Warning: These 3 Great Dividends Are in Danger

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Let’s talk about something a little bit uncomfortable. No, I’m not referring to that mental image you have of me in a speedo, although that is equally as awkward.

We’re talking dividend cuts, kids.

As we all know, a dividend is only as safe as the underlying cash flow supporting it. Much of the time this really isn’t an issue. The business generates profits, pays out a portion of those earnings as dividends, and everyone is happy. Earnings generally go up and a business can easily sustain its payout during recessions.

But sometimes, things aren’t quite that rosy. Certain companies pay generous dividends that really have no business doing so. Others seemingly look to be steady earners until some unforeseen event comes out of left field and impacts cash flow. There are even dividend payers who can afford the dividend who cut for other reasons, like CI Financial did back in 2018. They wanted to free up capital to repurchase what management thought were undervalued shares.

By the way, how’s that buyback going for them?

Oh.

Examples like this are why your author likes buybacks but insists on dividends. Buybacks are generally good, but can miss the mark. Dividends, meanwhile, can be reinvested in whatever I’d like. I’m guessing most long-suffering CI Financial shareholders would have preferred the dividend over the buybacks.

And in CI Financial’s defense, just think about how much lower the stock would be if it hadn’t of stepped in and bought more than 70 million shares since 2018.

Anyway, I’ve digressed a bit. Let’s take a closer look at a few stocks I think have a danger of cutting their dividends, including a couple that I actually own. I’ll talk about whether I plan to sell, too.

TransAlta Renewables

I wrote about TransAlta Renewables (TSX:RNW) about a year ago now, talking about how a temporary setback was a decent buying opportunity.

Here’s what happened. The company constructed a bunch of wind turbines in Fort Hills, which were built on faulty foundations. Each foundation had to be ripped out and rebuilt at a total cost of approximately $120M.

The stock sold off as a result, and your author took the opportunity to add to an existing position. I figured earnings would be temporarily depressed but they’d bounce back in 2024 once the repairs were finished.

The problem is those earnings aren’t contributing to the bottom line today, which is pushing the dividend payout ratio uncomfortably high. At the beginning of the year management expected cash flow available for distribution (CAFD) to be between $230 and $270M, or between $0.86 and $1.01 per share.

The dividend is $0.936 per year, which doesn’t leave us much wiggle room if CAFD comes in at the bottom of the range. In fact, the dividend exceeded CAFD last year and has crept consistently lower for a few years now.

The good news is results have been pretty good so far this year, with Q1 cash flow checking in at $0.27 per share. The company also said it’ll have a portion of the Kent Hills turbines back in service in the second half of the year, too.

Although Renewables doesn’t have a history of cutting its payout, many dividend investors swore off Renewables’ parent TransAlta years ago after it cut its dividend. You could argue Renewables is a little more likely to cut if the parent did too. After all, TransAlta owns about 60% of its subsidiary.

What Nelson plans to do — I own this one and will continue to hold patiently. At $11 per share it trades at about 10x next year’s CAFD, which I think is a pretty compelling valuation. Renewables also has a pretty solid balance sheet, which also bodes well for making it through today’s temporary rough patch.

Dividend risk — Medium. The company should have the ability to make it through this rough patch with the dividend intact, but CAFD has been flat for years now. It needs to show the market it can start to grow the bottom line again.

Fiera Capital

Fiera Capital (TSX:FSZ) is a Montreal-based asset manager with some $160B in assets under management. It has traditionally operated in North America but the company is expanding worldwide. Insiders own 16% of shares outstanding.

The company’s struggles are two-fold. Firstly, stock markets have been weak for basically a year now, and losses in equity portfolios translates into lower fees. And secondly, investors are slowly withdrawing capital from Fiera’s funds as simpler and cheaper options become more and more prevalent. It is attempting to offset this by putting more emphasis on asset management for wealthy clients and institutional investors, but results have been mixed at best.

The company also saw a big decline in performance fees in 2022, at least when compared to strong years in the equity market in 2020-21.

Put it all together and the company posted revenue of $157M in Q1, down nearly 9% compared to the same period a year ago. Adjusted earnings fell from $33M in the same quarter in 2022 to $23M this year. Weaker earnings is a trend that has been happening for a while, too.

On the plus side, the dividend is $0.86, while adjusted net earnings were $1.09 per share over the last year, giving us a payout ratio of just under 80%. The problem, based on that graph, is the trend is not going in the right direction.

On the plus side, Fiera is sitting on almost $90M worth of cash, which works out to about $0.85 per share. That cash cushion is enough to maintain the dividend for a year even without any earnings. Management stated in the last earnings call they expect free cash flow to normalize at $150M per year, or about $1.45 per share. And the CFO did tell investors paying the dividend continues to be a priority, but plenty of management teams have lied about that before.

In fact, shares are down so much that the dividend yield is more than 13%. That’s really high, and it’s obvious the market thinks the payout is going to get cut. What’s the point of having such a high dividend if the market gives you no credit for it?

What Nelson plans to do — I own a small position in this one purchased at about $10 per share. With the stock trading at about 6x trailing adjusted earnings I don’t have much interest in selling today. It’s just too cheap. I would also continue to hold if there’s a dividend cut. I’m not sure this is a great business to own long-term, however.

Dividend risk — Medium to high. I think management will be patient and try to make it through today’s rough patch. If results don’t improve in 2-3 quarters, consider this one cut.

Northwest Healthcare Properties REIT

Northwest Healthcare Properties REIT (TSX:NWH.un) owns medical-related property around the world, with operations spread out across North America, South America, Europe, Australia, and New Zealand.

It hasn’t been a great few years for this REIT. First it was hit by COVID and its impact to its senior’s living portfolio in Australia. Then its office property division was hit by the work at home movement. More recently it planned to partner with a British institutional investor, which was going to acquire most of NWH’s portfolio in the country (and, importantly, assume the debt), but it pulled out in the 11th hour.

The company was also caught holding a lot of variable rate debt right when rates shot higher, which did this to earnings:

The dividend is $0.80 per unit on an annual basis, meaning the company isn’t earning close to enough to cover the distribution.

On the plus side, management has taken steps to at least stem some of the bleeding. The floating rate debt has been hedged, resulting in a quarterly savings of a few cents per unit. It plans to dispose of some $550M in non-core assets, which should net the REIT some $150M in net proceeds.

It also plans to sell off most of its U.S. assets into a joint venture with a major institutional partner, something very similar to the UK deal that just fell apart. It would also be slated to collect management fees on such a deal, which would also help AFFO.

If these things happen, it could free up a lot of capital that can be used to repurchase shares, which would immediately help the sustainability of the distribution.

Put everything together — and assume the company can find a new partner in the UK — and AFFO could get back to the $0.80-$0.85 per share range, getting the payout ratio back to the 90-100% range. And that’s the best case scenario. Worst case is a company with a bloated balance sheet which can’t sell any of its assets into a weak market.

What Nelson plans to do — as I type this, shares trade at $6.39 each. Annualized AFFO today is $0.68. That puts us at around 9x AFFO, an incredibly cheap valuation. Best case scenario is a return to about $0.85 per share in AFFO, which is less than 6x AFFO. The value is there, and I have no plans to sell.

I also like a lot of the assets over the long-term. Healthcare spending has grown at a faster rate than global GDP for decades now, and much of the company’s assets have inflation-linked rent escalators.

Dividend risk — Consider this one cut. I’d be very surprised if the company was able to sustain the distribution at today’s levels.

Author owns shares of TransAlta Renewables, Fiera Capital, and Northwest Healthcare Properties REIT. Nothing written above constitutes investment advice. Consult a qualified financial advisor before making any investment decisions.

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