When a dividend yield rises into the double digits, it's often a sign of trouble. That's because the market tends to look at a stock's underlying financial metrics to gauge whether the payout is sustainable. When a company's numbers fall into the danger zone, it's a warning sign that a dividend cut could be forthcoming.
Three high-yield dividend stocks that seem to be in danger of a dividend reduction are Summit Midstream Partners (SMLP 6.25%), Enbridge Energy Partners (EEP), and Sunoco LP (SUN 2.10%). Investors are better off steering clear of this trio and considering safer options instead.
Too close for comfort
Summit Midstream Partners' dividend currently yields an eye-popping 14%, and appears to be on shaky ground. The master limited partnership (MLP) has generated only $91.3 million in free cash flow so far this year while it has distributed $90.4 million to investors, giving it a razor-thin distribution coverage ratio of 1.01. And it only expects to achieve full-year coverage ratio of about 1.
Because the company pays out everything that comes in, it must rely on outside sources to fund growth. That's going to become increasingly difficult to do, especially given its current yield, which has made selling new equity just too costly. That's why many of its rivals are shifting to a self-funding model where they retain a sizable portion of their cash flow to reinvest into growth projects.
Those factors could very well force Summit Midstream to reduce its payout so that it can internally fund some of its expansions, especially since it has a large natural gas pipeline project under development. On top of that, the company owes its parent a deferred payment, due at the end of 2020, for an acquisition completed in 2016. While Summit Midstream does have lots of liquidity on its credit facility to finance some of these obligations, it appears that the company will eventually need to reduce its distribution to a more sustainable level so that it doesn't stretch its finances too thin given what's coming down the pipeline.
That went downhill fast
Heading into 2018, Enbridge Energy Partners thought that it would be able to cover its now 12.3%-yielding distribution to investors with cash flow by a comfortable 1.2 times. However, changes in the U.S. tax code and a revision in a policy that allowed MLPs to collect a provision for income taxes along with their service fees whittled away at that cushion. As a result, Enbridge Energy Partners expects to generate just enough cash flow to cover its payout this year. Meanwhile, the company's parent, Canadian oil pipeline giant Enbridge (ENB 1.18%), has concerns that its namesake MLP won't be able to maintain its current payout level beyond 2018.
Enbridge recently offered to acquire Enbridge Energy Partners as well as its other MLP, Spectra Energy Partners (SEP). Under the proposed terms of the agreement, investors in Enbridge Energy Partners would receive 0.3083 shares of Enbridge for each unit in Enbridge Energy Partners they currently hold. That exchange ratio implies that investors would see their income stream drop by roughly 40%. Enbridge Energy Partners has yet to approve this deal, which is worth noting since sibling Spectra Energy Partners recently agreed to slightly improved terms with Enbridge. However, even a sweeter deal likely means that investors' income stream would be significantly reduced.
Getting better but still a concern
Sunoco LP (SUN 2.10%) ended last year with highly concerning financial metrics. The fuel-distributing MLP only generated enough cash to cover its now 12%-yielding payout by a tight 1.03 times in the fourth quarter. Furthermore, its debt-to-EBITDA (leverage) ratio was a worrisome 5.58.
However, the company has taken steps to improve its financial profile this year by selling the bulk of its retail gas stations and using the cash to pay down debt and repurchase some of its equity. As a result of those strategic moves, Sunoco has been able to boost its coverage ratio to a more comfortable 1.14, and its leverage ratio has improved to 4.52. While those metrics are much better, they're still above the comfort level of most MLPs, which is why Sunoco's sky-high payout remains in the danger zone.
A better option for yield seekers
While the double-digit-yielding payouts of this trio of MLPs might be tempting, there's too much danger that these companies could dramatically reduce their payouts. In light of that, investors are better off avoiding these income stocks for now. Instead, they might want to consider Enbridge's enticing 5.9% yield, since it's on rock-solid ground and should increase at a 10% annual pace through 2020. That growing income stream has the potential to generate market-beating gains for investors.