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Any time a company has a dividend yield north of 10%, your "investing baloney" meter should be on high alert. There is little to no chance that it can maintain that kind of payout for long -- whether it's because the fundamentals of its business are flawed, it's in a market in major decline, or its financial house is a mess. In the cases of Costamare (NYSE: CMRE), Seadrill Partners (SDLP +0.00%), and CVR Energy (CVI +3.81%), several factors have pushed these companies' dividend yields to levels that can't last. Here's a quick rundown of why these three are candidates for dividend cuts in the near future.
A dividend cut could help make the sailing smoother
Costamare, like so many other companies that had spent years gearing up for the Chinese growth engine, is now facing a situation where slower Chinese growth is leading to oversupply in a multitude of industries. For Costamare, the slowing rate of global shipping means less demand for containerships, which leads to lower charter rates and lower revenue. According to the company's most recent investor presentation, idle ships have increased from less than 2% of the global fleet, back in 2014, to close to 8% today. That may not sound like a huge change, but it's been enough to lower charter rates by more than 10%. These factors are weighing heavily on the company's stock, to the point that shares are now trading at a yield of 12.7%.
To be fair to Costamare, it's in better financial health than some of its peers, but that doesn't take into account the 12 new vessels the company currently has under construction that will need to be financed. If it were to pay for those exclusively with debt, it would probably have too onerous a debt load. Costamare would be more prudent to cut its dividend and use a share issuance to pay off the remaining obligations for the fleet, and perhaps improve on its balance sheet even further so it can capitalize when the market does pick back up again.
Can't work when sitting in dry dock
If you look at Seadrill Partners' financial results today, you might not worry about the company being forced to cut its 32% dividend yield just yet. The company is still generating decent profits that provide enough cash to cover its capital spending and its payout to shareholders, and build a $400 million cash cushion. The problem for Seadrill Partners is that the future looks bleak, and it will be difficult to weather the storm with a high payout like today's.
Seadrill Partners and Costamare face similar problems: There is simply too much supply in their respective markets. For Seadrill Partners, it's really only a matter of time before we start to see significant revenue declines. In fact, two of its clients have already canceled contracts with Seadrill Partners early. With a rather small fleet already, losing one or two rigs will result in pretty rapid declines in profits and cash generation. Once this happens, the company will draw down those cash reserves to service debt and maintain its fleet, which could leave little room to give cash to investors.
In the event that Seadrill Partners needs to raise cash to make ends meet or wants to receive another rig from its parent company Seadrill (SDRL +0.00%) via asset dropdown, the best way to do so would be to issue shares. Today's yield, unfortunately, is prohibitively expensive for that. Eventually, the company will need to slash its dividend, and investors won't want to be around when it happens.
Not enough support from subsidiaries
The only way that CVR Energy makes money is from the cash payments it receives from its two subsidiary partnerships CVR Refining (CVRR +0.00%) and CVR Partners (UAN +5.13%). The problem for CVR Energy is that the two subsidiaries' results have been less than robust of late, and it would be difficult for the parent company to maintain its current payout if these issues continue.
For CVR Refining, the issues are a tough refining market environment today and higher than usual costs to comply with the U.S. Environmental Protection Agency's renewable-fuels standards. Because of the higher costs and contracting margins, CVR Refining has suspended its dividend for at least a quarter to preserve cash. This is slightly more important to CVR Energy, because the refining partnership has historically made up to 75% of the company's segment EBITDA (earnings before interest, taxes, depreciation and amortization).
To make matters worse, CVR Partners hasn't been doing much better. Lower natural-gas prices coupled with fewer exports of nitrogen-based fertilizers has resulted in lower prices for its products. It's also trying to incorporate its recent acquisition of Rentech Nitrogen Partners.
Granted, both of these businesses are very cyclical, and perhaps after a couple quarters these issues could blow over. However, the cash contributions from these two companies are nowhere close to what CVR Energy needs for its own dividend, which is 13% today. A rumor that it is looking to acquire one of its competitors is enough reason to think that it cuts its dividend, so it can shore up its balance sheet to set up for better days ahead.
