Morningstar - Q3 2022 - 61

One of the neat things about Union Pacific is
with diesel prices at over $5, they become more
attractive than intermodal, and they get
to pass that cost through. We also think some
of the technology area has gotten hardhit.
Some of the semiconductor companies
interest us.
Audience question: How do you deal with
companies in the portfolio that cut or pause
dividends as part of a spinoff or M&A activity?
Hart: We owned Pfizer a long time ago when
they paused their dividend because they
were doing M&A. They were quick to say they
were going to bring it back on line within
one year, but that gave us some pause. The
dividend's really important in what we're doing.
The financial crisis was a bit different. A lot of
banks put their dividends on pause -eventually,
they were required to by the regulators. That
was the first time that I had to think about, what
do I do about a company that's actually not
going to honor its obligation? But it made sense,
because as one of those management chiefs
told me, " Clare, it's not that we can't pay the
dividend, but we don't really know what's going
on, and nobody does. "
Davis: The question is why they cut the dividend.
If it's because of real fundamental deterioration,
my hope is I'm not around that stock by the
time that becomes evident. In 2016, we sold
General Electric GE because I thought they would
have to cut the dividend. We sold Kinder Morgan
KMI, because we figured out that it was much
more dependent on oil prices [than was thought].
Dividend cuts are often timed to actions taken
by ratings agencies like Moody's. We knew once
Kinder Morgan was put on credit watch, the
company was going to have to make a choice.
It's not rocket science. In my mind, the dividend
is supported by free cash flow from operations.
There are times when we'll allow that to slip.
But historically, if that goes on for some time, that
is a classic type of dividend-cutting situation,
where you're either borrowing money or you're
selling assets to pay it. The stock of most dividend
cutters goes down before the dividend cut
The mutual fund that I manage has 43
names. Most indexes are 10 times that.
Don Kilbride
takes place, so you've got to figure it out
[early]. The average dividend cutter is down 20%
12 months going into the dividend cut.
The COVID crisis was a little bit different. We had
TJX TJX in the portfolio, and they had to shutter
their stores. But we knew that management team,
and we knew [the dividend cut] was to preserve
capital strength. They reinstated the dividend.
And there were others where historically we sold.
We did figure out Disney DIS was going to cut
because of the parks [being closed], but all of a
sudden, streaming became more important so we
looked pretty dumb on that one. But we stick
with the discipline, and the discipline is if we think
that your cash flows are impeded to the point
where you're going to have to cut your dividend,
we're not going to be in your stock.
Kilbride: If I understood the question right, how do
we view a company that takes a dramatic
corporate action that requires a dividend cut? We
want to try to avoid companies that have to do
something so dramatic to enhance the value
of their enterprise that they need to sacrifice the
dividend. That's not a model that we should
be engaged in. So hopefully, we never have to
be making that choice. K
Tony Thomas is an associate director, equity strategies,
at Morningstar Research Services LLC.
Photography by Matthew Gilson.
morningstar.com/products/magazine
61

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Morningstar - Q3 2022

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