Dividends in Danger? Frontier, CenturyLink, Conoco Phillips, 4 Others in the Crosshairs

by: David Van Knapp
This is the fifth installment in a series that collects and summarizes SA members’ opinions about companies whose dividends may be in danger. Not all information for each company has been independently verified. Readers’ comments have been integrated and edited. If you wish to see the full comment stream, consult last month’s article.
Frontier Communications (NYSE:FTR)
Frontier generated the most discussion last month. There were three articles about Frontier published on SA:
Here is a brief backgrounder on Frontier’s dividend: In June, the company announced its fourth consecutive dividend at $0.1875/share. The dividend had been cut to that amount last September, after the company had maintained its previous dividend of $0.25/share for the previous four years. The stock’s price peaked all the way back in 2007, and price declines since then have caused its yield (even with the frozen and cut dividends) to balloon up over 11%. In 2009, the company acquired wirelines from Verizon (NYSE:VZ) that tripled the company’s size, and FTR has been integrating those operations ever since. The company is on record as saying that its plan is to hold the dividend steady for the next two years while they fully integrate the wirelines, then begin raising the dividend again, presumably in 2012-2013.
The three articles reached different conclusions:
  • Frankly, I had some trouble following the logic in the first article, which used a dividend discount model to project a much lower fair value for FTR than its current price, then reverse-engineered a 300% payout ratio based on that fair value, but also speculated about a $0.70 dividend at some point in the future.
  • The middle article examined Frontier’s operations and its progress in integrating the wirelines acquired from Verizon (VZ) in 2009. The article seemed to conclude that the dividend was safe.
  • The third article (by the same author as the first) was confusing. Its first line was, “For anyone out there chasing dividend yields, Frontier Communications Corp….could be the stock for you.” But it ends with, “A sky high yield is not much use if it accompanies significant capital losses. [FTR’s] 8.5% short interest shows that I am not Frontier's only skeptic.”
I’ll let you read the articles and decide for yourselves. Chuck Carnevale’s capsule comment on FTR (Chuck commented on each stock discussed last month) was that FTR is in a similar position with Centurylink (NYSE:CTL), with a healthy cash flow and a reasonably well protected dividend.

CenturyLink (CTL)
Staying with telecom, CenturyLink (CTL) has drawn attention every month. Last month’s comments included these thoughts:
  • CTL is in a better situation than FTR and will increase their dividend within the next several quarters. CTL is moving into the number 3 position in the telecom industry in the USA and will want to maintain their Dividend Champion status.
  • The current high payout ratio is misleading because they are a cash flow story. Although earnings have been very weak over the last two or three years, cash flow per share remains very strong and is over three times their current dividend. The dividend is very well protected but probably not going to grow very much. Their strong balance sheet makes them a high-yield story today.
  • Even if CTL freezes its dividend, its high yield makes it a “hold,” because they are growing; hopefully dividend increases will follow in the near future.
CTL’s dividend has remained unchanged since March, 2010, and its current yield is over 9%. Coming into 2011, the company has raised its dividend for 37 straight years. If it does not raise its dividend before the end of the year, it will lose its Dividend Champion status. The company has done this before: In 2008, when CTL's board boosted the quarterly dividend by more than 10x, it stated its intention to pay out "essentially all" of its FCF to shareholders rather than basing its payout ratio on earnings per share. The company then went six quarters before raising the dividend, but then it did so and kept its Champion streak intact.
Conoco Phillips (NYSE:COP)
In early July, dividend stalwart Conoco Phillips announced plans to separate its refining and production businesses into two stand-alone, publicly traded corporations. (See Dow-Jones news article.)
Low Sweat Investing contributed a comprehensive comment on the situation concerning COP’s dividend. He stated that in a conference call with analysts, COP announced that the new Exploration and Production company will pay the entire current $0.66 quarterly dividend, and that on top of that, the new Refining company will pay a "competitive" dividend too. COP also said it expects to continue its "aggressive" distributions to shareholders and dividend increases, subject (as always) to board approval. As caveats: COP’s CEO will retire, so you have to accept that the company's longstanding corporate dividend policies were not a one-man show; and the spinoff plan will take several months to complete.

Another commenter stated that how you approach it as an investor depends on your personality. Do you tend to naturally trust people until they break your trust? Or do you tend to mistrust people until they earn your trust? If the former, you hold on to the positions until dividends disappoint. If the latter, might as well treat them like brand new companies, sell the position now, and wait 5 years to see how they perform.
A couple of other commenters stated that they would take a wait-and-see attitude, holding onto current positions unless or until specific facts suggest otherwise. As I write this, COP’s projected yield is 4.6%. and they have an 11-year streak of increased dividends (the most recent increase was in February).
Meridien Bioscience (NASDAQ:VIVO)
Previously, it has been noted that Meridien’s earnings did not cover their dividend last year and will barely cover it this year. Meridien has publicly announced a policy of setting a payout ratio of between 75% and 85% of each fiscal year's expected net earnings, although it is hedged by language that the actual declaration and amount of dividends will be determined by the board of directors in its discretion based upon its evaluation of earnings, cash flow requirements and future business developments, including acquisitions. (See press release.) Comments included:
  • In each of the last four fiscal years, VIVO’s cash from operations has exceeded their dividends paid. Their depreciation & amortization has consistently been more than capex needs and in all but their last fiscal year (ended September, 2010) their free cash flow exceeded dividend payments—and that was only a $3mm deficit. They have very low capex and working capital needs.
  • Much is dependent on VIVO’s illumigene test sales. If this important product is unable to grow as expected, future dividends could be in question.
Meridien Bioscience is a 19-year dividend raiser, but its last increase was in February of 2010. A recent plunge in its price has brought its yield up to about 4.4%.
Nokia (NYSE:NOK)
Nokia (NOK) made its first appearance here last month, with a couple of commenters saying that it would be foolish to chase its now-9.9% yield. Comments this month:
  • David Fish reminded that it has already cut its dividend, since it pays annually and the 2011 amount was lower than 2010.
  • Chuck Carnevale pointed out that NOK has experienced an earnings collapse since 2007 and appears to be one of the most likely candidates for dividend cut if things don't improve soon.
  • Another commenter opined that NOK is walking on “artificial thin air.” The N9 phone could be the last flagship being tested in the market before they become irrelevant. They give no sales guidance because they have no idea how to gauge the increasing losing battles with behemoth companies like Apple (NASDAQ:AAPL), Google (NASDAQ:GOOG), and Samsung (OTC:SSNLF) .
Harsco (NYSE:HSC)
Harsco was noted as having a payout ratio exceeding 100% of earnings. In June, the company announced its 7th consecutive dividend of the same amount. Its last increase was in February, 2010, putting its 16-year streak of increases at risk.
Low Sweat Investing, who has studied precursors of dividend cuts, commented that HSC shows several characteristics that correlate with future dividend cuts, such as low ROE and ROA, poor sales growth, a frozen dividend, and below average cash cushion. The company’s debt payments plus dividend exceeded its free cash flow recently.
Low Sweat asks the reasonable question: Companies with multiple warning signs for cuts also display weak business fundamentals, so what reason would there be to buy HSC or another such company even if the dividend were maintained? Here is this author’s article on dividend cut indicators: “Avoiding Dividend Cuts: Insights From the Number Crunchers.”
Old Republic International (NYSE:ORI)
Discussion of Old Republic will not go away. Previous reasons for concern had included negative cash from operations, declines in receivables, increases in payables, and Yahoo’s reporting of the payout ratio at 531%, and potential problems at their mortgage insurance subsidiary.
This month’s main comment came from the reader who originally brought up ORI as a Danger candidate. He stated that ORI’s Mortgage Insurance division is in the worst shape of all the mortgage insurers. It has already breached statutory capital limits and is operating on waivers. It is likely to enter a negative policyholder's surplus position within the next two quarters at current loss rates unless the parent company steps in with capital infusions. Not many state regulators will tolerate negative surplus positions, and the commenter estimates that over the next year the company will need around $500M to stay solvent. It is unclear if the parent company can handle that and still meet other needs (like paying dividends).

He recommends that for a 6% dividend, you are better off taking a slightly lower yield and buying a blue chip. ORI has a 30-year increase streak going, although its most recent increase was just 1.5% in March. Since the comment was written, ORI’s projected yield has jumped up to 7.5%.

One Quicky
The following company will be dropped from next month’s article unless something significant develops.
After major buzz in the first four articles in this series, Sysco (NYSE:SYY) generated no substantive comments last month. I think that Chuck Carnevale beat everybody into submission with his spirited defense of Sysco’s vitality and the sustainability of its dividend. For those who missed Chuck’s seminal article on Sysco, here it is: “Sysco: Gourmet Stock at Fast Food Price with Sweet Dividend Dessert.” His comment last month was, “I continue to believe that this is an extremely undervalued, high quality company whose dividend is very safe.”
Frozen Dividends
Last month, I wrote a section on frozen dividends. In David Fish’s monthly Dividend Champions document, he notes companies whose last dividend increase is more than a year ago (he uses red type). I stated that this meant that its dividend was frozen. David corrected me, stating that he would describe a frozen dividend company as one that has declared the same payout for a fifth quarter (not fourth).
He also noted that under his methodology, a company can have a frozen dividend for quite some time without being deleted from the CCC listing. Under his methodology, a stock is not deleted until the completion of the second calendar year without an increase. Thus if a stock’s 2011 total payout is greater than what they paid in 2010—as would be the case for companies that increased in the second (or subsequent) quarter of 2010—they would not get deleted until the end of 2012.
You can catch David’s latest (July 19) compilation of stocks walking the tightrope here: “30 'Overdue' Dividend Increases: Streaks in Doubt?
Payout Ratios
The sometimes-misunderstood subject of payout ratios received considerable attention last month. Robert Alan Schwartz contributed a list of 262 companies with payout ratios in excess of 100%. Many were MLPs and REITs, but some were not. There were also good discussions from Chuck Carnevale and Low Sweat Investing regarding the significance of the payout ratio and different ways to calculate it (against earnings or against some measure of cash flow). Please see the comments from last month, as describing them here would take too much space. This might be a good subject for a future article.
About This Series
The goal of this series is to provide a place where SA readers can trade ideas and pool knowledge about dividends that may be in peril. The first four articles have attracted more than 68,000 views and generated more than 410 comments.
The purpose is to alert others to stocks that may have dividends in danger for any reason. It’s great when people pool their knowledge and ideas for the benefit of all. In the end, though, it is up to each person to do their own due diligence and make their own decisions.
Thanks for your continued interest, and please comment on companies that you think might have dividends in danger!

Please use the Comments section to discuss the companies mentioned in this article or to nominate other companies for the Dividends in Danger series. 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.
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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.