For investors banking on dividends, the 'pain has just begun'

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Alex Gorsky, Chairman and CEO of Johnson & Johnson, rings the opening bell to celebrate the 75th anniversary of his company’s listing at the New York Stock Exchange, September 17, 2019.

Brendan McDermid | Reuters

Johnson & Johnson surprised investors with a modest dividend increase of 6.3%, followed by Procter & Gamble, which raised its dividend 6%.

But don’t kid yourself:  They are likely anomalies.

Dividends are under pressure because of a dramatic drop in cash flow used to fund them. There’s also concern that companies that take any government aid will be under pressure to suspend the dividend.

“Dividend pain has just begun,” analyst Charles Toole of Adviser Investments wrote in a recent note to clients.

Many companies have suspended share buybacks and even withdrawn guidance, but so far only a very few have suspended dividend payments, including Carnival, Darden, Ford, Hilton, Nordstrom, Delta, and Boeing

A significant subset of Wall Street investors view a dividend as a critical component of stock ownership, so management is very reluctant to cut. But with 30% to 50% declines in some stocks in the past two months, even with the rally, previously modest dividend yields of 2% to 3% are now in the 4%, 5% or 6% range for many companies and they are unsustainable given much lower cash flows. 

Some investors seem to feel the drop in dividends will be substantial. The Chicago Mercantile Exchange has maintained a S&P 500 Annual Dividend Index Futures contract for the past five years. Right now, investors are anticipating dividends will decline by 16% for full-year 2020 dividends. 

“Investors who rely on dividends for income are about to feel the pain of the coronavirus pandemic’s knock-on effects,” Toole wrote.

Finding companies at risk is fairly easy. Look for those that pay respectable dividends and have seen cash flow drop dramatically. 

“Regulation aside, companies most at risk of needing to cut their dividend are those whose cash generation is currently too low to sustain a dividend payment,” Michael Lerner at Credit Suisse wrote in a recent note to clients. Companies on his list include Royal Caribbean and many energy companies, including Halliburton and EOG.

Toole also compiled a list of 20 companies that have had dramatic increases in their dividend yield due to plunging prices. One that particularly stands out is Kohl’s, which has gone from $44 at the end of February to roughly $18 today. 

The retailer has suspended its share buyback program, dramatically cut back on capital expenditures, and slashed inventories. But it hasn’t cut its dividend, which is now yielding 14.8%, a huge increase from the 5.3% dividend yield on Dec. 31. The company has said it is evaluating the dividend.

Raymond James also compiled a list of names whose dividends are likely at risk if the economic disruption continues.  Not surprisingly, they are concentrated in hotels, airlines, retail and energy.

Dividends at risk?

What should dividend investors do?

Does this mean that dividend investors should flee the market? Not necessarily. 

In 2008, more than 80 companies in the S&P cut dividends. This time around, the group does not seem as large, a fact acknowledged by Savita Subramanian, head of U.S. equity  quantitative strategy at Bank of America. 

In a recent note, she opined  that overall dividends for the S&P will decline 10% in 2020.

“Risks seem contained for the S&P 500, and show up in the obvious, most stressed industries: Energy and Consumer,” she concludes. “For more conservative investors, we suggest a focus on our secure dividend screens. For more aggressive investors, it is worth considering that the market is discounting more cuts than we think is likely.”

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