The Surprising Reason Why Conagra Brands Is Up Since Cutting Its Dividend in Half

Cutting a dividend is supposed to be a death sentence for an income stock. Investors buy companies like this for the check, so slashing it should send shareholders running.

Yet since Conagra Brands (NYSE: CAG) announced on July 15 that it was halving its payout, the stock has done the opposite of collapse. It is up roughly 4% since the cut, and briefly climbed close to double digits in the days that followed. That reaction says a lot about what the market actually wanted from this company.

Why a dividend cut sent Conagra Brands stock higher

Here is the part that surprises people: Before the cut, Conagra Brands was yielding around 10%. For a slow-growing packaged-food company, a yield that high is not a gift. It is the market's way of screaming that the dividend is not safe. When a payout climbs to double digits, it usually means investors have already decided a cut is coming and have sold the stock down in anticipation. The dividend looks generous only because the share price has fallen so far.

So when new Chief Executive John Brase, who took the top job in June, reset the annual dividend from $1.40 to $0.70 a share, he was not shocking anyone. He was confirming what the stock price had signaled for months. The relief came from the honesty of it. Rather than defend an unsustainable payout until it broke, management ripped off the bandage on its own terms. Markets tend to reward that kind of clarity, because uncertainty is often scarier than bad news itself.

Image source: Getty Images.

What the freed-up cash actually does

The smarter reason to like this move is what happens to the money. Halving the dividend frees up somewhere in the neighborhood of $335 million a year that used to flow out the door to shareholders. For a company carrying meaningful debt and targeting net leverage of roughly four times earnings, that cash can now go toward paying down borrowings and covering the roughly $360 million in annual interest expense the company expects. Every dollar of debt retired is a dollar that stops draining the business.

Just as important, Brase has been clear that the reset is not only about defense. He wants to plow money back into the brands and the supply chain, the things that actually sell more Slim Jim, Birds Eye, Healthy Choice, and Marie Callender's products. His public message has been that every product needs to earn its keep, a "show-me" posture that suggests he is willing to prune what is not working. A dividend that eats up cash the company needs for its own turnaround is a poor trade, and management essentially said so.

The risks investors should not wave away

None of this makes Conagra Brands a slam dunk. The company is still expected to have another year of shrinking sales, with organic revenue expected to fall in the low single digits, and it swung to a loss last quarter after taking a roughly $2 billion writedown on the value of its brands. That is a real admission that some of its portfolio is worth less than it once was.

Packaged food remains out of favor, squeezed by cautious shoppers and worries about how weight-loss drugs might dent demand. Leverage is still high, the turnaround will take time, and most analysts rate the stock a hold with price targets near where it trades today. Even the reset dividend is only attractive if the business stabilizes.

The takeaway for investors

To me, the market's reaction makes sense. A smaller dividend that is well covered and paired with real debt reduction is worth more than a fat payout that the company cannot afford. The pop tells you that investors see the cut as the first credible step in a longer repair job, not as a retreat.

But that is exactly what it is, a first step. This is a turnaround stock now, best suited to patient investors who believe Brase can restore margins and stabilize sales. If you are tempted by the yield alone, wait for evidence that volumes are steadying and debt is falling before stepping in.

Micah Zimmerman has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.