V.F. Corp's Dividend Cut Provides Important Lesson as Uncertainty Rises

Fresh inflation fears gripped the market in February, pulling the S&P 500 down 2.5%. Data out last month showed upward wage pressure may continue as U.S. employers in January added almost triple the number of jobs economists had expected. Two measures of consumer price growth topped estimates, too. 
Marking a swift reversal from January’s surge in risk assets, investors lost confidence that the Fed will soon end its aggressive rate-hiking campaign, which seeks to cool the economy and stamp out inflation by raising borrowing costs.
These sudden shifts in sentiment can trigger feelings of fear and greed as stock prices zig and zag. But our goal has never been to time the market or anticipate when Tesla will next rally 50%.
As Warren Buffett penned in his 2022 Berkshire Hathaway letter last week, we are not stock-pickers; we are business-pickers. 
This rings especially true for investors seeking to live off dividends rather than generate income by selling shares at prices that could be foolishly low (or high) depending on the market’s prevailing mood.
As conservative dividend growth investors, our mission is simple: Own a diversified stable of time-tested companies with entrenched products and services, strong financial positions, opportunities for long-term growth, and shareholder-friendly managements.

Finding such remarkable businesses, buying them at opportunistic times, and holding them forever can create an almost unbelievable stream of rising passive income.
In Buffett’s letter, he reminisced about Berkshire’s $1.3 billion investment in Coca-Cola, which he began buying in 1988 after the 1987 stock market crash made the global beverage giant’s valuation too enticing to pass up.
In 1994, when Berkshire completed its seven-year purchase of the 400 million shares of Coca-Cola it owns now, the firm received $75 million in dividends from Coke. By 2022, the annual dividend had grown to $704 million – over half of Berkshire’s investment cost, with growth occurring every year along the way.
Buffett listed American Express as another example. This is one of Berkshire’s oldest and most successful stock picks. True to his value investor roots, Buffett in the mid-1960s began buying shares in the wake of the infamous salad oil scandal, which caused the financial services firm to incur major liabilities. 
Berkshire ceased making purchases of Amex after 1995 and, coincidentally, had invested a total of $1.3 billion in the company. Annual dividends grew from $41 million to $302 million as American Express found ways to increase its profits over time.
Rising dividends also tend to result in capital appreciation over time as stock prices track earnings higher. Berkshire’s Coke and Amex investments are each valued at over $20 billion today, representing more than 15 times Buffett’s cost basis.
I share these examples with a discussion of our Dividend Safety Score system in mind as both Coca-Cola and American Express were initially purchased by Buffett during times of distress and uncertainty.
These fear-filled moments are often characterized by plunging stock prices and spiking dividend yields. But they can bring some of the best opportunities for long-term investment if the storm eventually clears and the company retains its favorable economic qualities.
We strive for Simply Safe Dividends to serve as a steadying force during such times. Not only can this help you stick to your long-term investing plan, but it can help bubble up the next Coke’s and Amex’s in the market.
Our Dividend Safety Scores promote stability by taking a long-term view of dividend cut risk over a full economic cycle. 

We do our best to account for downside scenarios that a company could encounter. That could look like a plunge in energy prices for an oil producer, a cyclical decline in demand for construction equipment, or a more challenging capital funding environment for highly leveraged firms.
Since our scores bake in these possibilities, we don’t anticipate making many score changes if those events materialize, even if they cause dividend yields to spike. Some future risks can’t be anticipated in advance. But overall, this long-term focus reduces the odds of us needing to downgrade a broad swath of companies whenever the tide goes out.
The benefits of this approach were evident during the pandemic, when 25% (334 out of 1,313) of stocks we rated cut their dividends in 2020.

Our Safe and Very Safe buckets avoided all but 8 (or 97.6%) of the cuts. But had we looked only at our pre-pandemic scores as of January 2020 and ignored any score changes we made as new information rolled in, 93% of the 334 cuts would have still come from firms that scored below our Safe threshold.
That said, maintaining stable scores in the face of economic turbulence can require a lot of subjective analysis. 

How stretched will a firm’s payout ratio become? When will margins return to normal? Has the long-term outlook changed? Will debt reduction become the top priority? How committed will management remain to the dividend if headwinds persist?
We pour our heart and soul into these types of reviews. But we aren’t always right. Since our scoring system’s 2015 inception, our biggest “miss” came in February when former dividend king V.F. Corp slashed its payout by 41% despite maintaining a Safe score of 70.
The maker of North Face jackets and Vans shoes had seen its cash flow weaken after pandemic-related supply chain challenges led management to order too much inventory just as consumer spending shifted from goods like apparel to experiences and services, leading to a highly promotional environment and lower margins.
While we had grown wary of the company’s rising payout ratio and leverage, we expected V.F. Corp to lean on its healthy liquidity position to outlast these near-term challenges until margins rebounded to restore dividend coverage and debt metrics.

From Exxon to Leggett & Platt, dividend kings often fight especially hard to protect their payouts when times get tough. We were wrong, and management wasn’t as optimistic about a swift recovery.
As we shared in our note discussing the cut, we continue to feel terrible about being on the wrong end of this dividend announcement and wish we would have done better for those who relied on our research and ratings to invest in V.F. Corp. We hope you know we take this one to heart.

We won’t get every call right, but we will always do our best to be straight shooters and provide transparency. That includes publicly posting the complete real-time track record of our Dividend Safety Score system, which you can view here.
Since our scoring system’s inception in 2015, investors who stuck with companies that scored above 60 (our Safe threshold) would have avoided 742 of the 758 cuts we’ve seen. 
V.F. Corp is one of the 16 cuts we missed. Here are the others, in case you were curious:
  • Douglas Emmett (12/8/22): the office REIT lowered its dividend by 32% as management opted to return capital with a large new share repurchase plan instead.

  • HollyFrontier (5/4/21): the refiner suspended its dividend to fund an opportunistic acquisition. Holly had the lowest leverage ratio across its peer group and more than enough liquidity to fund the acquisition several times over. The dividend was reinstated at a higher level about one year later.

  • Dominion Energy (7/5/20): the utility opted to sell its gas and transmission storage business, which generated 25% of earnings and led the dividend to be right-sized.

  • Cantel Medical (5/12/20): the pandemic caused elective procedures to plunge, leading the low-yielding stock to suspend its payout. The stock was acquired less than a year later.

  • STMicroelectronics (4/22/20): the chip designer had a payout ratio below 20%, a BBB rated balance sheet, and a dividend yield below 1%. Shares of STM returned 39% in 2020, reflecting the firm’s underlying health despite the headline cut.

  • Rollins (4/29/20): the pest control company was generating strong cash flow and had a great balance sheet. Management cut the dividend by 33% out of an abundance of caution; shares were up over 20% year-to-date versus a 10% decline for the S&P 500, and the dividend was fully restored less than a year later.

  • HDFC Bank (4/17/20): the Indian government mandated the country’s banks to suspend their dividends in response to the pandemic. HDB shares yielded 0.8%, so the dividend was not a significant contributor to the stock’s total return.

  • CAE (4/6/20): with most flights grounded due to the pandemic, demand for pilot training services plunged.

  • Blackbaud (4/6/20): the software company wanted to preserve cash. Shares had a dividend yield below 1%, so the payout wasn’t a major consideration for investors.

  • Herman Miller (4/3/20): the furniture manufacturer opted to preserve capital in response to uncertainty created by the pandemic.

  • J2 Global (5/7/19): the internet services provider suspended its payout to prioritize acquisitive growth. The stock yielded just 2% and rose near an all-time high after the announcement. With a 25% payout ratio, low debt levels, and double-digit EPS growth, JCOM’s cut was hard to anticipate.

  • Vale (1/29/19): the miner suspended its dividend after one of its dams burst in Brazil, causing billions of dollars of damages. This was an unforecastable event (a German safety certifier had even found the mine to be stable in September).

  • MercadoLibre (2/22/18): the Latin American e-commerce ecosystem suspended its dividend to reinvest all cash into growth. The firm had a payout ratio below 15%, no debt, and $600 million of cash compared to an annual dividend of $27 million. Shares yielded less than 0.2%, so the dividend wasn’t a big factor for investors.

  • PG&E (12/20/17): California wildfires caused the regulated utility to come under investigation to see if it was responsible for the damage. Management wanted to preserve cash by suspending the dividend until more was known.

  • Ecology and Environment (7/18/16): the micro-cap stock had strong financial health but cut its dividend by 17% to invest more for growth.
On the flipside, sticking to our guns by maintaining many Safe ratings during turbulent times has hopefully helped investors stay the course or capture abnormally high yields that ended up remaining secure as short-term headwinds abated.
Here are a few examples that come to mind:
  • We kept Chevron rated Safe in March 2020 when shares yielded nearly 10% and the price of oil plunged to $20 per barrel. Shares have subsequently returned nearly 250% compared to an 86% gain for the S&P 500.
  • Our Very Safe rating on Lowe’s was maintained in March 2020 after we called several stores to confirm they remained open and busy. Shares yielded about 3.5%, double the stock’s norm, and went on to return more than 200%.
  • In June 2022, we reaffirmed Ennis’s Safe rating. The provider of business forms had a high yield near 6% with challenges posed by inflation, labor issues, high freight costs, and paper shortages. Shares have since gained over 30%, returning EBF’s dividend yield to its historical norm near 4.5%.
  • We maintained Cracker Barrel’s Safe rating in June 2022 when shares yielded near 6% as inflation pushed the restaurant chain’s payout ratio near 100%. The stock has since returned about 30% compared to the S&P 500’s 8% gain.
  • Main Street’s dividend yield touched 15% in the depths of the pandemic; we reaffirmed the BDC’s Safe rating in March 2020. Shares have gained nearly 200%.
  • General Mills saw its dividend yield shoot up to around 5% in late 2018 following its acquisition of pet food maker Blue Buffalo. Leverage spiked and the dividend was frozen, but we reaffirmed our Safe rating and positive outlook on September 1, 2018. Shares went on to return 100%, doubling the S&P 500.
This isn’t an exhaustive list. But it shows the potential value of sticking our necks out when opportunity appears to knock. And you don’t need to capitalize on very many of these moments to achieve acceptable performance.
Going back to Berkshire’s shareholder letter, Buffett wrote that the company’s “satisfactory results have been the product of about a dozen truly good decisions – that would be about one every five years” over his 58-year reign.
He branded his track record of capital allocation decisions at Berkshire as “no better than so-so,” noting that “a large group” of businesses in Berkshire’s portfolio have turned out to have only marginal economics. And “along the way, other businesses in which [Buffett] invested have died, their products unwanted by the public.”
Every successful portfolio will have its share of losers. But the winners should deliver outsized gains that more than offset any losses. Similarly, not all the nearly 500 stocks with Safe or Very Safe Dividend Safety Scores will prove infallible.
While we’d love to avoid every future dividend cut, surprises can happen. And we need to balance that desire for perfection with providing a large enough pool of income ideas, including those with potential to deliver the best returns after fleeting storm clouds lift.
In case you haven’t seen our dividend cut expectations for each Dividend Safety Score bucket (they are available in your portfolio’s Dividend Safety report), here is the percentage of stocks in each rating bucket that we expect to maintain their dividends over a full economic cycle:
  • Very Safe and Safe: at least 90%
  • Borderline Safe: at least 67%
  • Unsafe and Very Unsafe: less than 50%
These expectations are consistent with how our ratings have performed in real-time since 2015. Risk can never be fully avoided – dividends are a discretionary decision by a company’s board of directors, after all. But owning stocks with Safe and Very Safe scores can help produce a more secure income stream with better growth prospects.
Maintaining a diversified portfolio adds another layer of protection given the difficulty in predicting which holdings will achieve the best long-term performance.
While we continue to feel the sting of disappointment from V.F. Corp’s dividend cut, we will keep doing our best to strike a healthy balance with our scores between highlighting opportunistic income ideas and maintaining a level of conservatism that avoids most dividend cuts and results in primarily stable ratings.

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