When a Dividend Cut Is a Good Thing

Investors continue to take a favorable view of dividend cuts by U.S. companies. There has been a rash of dividend cuts since the start of the financial crisis, and companies have generally been rewarded by the market for taking a more cautious approach to distributing cash. Heck, some companies have been hailed for being responsible.

On Tuesday, oil refiner Sunoco Inc. (SUN) sliced its dividend in half. Its chief executive told analysts: “Sunoco, like every other refiner, is facing serious challenges. The near-term outlook remains challenging.”

The response? On Wednesday afternoon, the stock was up 1.6%. As Stocks To Watch Today blogger Bob O’Brien pointed out, there is more at work here than the dividend cut. Sunoco also announced plans to close one refining plant and double production at two others – a move that will save the company $250-million a year. Still, dividend cuts tend to overshadow other initiatives.

There have been relatively few high-profile cuts in Canada, but they tend to be greeted far differently. For example, Manulife Financial Corp. (MFC) announced a dividend cut in early August, and the response was vitriolic: Manulife shares fell 14.8% in one day.

Comments

[notsosmart:]

its just not good if a co has to cut a div.just like its not good if a co shows a profit on expense cutting rather than increased business.

Oct 07 05:00 PM

[David Van K...:]

Cutting the dividend can be a responsible response to worsening business conditions, and the market's response may well be a price bump for the stock if investors see it that way.

However, for a long-term dividend investor, the important return comes not from price changes, but from the dividend itself. For someone working a strategy to build wealth over time by collecting and re-investing dividends, or for someone who is using the dividends as current income, it is hard to paint a dividend cut as good news. Not only that, for every company that should be lauded for cutting its dividend, there are probably 10 that get hammered in the market. A dividend cut announces to the world either a significant strategic (and maybe cultural) shift for the company, or serious financial distress. Otherwise they wouldn't cut the dividend. There is a strong correlation between dividend cuts and future bad news emanating from a company. Dividend Growth Investor has written a couple of articles about this.

Bottom line, all else equal, a dividend cut is a big red flag for long-term dividend investors.

Oct 08 09:18 AM

[mbkelly75:]

A dividend cut for the long term investor is a bad thing - no doubt about. However, it can be used to give you some fast profits AND a good dividend stream in some circumstances. GE early this year is an outstanding example of how this can work.

GE is a solid company and unlikely to disappear. They cut their dividend for solid reasons as a defensive move that strengthened the company as a whole. The price of the stock got crushed. As a long-term holder of GE - I sold when they cut their dividend. I bought back in when the stock went so low that even the cut dividend was 9%-10% - around $6. They promptly moved up to $11.56 (I could have held for $12 but I chickened out when they stalled for a couple of days) and sold enough of the stock to pay all my expenses (both cash spent on the stock and commissions). I was left with a chunk of dividend-paying, ZERO cost-basis stock. It was a very good trade for me. I will not put the stock back into my Core Portfolio until it has a 5 year record again of raising that dividend, but it has a nice home in my Exploration Portfolio at this time.

Oct 08 11:00 AM

[Erichz:]

In Sunoco's case the cut maybe be good for them in the short term, but SUN has many more problems to deal with. For a SUN investor it is a bad signal. The company has a lot of issues (old refineries, shrinking market share) that to me indicate they are in trouble.

Oct 08 11:22 AM

[a fat panda:]

A dividend is excess capital which management can't reinvest at satisfactory returns. So dividend cuts are very good when the business offers investment opportunities which exceed standard market returns - even in a downturn.

Take for example banking last year. While it was a banking crisis for some banks, it was the greatest banking opportunity in history for others. Any bank that couldn't find ways to profitably invest capital last year should not be trusted to invest it now. Banks that paid dividends last year were either lazy or irresponsible.

AIG, Lehman, and the GSEs paid dividends to the end. Do you really want to invest with management whose primary goal is to let sleeping shareholders lie?

Oct 09 02:27 PM

[sethmcs:]

A dividend cut is never a good thing. Although the upward bounce caused by the cut may be a good opportunity to exit stage left.

Oct 10 12:03 AM

[Moon Kil Woong:]

A dividend cut is great under a few scenarios: 1) Obviously
if it staves off bankruptcy 2) If it needs the money for growth and expansion that has an aceptable IRR and is more affordable than raising equity due to high interest rates or because it adds unacceptable levels of leveraged risk to their capital structure 3) If it is purely done to prevent double taxation for long term shareholders on profit (they can get taxed when they want by selling shares at their leasure).

Just because a stock gets a bump doesn't mean it is done for a good reason let along long term. It can also be done to boost equity to protect against a hostile takeover, pad existing managements position by creating a kitty that can be used for interest income to offset losses, pay for bad expansions without having to go to capital markets, or make the company inordinately stable so business can coast without any losses at the expense of any strategy or opportunities for gains. The presumption of safety can be misinterpreted or overvalued in the market as well as takeover speculation leading to price appreciation even though fundamentally it's bad for the company.

I'm sure there are other reasons that are good and bad. Assuming it's good simply because the stock bounces on the news is insufficient in determining the long term value of the decision. The stock may simply rise because of sectoral or market strength offsetting the downside to some day later. I suppose this is good for investors. It gives you more time to figure out the deeper reasoning for the decision before you choose to stay in the stock or or rush to the exit.

Oct 11 12:50 AM