Income investors rely on the dividends that their favorite stocks pay. The worst news those investors can get is that a company has had to cut its dividend. That might not seem like something that would happen very often, but investors in blue-chip conglomerate General Electric are just the latest to learn that even the largest companies can face financial challenges that threaten their ability to pay dividends.
Recently, Coca-Cola, Merck, and Chevron have faced challenges that have sent their dividend payout ratios above the 100% mark. That's usually a sign of danger for dividend stocks, but in these three cases, there are good reasons why investors shouldn't panic. Below, we'll look more closely at these three companies to show you why they're safer than they look at first glance.
Coca-Cola (NYSE: KO)
Merck (NYSE: MRK)
Chevron (NYSE: CVX)
Data source: Yahoo! Finance.
Falling flat or fizzing up?
Coca-Cola had a tough 2017, underperforming the broader market as it faced the prospect of having to make major modifications to its business. Attacks on the company's namesake sugary beverages have led to sluggish growth for that segment of Coca-Cola's business, and it's taken dramatic shifts toward other product lines like bottled water and other still beverages for the company to hold its own amid the weakness in its carbonated beverage lineup. Reported earnings have fallen by roughly a third over the past 12 months, sending Coca-Cola's payout ratio soaring.
Image source: Coca-Cola.
Much of the negative impact on Coca-Cola's bottom line has come from one-time charges related to restructuring and asset sales. The company has sought to refranchise its bottling operations into separate companies, and when you look at losses on the sales of assets, asset writedowns, and restructuring charges, Coca-Cola has taken a hit of more than $3.2 billion. With restructuring now complete, investors can expect earnings to climb back toward the $2-per-share level, which would bring the payout ratio back down to a reasonable 75% or so.
Merck, heal thyself
Merck ran into substantial problems late in the year, with a combination of poor financial results and questionable strategic moves leading to a crisis of confidence among investors. The drug giant's third-quarter report showed weakness in sales and raised concerns about earnings growth, and its decision to withdraw an application for European regulators to approve its Keytruda cancer treatment for first-line use resulted in shareholders worrying about the key drug's future.
With Merck, investors have to look closely at the financial moves the company makes to write down the value of its assets. In late 2016, it recorded $3.6 billion in impairment charges related to its in-process research and development assets, most of which were related to its HCV treatment uprifosbuvir. Such charges aren't uncommon, but in previous years, the corresponding R&D-related charges were less than $65 million. As long as similar charges don't recur, Merck's earnings are poised to recover to more than $3 per share in 2018, which would put the payout ratio at around 65%.
Chevron has been at the epicenter of oil market turbulence in recent years, with falling crude prices weighing deeply on the integrated oil giant's earnings power. Weaker production has weighed on its earnings, and a generous dividend policy that past prices justified now looks somewhat overextended.
Lately, the energy market has cooperated more with Chevron, and that's likely to put the oil giant in a better position going forward. In addition, the completion of liquefied natural gas projects in Australia should help reduce capital spending and produce new sources of income. Those looking at the stock now expect more than $5.25 per share in earnings for 2018, and that would send Chevron's payout ratio down to about 80%. That's not as low as some would prefer to see, but it's a big improvement from where it's been in the past several years.
Looking at payout ratios out of context can lead to major concerns for dividend investors. By looking at the facts behind the numbers, you can often reach a greater comfort level about the challenges facing companies and get more confidence about their ability to sustain dividend payments in the futures.
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