Investors should always hold a few high-quality dividend stocks in their portfolios. Income stocks generally aren't exciting, but they can generate impressive compound returns over the years via the magic of reinvested dividends and compounding returns.
But at the same time, investors should be wary of companies that could cut their dividends. Here are three currently high-yielding stocks that fit the profile of a company with the potential to cut their dividend: Vector Group (NYSE:VGR), Tanger Factory Outlets (NYSE:SKT), and AT&T (NYSE:T).
1. Vector Group
Vector Group is a tobacco and real estate company. Its Liggett cigarette brands, which include Pyramid and Eve, make it the third-largest tobacco company in America after Altria and British American Tobacco's Reynolds American. It also owns Douglas Elliman, one of the country's top real estate companies, and numerous hotels, residential buildings, and commercial properties.
Vector pays a unique dividend -- it pays a 5% "stock dividend" every year, which boosts an investor's total share count by 5%, and a forward cash dividend yield of 6.5%. That payment plan might sound tempting, but it's dangerously unsustainable, for three reasons.
First, Vector pays out $0.80 per share in dividends annually, but analysts only expect it to generate earnings of $0.55 per share this year. Vector can still cover its dividend with its free cash flow, but a payout ratio over 100% is nevertheless a bright red flag.
Second, Vector's annual stock dividend increased its number of outstanding shares by more than 30% over the past five years, and that ongoing dilution will throttle its EPS growth. Lastly, Vector ended last quarter with more than $1.4 billion in debt, partly because it funded its prior dividend payments with debt.
Vector already cut its dividend once in late 2019. However, smoking rates are still declining in the U.S., and the pandemic is throttling the growth of the company's real estate portfolio. Those headwinds could all prompt Vector to cut its dividend again in the near future.
2. Tanger Factory Outlets
Last May, Tanger suspended its dividend to conserve cash throughout the pandemic. The move wasn't surprising, since its revenue fell 22% year over year in the first nine months of 2020 and it posted a net loss.
Tanger's core FFO (funds from operations) declined 40% during that period, and its occupancy rate fell 300 basis points to 92.9% as its tenants went out of business. It also struggled to collect rent from its remaining tenants throughout the year.
But despite all those headwinds, Tanger recently reinstated its dividend as a reflection of its "strong liquidity position, with more than $80 million of cash on hand and $600 million of undrawn lines of credit." It believes its improving store traffic and rent collection rates, especially in the second half of the year, will support its forward yield of about 5.6%.
Tanger certainly has enough liquidity to support its dividend, which will consume about $35 million per quarter, as its business improves. But if the pandemic worsens and causes businesses to close down again -- as we've already seen in several states -- Tanger's outlook could be too optimistic.
If Tanger's outlets close down again, it could suspend its dividend again instead of funding it with debt. As a REIT (real estate investment trust), Tanger still needs to pay out most of its earnings as dividends for a favorable tax rate -- but that point could also be moot if it remains unprofitable.
Some investors might not believe that AT&T will ever cut its dividend. However, it didn't raise its dividend at the end of 2020, marking the first time it broke its four-quarter cycle of dividend hikes since 2005. Its payout ratio also exceeded 100% over the past 12 months.
AT&T is still a Dividend Aristocrat that has raised its payout annually for 36 straight years, but it could lose that elite status if it doesn't raise its payout this year. That probably won't happen, since AT&T can still easily cover its dividend with its free cash flow.
Yet it might be smarter for AT&T to reduce or suspend its dividend, which cost nearly $15 billion last year, for two reasons. First, AT&T ended last quarter with $153 billion in long-term debt, and it faces mounting pressure to divest its weaker businesses -- such as DirecTV -- to reduce that debt. Cutting its dividend could speed up that process.
Second, AT&T is investing billions of dollars in its streaming platforms, such as HBO Max, to offset its ongoing loss of pay-TV subscribers and keep pace with Netflix and Disney in the streaming race. Plowing cash into that competitive market instead of its dividend would be a smarter long-term move.
Therefore, investors shouldn't get too comfortable with AT&T's dividend right now, especially as CEO John Stankey -- who took the helm last July -- faces intense pressure to shake up and streamline the telecom giant.