SeaWorld Entertainment (SEAS) was the latest company to announce a dividend cut, dropping the news yesterday evening.
SeaWorld declared a quarterly dividend of 10 cents per share, which is down more than 50% from its previous quarterly dividend of 21 cents per share.
After the next quarterly payment, SeaWorld will completely suspend its dividend.
To make matters worse, the company’s stock was trading down as much as 10% after the market closed, adding to its -35% plunge year-to-date.
Prior to the dividend cut, SeaWorld’s shares offered a high yield of 6.6%, but it proved to be a trap.
Investors were beginning to wonder about the sustainability of SeaWorld’s dividend, but management didn’t offer any hints of an impending cut during the company’s earnings call on August 4th – less than two months prior to yesterday’s dividend reduction.
Here are a few quotes from SeaWorld’s CEO Joel Manby
“Regarding our dividend, based on our reported results we believe that we will declare the October dividend payment. Of course, our Board will make any dividend declaration and our capital allocation decisions now and in the future be in the best interests of all shareholders. Again, while we are disappointed with this quarter, we are seeing several positive trends that indicate that the strategy we shared with you last November and are implementing has begun to gain traction…Right now we have not had discussions about cutting the dividend to any great degree. We believe it’s an important component of our total capital allocation…”
Source: Seeking Alpha
Management teams hate to cut the dividend, but sometimes they are left with no choice. Unfortunately, news of a dividend cut often catches investors off guard, especially when a management team dances around the issue.
In the case of SeaWorld, investors could have avoided its steep dividend cut. There were a number of signs that SeaWorld would need to slash its dividend, and fortunately our Dividend Safety Scores flagged SeaWorld’s dividend as being one of the riskiest in the market.
No scoring system is ever going to be perfect, but low Dividend Safety Scores are usually a good signal that something is dangerous about a company’s business and should be investigated further by investors.
Before taking a closer look at why SeaWorld scored so low for Dividend Safety, I’ll quickly review the business for context.
SeaWorld has been in business for more than 50 years and owns a portfolio of 11 destination and regional theme parks operating under well-known names such as SeaWorld and Busch Gardens.
Over 22 million guests visited the company’s theme parks in 2015, and the business generated nearly $1.4 billion in total revenue.
Theme park admissions accounted for 62% of sales last year, and food, merchandise, and other revenue accounted for the remainder.
SeaWorld has been facing a number of challenges in recent years that have caused the company to attempt to revamp its business model.
SeaWorld chose to end its controversial killer whale shows and stop breeding killer whales in March 2016. However, efforts to focus more on animal conservation have largely failed to move the needle with consumers.
SeaWorld’s attendance dropped over 7% last quarter, management slashed full-year guidance, and the company’s balance sheet was increasingly stretched.
Let’s take a look at the factors that drove SeaWorld’s dividend cut.
Dividend Safety Analysis: SeaWorld
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a dividend. SeaWorld’s dividend and fundamental data charts can all be seen by clicking here.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at factors such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, ROIC trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their track record has been, and how to use them for your portfolio here.
At the time of SeaWorld’s dividend cut announcement yesterday, the company’s Dividend Safety Score was 3, indicating that the dividend payment was at very high risk of being cut.
Since tracking the data, companies that have cut their dividends by at least 50% had an average Dividend Safety Score of 6 at the time of their dividend reduction announcement, and SeaWorld was no exception.
SeaWorld starting paying dividends in 2013 after the company’s IPO and just before its troubles were beginning with the launch of the documentary Blackfish.
As seen below, the company’s revenue growth began to slow and even declined in fiscal years 2014 and 2015:
Source: Simply Safe Dividends
Unfortunately, SeaWorld’s business model has high fixed costs. No matter how many people visit its theme parks, SeaWorld pays a lot of money to keep them open and running. As sales growth slowed, SeaWorld’s margins contracted:
Source: Simply Safe Dividends
As margins contracted, SeaWorld’s payout ratios began to climb. The company’s free cash flow payout ratio roughly doubled from 2013 to 2015, and it currently sits above 90% over the trailing 12-month period.
From an earnings perspective, management’s revised guidance for 2016 resulted in a payout ratio in excess of 100% as well. This should have been investors’ first and most obvious warning sign.
Source: Simply Safe Dividends
For a capital-intensive business struggling to grow, a high payout ratio can be the kiss of death for the dividend, especially if the balance sheet has little flexibility.
Dividends are discretionary compared to debt payments, and companies with high financial leverage, capital-intensive operations, and declining business trends are more likely to trim the dividend to save cash.
Unfortunately for SeaWorld, its balance sheet had very little flexibility. As seen below, the company held just $29 million in cash compared to more than $1.6 billion in book debt and $72 million in dividends paid last year. The company’s long-term debt to capital ratio had also increased to 80%, which is well above the 50% maximum I prefer.
With profits contracting, little cash on hand to run the business, and no room to further stretch the balance sheet, it was probably in the company’s best long-term interest to preserve cash.
Source: Simply Safe Dividends
What is the lesson learned for dividend investors? For one thing, excessive financial leverage can be lethal. Buying companies with high debt loads can be dangerous if they run capital-intensive businesses, lack predictable cash flow, and/or are experiencing headwinds.
Equally important, be aware of high yield stocks that have come under pressure. SeaWorld’s struggles were no surprise. The company’s stock price was cut in half during 2014 and has fallen even further since then. When there’s smoke, there is a real risk of fire in the high yield world.
Sticking with businesses that score strongly for Dividend Safety and have shown a commitment to paying dividends (e.g. Dividend Aristocrats) can help avoid these messy situations and result in a stronger dividend portfolio.
Leave A Comment