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2 High-Yield Companies with Unsustainable Dividend Growth

Pitney Bowes and Windstream are risky plays

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When I analyse dividend paying companies, I always look for strong competitive positions. This is because a company in a strong competitive position might be able to enjoy rising profits for several decades. As a result, it might be able to boast a long streak of regular dividend increases.

However, changes in technology can jeopardize a company’s economic moat. This could mean that the company might be unable to afford to keep raising dividends. In addition, such companies might find themselves in a precarious position, where the dividend has to be sacrificed, in order to maintain the business.

The dividend rate is usually determined by the company’s Board of Directors, who take a look of near term prospects for the business. If the Board expects that the company would be able to generate a higher amount of earnings over the next two, five and ten years, they are much more likely to boost distributions. As a result, sometimes there might be a short term disconnect between current year earnings per share and dividends per share. In this article, I have highlighted two high yield dividend stocks, whose dividends are at risk of a dividend cut. I have always argued that dividend investors should avoid chasing yield at all costs.

Over the past 20 years, we have seen plenty of companies fall victims to the rapidly changing world. Even some boring companies with strong moats have been victims of the process. Examples include newspapers, photography, mail and fixed line telecoms. These industries would have to adapt very well to the new world of technological innovation, or they would be extinct. Even if these companies can support the current high dividend payments for the next one or two years, their long-term prospects are grim.

Windstream (NYSE:WIN) provides communications and technology solutions in the United States. The company derives its revenues from wireline operations. The long term trend is for erosion in wireline revenues, given the wide adoption of wireless technology. The company has managed to plug the hole in its dwindling customer count by making acquisitions.

That being said, the dividend payment has not been covered for several years. Windstream’s peer CenturyLink (NYSE:CTL) recently cut distributions in February 2013, which led to steep declines in shares of other fixed-line telecoms such as Windstream and Frontier (NYSE:FTR).  Given the expected erosion of the company’s customer base, and the competition from wireless, cable and VoiP technology, it seems like it is only a matter of time before the firm would find that it has to cut the dividend.

Most analysts are using cash flow payout ratios when analyzing telecom firms such as Windstream. Their calculation adds non-cash items such as depreciation expense to the net income amounts as the denominator in the cash flow payout ratio.  While using a cashflow payout ratio is appropriate for a real estate investment trust, it clearly shows a lack of basic understanding behind the wireline telecom model.

A REIT owns a building with a useful life of 30 years, which would probably would still be there for a few decades after it stops accounting depreciation, and would still be a useful asset for generating revenues. A company like Windstream on the other hand, needs to continuously invest in its technology and equipment simply to keep its operations functioning normally. The telecom equipment that you had purchased even five or ten years ago would likely need some improvement or replacement.

In addition, the company is also trying to invest in its future in order to still be able to generate revenues after the wireline segment dies off. As a result, analysts should be looking at earnings only, and those who ignore this logic have an increased likelihood of suffering devastating losses in dividend income and principal investment amounts. A look at the company’s ratio of capital expenditures to depreciation over the past four years shows that for every dollar in depreciation, the firm had to invest almost one dollar in new capital projects.

In Millions of $
Capital Expenditures
At the same time, the dividend payout ratio has been increasing over the past four years, and has reached stratospheric levels:
Diluted EPS Excluding Extraordinary Items
Dividends per Share – Common Stock Primary Issue
Dividend Payout Ratio

As a result, I find that the dividend is at a risk of a cut at present levels.

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