Whenever a sinking share price pushes a dividend yield above 10%, the market is usually expressing some skepticism regarding dividend sustainability. That’s even more true at 15% and higher…

With an annual dividend of $1.00 per share and a current share price below $4, WPG carries an extreme yield above 25%. Clearly, investors have some serious doubts.

The market was expecting a dividend cut when the company released its second-quarter results a few ago. They didn’t get one. Washington Prime reaffirmed its policy of distributing $0.25 per share each quarter. And it earned $0.27 in funds from operation (FFO), enough to cover the distribution with room to spare.

Management forecast full-year FFO of $1.20 per share – providing a minimum coverage ratio of 120% on the $1.00 per share annual distribution. Unless that has changed over the past few days, the company is generating enough cash to continue paying its current dividend.

But should it? That’s a better question to ask. I say no.

Dividends are eating up most of the firm’s cash flow, leaving little for required maintenance expenditures. They run about $65 million annually, or $0.30 per share. But the bigger drain on capital is redevelopment costs needed to revitalize older properties and make them more appealing to today’s shopper. These are high – over $100 million this year alone.

And while CEO Lou Conforti is always entertaining in his colorful and humorous commentary defending his company, it’ll take more than that to convert WPG’s malls into the vibrant “town centers” he envisions.

With all this in mind, I would like to see distributions reset at a lower level more compatible with the current environment. While that would certainly drive many investors to the exits and temporarily hurt the shares, what matters most is the long-term health of the business and its future cash flow potential.

Cutting the distribution in half would still leave one of the highest payouts anywhere. Few investors would complain of “only” a 12% yield. This would also preserve more than $100 million per year, funds that could be rediverted to accelerate property redevelopment efforts and lead to higher rental rates in the future.

A classic example of short-term pain, long-term gain.

Action to Take
Washington Prime showed considerable progress recently, addressing 50% of its department store vacancy and leasing 1.4 million square feet of space (at higher rates than the previous leases). I will be watching closely to see if these and other metrics continue to stabilize and improve.

If the company does reduce dividends, this might be the time.

Trading at less than three times cash flows, WPG has the potential to ultimately deliver triple-digit gains to patient investors. But I have it rated as a “Hold” over at High-Yield Investing, due to the risk involved. So please bear that in mind and remember that this is a speculative stock best suited to risk-tolerant investors who can withstand volatility during this turnaround phase.

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