Lessons From a Dividend Cut: How Stocks Can Benefit, and More

An oversupply of paper products has weighed on prices. (Akos Stiller/Bloomberg)

Key Points

• Sappi, a South African paper company, suspended its fiscal 2025 dividend due to high debt and weak industry fundamentals.
• The company’s earnings are projected to fall for the third consecutive year in 2025, with net income expected around $62 million.
• High dividend yields often signal potential problems and precede dividend reductions.

The pain of dividend cuts can encourage investors to learn something: how to spot problem companies and when struggling stocks might be safe to buy again.

Events around Sappi, a South African paper company with a market value of less than $1 billion, offer a lesson. Sappi said Friday that its board of directors has decided to “suspend the dividend for fiscal 2025 to preserve cash,” citing high debt levels and weak industry fundamentals.

The company’s fiscal year ended in September, and Wall Street believes its results will show that sales and operating profits fell for the third consecutive year. Global economic weakness, trade tensions, and oversupply have led to falling prices for Sappi’s products.

The company, which earned about $540 million in fiscal year 2022, is expected to report a profit of about $62 million in 2025. Things are expected to get better, but not much, in 2026, with estimated net income rising to $166 million.

Dividend payments stopped in fiscal 2020 as a result of the Covid-19 pandemic. They resumed in fiscal 2023, when the company handed out about $84 million, making the payment from free cash flow. It paid out the same amount in 2024, even though free cash flow didn’t cover the total. Free cash is expected to be negative in 2025.

Companies can pay dividends without net income or cash flow for a while, but it becomes increasingly difficult with high debt levels. From the end of 2019 to through June, Sappi’s long and short-term debt, less its cash on hand, has been steady at roughly $2 billion. Stable is fine, but with falling earnings, current debt is 3.1 times estimated fiscal year 2026 earnings before interest, taxes, depreciation, and amortization.

That is high for a company without much growth. The average debt-to-Ebitda ratio for stocks in the S&P 500 is less than two times.

Falling earnings, high debt, income insufficient to cover payouts, and a lack of significant improvement in fundamentals are four warning signs that precede dividend cuts. Those elements are typically reflected in the dividend yield.

High yields, or the annual dividend as a percentage of the stock price, are a quick way to spot problems. Before the cut, Sappi stock yielded north of 11%, according to FactSet.

Now that the cut has arrived, Sappi might actually be investible again. Wolfe Research strategist Chris Senyek points out that stocks at risk of dividend cuts often underperform before the bad news and outperform afterward.

That makes sense. The stock market is forward-looking. While Sappi stock, traded in South Africa, was still down 56% year to date as of the close on Friday, it rose 5.1% during the day.

All that has implications for U.S. companies. LyondellBasell , a chemical maker, has some things in common with Sappi. Shares yield north of 11%. The stock has dropped 50% over the past 12 months; earnings have diminished as fundamentals in the industry have deteriorated.

Both LyondellBasell and its peer Dow, Inc. were listed as potential cutters in Senyek’s second-quarter dividend update. Dow cut its dividend in half in July. Its shares haven’t bounced back, but have been relatively stable since the cut. Dow stock is off about 59% over the past 12 months.

By Seynek’s thinking, investors can start looking at Dow again, and even at Sappi. They might want to wait to revisit LyondellBasell until management takes action on the dividend or until conditions in the chemicals market start to improve significantly.

Write to Al Root at allen.root@dowjones.com