billion in debt coming due in 2018 and 2019, GNC is wise to position itself as best as it can to refinance its loans, especially with its turnaround efforts likely several quarters away from delivering any meaningful traction (if they ever do).
In fact, S&P lowered GNC’s credit rating from BB+ to BB with a negative outlook in August 2016 as management’s turnaround efforts failed to generate traction.
Here’s what management said about the dividend cut:
“As you know, the board regularly reviews uses of cash. Their decision to suspend the dividend is consistent with the fundamental changes in our business and will give us greater flexibility as we implement the One New GNC. Consistent with prior periods, we expect to use cash flow in excess of what we invest in our business to pay down our debt…”
A combination of pricing and merchandising blunders, secular pressure on mall-based stores, a continued shift in consumer shopping preferences, and excessive financial leverage ultimately brought down GNC’s dividend – even despite its “healthy” payout ratio and free cash flow generation.
Closing Thoughts on GNC’s Dividend Cut
If it sounds too good to be true, it usually is. Dividend yields above 5% begin to get murky, and most yields near 10%, such as GNC’s, often don’t end well.
The pursuit of current income through high dividend stocks has many benefits, but it should never come at the cost of capital preservation.
Payout ratios and free cash flow generation can help assess how safe a dividend is, but they are only part of the picture.
Financial leverage is an extremely important dividend safety factor, and investors should also be confident in the long-term outlook of the companies they invest in.
Given the number of business challenges that bubbled up at GNC over the last year, a number of questions should have been raised about the company’s future well before the dividend cut.
Retail has always been a challenging industry to invest in because of fickle consumer preferences, and the ongoing e-commerce wave has only further complicated life for brick-and-mortar retailers such as GNC.
Turning around a struggling retailer is extremely difficult (just take a look at J.C. Penney), and GNC’s financial strain won’t make things any easier going forward.
As a conservative investor, I will continue to avoid GNC. Sure, there is potential for the stock to do extremely well from here if management’s turnaround is successful, but the stock could also go to zero if cash flow shrinks at a brisker pace over the coming years. The odds seem stacked against GNC’s recovery for now.
