Friday, November 4, 2011

Stock Spin-Offs – What Should Dividend Investors do?

Several companies I own have announced that they plan on splitting in two separate entities. Abbott Labs (ABT) was the latest one to announce its intentions to split in two companies. Check my analysis of the stock. The question in the mind of every dividend growth investor is: “What should I do”?

In general, as long as the characteristics which enabled the original company to raise dividends for decades are still intact, chances are that the separate entities will continue raising distributions. For example, Altria Group (MO) was able to spin-off Kraft (KFT) in 2007 and Phillip Morris International (PM) in 2008. Before that, the original company was able to raise annual distributions for over three decades. After the spin-offs, Altria (MO) has kept up with raising dividends to its shareholders, as did Phillip Morris International (PM). Both companies were able to increase earnings per share over the same period, which enabled them to achieve the task of higher dividends ever since.

Kraft (KFT) on the other hand has been unable to increase distributions more than once since the spin-off, due to its inability to increase earnings and due to the costs associated with the acquisition of Cadbury in 2010. Now Kraft (KFT) itself is in the process of splitting in two separate companies, the global snacks business with annual sales of $32 billion and a high margin grocery business, with annual sales of $16 billion.

Abbott Labs on the other hand is splitting in two companies. The first one will be a research-based pharmaceuticals company, which will own Abbott’s premier drug names such as Humira, Lupron, Synagis to name a few. It would be basically a drug company, which focuses on keeping its pipeline of new drugs coming to the market, through constant investment in research and development. Drug companies have faced steep patent cliffs over the past several years, which has intensified mergers in the sector.

The second company will be a diversified medical products company, and its name would remain Abbott. It would own established nutritional products, medical devices and diagnostics products as well as generic drugs outside of the US.

As a dividend growth investor, I plan on holding on to these stocks after the spin-offs. I believe that both companies would be able to better focus on their goals as standalone entities. Despite the fact that I do require a minimum of ten consecutive annual dividend increases in order to purchase new stocks, I make an exception for spin-offs. I do monitor each situation closely however, as inability to raise dividends over time would prohibit me from allocating any new capital to such positions.

Once investors receive the new shares in each of the new companies, initially I expect that the dividends in total to be equal to the total dividend paid out by Abbott. Overtime however, I expect these dividends to grow. As a result, given the fact that Abbott has had a long culture of dividend increases and the fact that it is priced attractively at the moment, I would keep accumulating the stock in my income portfolio.

Full disclosure: Long KFT, PM, MO, ABT

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