Pitney Bowes Violated Every Principle Of Conservative Dividend Investing

| About: Pitney Bowes (PBI)

Have you ever stopped and considered why Coca-Cola (NYSE:KO), Johnson & Johnson (NYSE:JNJ), and Procter & Gamble (NYSE:PG) are the portfolio backbones of most dividend investors?

Generally, it's for a combination of the following reasons:

  • each of those three companies has a wide moat in a durable industry
  • each of those companies churn out more and more profits over almost every five-year rolling period
  • each of those companies grants investors meaningful dividend growth rates that match the earnings growth rates
  • each of those companies have manageable debt levels

Those are the characteristics of dividend stocks that you want to own for the long-term. If those five things remain true, it is very difficult for you to experience dividend blowups as you go through life collecting income-producing assets.

If you evaluated Pitney Bowes (NYSE:PBI) through this lens, then it is very unlikely that a conservative income investor would have spent more than ten minutes flirting with this stock.

Let's look at the first element, and judge whether the company operates in a durable industry. Pitney is the largest manufacturer of postage meters and mail equipment in the world. Personally, I wouldn't be able to keep a straight face if I looked myself in the mirror and said, "I'm in a long-term investor in the mail industry."

Everything about operating in the mail industry is terrible. This is not just me editorializing here, just look at what Pitney has been doing this decade: since 2003, Pitney's operating margin has been on a long-term slide from almost 30% to 20%. The company's total net profit has decreased every year since 2005. And since 2003, the company's net profit margin has decreased every year since 2003 (with one exception from 2010 to 2011, when the net profit margin increased from 8.5% to 8.7%).

The company, which has 27,000 employees, has gotten rid of 9,000 of them in the past six years. Management said they will be "exploring all options" when asked if there will be more future job cuts. Effectively, the company tried to mask the deterioration in the business model by getting rid of employees to lower costs and try to keep earnings intact (this practice usually becomes unsustainable after a certain point).

Let's move on to the next element of sound dividend investing: most good dividend paying companies churn out increasing profits over most rolling five year periods. If you look at the company's cash flow over the past five years, it has been easy to recognize Pitney as a company on the decline. In 2008, Pitney generated $4.66 in cash flow per share. Then that figure fell to $3.92 in 2009. Then it fell to $3.76 in 2010. Then, $3.67 in 2011. Then, $3.35 in 2012. If you look at the cash flow fundamentals of the company, it has been easy to map out the decline. The most optimistic analyst estimate for 2016 guesses that Pitney will be generating $2.95 per share in cash flow. Since 2008, this company's cash flow has been a linear chart decline. What more of a signal could investors ask for to indicate that a business is failing?

One of the useful things about dividend growth rates is that they can be more forward looking than you initially think: management teams won't usually give shareholders 8-12% dividend increases unless they believe that the company will be generating growing profits over the coming years to fund those increases. Over the past ten years, Pitney's dividend has only grown at 2.5%. That doesn't even keep up with the rate of inflation. When a company's annual dividend increases become that small, it should be a very strong signal for you to do some further investigation. The fundamentals of the business have been steadily deteriorating, and the anemic dividend increases over the past decade telegraphed this fact.

And let's take a look at the last element: debt. Pitney is a $3 billion company. Well, Pitney has over $4 billion in debt (taking into account leasing obligations). Anytime a company has more debt than its market capitalization, it can be worth asking yourself the question, "Does this company have a crippling amount of debt that will hamstring future growth prospects?" When you're a company reporting annual profits of only $400-$500 million and you've got $4 billion in debt liabilities ($2.4 billion of which is due within five years), you shouldn't be surprised when the company has to scale back from its previous commitment to pay more than $300 million in annual dividends.

Some people will point out that Pitney has been increasing its dividend since 1983, and see the cut from $0.375 to $0.1875 as some kind of proof that investing with a dividend growth strategy doesn't work. No, Pitney's failure is a vindication of sound dividend investing principles, not a rebuke of them. There is a reason why people choose to allocate their dollars towards a company like Colgate-Palmolive (NYSE:CL), even though the current dividend yield there is only 2.25%. That company is growing earnings, has minimal debt, and gives you great dividend increases while operating within the durable industry of house care products.

The failure of Pitney proves that fundamentals still matter. This had to have been the most telegraphed dividend cut that I have seen in my lifetime. The dividend growth rate hadn't kept pace with inflation for the past decade. Cash flow has been declining every year since 2008. The company has laid off a significant chunk of employees annually since 2007. Heck, the company has more debt (counting leasing) than its market cap. And the company operates in the mail industry, for crying out loud. The writing was on the wall with this dividend cut. The company betrayed every principle that should drive conservative dividend investing decisions.

Disclosure: I am long JNJ, PG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.