Don't cut your dividend: 3 lessons from Yancoal and Deterra's dividend changes

It's a pretty tough ask but companies that are known to pay a consistent and stable dividend need to sustain that payout instead of chasing shiny acquisitions.

The main suspects here are Yancoal (ASX: YAL) and Deterra Royalties (ASX: DRR).

From a reporting season perspective, there have been a few notable weaker-than-expected payouts from names like Aurizon (ASX: AZJ) and Insignia Financial (ASX: IFL) – which we will talk more about below.

Recap of events

Yancoal is notorious for being one of the highest-yielding stocks on the market. Between FY21-23, the company recorded a dividend yield of 14%, 20.2% and 27.0% respectively. Its latest result (released 19th August) dropped an absolute bombshell: "The Board has not declared an interim dividend in respect of the six months ended 30 June 2024, with the retained cash providing flexibility for potential corporate initiatives and may be distributed in the future if not." Yancoal finished the session down 14.5%.

Yancoal 12-month price chart (Source: Market Index)

Deterra manages a portfolio of resource royalties, most notably its Mining Area C (MAC) project, which is operationally managed by BHP. This asset is underpinned by a royalty agreement that ensures Deterra receives quarterly payments equivalent to 1.232% of the revenue generated plus a one-off $1 million for each tonne increase in annual production capacity. In essence, Deterra is iron ore exposure with greater stability.

In June, Deterra did something that complete detracts from their identity as a consistent and stable income stock. The company cut its payout ratio from 100% to 50% in order to fund a lithium-centric acquisition. Deterra shares fell 7% on the news and two months later, it was down another 11%.

Deterra 12-month price chart (Source: Market Index)

Aurizon reported a weaker-than-expected FY24 result and FY25 guidance. The company's full-year dividend was also around 2.2% below market expectations. Aurizon shares finished the results session down 8.8%.

Insignia Financial's FY24 result including revenue, funds under management and net profit was slightly ahead of market expectations. But nobody expected the company to pause its final dividend to enhance its balance sheet and allow for strategic flexibility. Insignia shares are down around 11% on Thursday.

Why is this a problem?

#1 Identity Crisis: Yancoal and Deterra Royalties are known for their dividends. You would argue that most long-term shareholders are primarily holding the stock for income. So what happens when the stock suddenly decides to do something else?

Imagine if your favourite coffee joint (that you visit every single day) abruptly turned into a smoothie bar. You'd probably go somewhere else for coffee.

#2 Forced Selling: The identity crisis leads me to my next point. If the stock is no longer paying a dividend (or made dramatic cuts) – this will drive a substantial amount of forced selling. This may take place across a few types of investors:

• Institutions and funds may exit the stock as it no longer meets their dividend requirements

• Financial advisors may advise clients to exit the stock as it no longer meets their income requirements

• Retail investors may sell for the above reasons or other factors such as stop losses, emotions etc.

On the announcement day, Yancoal opened 13.8% lower but fell as much as 23.1%. That's a lot of downward pressure and likely comprised of the above factors. The stock also fell another 4.0% the next day.

Yancoal intraday chart on 19 August 2024 (Source: TradingView)

#3 The aftermath: What investors are left with is a lot of uncertainty. In the case of Yancoal, the company has $1.55 billion cash on the sidelines and likely waiting for an M&A opportunity.

This raises the risk of overpaying for assets, diversifying into new geographies or like Deterra, into a new commodity that is not aligned with the company's longstanding identity.

While missing dividend expectations due to weaker earnings is understandable, abruptly cutting or pausing dividends is almost unacceptable. Yancoal investors now face an uncertain wait, hoping a potential M&A announcement will restore the company's dividend-paying status and justify the retained cash.