Dividend Freeze: How Should Shareholders React?

Printed on November third, 2021 by Nate Parsh

At Certain Dividend, we place an immense worth on proudly owning shares with rising dividends over lengthy intervals of time. It is because firms which can be in a position to take action usually have a items or companies which can be in demand via all parts of the financial cycle.

We all know that many dividend development buyers really feel the identical means and need to load up their portfolio with high quality dividend shares which have prolonged dividend development histories, such because the Dividend Aristocrats.

You possibly can obtain the total Dividend Aristocrats checklist with all 65 Dividend Aristocrats (plus vital monetary ratios akin to payout ratios and P/E ratios) by clicking on the hyperlink beneath:

Firms additionally notice that shareholders have grown accustomed to receiving an annual elevate.

Nevertheless, generally buyers encounter a dividend freeze, which is why an organization decides to maintain its dividend flat.

This text will discover a dividend freeze and why it occurs, to assist buyers perceive the mechanics of the pause of dividend development.

We may also focus on some examples to assist buyers higher perceive if they need to promote a inventory following a dividend freeze.

Desk of Contents

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What’s a Dividend Freeze?

Top-of-the-line facets of a dividend enhance is that it lets shareholders achieve a window into how an organization is performing. A bigger-than-usual dividend elevate will be seen as a really optimistic improvement, signaling to buyers that the corporate could be anticipating an uptick in enterprise.

Even a elevate that’s in-line with the historic common can reassure shareholders that the underlying enterprise is performing nicely, giving the investor motivation to keep up or enhance their possession of the inventory.

Nevertheless, a weak elevate can have the alternative impact, giving shareholders the impression that maybe enterprise isn’t as robust as anticipated.

That stated, many dividend development buyers don’t exit their place merely attributable to a token or smaller than common elevate. A rise is a rise in any case, and shareholders are nonetheless receiving a much bigger dividend than they did earlier than.

However a dividend freeze means shareholders will see the identical degree of revenue (assuming dividends usually are not reinvested). For shareholders accustomed to seeing that annual elevate, this could trigger concern.

Whereas not as dangerous as a dividend minimize, a dividend freeze implies that firm administration doesn’t have the arrogance or capability to extend the dividend fee.

Every dividend freeze is completely different, as no two firms are precisely the identical. A dividend freeze can imply that the enterprise is going through worse than anticipated enterprise prospects. Alternatively, the dividend freeze will be for an precise optimistic motive, although that is a lot rarer.

Whereas many revenue buyers imagine a pause or a minimize as an computerized motive to promote, we imagine that it’s essential to know why the dividend was paused earlier than investing resolution.

When is a Dividend Freeze a Signal of Bother?

To most, a dividend minimize is the worst-case state of affairs. Decreasing dividend funds is seen as taking cash away from shareholders, and is often met with steep declines within the share worth.

Associated: Dividend Lure: What Earnings Buyers Want To Know

Contemplate the financial institution shares throughout the 2007 to 2009 time intervals. Among the U.S. and Canadian banks paused their dividend development throughout this time.

Finally, practically each one of many massive monetary establishments within the U.S. slashed their dividends to the bone, partially as a result of they have been compelled to by Federal Reserve, but in addition as a result of their companies have been in dire straits and so they wanted the capital to remain afloat.

In nearly each case, the share worth plummeted.

After all, a superb portion of the decline was because of the present enterprise setting and the specter of monetary market collapse.

If the banks had managed to keep up their dividends and even raised them, then buyers would have the sense that firm administration believed that the present headwinds would ultimately subside.

A dividend minimize, coupled with market circumstances, drove down the costs of some banks that have been previously thought of to be well-run.

Can a Dividend Freeze Be a Good Factor?

Extra instances than not, a dividend freeze is probably going an omen of bother forward, and that maybe a dividend minimize can be potential.

There are occasions when a dividend pause may truly be a optimistic improvement for the long-term.

Take CVS Well being Corp (CVS) for instance. Up till 2018, the well being care companies supplier had 14 years of dividend development and the dividend had greater than doubled over the earlier 5 years.

That modified when the corporate bought medical health insurance firm Aetna.

The acquisition, competed in November of 2018, value the corporate $77 billion, together with the belief of Aetna’s long-term debt. This added $45 billion in new debt to CVS Well being Corp’s steadiness sheet.

Because of this, management introduced its intention to keep up its dividend till its leverage ratio declined to extra manageable ranges, ideally to the low 3x vary.

Shareholders have acquired the identical $0.50 per quarter dividend for 20 consecutive quarters, together with the latest fee distributed November 1, 2021.

Though the corporate was pretty clear with the rationale behind the pause, the market did punish the inventory, each for the price of the Aetna buy in addition to the dividend pause.

It took the inventory a number of years to get well.

5 years and not using a dividend elevate could be a deal breaker for a lot of dividend development buyers, however the acquisition of Aetna has paid off for the corporate.

Aetna had a membership of practically 40 million individuals on the time of buy, which added a considerable variety of potential prospects to CVS Well being Corp’s enterprise.

The acquisition has additionally offered a boast to income and earnings whereas additionally producing money movement that the corporate may use to pay down debt.

Supply: Investor Presentation

Powered by the Aetna acquisition, adjusted earnings-per-share are anticipated to succeed in a brand new excessive in 2021. And that is after the corporate needed to problem an enormous quantity of fairness to finish the deal.

CVS Well being Corp has additionally taken steps to cut back its debt burden, usually spending its additional money movement to retire excellent debt.

For instance, CVS Well being Corp repaid greater than $2 billion in debt final quarter, bringing its year-to-date debt reimbursement to $5.4 billion.

In complete, the corporate has repaid greater than $17 billion of debt for the reason that acquisition closed. Because of this, the corporate stays on observe to hit its goal of a leverage ratio within the low 3x vary.

The dividend is prone to stay paused for a while, however CVS Well being Corp is an instance of a strong motive for pausing development.

The corporate pursued an acquisition that appeared costly on the face of it, one we have been truly skeptical of when introduced, however has offered CVS Well being Corp with an inflow of consumers, a rising bottom-line and robust free money movement.

Initially, the market didn’t take care of the acquisition or dividend pause, however shares are up practically 50% for the reason that lows.

Not a nasty return for the investor who was in a position to perceive that the corporate was freezing its dividend to assist pay for a purchase order that might assist in future outcomes.

Ultimate Ideas

Apart from a dividend minimize, a dividend freeze could be the very last thing revenue buyers desires to come across. It’s usually the case {that a} dividend pause is foreshadowing of bother for a enterprise. This was the case over the last recession for most of the main banks.

AT&T is a newer case, because the dividend pause is a direct end result from the spinning off of property beforehand acquired. This was primarily a “white flag” by administration, declaring to the market that its earlier technique of constructing high-priced acquisitions was a mistake.

However a pause doesn’t all the time imply buyers ought to promote the inventory.

Within the case of CVS, the dividend was frozen as a result of the corporate acquired one other enterprise that might complement its present enterprise.

The dividend has remained fixed for a while, however the inventory has railed within the ensuing years because of the enhanced development prospects of the acquisition.

AT&T and CVS Well being Corp are two firms that paused their dividends for very completely different causes.

In our view, pausing the dividend due to failed enterprise journey is way completely different from doing so due to an acquisition that can energy the father or mother firm.

Because of this, it’s our opinion that buyers ought to be certain that they perceive why a sure firm has frozen its dividend earlier than promoting the inventory.

You possibly can see extra high-quality dividend shares within the following Certain Dividend databases, every based mostly on lengthy streaks of steadily rising dividend funds: