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  1. Home
  2. / Investing

Making the (Dividend) Cut

Companies to avoid until the dividend falls or earnings rise.
By TIM MELVIN Oct 03, 2014 | 10:00 AM EDT
Stocks quotes in this article: XCO, LDR, CLF, CTL

I use search engines and news alerts to help me stay on top of what is going on in the world and markets. I have Google alerts set to send me news of any press releases containing fun phrases like "plan of liquidation," "deep value," and "strategic review." I also have it set to send me news on what James Montier, Wilbur Ross and other well-known investors might be up to. One of the most valuable news alerts over the years has been dividend cut/dividend reduction. When a company cuts its dividend, the selling can often be intense and the stock is knocked down to bargain levels. One of my best investments this year has been Boardwalk Pipeline Partners (BWP), which I bought after a 50% decline following a dividend cut.

It is easy to run a screen of companies that have above-average yields that are not earning the dividend. That makes a potentially lucrative list of stocks that could announce a reduction and see their stock prices tumble. This also might make for a good list of companies to avoid until the dividend outlook is cleared up by a cut or earnings improvement.

A classic example of this right now is also a stock I happen to like a lot for the long term. EXCO Resources (XCO) is one of the best stocks to play a recovery in natural gas prices, but the high yield of the shares telegraphs a dividend cut. The quoted yield is 6.56% but the company is not anywhere close to earning the payout. Even if it hits the very optimistic analyst expectation for 2015, it would be a 100% payout. The stock is already down substantially but a dividend cut announcement could induce an additional wave of selling that takes the shares down to very attractive levels form a long-term perspective.

The payout at Landauer (LDR) looks a little suspect as well. The medical-products company is not earning the dividend this year, and won't cover it in 2015 either, according to analysts. Earnings have been horrible this year and Landauer has seen a shakeup to its management team with both the CEO and CFO stepping down. Any discussion of getting the business back on track has to include a discussion about the dividend, and I would avoid the stock until that is cleared up.

Cliffs Natural Resources (CLF) should have cut the dividend several quarters ago. The 6% yield may be tempting to yield-hungry investors, but it is not going to last. It's not earning the dividend and won't until iron ore prices recover. I like this stock and would be a buyer if we see additional dividend-related selling this earnings season. Iron ore markets will recover at some point and in the shorter-term, current management is amenable to making moves that might unlock the value of the shares.

Village Super Market (VLGEA) should also consider cutting its dividend. It does not earn the payout and probably won't next year either. Given the incredibly competitive nature of the grocery business, it makes sense from a business standpoint to conserve cash. Supermarkets are an industry that I expect to consolidate further in the years ahead, so selling after a dividend cut could makes this a very attractive long-term holding.

CenturyLink (CTL) cut its dividend in 2013 and another cut is not out of the question. It doesn't earn the dividend and is not earning the current payout either. Telecom is one of the most competitive businesses in the world and the cash might be needed to keep up with the likes of AT&T (T) and Verizon (VZ).

Buying after a dividend cut may run counter to traditional thinking, but it is not a new idea. Like so many of the concepts I use to pick stocks, I stole this one from Walter Schloss. He recognized that the selling after a dividend cut was usually excessive in nature and often provided astute patient value investors a fantastic entry point.

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At the time of publication, Melvin was long CLF and XCO, although positions may change at any time.

TAGS: Investing | U.S. Equity

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