If you're like me, you love dividend stocks, particularly ones with high yields. However, you have to look past the yield when you weigh an investment, because all dividends are not created equal. Today, for example, utility SCANA Corp. (NYSE:SCG) and bookseller Barnes & Noble Inc. (NYSE:BKS) both offer hefty payouts, but neither should be added to your portfolio.
If this fails...
SCANA delivers electricity to around 500,000 customers in South Carolina, and natural gas to 1.3 million customers across South Carolina, North Carolina, and Georgia. As a regulated utility, it has a monopoly in its service areas, but the rates it charges customers must be approved by state governments. Normally, utilities are pretty boring investments that are known for slow and steady growth.
However, when a utility makes a large capital investment decision that doesn't pan out as planned, it can impair the company's ability to keep paying its dividends. And that's exactly what's happened to SCANA. The company started to build a new nuclear power plant, which in and of itself wasn't a bad idea. However, the process didn't go as hoped. The company it hired to build the plant went bankrupt in the middle of a construction process that was already over budget and missing deadlines. SCANA decided to scrap the project midway through.
That left it with big bills to pay, angry customers on the hook for the money spent, agitated regulators, and a partially built nuclear facility that was going nowhere. There have been calls from consumer groups and regulators for SCANA to cut its dividend. Complicating the issue, the utility has had a hard time covering its interest expenses, with its interest coverage ratio falling to a terrible 0.3 times in the first quarter, suggesting it's facing some fiscal strain today. In fact, there have been hints from management that the dividend cut being demanded could soon be in the cards.
Larger utility Dominion Energy (NYSE:D) has leaped to the rescue, agreeing to acquire SCANA. However, it will walk away from the deal if its terms aren't agreed to by regulators, specifically regarding the nuclear power mess. Moreover, because of the circumstances around the nuclear issue, it isn't clear that regulators will approve the deal. At this point, there are two potential outcomes for dividend investors drawn to SCANA's hefty 7% yield. The Dominion deal gets approved and the all-stock transaction reduces dividends received by SCANA shareholders by around 9%. Or, the deal fails and SCANA's weak financial state leads to a dividend cut or, worse, a complete suspension.
Neither one of those options is a clear win for dividend investors. SCANA is a special situation stock today that's not appropriate for investors seeking reliable dividend income.
The stumbling bookseller
Barnes & Noble's yield is even higher than SCANA's at 11.5%. But the once-dominant bookseller's business model troubles are pretty well publicized. To sum it up, online booksellers ate the brick-and-mortar company's lunch, with Barnes & Noble among the first to feel the pain of the so-called Amazon effect. To the company's credit, it has managed to remain alive while others (Borders, for example) have not.
Simply surviving, however, isn't a good reason to buy a company if you want reliable dividends. The company's revenue has fallen in each of the last five years. It's income statement has been covered with red ink in three of those years. And while long-term debt is a modest 12% of the capital structure, earnings haven't covered the dividend since it was restarted in late 2015. Although dividends are paid out of cash flow, the inability to earn more per share than gets paid out in dividends per share over such a long stretch is a worrying sign.
If Barnes & Noble's business was improving, dividend investors could be excused for taking on the risks here. But that's just not the case. Barnes & Noble is a high-stakes turnaround situation at best. And the double-digit yield is highlighting the extreme risks, including the fact that the dividend could get cut. Dividend investors should avoid this bookseller as it tries to muddle through the internet age.
The story behind the yield
Like all dividend investors, I'm attracted to a high yield. But a high yield alone isn't enough information to make an investment decision. You need to look past the tempting dividend payments and examine the company and its background story. And that's where the dividends offered by SCANA and Barnes & Noble lose their appeal. Both are high-risk situations that just aren't worth owning for investors seeking reliable dividend income.
John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Amazon. The Motley Fool has a disclosure policy.