TBC - Dividend Cut Alert: 3 Revered High Yield Stocks Getting Risky

2023-07-05 08:00:00 ET

Summary

• High-yield investing can be rewarding but carries significant risks, primarily in the form of potential dividend cuts.
• We discuss three high-yield stocks whose track records are quite impressive.
• However, after peaking under their hoods, we have determined that their dividends are potentially at risk of getting cut.

While high yield investing can be extremely rewarding, it is certainly not risk-free. The biggest risk facing high yield investors is dividend cuts. When a company cuts its dividend, investors face a double hit:

• Their passive income declines significantly due to the reduced dividend payout.
• The stock price typically plummets due to investors fleeing the stock as a result of the reduced payout and the other problems at the company that prompted the dividend cut.

As a result, the single most important thing a high yield investor can do is successfully navigate the high yield minefield and avoid dividend cuts while buying high yielding stocks that can continue to sustain and even grow their lucrative dividends.

To assist you in that undertaking, in this article, we will discuss three high yield stocks whose dividends are looking increasingly risky.

#1. Medical Properties Trust ( MPW )

MPW's dividend has grown for quite some time, and the recent sell-off in the stock price has caused its yield to balloon to north of 12%:

While management has continued to double down on the dividend and has given no indication that they plan to cut it, the market clearly thinks otherwise. The reasons for this growing apprehension about the sustainability of MPW's dividend include:

• Financial challenges for Steward (~25% of MPW's assets) and Prospect (~8% of MPW's assets) is concerning given that around one-third of MPW's portfolio is closely tied to these struggling operators. On top of that, MPW has also made loans to these operators in an attempt to help get them through their current struggles and prop up its portfolio occupancy and rental income. If one or both of these tenants goes belly up and is unable to repay its debt from MPW and has to renegotiate rents to significantly lower levels, MPW shareholders will face a significant hit.
• Wall Street analysts currently project that MPW will face declining AFFO per share decline in the coming years due to a combination of its aforementioned operator issues and rising interest rates.
• MPW is also heavily leveraged and lacks an investment grade credit rating. This means that any disruption to cash flows from tenant issues and/or rising interest rates will have an outsized impact on shareholders' bottom line and equity in the company. As a result, while MPW appears to trade at a steep discount to NAV at the moment, any substantial repricing of the portfolio's assets could mean that MPW does not really trade at a discount after all.

Given the challenges facing the company, the lingering inflation and interest rate headwinds facing MPW and its tenants, the possibility of facing a recession, and the very tight dividend coverage ratio at the moment (just barely over 1x AFFO coverage expected for 2023), MPW looks like a prime candidate for a dividend cut.

#2. Boston Properties ( BXP )

BXP's dividend appears safe on the surface when taking into account its:

• High quality, well-diversified asset portfolio.
• Solid investment grade balance sheet.
• Adequate FFO and AFFO coverage of its dividend payout.

However, given the massive headwinds facing the office real estate sector, the large capex requirements, and interest rate headwinds that BXP has to deal with, the prudence of sustaining the dividend at its current level has been called into question. Management even acknowledged this fact on its latest earnings call and all but admitted that a dividend cut could be on the table later this year:

Another question we've received from investors is about our dividend policy, given we are trading at a historically high 8% dividend yield.

We have maintained a consistent dividend since the beginning of 2020. Our FAD provides reliable coverage of our dividend, such that we're able to reinvest excess cash flow into the growth of our business. We've been successful in selling assets annually and fitting the gains on sale within our regular dividend policy without the need for special dividends.

Long term, our goal is to maintain a steady dividend and increase it over time as our developments add to our income. In the near term, a slowdown in expected sales activity would create room in our dividend relative to the REIT distribution requirements. If our outlook for the economy and the capital markets become more negative and asset sales slow, we do have flexibility to modify our policy.

The odds seem firmly stacked against the sustainability of BXP's dividend given that:

• BXP has heavy concentration in coastal cities like San Francisco and New York where the office apocalypse is at its worst
• We could very well be on the verge of a meaningful recession
• BXP's Wall Street analyst consensus estimate for 2023 free cash flow per share comes in at $3.77 compared to its projected dividend per share of $3.92
• The negative outlook on its credit rating at a time when access to office property mortgages is strained and interest rates are rising.

Yes, BXP is a traditional blue chip stock with high quality assets and an impressive track record of growing its dividend over time. Management is likely among the very best in the industry and the balance sheet is certainly in better shape than those of many of its peers. Moreover, the stock price has been beaten down severely already and the headwinds to the company are quite possibly already priced in.

However, for those wanting a dependable dividend at current levels, BXP is - by its management's own admission - not a very safe bet.

#3. 3M Company ( MMM )

This stock may be surprising to find on a list of stocks that might cut their dividend. This is because MMM is a Dividend King with an illustrious 65 year streak of growing their dividend year after year.

However, the company's dividend growth rate has slowed dramatically in recent years to a ~1% CAGR due to a plethora of headwinds hitting the company, including:

• Very costly legal settlements (numbering in the tens of billions of dollars), with more potentially on the way.
• Inflationary headwinds.
• Supply chain bottlenecks.
• Slowing global economic growth.

As a result of the poor stock performance, the dividend yield has ballooned to over 5.9%, making it appear quite attractive at first glimpse, especially for a Dividend King with such a storied history. However, the payout ratio on cash flow net of interest and capital expenditures is currently ~94%, leaving little wiggle room for coverage.

With potentially tens of billions of dollars' worth of additional settlements likely to hit the company in the near future, the leverage ratio is set to soar and the company's dividend could be at risk . Keep in mind that Dividend King V.F. Corp ( VFC ) already had to slash its dividend this past year, so such a cut at MMM would not be unprecedented. Moreover, longtime dividend growth stalwart AT&T ( T ) slashed its dividend not too long-ago as part of a spin-off. Given that MMM is about to do a spin-off of its own, management could ultimately decide to pursue a similar move with the dividend through the spin-off as it determines how to deal with its snowballing litigation settlements.

Investor Takeaway

High yield investing can be extremely lucrative, and our massive outperformance at High Yield Investor is evidence of that. However, it is important to look under the hood at why a stock is offering such a high yield in order to determine if it is a truly sustainable high yield that is likely to deliver long-term outperformance, rather than a ticking time bomb that could blow up in an investor's face. We believe that MPW, BXP, and MMM - while all boasting strong track records - have very risky dividends that should not be counted on to sustain them moving forward.

For further details see: