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Six Flags Dividend Cut Likely

About: Six Flags Entertainment Corporation (SIX)
by: Bill Maurer
Bill Maurer
Long/short equity, long only, short only, Growth

Stock plunges after Q4 pre-announcement.

Payout ratio should top 100% for 2019.

25% reduction would still be meaningful yield.

One of Friday's worst performers was theme park giant Six Flags (SIX), after the company issued a large revenue warning for Q4. Not only were attendance numbers below the prior year, but the company disclosed some major issues with its partners in China. Part of the reason why shares are down roughly 20% is that investors are likely factoring in a dividend cut, which I'll explore the possibility of today.

(Source: Yahoo Finance)

For the final quarter of 2019, the company stated that revenues would come in $8 million to $10 million below the prior-year period. That's well below the street forecast, which was actually expecting a 6% growth to more than $285 million. Analysts saw a large drop in earnings per share coming already, so this warning will actually make the bottom line situation even worse.

Six Flags has been one company that's shown impressive dividend growth in recent years. At the start of 2015, the company was paying out $0.52 per share a quarter, and in late 2019, a raise was announced to $0.83 per share. Over time, the payout ratio has thus soared to nearly 100% of free cash flow as seen in the table below.

(Source: Company annual filings, seen here)

We still will have to wait a little while to see the full 2019 results, but it is certainly possible to see the payout ratio top 100%. Through the first three quarters of last year, free cash flow was down about 5.5% as compared to the first nine months of 2018, while cash dividend payments were up about 5.3%. If I project those changes out for the full year, it would put the 2019 payout ratio at more than 107%.

Now, the payout ratio could soar even higher if cash flow numbers for Q4 are worse than the first three quarters of 2019, and that's possible thanks to the large drop in earnings. We also though have to consider that if the current dividend payment is maintained, the total cash payout will continue to rise moving forward. That's because the company has basically stopped buying back shares, so the outstanding share count is now on the rise.

The company finished Q3 in a net debt position of more than $2 billion, so it isn't exactly flush with cash. While no major debts are due for the next couple of years, there isn't a lot of financial flexibility here. That means it will be hard for the company to keep the dividend going in excess of free cash flow for the indefinite future, especially if the revenue and earnings picture does not turn around in the coming years.

With shares down nearly 20% on Friday, the dividend yield has soared to almost 9.50% on an annual basis. At this point, a 25% dividend cut would still give the stock an annual yield above 7.00%, which would still be extremely high and well above US fixed income levels. A move of this size would save about $70 million in cash per year, which would be equal to about half of a year's capital expenditures right now.

In the end, Six Flags' warning on Friday may just be the first part of bad news for the company. Q4 results look like an absolute disaster, and the next shoe to drop could be a dividend cut. With the company's payout ratio likely to top 100% of free cash flow in 2019 and the balance sheet not exactly strong, it just doesn't make sense to be paying out this much to shareholders.

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.

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