Any stock with a nearly 12% yield generates a lot of attention from income investors. So it’s no surprise that Don, Bruce and Jack all asked me to take a look at the dividend safety of American Capital Agency Corp. (Nasdaq: AGNC) this week.
To analyze American Capital Agency’s dividend safety, you have to look at its past, present and future.
The Past
American Capital Agency’s recent dividend track record isn’t pretty.
[ad#Google Adsense 336×280-IA]The company cut its dividend four times in the past three years.
The current $0.65 per share quarterly dividend is 54% lower than the $1.40 that was paid in December 2011.
One of the best indicators of whether a company will lower its dividend is if it has done so before.
A company that has raised its dividend for years, even during difficult times, is showing investors that it is committed to increases and will do whatever it takes to continue to raise or, at the very least, maintain the dividend.
A company that lowers its dividend several times is telling investors, “We will cut the dividend at any time that it’s necessary.” Keep in mind, sometimes it is necessary to cut the dividend. If a company doesn’t have the cash flow to support its dividend and isn’t confident that cash flow will return to previous levels anytime soon, then reducing the dividend is the appropriate step to take.
But as dividend investors, we are very wary of companies with a tendency to cut their dividends.
The Present
The present is just fine for American Capital Agency. In the first six months of 2014, the company generated $932 million in cash from operations. That’s down $80 million from last year during the same period.
But because the company slashed the dividend, it paid out only $468 million versus $926 million last year. So the payout ratio is a very comfortable 50%.
Should cash flow remain stable, the company can easily sustain – and possibly even raise – the dividend. Granted, American Capital Agency has raised the dividend only three times in the 26 quarters that it has paid one. That compares with six cuts during that time frame.
The way it stands at this moment, cash flow is more than sufficient to pay the dividend.
The Future
With mortgage REITs, the future is even more of a question mark than with other companies.
Mortgage REITs’ businesses are very dependent on interest rates and how quickly they move. They make their money from the spread between short- and long-term rates, borrowing money at short-term rates and lending at long-term rates.
I suspect that when interest rates rise (if they ever do), there will be fewer people taking out mortgages, which may make it more difficult for the mortgage REIT companies.
As far as the spreads, I don’t have a crystal ball to reveal which way they’re headed. Any tightening of spreads should have a negative impact on the company’s ability to make money.
The most recent two-year Treasury had huge demand, which should keep the short-term rate low for the immediate future.
That’s positive.
Though what will happen over the next year or two is anyone’s guess.
With a poor track record and an unpredictable future that relies on variables mostly out of its control, I think it’s reasonable to expect that American Capital Agency may cut its dividend again in the future.
I’m not saying I’m expecting it to, just that it wouldn’t surprise me at all.
Dividend Safety Rating: C
— Marc Lichtenfeld
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Source: Wealthy Retirement