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Are These Dividends Safe? AstraZeneca plc (ADR) (AZN), Two Harbors Investment Corp (TWO), Windstream Corporation (WIN)

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Cliffs Natural Resources the biggest U.S. iron ore producer, fell the most in more than three years after cutting its quarterly dividend by 76 percent and announcing a share sale to repay debt.’

‘Cliffs reduced the payout to 15 cents a share, the Cleveland-based company said in a statement after the close of trading yesterday. That erases the increase made in March, when Cliffs raised the dividend to 62.5 cents from 28 cents’

Source: Bloomberg

This is the kind of announcement that dividend investors fear. Before Cliffs announced this cut, the share was yielding 7.5%, a yield far above the market average. Now, the stock yields just 2%, below the market average.

AstraZeneca plc (ADR) (NYSE:AZN)The problem is it’s hard to spot when dividend cuts like this will happen. You see, Cliffs raised its dividend earlier this year, making investors believe the dividend was strong, well covered and there was plenty of good news to come. However, a detailed analysis of the company’s cash flows reveals a different story.

In the second, third and fourth quarters of 2012, Cliffs spent $89 million a quarter on its new higher dividend of 62.5 cents a share. Cliffs was spending this cash on dividends even though the company had a negative free cash flow of around -$200 million, which meant that Cliffs had to either borrow the money, issue shares or dig into is cash reserve to fund the dividend.

With Cliffs’ failure still fresh in investors’ minds what is the situation of other high yielding companies in the S&P 500, can they sustain their dividends?

Two Harbors Investment Corp (NYSE:TWO)

Market cap $3.74B
P/E ratio 11.24
EPS $1.13
Dividend $1.70
Div. yield 17.3%

At first glance it would appear as if Two Harbors Investment Corp (NYSE:TWO) cannot sustain its dividend. Two Harbors Investment Corp (NYSE:TWO) paid out $1.70 in dividends only EPS of $1.13.

$US 03/01/2012 06/01/2012 09/01/2012 12/01/2012 Average
EPS 0.28 0.11 0.10 0.64 0.3
Dividend 0.40 0.40 0.36 0.55 0.4
Cover from EPS 0.7 0.3 0.3 1.2 0.6

Indeed, on a quarterly basis the only periods where Two Harbors Investment Corp (NYSE:TWO) has been able to sufficiently cover its dividend from earnings was in the last quarter of 2012. During all three previous quarters the dividend was almost double EPS.

$US Millions 12/01/2011 03/01/2012 06/01/2012 09/01/2012
Net Operating Cash Flow 63 36 49 78
Net Investing Cash Flow 583 -2532 -1810 -4040
Cash Dividends Paid 56 56 86 87
Change in Capital Stock 0.1 692 55 790
Issuance/(Reduction) of Debt, Net (640) 2030 3780 3600
Net Financing Cash Flow -696 2670 1710 4300
Net Change In Cash -50 185 -50 336
Free Cash Flow 7 -20 -109 -128

Two Harbors Investment Corp (NYSE:TWO)’ is an mREIT; therefore the company’s cash flows look a lot different to the rest of the group. While other companies have to balance net operating cash flow with net investing cash flows, mREITs do not as they are constantly re-shuffling their mortgage backed assets and loans. In addition, the company will issue a lot of debt to finance its purchase of mortgage backed securities. However, this debt is usually re-purchase agreements, which are mostly risk free

So, with that in mind does Two Harbors Investment Corp (NYSE:TWO) have room to pay its dividend? Well in contrast to the rest of the group, I will analyze Two Harbors Investment Corp (NYSE:TWO)’ dividend based on the company’s net operating cash flow only.

It appears Two Harbors Investment Corp (NYSE:TWO) cannot afford its dividend from its net operating cash flow. Consistently, the company has paid out more in dividends than it has received in operating cash flow from its operations, meaning the company has needed to issue stock or debt in order to finance its dividend payouts. I’m afraid Two Harbors does not survive this dividend test.

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