3 Hefty Dividend Yields to Keep an Eye On

by Alyssa Oursler | September 20, 2013 6:00 am

Dividend185 3 Hefty Dividend Yields to Keep an Eye OnIncome investors must be drooling these days.

The percentage of S&P 500 companies paying dividends is sitting at 83% — the highest level in 15 years, according to FactSet[1]. And Q2′s $82 billion in dividend payments ranked as the second-largest quarterly amount in the past decade.

Of course, these amped-up dividends also might be a reason for concern when you consider earnings growth hasn’t really justified the increase in payouts. According to Michael Farr of CNBC[2], earnings growth for the most recent quarter was close to zero if you back out the strong financial sector.

No wonder, then, that the aggregate dividend payout ratio in the S&P 500 is sitting at its highest level (32%) since mid-2010 after rising for six straight quarters.

So while it’s nice to get paid, investors should take care not to be too overly wowed by big-number dividend yields, as a few of them are starting to look iffy. To wit, here are three companies with juicy yields worth a deeper look:

Ship Finance International Limited

ShipFinance185 3 Hefty Dividend Yields to Keep an Eye OnTrailing Dividend Yield: 10.4%
Payout Ratio (based on 2014 earnings): 121%

If you think Ship Finance International Limited’s (SFL[3]) double-digit dividend yield looks too good to be true, you’re probably right.

The company, which owns various vessels and rigs, gave its dividend a hefty haircut in late 2008, axing the quarterly payout in half from 60 cents to 30 cents per share. Since then, SFL’s dividend[4] has recovered 30% to 39 cents quarterly, good for a 10%-plus yield.

However, earnings have been sliding at the same time. During the past five years, Ship Finance’s earnings per share have decreased by just under 10% … per year.

Where does that leave things now? Well, Ship Finance generally pays out the majority of its net income as dividends. Problem is, at 39 cents per share, it’s slated to pay out $1.59 per year to shareholders … yet is only expected to earn $1.13 per share this year and $1.39 in FY14.

Another red flag: Ship Finance’s annualized operating cash flow was nearly sliced in half from 2011 to 2012 thanks to issues at Frontline (FRO[5]), its largest customer.

Right now, SFL’s sweet yield is only helping to make up for 9% year-to-date losses. And eventually, that big dividend will have to give.

FirstEnergy

FirstEnergy185 3 Hefty Dividend Yields to Keep an Eye OnTrailing Dividend Yield: 5.8%
Payout Ratio (based on 2014 earnings): 74%

Looking closer at recent dividend data, FactSet shows that telecom and utilities stocks have maintained the highest payout ratios for the 10th consecutive quarter, with respective ratios of 152% and 62%.

Of course, the telecom sector has suffered from large asset impairment charges, and if you exclude them, the ratio slides to 22%.

Utilities — whose average payout ratio doubles the broader market’s — don’t have a similar excuse[6]. Sure, depreciation often weighs on earnings, but many stocks in the sector are suffering from falling cash flow as well.

One such example: FirstEnergy (FE[7]). The company’s earnings have slipped 8% per year over the past half-decade and are only expected to regain around 2% of that annually during the next five years — one reason its payout ratio is sitting at an above-average 74%.

Beyond that, FE’s annual operating cash flow has been in a downtrend. And as Seeking Alpha’s Rupert Hargreaves explained this summer[8], the company has been spending most of that cash on capital expenditures, requiring it to borrow to pay investors.

That’s hardly a recipe for a reliable payout going forward.

Kohlberg Kravis Roberts & Co.

KKR185 3 Hefty Dividend Yields to Keep an Eye OnTrailing Dividend Yield: 8%
Payout Ratio (based on 2014 earnings): 70%

Since Jan. 1, investment firm Kohlberg Kravis Roberts & Co. (KKR[9]) has beat the market with a 33% climb, and also boasts a dividend currently yielding north of 8% based on its past four payouts.

However, that sky-high yield is a little skewed. A bang-up fiscal fourth quarter that saw profits jump by 49% led to a 70-cent payout in early 2013 that was well above the norm. Most payouts have come in a range of 10 cents and 40 cents in recent years.

Tallying up the past four payouts, including that 70-cent reward, the company’s annual dividend comes to $1.63 per share — three-quarters of projected 2013 earnings and 70% of projected 2014 earnings. Add in expectations that KKR’s net income will actually fall 7% annually over the next half-decade, and that operating cash flow is also in a downtrend, and it’s extremely likely “8%” isn’t a sustainable yield.

The good news, of course, is that even excluding that outlying 70-cent payout, KKR still would offer a yield of roughly 4% to 5%. Plus, KKR has shown that a big quarter will trickle down in the form of additional income.

Just don’t get blinded by the headline 8% yield.

As of this writing, Alyssa Oursler did not hold a position in any of the aforementioned securities.

Endnotes:
  1. according to FactSet: http://www.factset.com/websitefiles/PDFs/dividend/dividend_9.16.13
  2. Michael Farr of CNBC: http://www.cnbc.com/id/100950149
  3. SFL: http://studio-5.financialcontent.com/investplace/quote?Symbol=SFL
  4. SFL’s dividend: http://www.shipfinance.bm/index.php?name=Share%2FDividend_Policy_and_History.html
  5. FRO: http://studio-5.financialcontent.com/investplace/quote?Symbol=FRO
  6. don’t have a similar excuse: http://investorplace.com/2013/08/sell-most-utility-stocks-dividends/
  7. FE: http://studio-5.financialcontent.com/investplace/quote?Symbol=FE
  8. explained this summer: http://seekingalpha.com/article/1500312-these-6-companies-cannot-support-their-dividends
  9. KKR: http://studio-5.financialcontent.com/investplace/quote?Symbol=KKR

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