Ways to reduce the risk of a dividend cut

By Anne Kates Smith
Posted on February 24, 2016

When investors think of dividends, they often think “safety.” Checks that arrive like clockwork come to mind.

But a recent round of dividend cuts has given some income-seekers a rude awakening. Among the rudest: Kinder Morgan (symbol KMI), the energy pipeline giant, slashed its dividend 75 percent in December, cutting the quarterly payout from 51 cents a share to 12.5 cents. A day later, Freeport McMoRan (FCX), a copper and gold producer with an ill-timed expansion into oil and gas production in 2013, suspended its dividend.

Dividend cuts are still rare. In fact, 337 companies in Standard & Poor’s 500-stock index increased their payouts last year. But the average increase is running at 13 percent — below the 18 percent average increase in 2014 and 20 percent in 2013.

The country’s third-largest telecommunications company has been trying to move from last century’s landlines to this century’s cloud, but the company lost four senior cloud executives in 2015. For the 12-month period that ended September 30, the company paid out 168 percent of what it earned. “They’ve been paying out well in excess of what they’re taking in for many quarters,” said Eric Ervin, Reality Shares’ CEO. “In that case, the writing’s on the wall.” CenturyLink cut its dividend by 26 percent in 2013.

Newmont Mining (NEM, $16.56, 0.6 percent)

Yes, the yield for this gold-producing behemoth is already minuscule. But it should be even lower; in fact, it’s supposed to be nothing.

That’s because Newmont’s dividend policy is explicitly tied to the price of gold — in theory, when gold sells for less than $1,200 an ounce, the company shouldn’t be paying a dividend, although declaring one is at the discretion of the board of directors. The average price for the metal did breach the $1,200-an-ounce threshold in the third quarter. The company maintained its quarterly payout of 0.025 cent a share, “but that can’t go on forever,” said Ervin, especially with gold selling today at $1,111 an ounce.

Caterpillar (CAT, $59.81, 5.15 percent)

The heavy-equipment manufacturer rarely sports a dividend yield this high. Only once in the past 16 years has the average annual yield climbed above 3 percent. The company is reeling from a global industrial slowdown, and analysts expect an 8 percent slump in sales and a 22 percent drop in earnings in 2016. Cost-cutting has resulted in thousands of layoffs.

Yet the company has continued to raise its dividend aggressively — from an annual rate of $1.84 a share in 2012 to the current rate of $3.08 per share, even as its customers in the energy and mining industries have struggled.

Targa Resources (TRGP, $16.23, 19.38 percent)

Kinder Morgan’s dividend cut has paved the way for other companies in the business of processing, storing, transporting and marketing oil and natural gas. A toxic combination of high debt and sinking commodity prices will put pressure on Targa’s dividend for years, said analyst John Edwards of Credit Suisse.

He recently downgraded the stock to “underperform” (translation: sell), despite a one-year price target of $36 a share, which is 38 percent above the current price. But Edwards’s previous target price was $79. “We see no way out of the woods for TRGP without a substantial dividend cut,” he said.