Frozen Or Cut Dividends Are Not The End Of The World

|
Includes: CPB, K
by: Cash-Centered Creep

Summary

A couple of recent comments from two of my favorite Seeking Alpha contributors has inspired this article.

Dividend freezes, and for that matter dividend cuts, are not a valid reason to entirely dismiss a decent stock.

Every investment must be looked at on its own merits.

I commented on a recent article by the Dividend Sleuth, Ted Leach, entitled 'Consumer Staples Review.' The article is well worth a read, as is all of Ted's stuff, and the title itself is self-explanatory regarding what the content of the article entails without needing further exegesis here.

It was the comments following my own that spurred me to write this particular piece. I had asked Ted for his opinion of Campbell Soup (CPB) after its sell-off following a rather poor Q4 earnings report and a grim forecast regarding future earnings - which the company advised investors would not be specific to Campbell Soup, but would affect the entire food industry.

Ted stated that the FAST Graphs stock analysis tool developed by fellow contributor Chuck Carnevale corroborates my contention that the stock is a buy now, as the P/E ratio appears to be at 15 or lower. His response to me entailed a response from the sweet-natured and very smart RoseNose, who opined as follows:

Note also CPB had 3 years of dividend being frozen... no thanks.

Ted replied to this in typically jocular fashion, stating, "That's a deep freeze!"

Now, I should state for the record that Ted and Rose are two of my favorite contributors to Seeking Alpha, they have always been very nice to me in any interactions that I have had with them, and I believe any investor will learn a great deal from reading their contributions to this site. With all of that said, however, I disagree with their contention that a dividend freeze is sufficient reason to dismiss a stock from consideration as a potential purchase.

Indeed, I'll go further - I do not believe that a dividend cut is sufficient reason to dismiss a stock either. Of course, as Seeking Alpha commenter smurf once said to me "We can disagree without being disagreeable." I shall state my reasons for thinking as I do, but with no intent to offend. I will use two companies covered in Ted's article - Kellogg (K) and Campbell Soup itself - to illustrate my points.

Dividend Freeze Example: Kellogg Company

Campbell Soup was not the only stock to have experienced steady but non-rising dividend payments for a stretch. Kellogg's quarterly dividend remained at $0.25 from December 15th, 2000 until June 15th, 2005. The next dividend raise, up to $0.28, was paid on September 15th, 2005.

The reason for the dividend freeze was addressed by Tim McAleenan Jr. back in 2015:

...it was paying out $1.01 in dividends while only making $1.31 in profits, for a 77% payout ratio. Back then, the company had to freeze the dividend from 2001 through 2004 to allow profits to rise to $2.16 before once again rewarding shareholders with more cash.

And reward them Kellogg did: the company has paid consecutively rising dividends since 2005 - a twelve-year record.

Dividend Cut Example: Campbell Soup Company

While Campbell Soup did freeze its dividend between October 28th, 2013 and August 1st, 2016 at $0.31, more glaring was the 30% dividend cut it implemented with effect from October 31st, 2001.

The reason for the dividend cut was due to the fact that business was struggling and more money needed to be invested in product innovation, marketing and technology. As a consequence, Campbell also lowered their earnings target for fiscal 2002 from $1.40 per share to $1.30 per share.

Since then, however, Campbell's dividend has been either steady (between 2002-2004 and 2013-2016) or has been raised annually.

Summary

In both cases, companies that had to take short-term financial decisions to return to long-term profitability needed to compromise their dividend, and in the long term, both companies (and eventually, their shareholders) benefited.

I understand why people see a frozen or cut dividend as a reason to divest the stock. After all, if you have bought a company on the basis that it will continue to reward you with income that will grow over time, and that income stalls or is reduced, you may see that basis undermined. Short term, that thought process is correct.

However, if you sell a stock on the basis of a freeze or cut, you will likely sell on a loss. This is due to the fact that such sell-offs beat down the share price and guarantee paper losses for investors seeking to sell. Furthermore, if the freeze or cut was implemented to address the company's short-term financial issues, it does not mean that long-term harm is done.

Both Kellogg and Campbell Soup delivered to their shareholders after their issues had been resolved. In neither case had the competitive advantages which made these firms attractive long-term investments been irreparably damaged by said issues. Both are solid companies in the stable food and beverages sector with portfolios of household name products: Kellogg's has Corn Flakes, Fruit Loops, Special K and Pop Tarts; Campbell Soup has Pepperidge Farm, V8, SpaghettiO's and the Campbell-branded products, among others. And the steady profitability that their respective portfolios generate is borne out by their net sales over the past twenty years.

Year Kellogg Net Sales ($) Campbell Soup Net Sales ($)
1997 6.830 billion 6.614 billion
1998 6.762 billion 6.696 billion
1999 6.984 billion 6.424 billion
2000 6.954 billion 5.626 billion
2001 7.548 billion 5.771 billion
2002 8.304 billion 6.133 billion
2003 8.811 billion 6.271 billion
2004 9.614 billion 6.660 billion
2005 10.177 billion 7.072 billion
2006 10.907 billion 7.343 billion
2007 11.776 billion 7.867 billion
2008 12.822 billion 7.998 billion
2009 12.575 billion 7.586 billion
2010 12.397 billion 7.676 billion
2011 13.198 billion 7.719 billion
2012 14.197 billion 7.175 billion
2013 14.792 billion 8.052 billion
2014 14.580 billion 8.268 billion
2015 13.525 billion 8.082 billion
2016 13.014 billion 7.961 billion

In conclusion, it is my view that if the investment thesis for a company remains intact, and you are well-enough diversified to ensure that an issue with one individual stock will not adversely affect your income stream, there is little need to jettison a decent company that is undergoing short-term problems and forego the long-term profits that it can deliver. Both Kellogg and Campbell Soup bounced back, but the investors who would have divested them in the early 2000s due to a frozen/cut dividend would not have been able to benefit from that.

I expect there to be some disagreement in the comments below, but hopefully these comments are not disagreeable!

DISCLAIMER: The author is not a financial professional and accepts no responsibility for any investment decisions a reader makes. This article is presented for information purposes only. Furthermore, the figures cited are the product of the author's own research and may differ from those of other analysts. Always do your own due diligence when researching prospective investments.

Disclosure: I/we 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.