I’ve written reams on the virtues of dividend stocks in recent years. With savings accounts and CDs yielding nothing — and bonds not yielding much better — the income alternatives have been slim. This has corralled investors into “bond substitutes” like dividend stocks.
Dividend stocks are generally a much better choice than bonds if your time frame is more than a couple of years. In addition to a competitive current income, you generally get dividend growth that keeps you a step ahead of inflation.
Even modest dividend growth of 5% per year will double your annual income after 14 years.
All of that is fine and good, but it won’t matter much in the event of a dividend cut. Years of dividend growth can disappear in a heartbeat when a company hits a rough patch. And I’m not talking about a market Armageddon like the 2008 meltdown. In 2015, a benign year here at home, there have already been 904 dividend cuts so far.
If you’re still saving for retirement, then a dividend cut is more of an annoyance than a cause for real concern. But if you’re already in retirement and you were counting on those dividends to pay your bills, then a dividend cut can be catastrophic.
Today, I’m going to take a look at three high-yielding dividend stocks I consider to be at serious risk of cuts.
Dividend Cut Danger: Caterpillar (CAT)
I’ll start with a company that has a front-row seat to China’s slowing … and the ripple effects that it is having on the world’s major commodities markets. And that would be Caterpillar (CAT).
Caterpillar is one of the highest-yielding stocks in the S&P 500 with a dividend yield of 4.3%. It has also raised that dividend at an 11% clip.
But the revenues and profits that fueled that dividend growth were themselves fueled by China’s construction bubble and by the decade-long boom in commodities prices. From 2002 to 2012, Caterpillar’s revenues more than tripled. But since then, they’ve stagnated and have actually fallen by nearly a quarter.
Caterpillar currently pays out a little less than half of its profits as dividends, so its dividend is safe for now. But Caterpillar’s business has hit a serious rough patch, and it might be one that lingers for a while. China is almost universally considered to be overbuilt, and most industrial commodities are in a deep bear market.
Caterpillar is a great company that makes great products. But none of that matters if there is no demand.
If CAT’s revenues continue to sink, expect to see management reconsider its juicy dividend.
Dividend Cut Danger: BHP Billiton (BHP)
Along the same lines, we have global mining giant BHP Billiton (BHP). Slumping commodities prices have taken a sledge hammer to BHP’s profits, yet the company sports a fantastic 7% dividend.
While BHP is a quirky company that is half British and half Australian, it is first and foremost a China story. Insatiable Chinese demand for iron ore helped to explode BHP’s revenues by more than a factor of four between 2001 and 2012. But since then, revenues have tumbled by about 40%.
BHP is already paying out more than it earns in dividends. And when you add to that BHP’s quirky corporate structure — which doesn’t allow the Aussie side of the business to pay dividends to British shareholders and vice versa — a dividend cut could come a lot sooner than anyone seems to expect.
For now, BHP management says that it is committed to keeping the dividend at current levels. We shall see…
Dividend Cut Danger: International Business Machines (IBM)
My last stock might raise a few eyebrows. For it is none other than Warren Buffett’s favorite, International Business Machines (IBM).
I should be clear here: I don’t see IBM cutting its dividend in the next year. IBM has enough cash on hand or, in the worst case, enough borrowing capacity to keep the divided intact for another several quarters. But IBM needs to get its business back on track pretty soon, or its fat 3.6% dividend will be on the chopping block.
Let’s look at the numbers.
At first glance, IBM’s dividend would appear to be the very definition of safety. The company only pays out 31% of its profits as dividends. But scratch below the surface, and you get a very different picture.
IBM’s revenues are in freefall. Over the trailing 12 months, IBM has brought in about $84 billion in revenues … less than what it made in 2000, 15 years ago. In 2011, IBM grossed $107 billion, meaning that IBM’s revenues have shrunk by more than a fifth — and that’s during a period when many of IBM’s competitors have enjoyed robust growth.
IBM has managed to keep its earnings per share high due to aggressive share buybacks. IBM’s share count has declined by about 19% since 2011, but a lot of this has been fueled by new debt. Long-term debt has ballooned by more than $9 billion over that same period.
Right now, IBM is getting its tail kicked by cheaper and more flexible cloud competition. They might be able to tough this out.
Then again, they might not.
I wouldn’t recommend sticking around to find out.
Charles Lewis Sizemore, CFA, is the chief investment officer of investment firm Sizemore Capital Management. Click here to receive his FREE weekly e-letter covering top market insights, trends, and the best stocks and ETFs to profit from today’s best global value plays.
