Dividends in Danger? Readers Discuss Sysco, Hudson City, Pitney Bowes and More

by: David Van Knapp

This monthly series collects and summarizes SA reader opinions about companies whose dividends may be in danger. The information for each company has NOT been independently verified. Readers’ comments have been ordered, integrated, and edited. Please note that “I” in a comment refers to the commenter, not to this author. If you wish to see the full comment stream, consult last month’s article.

Sysco (NYSE:SYY)

The consensus on Sysco seems to be that Sysco's dividend is not in great danger, but that it bears watching because of the effects of rising food costs.

Favorable comments and points made about Sysco’s dividend:

  • SYY's dividend is absolutely secure. It has a steady growing business that earns decent returns on invested capital. The last three years represent a worst-case scenario (high unemployment and a sharp drop in the net worth of Americans). Food inflation costs will be passed on to customers when the time is right.

  • SYY had a one-time cash flow issue, but the balance sheet is strong and cash flow is improving to more normal levels. Its margin slide is solely due to food price inflation, which is the highest in 30 years.

  • SYY’s payout ratio is just over 50%, since it pays $1.04 per share and its consensus EPS for fiscal 2011 (ending in June) is $1.91 and for fiscal 2012 is $2.06, per 12 analysts as shown on Yahoo Finance.

  • SYY is more profitable than its competitors, who will be incapable of absorbing food price increases for long.

Here were negative comments about Sysco’s dividend:

  • SYY has only covered its dividend with FCF (free cash flow) once in the last 6 quarters. The company has borrowed (or used existing cash balances) to cover the dividend.

  • Food cost inflation looks like it's worsened in this quarter, so we'll probably see another drop in SYY’s gross margin for Q1 2011.

  • SYY is unlikely to grow its dividend materially from current levels in the near term. Without much dividend growth, it is no longer attractive as a dividend growth stock.

  • SYY's annual dividend growth over the past four years has been 16%, 9%, 4%, 4%--a clear and rapid deceleration. I don’t see a cut or freeze, but I can see 2%-3% dividend growth, which is not much when you start at 3.7% yield.

  • SYY decided to pump cash into building out its network, including acquisitions. Sysco's CFO recently said the company's target payout ratio is 40% to 50%. The current payout is over 50%.

  • SYY has stated that it would like to keep its payout ratio at 40%-50% of current year net earnings. So its current $1.04 dividend would require $2.08 EPS vs. current and next year consensus estimates of $1.91 and $2.06. Sysco's CEO emphasized that SYY will focus on its strategic business initiatives, including investing in its network and making acquisitions. These, of course, compete with dividends for cash.

  • There are too many doubts regarding SYY and the dividend, even though I feel the company won't decrease it. I didn't start buying dividend stocks for controversy and debate. That type of uncertainty is for funds in my growth portfolio.

Hudson City Bancorp (NASDAQ:HCBK)

Hudson City drew a lot of opinions. On the positive side were comments like these:

  • HCBK has a regulatory issue that could put the dividend at risk, but I doubt it.

  • HCBK has a very strong balance sheet and steadily increasing shareholder equity per share over the years. The only reason the yield has risen to 6.1% is because the share price got clobbered with the whole financial sector.

  • If you believe that HCBK is a good company and undervalued, wouldn't it be a prime target to acquire some more at the higher yield? Since 2005, HCBK's total shareholder equity has increased by about 20%. The company is highly levered, payout ratios based on FCF over the last three years have averaged around 160%, but based on earning they are around 55% to 60%. HCBK seems to be buying back shares, having reduced shares outstanding by about 14% since 2005. To me, it has grown its business with leverage, which is not always a bad thing.

  • HCBK’s price seems to reflect an enormous discount. It's trading around 9 P/E. Even if its dividends are suspended for a few quarters, does anybody seriously believe a quality, well-managed company with 10 years’ worth of credibility will sustain that low a multiplier? Its 5-year P/E average is about 18, in line with the industry’s 19. With lower P/B, P/S & PEG ratios than industry averages, there's enormous downside protection even while operating on a “worst case” set of assumptions.

And on the negative side were these:

  • In its last financial statement, HCBK stated that the dividend was not a given and would be under review.

  • A Wall Street Journal article (first week of March) said HCBK expects to receive regulatory enforcement action. After a conference call with the CEO, analysts inferred that the CEO hinted they may have to cut the dividend. There are those who think a freeze is more in order, not a cut. HCBK was not in compliance with interest rate risks under new regulatory rules.

  • I decided to sell first and ask questions later. In the absence of any guidance from the CEO with regard to the dividend, I was concerned it could be cut.

  • Given all we know of HCBK (and don't yet know pending regulatory action and the bank's subsequent reaction), it is too risky for my dividend-growth portfolio.

  • The CEO's statement about the dividend reflects a ton of uncertainty for 2011-2012. HCBK has gone from a dividend play to a value play.

  • Since the last increase for HCBK came in May 2009, the dividend has already been frozen. If there's no increase in 2011, the stock will be deleted from the CCC list.

  • From a Reuters news release: HCBK says dividends to continue, rate to be decided later. The company expects to slip into losses in Q1 as it restructured its balance sheet, which involved clearing off $12.5 billion in debt. HCBK has been facing regulatory issues from a high exposure to shifting interest rates. It is the largest U.S. thrift, and it said it plans "to continue paying dividend," with the rate to be decided by the board on April 19. An analyst from FBR Capital Markets said "...expects HCBK to cut its annual dividend to about $0.40 from $0.60."

  • HCBK is just too complicated a stock to own when other companies offer the same yields with much less risk of a dividend cut.

  • Morningstar came out with an analysis that HCBK will show a loss for the reporting quarter and will need to cut its dividend.

Old Republic International (NYSE:ORI)

There were just a few comments on ORI. Positive comments:

  • ORI has earnings issues, but the dividend seems well covered by cash flows.

  • ORI just announced in February its 30th consecutive year of dividend increases. The dividend went from 69 cents/share to 70 cents/share.

And negative comments:

  • I see a negative $280M for its latest fiscal year for cash from operations. Receivables are down, payables are up, and other related cash measures are trending poorly.

  • Yahoo! Finance shows the yield at 5.7%, and the payout ratio at 531%. Its recent increase was only a penny.

Pitney-Bowes (NYSE:PBI)

Although just one reader mentioned PBI in the first article and provided no supporting data, that single mention generated a lot of interest.

There was only one positive comment:

  • Be careful measuring PBI by cash flow. It sells a contract for service, gets that money up front, and then the expenses are back-loaded. PBI has been aggressively pushing into the online space with at least three new products in the last year. In any case, it isn't just standing still waiting for the paper mail business to drop dead. In fact, it should be able to leverage its dominance in physical mail into a solid position in secure electronic communication. So for now I'm not worried much about the dividend.

That sentiment was offset by several negative comments:

  • PBI’s payout ratio of earnings has been quite high (exceeding 100% for 2010), but it has been only 40% or less of FCF. Earnings for 2010 are about the same as 2005 and appear on a slow decline. There is debate about whether its business model is sustainable. The company has only averaged DGRs of around 2.5% to 3.5% for the past 3, 5 and 10-year periods.

  • PBI's business is tied to physical communications. Physical mail is in a rapid decline, packages are handled much more efficiently at FedEx (NYSE:FDX) and UPS (NYSE:UPS). PBI's attempt to switch to a software integrated mail solution puts them up against giants of the industry as well as the bundled services of ISPs. Its financials show declining sales and earnings but increasing dividends and net share buybacks over the years. In 2010, the sum of dividends and stock buybacks ($390M) was well over its capital expenditures ($120M).

  • PBI is paying out far more money than it is investing in its business. Its capital spending is less than depreciation. The decline in paper communications has continued, leading to PBI’s merger with a competitor, a bankruptcy, and new top management every year or so. Some things may always require paper, but I would not count on PBI even as a cash cow.

  • PBI’s dividend growth has shrunk over the past several years, and while a cut may not be in imminent, the company's fundamentals are not strong. The dividend could flatline and ultimately turn over. If I were a PBI investor, I'd take this under serious consideration if I were dependent on that dividend.

And a Few Quickies

The following stocks were briefly mentioned.

  • SuperValu (NYSE:SVU). SVU already halved its dividend in 2009. The current dividend of 35¢/share/year seems to be well covered by the next two year's estimated EPS of $1.29 and $1.19, respectively.

  • Frontier Communications (NYSE:FTR). With a 9.3% yield, the CEO says the dividend is sustainable. Frontier's announced plan is to hold the dividend steady for the next two years to fully integrate Verizon wirelines, and then begin raising the dividend again.

  • Black Rock Kelso (BKCC). This BDC’s price has dropped due to concerns on declining EPS vs. dividend coverage. Based on its brief history and a 2009 dividend cut, it seems quite possible that it could cut the dividend again, especially when you compare the annual rate of $1.28 per share with the earnings estimates of 95¢ this year and $1.09 in 2012

  • Chimera Investment (CIM). Chimera cut the dividend now and then only to increase it later. It is at 106% payout now but in the past hewed pretty closely to the 90% range.

  • Meridian Bioscience (VIVO). Over 100% payout ratio, financing the dividend with its cash stockpile. EPS estimates for this year and next are discouraging at 78¢ and 93¢ per share, respectively. The 78¢ equals the current annual dividend. Also, the latest expected dividend increase is "overdue" as the last one came in the first quarter of 2010...more than a year ago. That said, the Board already announced they'll maintain the current FY payout. Also 78c/93c = 82%, moving the company back into the target payout range it has managed for nearly a decade.

A Few Observations about This Series

This series of articles is an experiment. The goal is to provide a place where SA readers can trade ideas and pool their knowledge about dividends that may be in peril.

A few readers of the first article were critical of the concept, finding fault with the quality of the data or even the motivations of commenters. Most readers, though, stated that the central discussion point is useful if used properly.

Please note that David Fish writes two articles per month that lay out what companies are actually doing with their dividends. His work allows him to identify companies whose “usual” dividend increases are coming up as well as others whose dividend increases are “overdue.” Use his articles in conjunction with this series. His observations are based on known facts, while the comments in this series attempt to peer into the future. Click here to see his most recent article, “34 Companies Expected to Raise Dividends in the Next 8 Weeks.”

The interest level for the first article in this series was high, with more than 145 comments. Thanks to all who contributed cogent, fact-based observations and ideas about what dividends may be in danger.

Please use the Comments section to discuss further the companies mentioned in this article or to nominate other companies for the Dividends in Danger series. Support your thesis with data and reasoning. If you feel that an entire industry is in danger, please explain why and give examples of companies in the industry that are at risk. The best comments are focused, factual, specific, and reasoned.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

Disclaimer: Always perform your own due diligence before making any investment decisions.