Dividend investors always have to balance the desire for a high yield against the risk that the yield is unsustainable. As a dividend investor myself, I know how hard that can be. Right now, I believe the yields offered by CenturyLink, Inc. (NYSE:CTL) and Barnes & Noble, Inc. (NYSE:BKS) are simply too high to be sustainable. As a result, reduced payouts could be coming for both of these high-yield dividend stocks. Here's why their big dividend yields aren't worth the risk.
1. A highly leveraged telecom play
CenturyLink recently completed the purchase of Level 3 Communications. The goal of the acquisition was laudable, in that it expanded CenturyLink's business offerings. However, it also required the company to materially increase its debt load. Long-term debt roughly doubled from about $18 billion to around $37 billion in less than a year.
Leverage has remained relatively constant, with long-term debt at around 60% of the capital structure. However, CenturyLink paid a roughly 40% premium for Level 3, so there's a fair amount of goodwill (the amount it paid that exceeded Level 3's book value) associated with this transaction.
In fact, at the end of 2017, CenturyLink reported that nearly 60% of its consolidated assets consisted of goodwill. If the deal doesn't work out as planned, CenturyLink could end up writing down the value of its goodwill, which would reduce shareholder equity and make its leverage position look much worse. That could easily push the company to prioritize debt reduction over dividends.
Meanwhile, there are specific dividend issues to worry about, too. Dividends come out of cash flow, not earnings, so the fact that the company's payout ratio is greater than 100% is more a warning sign than anything else. However, CenturyLink's trailing 12-month free cash flow fell dramatically leading up to the merger and hasn't been enough to cover the annual dividend recently. The stock's nearly 11% yield reflects this concern. There are some signs of improvement, but investors should wait until this telecom provider has proven it can support its hefty debt and the dividend on a sustained basis before jumping aboard. There's simply not a lot of room for error.
2. Struggling to adjust
Barnes & Noble has managed to muddle through the internet's dramatic impact on book retailers. That's an impressive feat, given that competition from online book retailers led to the bankruptcy of peers like Borders and the closure of many mom-and-pop booksellers. However, Barnes & Noble's results haven't been pretty of late.
For example, revenue has fallen year over year for six consecutive quarters. That, notably, includes two holiday seasons in which Barnes & Noble's results were relatively weak compared to previous years. The company has lost money in eight of the last 10 quarters, including, somewhat shockingly, in the most recent holiday quarter: the key selling period for retailers.
Barnes & Noble's payout ratio is well over 100%, and free cash flow hasn't come close to covering the dividend. This is not a great story, especially when internet sales continue to grow at the expense of brick-and-mortar stores.
But that's not the only trouble brewing at Barnes & Noble. The company just parted ways with its CEO, who lasted barely a year in the position. The previous CEO was fired in 2016, so the company has now gone through three CEOs (including an interim CEO) in roughly three years. That's a lot of turmoil in the company's leadership ranks at a very difficult time. Each time a new CEO is named, there's a chance that he or she will decide to clean the slate, which could easily mean cutting or eliminating the dividend to free up cash. The risks at Barnes & Noble vastly outweigh the benefits if you are looking for reliable income.
"Maybe" isn't worth a high yield
CenturyLink has made a big, debt-fueled acquisition that has yet to fully play out. Barnes & Noble is struggling to adjust to a changing retail landscape while also dealing with turbulence in its executive suite. And neither company is comfortably covering its dividend payments with free cash flow right now. Of the two, CenturyLink appears to be in the better position, but that's really not saying much. If you are tempted by the huge yields these two companies are offering today, take a step back and look at their numbers. I think you'll agree that the risks outweigh the rewards right now.