Is This 9.4% Dividend Too Good to Be True?

Dorel Industries Inc (TSX:DII.B) has a 9.4% dividend. Is this a classic dividend trap, or an income investor’s dream?

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With a dividend yield of 9.4%, income investors are starting to pay attention to Dorel Industries Inc (TSX:DII.B).

Since 2013, Dorel has paid a $0.30 quarterly dividend. Not once has it missed a payment. From 2013 through 2016, the stock averaged roughly $35 per share, meaning that the annualized yield was only around 3.5%. However, since the start of 2017, Dorel stock has fallen from more than $40 to under $17. Still paying the same $0.30 quarterly dividend, this has caused the yield to triple amidst a collapsing share price.

Still, last quarter, Dorel’s management reaffirmed the dividend. Additionally, Dorel’s second half outlook called for “higher revenue and improved adjusted operating profit” versus the prior year.

Can Dorel really back its outsized 9.4% dividend?

Dorel is diversified, but faces one major hurdle

Dorel operates under three segments, each of which has $800 million to $900 million in revenues: Dorel Home, Dorel Juvenile, and Dorel Sports. In total, the company had sales of $2.6 billion last year, with 9,200 employees across facilities in more than 25 countries. Combined, its business segments sell to customers in more than 100 countries.

While it often operates in niche segments, you may have heard of some of its brands: Schwinn, Cannondale, Cosco, DHP, Mother’s Choice, etc.

The company may be setting revenue records, but its businesses continue to face stiff competition, thereby hurting profit margins. Trade wars also continue to impact profitability.

For example, Dorel imports large amounts of finished goods from China into the U.S. All of these imports now incur a 10% tariff. Dorel has thus far pushed these costs onto customers, but it will no doubt have an impact on both sales growth and profitability, especially considering the tariff rate is scheduled to increase to 25% in 2019. Even the company admits that this poses a major headwind, saying that “these increases could impact consumer demand in the longer term.”

Customers are going bankrupt

In March of 2018, Toys “R” Us declared bankruptcy. Not only did Dorel lose a major customer, but $17.3 million in accounts receivable was put into peril. In August, the company was informed that it would only receive 22 cents on the dollar for this debt.

The pressure that’s impacting Toys “R” Us is also hitting other customers. Since 2000, Dorel has amassed an impressive suite of brands, largely through acquisitions. Since the turn of the century, Dorel has purchased big name brands like Hot Wheels, Infanti, and Iron Horse Bicycles. With a growing number of direct-to-consumer competitors, these once renowned brands have much less value than the past.

The destruction of brand value is demonstrated in Dorel’s reported book value. In 2013, they had a book value per share of $42.20. Since then, it’s decreased nearly every year to just $33.67 last year. For decades, controlling big brands was a sure-fire path to success. In a world of cheap manufacturing and rampant online competition, these once steady brand conglomerates are fighting for their survival.

Here’s what will happen to Dorel’s dividend

It’s difficult to foresee Dorel sustaining its 9.4% dividend for long. Internally, its business model gets weaker and weaker each year. Additionally, the cash intensity of manufacturing products requires large amounts of sustaining capital.

In 2018 and 2019, the company will likely earn less per share than what it pays out in dividends. Expect a dividend cut as early as next quarter. Income investors should beware of this dividend trap.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool contributor Ryan Vanzo has no position in any stocks mentioned.

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