Steer Clear of This Dividend

Visteon (VC Quote) discontinued its 6-cent quarterly dividend last week, wiping out value investors' hopes of collecting the 2.5% yield. The auto components maker had paid a dividend since the summer of 2000, when the company was spun out of Ford (F Quote). Management said the move will save $32 million annually, a cost-cutting move that's necessary as Visteon has failed to post a full year of positive net income in its short life as a public company.

So, could Delphi (DPH Quote), General Motors' (GM Quote) equivalent components-maker spinoff, be the next to cut its own 7-cent quarterly dividend (a 3.9% yield)? I believe the answer is yes, and that investors should avoid bottom-fishing with the stock here around $7.

Since its 1999 IPO, Delphi's earnings record has been just as volatile as Visteon's. And even though both of these companies sell to customers other than their former parent company, GM still accounts for about 50% of Delphi's total revenue, which makes it highly dependent on that automaker's fortunes.

In addition, there has been little growth to speak of in the automotive industry over the past year, outside of Toyota Motor (TM Quote) and a few other select foreign producers. This is evidenced by the fact that Delphi, the largest auto components maker, with sales of $28.7 billion in 2004, lost $36 million for the year. It is expected to lose another $350 million in 2005.

GM's 5.8% expected decline this year in North American vehicle unit sales is hurting Delphi. The company is also losing "market share" in GM's production plans, as its parts per vehicle (the percentage of Delphi components in each vehicle) is expected to drop 7.1% year over year. Gross margin fell to 9.2% in the fourth quarter from 12.1% last year, and Delphi guided to just 6% to 7% margins in the first quarter. Profits also are being squeezed by high raw-materials costs, which show no sign of letting up in the near term. Plus, management said the majority of full-year profits will be realized in the second half of the year, increasing the likelihood the numbers could fall even further. Delphi has been trying to shed money-losing operations, but it hasn't been able to cut costs fast enough to keep up with declining revenue.

On Jan. 20, Delphi offered operating cash flow guidance for 2005 of $900 million to $1.1 billion, compared with $1.5 billion last year. The company already has earmarked $600 million for pension contributions and $150 million for restructuring costs. Should management only hit the low end of its targets, Delphi would generate just enough cash to cover its dividend.

Following the company's latest earnings report, Moody's downgraded its rating on Delphi's long-term debt to Baa3, the first step above "junk" status. Not only will this increase the company's future borrowing costs, but it also gives management less flexibility to finance the dividend externally should 2005 cash flow fall short of expectations.

The increased demand for dividend-paying stocks has moved yields up across the board, so there aren't many stocks still yielding around 4% or more. Even so, don't be tempted by Delphi's payout. If the company doesn't cut its payment at its next planned dividend announcement in March, I believe a reduction or elimination of the payout will come by the end of the year.

Editor's Note: In RealMoney.com's Columnist Conversation on Friday, Peltier made the following comments: The stock is down 14% today, on word CFO Alan Dawes is stepping down amidst an accounting scandal. I already knew the auto component maker's numbers were bad, but now it appears they weren't even clean.

With Delphi's debt rating teetering toward junk status, don't count on the next CFO keeping the 7-cent quarterly dividend policy (now 5.1% yield).