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There are few things that can challenge your investment thesis more than a dividend cut. Chances are, you bought a particular stock with expectations of a constant or modestly growing dividend. After a major dividend cut, it can take years for your long-term returns to recover.
One way to prevent this from happening is to steer clear of companies that are likely to cut their dividends. Stocks with very high yields and an uncertain future are perfect examples of what to avoid. Here's a quick look at some companies with sky-high yields that don't look like they will last much longer.
Williams Companies/Williams Partners: The post-breakup blues
Now that Energy Transfer Equity has called off its acquisition of Williams Companies (WMB -0.63%), both Williams and its subsidiary partnership, Williams Partners (NYSE: WPZ), have a lot of hard questions to answer as they try to come up with a new strategy for the future.
Here's the promise for Williams: It has a $30 billion backlog of potential projects that could lead to substantial growth over the next decade. Its position as a major natural gas transporter between the Gulf Coast and Mid-Atlantic provides it with plenty of opportunities to invest in high-impact projects with a decent chance of high returns. If it is able to tap this potential, there's a lot to like.
The problem for Williams is that need to find a way to pay for all that potential growth. Both Williams and Williams Partners have stretched their balance sheets enough that credit ratings agencies have already cut their credit rating. Also, with the stock of Williams Companies and Williams Partners trading at 11.6% and 9.5%, respectively, it's just too prohibitively expensive to issue new shares to raise capital at the current dividend payout.
If the company is serious about developing all of those assets, it will cut its dividend much like Kinder Morgan did at the end of last year and dedicate its cash-generating abilities toward funding growth internally and getting its debt levels back on track. Wall Street has already pretty much priced in a cut, so don't be surprised if it happens soon.
Golar LNG Partners: Righting the ship
Golar LNG Partners' (GMLP) situation is a lot like Williams'. The company has a marvel concept of building floating liquefied natural gas infrastructures like liquefaction and regasification vessels, which are ideal for places where the economics of building a permanent structure don't work. It has already signed some promising deals with private equity and oil services giant Schlumberger, which suggests the company is headed in the right direction.
The one thing that makes this business proposal risky right now is that there isn't much of an appetite to invest in new LNG projects. Many of the exploration and production companies that would be interested in employing Golar LNG Partners' services are either wrapping up or in the middle of their own massive LNG projects, and the lack of cash coming in the door means that Golar may need to wait for demand to pick back up again.
Here's the rub for the long term, though. In order for Golar LNG Partners and its parent company, Golar LNG (GLNG -0.48%), to grow their fleet, they need a lot of external funding through debt and equity. This is where the company has backed itself into a corner. The partnership's debt levels are too high for comfort -- total debt to capital is 70% -- and that 12.3% distribution yield is too costly to issue new shares. If it has any hopes of receiving dropdowns from its parent, it will need that third source of funding: internally generated cash flow. With such a high yield, Wall Street is already assuming the worst with this dividend, so it's a good time to rethink its current dividend and funding strategies to make for a more long-term sustainable business.
A dividend about to run aground
Offshore rig owner Seadrill Partners (SDLP) has already cut its dividend once in the past 12 months, but that doesn't mean the company could have another one soon. With a dividend yield of 16% today, there will be some things working against Seadrill Partners in the coming years.
Unlike the other companies on this list, Seadrill Partners doesn't have to grow to be successful over the long term. It could simply contract out the rigs it owns, collect the revenue, and hand it out to shareholders on a regular basis. The issue is that those lucrative contracts are one step closer to their expiration date every day, and not many companies these days will line up to sign a new contract. Even more concerning is whether its customers will keep using the rigs under their current contracts.
In May, ExxonMobil canceled a contract with one of Seadrill Partners' vessels. The rig was contracted at a very attractive daily rate and the cancellation fee doesn't generate nearly as much revenue. Furthermore, another three of Seadrill Partners' 11 rigs are slated to come off contract in 2017. Like Golar's problem with LNG vessels, producers aren't too ambitious about hiring expensive offshore equipment to explore for and develop new reservoirs, and that's a trend we could see continue for a while as producers like ExxonMobil focus on less capital-intensive forms of production like shale oil and gas.
If Seadrill Partners' contracts keep evaporating, there is little chance its reduced cash flows will be able to meet finance its debt and pay shareholders. It may not be an imminent threat, but the chances increase every day that oil producers will forgo spending on new oil and gas sources.
