Are These Dividend Stocks Doomed?

Includes: CLF, EXC, POM
by: Fusion Research

Does investing in high-dividend stocks means more growth in the stock prices as well? The answer is not always yes! These three companies -- Cliffs Natural Resources Inc. (CLF), Exelon Corporation (EXC), and Pepco Holding Inc. (POM) -- have a five-year average dividend yield of 2.20%, 5.00% and 5.50% respectively. However; their stock performance has remained dull as compared to the S&P 500 index in the last 12 months. This under-performance is mainly due to the decline in prices of their core products, associated with low demand. Consequently, it has forced the companies to reduce their dividends. The reduction is done mainly to generate cash to offset the otherwise weaker position of the profits. Let's analyze these stocks and find out whether they still offer an opportunity for the investors to cash-in.

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Source: Yahoo Finance

Cliffs Natural Resources Inc - Repairing the balance sheet

Cliffs Natural Resources Inc. has ended the fiscal year 2012 with a slight disappointment. The company posted its quarter four and full year revenue figures in the negative. It has reported $5.9 billion as its full year revenue that has declined by around 11% as compared to that of 2011. The decline was due to the falling iron-ore prices and increasing costs that harmed the overall profitability. In the fourth quarter, the company witnessed a decline of around 50% in its sales margin mainly caused by a rise in the COGS (cost of goods sold). Cliffs's overall cost per metric ton stood at $60 that is in line with industry standards. But; with this per metric ton cost, the company is not able to compete with its major rivals such as BHP Billiton (NYSE:BHP), Rio Tinto (NYSE:RIO), and Vale (NYSE:VALE). These companies have their cost per ton in the range of $30 to $45. The higher per metric ton cost for Cliffs, as compared to its peers, is affecting its overall profitability. In order to reduce its overall cost, Cliffs has recently introduced its capex plans for 2013. Cliffs will invest $800 million - $850 million during this year and this capex may boost up its overall production levels that can bring the cost down.

Along with this, Cliffs has recently announced its capital restructuring program. The management has approved a cutback in quarterly dividend by around 76% to $0.15. Via this measure, the company will save around $220 million. Further, it has announced to sell new equity shares through two new offerings. With the help of these offerings, the company will raise around $900 million of cash. The proceeds from the proposed dividend reduction and from the new issue will be utilized by the company to reduce its liability by repaying debt worth $850 million.

The company is also undertaking various initiatives to reduce its cost to offset the decreasing profitability. However at this moment I am doubtful about the company's future progress as it is highly dependable on the iron-ore prices. I recommend a hold on this stock for now.

Exelon Corporation - Falling demand, falling dividend!

Exelon, along with its fourth quarter results for 2012, announced a cut in its dividend by about 41% to $0.3, whereas the annual dividend stood at $1.24 from $2.10. This reduction was a repercussion of the falling profits of the company. In the fourth quarter, Exelon posted about 38% decline in its earnings mainly due to huge increase in operating costs. The dividend cut will help the company to enhance its cash flow with around $740 million of expected savings. With these proceeds, the company may initiate various programs including debt reduction, and can also go for share repurchase in the coming years. I expect the company to reduce its debt burden approximately by $550 million, during 2013 - 2015 and consequently save huge amount of interest.

The future outlook for Exelon still remains shaky. The ample amount of supply of natural gas has impacted the gas prices, reaching the lowest level of the decade. The poor demand of natural gas has also forced a lot of companies to reconsider their expansion plans, and Exelon is no exception to this. Consequently, the company has recently postponed its spending on various projects including its nuclear power plant. The company was earlier going to spend around $2.3 billion on all these projects in the coming years. This spending cancellation decision does not mean the shutdown of all or part of its current operations. But this news brings a bearish trend in the minds of the investors.

Overall, the company's long-term position highly depends upon the recovery in the natural gas prices. Despite the company managing the much needed cash support, I am skeptical about the stock in the short-term.

Pepco Holdings Inc.

Since 1995, Pepco is availing tax benefits with its long-term cross-border leasing agreements. The company has seven power plants, leased to third parties under these agreements. These assets offer a significant amount of annual tax benefits to the company. It has taken tax benefits of around $760 million since 2001. However, the Internal Revenue Service is continuously making efforts to disapprove such benefits for Pepco. The recent news about the court decision on Consolidated Edison (NYSE:ED) is further catching the investors' attention on the issue. The US court of Appeals has disallowed Edison to get any further tax benefits on the offshore lease transactions. In the worst case scenario; if a similar situation arises for Pepco, the penalties would cost around $855 million.

Pepco's recent decision to deposit around $220 million-$260 million with IRS, will take-off some pressure from its profile. This deposit will increase the company's burden in the short run, but will reduce the additional interest payment on tax liability. The deposit amount is quite less than the tax benefits worth $760 million, which the company has already realized. The company may liquidate all or part of its lease portfolio within the next one year, utilizing the proceeds for further debt reduction.

Even after these deposits, the exact impact of loss and tax benefits remains blurry. I am neutral on this stock until any further clarification is obtained.


Both the companies, Cliffs and Exelon, have reduced their dividend drastically aiming to improve their balance sheets by decreasing their debt burden. However, the future growth of both the companies depends upon their core products, i.e. iron-ore and natural gas. On the other hand, until any further details are obtained on Pepco's settlement with IRS, the stock will not gain any momentum.

I will not advise the investors to make a position on any of these stocks for now.

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