I recently wrote a cautionary story about the risk of dividend cuts in high-yield stocks, using Pengrowth Energy (NYSE:PGH) as the example.
And on Wednesday, the shock of reduced dividends was highlighted for shareholders with the crash and burn of RadioShack (NYSE:RSH). The retailer eliminated its dividend altogether, and shares melted down around 30% in one day as a result. Those who bought in recent weeks with the hopes of an 18% annual dividend yield learned a painful lesson.
The disastrous implications of a dividend cut need no further explanation. So today, I’ll focus instead on a look forward to companies that might be in store for dividend trouble. That’s because the dividend payouts are consuming the lion’s share of company earnings — and simple math dictates that it will be impossible for the company to increase the dividends, and a drop in profits might result in a cut to dividend payments.
For the record, I’m not talking about mREITs that have volatile dividend histories here because of their structures — or ADRs that pay semiannual or annual dividends. I’m talking about your conventional stocks that pay dividends each quarter on a supposedly consistent basis; these are stocks that you expect to keep dividends steady … but actually are at risk.
So what dividend payers are cause for concern? Here are two:
Annual dividend: $1.08 (27 cents quarterly)
Fiscal 2012 EPS forecast: $1.28
Payout ratio: 84% of earnings
I live in the D.C. metro area served by Pepco (NYSE:POM), so I’m painfully aware of its problems as a utility stock. Service is lackluster, and response to storms is abysmal. As a result, regulators and politicians have been looking for ways to punish the stock, force it to improve its infrastructure and demand accountability. As a result, Pepco reluctantly invested nearly $900 million in its transmission and distribution infrastructure last year — 15% of its fiscal 2011 revenue that totaled $5.9 billion. Throw in a slow economic recovery in the U.S. hurting energy demand, and things aren’t pretty.
The result is that the company is using more than 80 cents out of every dollar in profits to pay its dividend. That doesn’t bode well for dividend increases. You might like the 5.5% yield, but there are much more stable utility stocks out there with a better chance of dividend increases.
Annual Dividend: 84 cents (21 cents quarterly)
Fiscal 2012 EPS forecast: 94 cents
Payout ratio: 89%
Regal Entertainment Group (NYSE:RGC) is a cinema operator that is being pinched by both weak consumer spending and the rise of high-quality home entertainment in a digital age. The movie-going public does like a good blockbuster, as evidenced by The Avengers from Disney (NYSE:DIS) that shattered box-office records earlier this year, and the recent reception of Time Warner (NYSE:TWX) Batman flick The Dark Knight Rises, but theaters certainly aren’t seeing the profits they used to.
Just look at RGC revenue, which has flat-lined — actually declined slightly — for the past four years. Earnings haven’t been much better. The company has a five-year “growth” rate of -20%. The result is a dividend that has flat-lined and is in danger of being cut if profits head farther south. The company spends roughly 90 cents out of every dollar to pay a dividend, so think twice before chasing that 6.3% yield.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves did not own a position in any of the stocks named here.