal 2019, IGT had free cash flow of $456.0 million, which is substantially higher than the first nine months of 2018. But the timing of FCF can be sporadic, depending heavily on things such as sales contracts. Furthermore, note that International Game Technology has net debt of $7.4 billion, which is more than three-and-a-half times greater than its market value, and dwarfs its cash of about $202 million.
One last negative indicator is a Bloomberg dividend health score of -31 (a scale of -100 to 100; a positive score indicates a higher potential for dividend growth), which tells investors you shouldn't expect much if any dividend growth in the future.
Market value: $7.2 billion
Dividend yield: 3.0%
DIVCON rating: 2
DIVCON score: 43.75
Xerox's (XRX, $33.69) DIVCON score isn't anything to write home about, but perhaps the most pressing issue for the printer-and-copier company right now is its inability to successfully navigate a hostile takeover of HP (HPQ).
In November, Xerox made an offer to buy the maker of laptops, printers and printer cartridges for $22 a share, with 77% of the acquisition price paid in cash and the rest with Xerox stock. In February, Xerox upped its offer to $24 a share, stating that it would begin a tender offer in early March. That offer would have paid interested HP shareholders $18.40 in cash and 0.149 Xerox shares for each share of HPQ – a 41% premium to its 30-day volume-weighted average trading price as of Feb. 10.
It would have – but HP rejected the deal, saying it "meaningfully undervalues HP and disproportionately benefits Xerox shareholders" and would offer "shareholders something they already own."
Instead, HP has adopted a one-year shareholder rights plan that would prohibit anyone (including activist investor Carl Icahn, who owns 10.9% of Xerox and 4.2% of HP) from acquiring more than 20% of the company. In addition, HP has said it will buy back $15 billion of its stock over the next three years and secure annual cost savings of at least $1 billion by the end of fiscal 2022.
Ironically, the rejection might force Xerox to spend its cash elsewhere – perhaps improving a dividend that has remained flat for years. Or perhaps it will pay off some of its debt, which stands at $4.6 billion, versus $2.7 billion in cash. But the fact that Xerox has been rebuffed on a takeover it has so aggressively pursued might indicate that it's struggling to come up with other means of growth.
Market value: $13.5 billion
Dividend yield: 4.7%
DIVCON score: 26.5
Halliburton (HAL, $15.39), the world's second-largest oilfield services company, hasn't had an easy time in recent years – something you can say about many oil-related stocks. Analysts were optimistic about the company's prospects for the year ahead, but the coronavirus's hit to energy demand in 2020 has been downright dreadful. HAL shares have hemorrhaged 37% in just more than two months.
It was struggling before that, too. In January, Halliburton reported a fourth-quarter loss of $1.7 billion, due to a $2.2 billion pretax charge against earnings to account for deterioration in the U.S. shale market. The company had to cut 8% of its North American workforce in mid-2019. In October, Halliburton cut 650 jobs in four states out west. Then in early December, it cut another 808 employees from its El Reno operations in Oklahoma.
If you're an income investor, you want to avoid dividend stocks that might have trouble paying their quarterly dole, both in the short-term and on a sustainable basis in the future.
Halliburton's DIVCON 1 score, which is down from its DIVCON 2 status late last year, reflects several weaknesses, including an increasingly troubling dividend-to-FCF ratio. At the end of fiscal 2019, Halliburton had $920 million in free cash flow, down from $1.1 billion a year earlier. The company paid $630 million in dividends, representing 68% of free cash flow. That's up from 57% the year before. Pressures on its profits threaten to further weaken that stance.
Halliburton's yield is nearing 5%, but don't let that tempt you.
Market value: $2.8 billion
Dividend yield: 2.8%
DIVCON score: 25.75
Spectrum Brands Holdings (SPB, $60.58) had a transformational year in fiscal 2019, selling Rayovac, Armor All and STP for a total of $2.9 billion, reducing the number of brands it owned and the businesses it operated, opting instead to focus on cutting costs, paying down its debt, and returning capital to shareholders. Its remaining brands are nothing to sneeze at, including Kwikset door locks and hardware, Pfister faucets and showerheads, Iams pet foods and Hot Shot insecticides.
The good news? As a result of its divestitures, Spectrum Brands' long-term debt fell from $4.6 billion in fiscal 2018 to $2.3 billion at the end of December, the first quarter of its fiscal 2020. That's a healthy 50% reduction in its debt. The stock did fantastically last year, gaining more than 50%.
Its quarterly results weren't as encouraging, and in fact were downright ordinary. Organic sales declined 0.3% year-over-year to $871.5 million while its adjusted EPS fell by a penny to $0.20. Spectrum continues to work on its productivity improvement plan that's expected to boost sales while cutting costs, resulting in free cash flow growth in 2020.
Nonetheless, in 2020, Spectrum Brands' DIVCON rating dropped from 2 to 1, putting it among the riskier dividend stocks out there.
One of the biggest issues is free cash flow, which continues to be a worry. It has plenty to cover the dividend, but it's looking more extended when you factor in the stock buybacks; the company entered into an accelerated share repurchase program during the first quarter. On Feb. 19, the company reaffirmed its annual guidance to generate an adjusted net free cash flow of $240 million to $260 million. It has already paid out $236 million in dividends and share repurchases with three quarters to go in fiscal 2020.
Market value: $13.4 billion
Dividend yield: 5.1%
DIVCON score: 40.75
In the fourth quarter of 2019, Seagate Technology (STX, $51.44) is a data storage company that provides hard drives, solid state drives and other solutions, and its shares have been a roller-coaster ride for years.
Its DIVCON rating was recently lowered from 3 to 2, and its DIVCON score of 40.75 isn't close to being the worst among these stocks. But it doesn't look great. A decline in earnings, an Altman Z-score of 2.49 (which is neither distressed nor safe, but somewhere in between) and a Bloomberg dividend health score of 8 (between -100 and 100) are all reasons to give the company a leery eye.
For the quarter ended Jan. 3, 2020, Seagate reported revenues of $2.7 billion that were slightly down year-over-year. Its adjusted profits were much worse, sinking 16.9% to $359 million. It wasn't so bad on a per-share basis, down 10.6% to $1.35 per share, mostly because the company has been buying back shares at a rapid clip.
That's no surprise, despite a yield of 5%-plus that's sky-high among tech-focused dividend stocks. According to DIVCON's data, Seagate spends 186% more in share repurchases than it does on dividends. In the first six months of its current fiscal year, STX repurchased $639 million of its stock at an average price of $48.92 a share. By comparison, it paid out $335 million in dividends during the first two quarters of the current fiscal year.
The worry here is more years like in its fiscal 2019, ended June 28, when it paid out $1.68 billion in dividends and share repurchases, versus $1.16 billion in free cash flow. That left nothing for debt repayment – and considering Seagate's $4.1 billion in long-term debt versus $1.7 billion in cash, that's not great.
Market value: $7.9 billion
Dividend yield: 10.7%
Targa Resources (TRGP, $33.96) has failed to deliver for shareholders for years now, delivering a 49% loss over the past five years, even including its generous dividend. But the midstream energy company – it owns natural gas, natural gas liquids (NGLs) and crude oil transportation, processing and storage infrastructure – is flashing small signs of a potential turnaround. That would go a long way in ensuring Targa's 91-cent-per-share quarterly dividend remains a big part of its shareholder rewards.
You wouldn't know it by its lousy DIVCON rating and score, but Targa actually finished fiscal 2019 in an upbeat fashion. Revenues fell 5% to $2.47 billion in the fourth quarter, but its distributable cash flow (DCF, an important profitability metric for midstream energy companies) jumped 53% to $327.8 million. For the year, DCF was basically flat at $947.2 million.
In the fourth quarter, Targa paid out $212 million common stock dividends, along with $22.9 million in Series A preferred stock dividends. Thanks to the higher year-over-year distributable cash flow, TRGP's dividend coverage was 1.4 times the dividends paid out in the quarter compared to 1.0 dividend coverage for all of 2019.
That said, Targa is being dragged down by the rest of the energy sector amid the coronavirus outbreak and the subsequent worries about energy demand. The company also boasts an Altman Z-score of 1.07, which indicates a high possibility of bankruptcy over the next two years. Total debt of $7.9 billion at the end of December 2019, versus just $331 million, really drives that point home.
The dividend might very well be safe in the year ahead, but TRGP still belongs among dividend stocks to sell or avoid until it looks better prepared to make a concerted comeback bid.
Market value: $11.4 billion
Dividend yield: 3.8%
DIVCON score: 24.25
Wynn Resorts (WYNN, $105.66) is among the stocks being hit hardest by the coronavirus outbreak. While Americans are likely to know the company for its U.S. properties, the company has a deep, established presence in the China's special district of Macau – almost 75% of its adjusted property EBITDA (earnings before interest, taxes, depreciation and amortization) effectively comes from China.
And Macau just suffered a record 87.8% year-over-year plunge in gross gaming revenue during the month of February, with much of that coming amid casinos shutting down wholesale for two weeks to stem the outbreak's tide.
Wynn Resorts is expected to pay out $4 per share in dividends; analysts estimate the company will earn $4.25 per share this year – already exceedingly tight dividend coverage, and that's based on current expectations that could very well erode if the outbreak continues apace. The picture isn't any better when you look at free cash flow; Wynn's FCF has been negative in five of the past six years.
Other indicators, including a negative Bloomberg dividend health score and an Altman Z-score of 1.44, don't bode well for Wynn's stock or its payout. But the biggest danger to the stock right now is the most apparent and obvious one, and it's more than enough reason to avoid this dividend stock right now.