In February, I gave biotech royalty company PDL BioPharma (Nasdaq: PDLI) a “B” rating for dividend safety. At the time, the company had a payout ratio of just 46% based on free cash flow.
That’s comfortably below my 75% limit and gave me confidence that the company would continue to pay the $0.15 quarterly dividend as it had since early 2011. And with a payout ratio that low, there was even room to raise it.
However, that dividend is in jeopardy today – for a very unusual reason.
It has nothing to do with earnings or free cash flow.[ad#Google Adsense 336×280-IA] In fact, over the past 12 months, free cash flow totaled more than $254 million while the company paid out just $90 million in dividends.
So, PDL BioPharma generates plenty of cash flow.
Earnings also aren’t the problem.
The company’s earnings per share comfortably covers the dividend.
The issue is that in September, PDL BioPharma’s independent auditor, Ernst & Young, suddenly quit.
When an auditor quits, it can be for a wide variety of reasons. It may have found fraud and doesn’t want to have its name associated with a financial statement that it deems as fraudulent.
There may be irreconcilable differences with a company’s management on a specific accounting issue. Or it could be something far less sinister like a member of the auditor’s staff having an improper relationship with a client.
But as you can imagine, when news breaks that an auditor quits, the market automatically jumps to the conclusion that it must be fraud.
As a result, shares of PDL BioPharma plummeted to $7.50 from $9.65 in the two days after Ernst & Young’s resignation was announced.
The stock has gained back about half of its losses since then.
If you look up recent headlines on PDL BioPharma, the newsfeed is clogged with ambulance-chasing lawyers suing the company on behalf of shareholders. If there were fraud committed, then the shareholders should be entitled to damages. But at this point, we still have absolutely no idea why Ernst & Young quit. It’s ridiculous that all of these lawsuits are filed before anyone has any facts.
The problem is that until we know more, we have to consider the company’s numbers as questionable. This isn’t innocent until proven guilty. We’re talking about risk in the markets, and if there is a question of uncertainty, then the risk is significantly higher.
Of course, that risk can lead to opportunities, but the Safety Net is about analyzing the safety of whether a company’s dividend will continue to be paid.
If I had to take a guess, I’d say yes, it will get paid. There was enough of a buffer between free cash flow and the dividend that even if the cash flow numbers have to be adjusted lower, there should be enough to pay the dividend.
The problem is, it’s just a guess right now. I’m going to err on the side of caution and say that the safety of the dividend can’t even be gauged at this point since there is at least some chance that PDL Biopharma’s numbers aren’t real.
Therefore, I’m doing something I’ve never done since starting this column. I’m suspending the Dividend Safety Rating of a stock. Normally, if I’m very concerned about a dividend’s safety, I’ll give it an “F.” But in this case, it’s impossible to determine. It’s like trying to analyze a company with blank financial statements. Once we have more information, I can reinstitute the rating. But for now, consider it suspended.
Dividend Safety Rating: Rating is suspended
— Marc Lichtenfeld[ad#wyatt-income]
Source: Wealthy Retirement