Yellow Media's dividend under the microscope

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Yellow Media Inc. has made plenty of investors blue, with successive dividend cuts and a stock that's landed with a thud louder than one of its telephone books.

Since peaking at more than $17 in 2006, the shares have plunged nearly 70 per cent, closing Thursday at $5.29. Adding to the pain, the directories publisher has chopped its dividend twice as it grappled with the financial crisis, its transition from print to digital media and a recent conversion from an income trust to a corporation.

Now some investors are asking: Is another dividend cut in the cards? The sky-high yield of 12.2 per cent isn't a comforting sign.

Such a high yield "tells you the market doesn't believe [the dividend]is sustainable," said Norman Levine, managing director of Portfolio Management Corp. in Toronto, who doesn't own Yellow Media shares.

"To me, it's a dying business. They're trying to transition to the Internet, but once you go [online]there are all kinds of other options" for searching.

Analysts aren't sold on the company's prospects, either. According to Bloomberg, just one analyst rates the stock a "buy," nine have it as a "hold" and one calls it a "sell."

The "hold" camp includes TD Securities analyst Scott Cuthbertson, who published a note this week examining whether Yellow Media's 65-cent annualized dividend is sustainable.

His conclusion after poring over the financials: Probably, but it's not a slam dunk.

"Based on our estimates for 2011 and 2012 (which are in line with consensus), YLO should be able to continue to pay its $0.65 dividend from free cash flow in both years," he wrote.

"With that said, non-operational items such as acquisitions, divestitures, one-time cash charges etc., could potentially put pressure on both the company's ability to completely fund its dividends through free cash flow and the achievement of recently articulated debt-reduction goals."

Credit Rating Blues

Maintaining Yellow Media's investment-grade debt rating is critical to sustaining the dividend at current levels, he said. Losing the rating would trigger more restrictive covenants in Yellow Media's loan agreements, which would put the dividend in jeopardy because the company would be permitted to pay out a maximum of 50 per cent of distributable cash as dividends.

The company doesn't have a lot wiggle room with its credit ratings. Standard & Poor's rates Yellow Media's senior unsecured debt at triple-B-minus, which is one notch above speculative status. DBRS rates it triple-B (high), which is three notches above speculative.

Underlining the dangers, S&P has said it would like to see Yellow Media reduce its net debt by $450-million this year and that "downward pressure on the ratings would likely come from a failure to reduce debt levels as noted … as well as a failure to improve adjusted debt leverage as targeted."

Mr. Cuthbertson believes Yellow Media can meet S&P's debt-reduction targets, helped in part by the company's dividend reinvestment plan, which allows it to conserve cash by paying dividends with more shares. However, others are skeptical that the company can meet the debt targets without selling assets.

Maher Yaghi of Desjardins Securities Inc. - the sole analyst with a "buy" on the stock - is more optimistic. "Our analysis indicates that the annual dividend of $0.65/share is manageable and should be funded by free cash flow," he said in a February note.

"We view this dividend payout rate to be sustainable so long as the company's financial performance does not deteriorate substantially from current trends."

After the drubbing investors have already suffered, they'd better cross their fingers.