In a world where savings accounts, bank CDs, and even certain Treasury bonds seem to be yielding fractions of a penny on the dollar, it can be tempting for income investors to chase high-yielding dividend stocks in an effort to grow their nest egg. While dividends often serve as a beacon to attract investors to a healthy and profitable business model, not all companies that pay a high-yield dividend are necessarily healthy.
With this in mind, we asked three of our Foolish contributors to name a high-yield dividend stock that they felt should be avoided by investors. Companies such as StoneMor Partners (NYSE:STON), Sunoco LP (NYSE:SUN), and Xerox (NYSE:XRX) topped the list.
Yield chasers could be dead wrong about this stock
Sean Williams (StoneMor Partners): Despite sporting a 16% yield and a perceived-to-be very low multiple relative to its expected funds from operations in 2016, master-limited partnership StoneMor Partners is probably best off avoided.
StoneMor, which has what looks to be a foolproof business model -- operating funeral homes and cemeteries in the United States -- has encountered a rough patch recently. Just two weeks ago, the company announced that it was slashing its payout in half to $0.33 per quarter in order to conserve cash as it attempts to regrow its salesforce. To that end, StoneMor also announced that it's had to engage with a recruiting firm (meaning more expenses) to help rebuild its salesforce. It takes time and money to train these employees, meaning we could be looking at multiple quarters of sustained weakness in StoneMor's underlying business.
As noted by CEO Larry Miller:
While we are striving to accelerate the timeline of hiring and training additional sales talent, we estimate that this could take up to an additional six to nine months to attain the level of productivity we expect. We intend to provide monthly updates on the sales team expansion for greater visibility on our progress to the levels we are targeting. At that time, we will reassess the distribution and will look to reset it at the appropriate level.
Note that portion at the end? It suggests StoneMor's 50% dividend cut could grow even steeper, depending on how much its business struggles.
A recent analysis by Insider Monkey also brings up a valid point: The cremation rate is increasing in America. Based on projections from the National Funeral Directors Association, the percentage of people being cremated could increase from 40% in 2010 to more than 71% by 2030. Cremation margins are considerably lower, which could constrain StoneMor's longer-term profits.
Until we have better clarity of what's really wrong with StoneMor's business model and how long it'll take to fix, income investors should avoid it.
Good business model, bad financials
Tyler Crowe (Sunoco LP): At first glance, shares of Sunoco look as if they would be a great high-yield investment. Gas stations and wholesale distribution of gasoline and diesel are steady businesses. Sure, gas prices can go up and down, but the cut that sellers get typically remains consistent throughout the ups and downs of the commodity market. Also, the total amount of gasoline and diesel consumed remains remarkably consistent, and the retail filling-station market is pretty saturated in the U.S., so there isn't a great need to spend a lot on building new stations. Throw in 30% margins for selling merchandise in convenience stores, and you have a business that's seemingly built to throw off lots of cash.
Sunoco has a lot of these things going for it, but one issue is starting to become a larger and larger problem: It's trying to grow quickly through acquisitions, and its taking on an uncomfortable amount of debt to do it. As of the company's most recent earnings release, net debt to EBITDA stood at an alarmingly high rate of 7.5, and it isn't retaining much cash right now to pay down that debt load. Management says its target is to see that figure drop dramatically as the company grows into its balance sheet, but that involves a lot of growing that may not be there.
Today. shares of Sunoco have a distribution yield of a whopping 12.2%. At a yield that high, it seems as though Wall Street is pricing a payout cut soon. If Sunoco's management can't adequately address these debt issues, then this stick has "yield trap" written all over it.
This profit printer is best off avoided
Jamal Carnette, CFA: (Xerox): Value investor Raymond DeVoe once quipped, "More money has been lost reaching for yield than at the point of a gun." This statement has been repackaged by many, most famously by Warren Buffett, who used it in his 2011 letter to shareholders. As a result of historically low interest on bonds and other fixed-income investments, many investors are reaching for dividend-paying stocks. Unlike bonds, where the long-term investor's main concern is the coupon and return of capital, yield investors in stocks need to consider the stock's price performance as well.
In the technology space, one company in I'm wary of is Xerox. Although the dividend-payout ratio and free cash flow support the thesis that the company can continue to pay its 3.2% dividend, the company is spinning off its business outsource processing business division to a new company, Conduent Incorporated, while keeping the legacy document technology business under the Xerox name. This is similar to Hewlett-Packard's earlier split of Hewlett-Packard Enterprise and HP Inc. The theory is this will unlock value, with Conduent attaining higher valuation multiples while the dividend investors will remain with Xerox.
However, the remaining document technology business is having troubles adjusting to a shift in technology. Throughout the first nine months of 2016, the company reported a year-on-year revenue decrease of 8.6% (7% in constant currency). Additionally, the company has seen a decrease of operating margin from 13% to 12% during this period. Post-spinoff, I expect both conditions to continue and the stock to continue to underperform the market, dividends included.
As I stated earlier, I think Xerox will continue to be able to pay its dividend, but there are better risk/reward investments for your dollar.