10 Warning Signs a Dividend Cut is Coming: Real Examples from 2023

Dividend cuts can be devastating for income-focused investors, eroding portfolio returns and undermining the reliability of a once-trusted income stream. While not all dividend cuts can be predicted, there are often warning signs that savvy investors can watch for to identify potential risks and adjust their portfolios accordingly. In this article, we'll explore 10 key warning signs of a looming dividend cut and examine real-world examples from 2023 to illustrate these red flags in action.

1. Declining Earnings or Cash Flow

One of the most obvious warning signs of a potential dividend cut is a sustained decline in a company's earnings or cash flow. When a company's financial performance deteriorates, it may struggle to maintain its dividend payments, increasing the likelihood of a cut.

Real Example: Intel Corporation (INTC) In February 2023, Intel slashed its quarterly dividend by 66%, from $0.365 per share to $0.125 per share. The cut followed several quarters of declining revenue and earnings, as the company grappled with intensifying competition and a slowdown in the PC market. The reduced dividend aligned with Intel's lower cash flow generation and the need to invest in its turnaround strategy.

2. Unsustainably High Payout Ratio

The payout ratio, which represents the proportion of earnings paid out as dividends, is a crucial metric for assessing dividend sustainability. An excessively high payout ratio, particularly one that exceeds 100%, suggests that a company is distributing more than it can afford, increasing the risk of a dividend cut.

Real Example: Lumen Technologies (LUMN) In November 2022, Lumen Technologies, a telecommunications company, announced a 50% reduction in its quarterly dividend, from $0.25 per share to $0.125 per share. The cut was driven by an unsustainable payout ratio that had exceeded 100% in some quarters, as the company struggled with declining revenue and high debt levels. The dividend reduction aimed to improve Lumen's financial flexibility and support its deleveraging efforts.

3. Ballooning Debt Levels

Companies with rapidly increasing debt levels may face pressure to reduce their dividends, as servicing debt obligations becomes a higher priority than maintaining payouts to shareholders. High debt-to-equity ratios or debt-to-EBITDA ratios can signal an unsustainable debt burden that could lead to a dividend cut.

Real Example: Tupperware Brands Corporation (TUP) In April 2023, Tupperware Brands suspended its quarterly dividend of $0.275 per share, citing the need to preserve liquidity and reduce debt. The company had been grappling with high debt levels and declining sales, exacerbated by the COVID-19 pandemic's impact on its direct-selling business model. The dividend suspension was part of a broader turnaround plan to improve Tupperware's financial position and operational performance.

4. Dividend Yield Significantly Above Peers

While a high dividend yield can be attractive to income-seeking investors, an unusually high yield compared to industry peers can be a warning sign. This may indicate that the market is pricing in a higher probability of a dividend cut, as investors become skeptical of the payout's sustainability.

Real Example: Algonquin Power & Utilities Corp. (AQN) In January 2023, Algonquin Power & Utilities, a Canadian renewable energy and utility company, reduced its quarterly dividend by 40%, from $0.1808 per share to $0.1085 per share. Prior to the cut, Algonquin's dividend yield had risen to over 10%, significantly higher than the average yield of its utility peers. The elevated yield reflected market concerns about the company's payout sustainability, given its high debt levels and the impact of rising interest rates on its financing costs.

5. Negative Industry or Regulatory Trends

Dividend cuts can often be triggered by adverse developments in a company's industry or regulatory environment. These challenges can pressure a company's financial performance and force it to reassess its dividend policy to adapt to new market realities.

Real Example: Mortgage Real Estate Investment Trusts (mREITs) In 2022 and 2023, several mortgage REITs, such as Annaly Capital Management (NLY) and AGNC Investment Corp. (AGNC), reduced their dividends as the sector grappled with the impact of rising interest rates and a challenging mortgage market. As interest rates increased, mREITs faced compressed net interest margins and lower book values, prompting them to adjust their dividends to reflect the new economic landscape and maintain their financial health.

6. Slowing Dividend Growth Rate

Before cutting a dividend outright, some companies may first signal their financial strains by slowing the rate of dividend growth. A marked deceleration in dividend increases can be an early warning sign that a company is facing headwinds and may eventually need to reduce or suspend its payout.

Real Example: 3M Company (MMM) In February 2023, 3M announced a 24% reduction in its quarterly dividend, from $1.49 per share to $1.13 per share. The cut followed several years of slowing dividend growth, as the company faced challenges related to the COVID-19 pandemic, supply chain disruptions, and litigation risks. The slower pace of dividend increases in the years leading up to the cut served as an early warning sign of the company's mounting financial pressures.

7. Asset Sales or Spinoffs

When a company announces significant asset sales or spinoffs, it can sometimes signal a shift in capital allocation priorities that may lead to a dividend cut. As a company reshapes its business portfolio, it may need to redirect cash flow to support the remaining operations or pay down debt, potentially at the expense of the dividend.

Real Example: General Electric Company (GE) In November 2022, General Electric completed the spinoff of its healthcare division, GE HealthCare, as part of a plan to split into three separate companies. Following the spinoff, GE reduced its quarterly dividend from $0.08 per share to $0.04 per share, reflecting the smaller size and altered financial profile of the remaining company. The dividend cut was part of a broader restructuring effort to simplify GE's business and improve its long-term financial performance.

8. Weak Balance Sheet or Credit Downgrades

A company's balance sheet strength and credit ratings can provide valuable insights into its financial health and ability to maintain its dividend. A weak balance sheet, characterized by high debt levels or low cash reserves, may signal an increased risk of a dividend cut. Similarly, credit rating downgrades by major agencies can indicate growing financial strains that could lead to a reduced payout.

Real Example: Frontier Communications Parent, Inc. (FYBR) In February 2023, Frontier Communications, a telecommunications company, eliminated its quarterly dividend of $0.25 per share, citing the need to prioritize debt reduction and network investments. The decision to cut the dividend came as the company held a non-investment grade credit rating and faced the challenge of upgrading its infrastructure to remain competitive in the broadband market. The dividend elimination aimed to strengthen Frontier's balance sheet and support its long-term growth initiatives.

9. New Management with Different Capital Allocation Priorities

Changes in a company's management team, particularly the arrival of a new CEO or CFO, can sometimes herald a shift in capital allocation priorities that may lead to a dividend cut. New leaders may have different philosophies on the balance between shareholder returns and business reinvestment, potentially leading to a reassessment of the dividend policy.

Real Example: Sanofi S.A. (SNY) In February 2023, French pharmaceutical giant Sanofi announced a 30% reduction in its annual dividend, from €3.33 per share to €2.33 per share. The decision to cut the dividend came under the leadership of CEO Paul Hudson, who took the helm in 2019 and has prioritized investing in the company's drug pipeline and strategic growth initiatives. The dividend reduction reflected Sanofi's shifting capital allocation strategy, which aimed to strike a balance between shareholder returns and funding the company's long-term growth and innovation.

10. Recessionary or Macroeconomic Headwinds

During economic downturns or periods of significant macroeconomic uncertainty, companies may face pressure to reduce their dividends as a means of conserving cash and weathering the storm. Recessionary environments can strain corporate profitability and cash flows, making it more difficult for companies to sustain their payouts.

Real Example: COVID-19 Pandemic and Inflationary Pressures The economic fallout from the COVID-19 pandemic in 2020 and the subsequent inflationary pressures in 2022 and 2023 led to numerous dividend cuts across a wide range of industries. Companies in sectors such as travel, hospitality, energy, and retail were particularly hard hit, as lockdowns, supply chain disruptions, and changes in consumer behavior weighed on their financial performance. Many companies reduced or suspended their dividends to preserve liquidity and navigate the challenging macroeconomic landscape.

Conclusion

Recognizing the warning signs of a potential dividend cut is a crucial skill for income-focused investors seeking to protect their portfolios and maintain a reliable income stream. By monitoring factors such as declining earnings, high payout ratios, increasing debt levels, and relative dividend yields, investors can identify companies at a higher risk of reducing their payouts.

Real-world examples from 2023 illustrate how these warning signs can manifest in practice, affecting companies across various sectors and geographies. By learning from these cases and incorporating the lessons into their investment process, dividend investors can make more informed decisions and proactively manage the risks associated with dividend cuts.

However, it's important to remember that no single warning sign guarantees a dividend cut and that a comprehensive analysis of a company's financial health, industry dynamics, and management strategy is essential for making sound investment decisions. By combining an understanding of these warning signs with thorough due diligence and a diversified investment approach, dividend investors can navigate the challenges of income investing and build more resilient portfolios for the long term.