A common measure of dividend sustainability is the payout ratio, the percent of earnings that are paid out to shareholders. Unfortunately, earnings don't always represent how much money is available to management because they include noncash items. That's why free cash flow -- what's left of sales after the expense of running the business and buying and maintaining physical assets -- can provide a more useful way to gauge how much a company could pay out and how likely a dividend cut might be. For high-yielders under threat, like Realty Income (NYSE:O), ExxonMobil (NYSE:XOM), and Gilead Sciences (NASDAQ:GILD), comparing free cash flow to the dividends helps us determine how easily the company can keep doling out the cash while working through obstacles.

A lady cutting a stack of five-dollar bills with scissors.

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1. Realty Income

Known as the monthly dividend company, Realty Income owns more than 6,000 properties, with the largest categories being convenience and dollar stores, drug stores, as well as gyms and theaters. The company offers triple-net leases, meaning the tenants pay the taxes, insurance, and maintenance on the property.

The arrangements have worked brilliantly for the company, allowing it to pay a monthly dividend that has increased for 92 straight quarters. That monthly payout of $0.2345 currently translates to a 4.7% annualized yield. While the dividend climbed 60% from 2015 through 2019, revenue and earnings per share only increased 46% and 27%, respectively. 

With the quarterly increases outpacing sales, the math is catching up to the company as some retail categories are hampered by the pandemic. Theaters, which make up nearly 7% of all leases, have been hit especially hard, with management estimating that only half will ever catch up on rent. Because of the hit, year-over-year same property rent dropped 4.4% in the most recent quarter ended Sept. 30. With the decline, free cash flow is approaching the amount of dividends paid out.

Year Dividends Free Cash Flow Cash Dividend Payout Ratio
TTM $940 million $1.10 billion 85%
2019 $850 million $1.07 billion 80%
2018 $760 million $0.94 billion 81%
2017 $690 million $0.88 billion 79%

DATA SOURCE: MORNINGSTAR; TABLE BY AUTHOR; TTM = TRAILING 12 MONTHS.

The danger may be over soon. Box office revenue returned to 80% of pre-pandemic levels once the virus was under control in China. As long as cases in the U.S. continue trending downward, the dividend should safe. A longer-term threat could be e-commerce. Digital sales grew 36% during the first two weeks of December compared to 2019. That trend, which means less need for retail stores, could undermine the company's business model over the next few years. While Realty Income looks like a reliable dividend payer for now, the company faces short-term and long-term risks that could change that.

2. ExxonMobil

Since revenue peaked for the oil giant in 2011, it had fallen 46%, to $256 billion in 2019. That's before a pandemic put a dent in oil-intensive business travel and commutes. For the first nine months of 2020, sales were $135 billion, down another 32% from 2019. The stock has fallen even more than sales and now yields 7.4%, or $3.48 per year. That massive yield came under scrutiny in 2020 when the company continued its streak of raising the payout for 37 consecutive years. Falling free cash flow and rising payouts have pushed Exxon into unsustainable territory.

Year Dividends Free Cash Flow Cash Dividend Payout Ratio
TTM $14.9 billion ($3.3 billion) (445)%
2019 $14.7 billion $5.4 billion 274%
2018 $13.8 billion $16.4 billion 84%
2017 $13.0 billion $14.7 billion 89%

DATA SOURCE: MORNINGSTAR; TABLE BY AUTHOR; TTM = TRAILING 12 MONTHS.

It remains to be seen whether management will signal a dividend increase in April, as it typically does. In the meantime, Exxon is taking serious action to preserve cash. Last year, the company announced it was cutting 2020 capital spending by 30% and reducing its global workforce by 15% over the next two years. On top of those moves, management has suspended some employee benefit programs like the 401(k) match.

With oil consumption not expected to reach pre-pandemic levels until 2023, the spending cuts may not be enough. For yield-seeking investors, the longer the company pays its attractive dividend, the riskier the financial situation becomes. Anyone buying shares should be prepared for a possible dividend cut in the near future or more curbs in spending that limit ExxonMobil's long-term growth and ability to attract talent.

3. Gilead Sciences

The company best-known for its HIV and hepatitis C (HCV) drugs has seen sales fall about 30% from a peak in 2015 to $23.2 billion over the past 12 months. With a dividend of $2.72 per year and 4.1% yield, Gilead offers an attractive payout. However, declining sales are not a recipe for sustaining and growing the dividend over the long term. Revenue stabilized in fiscal 2020 thanks to Veklury, the brand name for Remdesivir, which is used to treat patients with COVID-19, but no one knows how long that will last.

As patients shied away from checkups and screening for fear of COVID, sales of Gilead's HCV drugs fell 47% and 31% in the second and third quarters of 2020, respectively. Veklury filled the gap. In December, about half of all COVID patients in the U.S. received the treatment. That's despite a warning from the World Health Organization that it failed to show enough evidence in four global trials to support its use. While Veklury has kept Gilead bringing in plenty of cash to keep paying the dividend, the outlook remains murky.

Year Dividends Free Cash Flow Cash Dividend Payout Ratio
TTM $3.4 billion $8.2 billion 42%
2019 $3.2 billion $8.3 billion 40%
2018 $3.0 billion $7.5 billion 40%
2017 $2.7 billion $11.3 billion  24%

DATA SOURCE: MORNINGSTAR; TABLE BY AUTHOR; TTM = TRAILING 12 MONTHS.

The company spent $26 billion on two large acquisitions in 2020 to bolster its oncology pipeline in the hopes of reversing falling sales. It will need more success than it had when Kite Pharma was purchased for $12 billion in 2017. Since that deal, management has written down the value of Kite by $820 million twice.

For now, investors can breathe easy as long as Veklury continues to play a sizable role in fighting COVID in the U.S., but even that is unpredictable. Just this week, a San Francisco-based research team identified a cancer drug that may be 30 times better at fighting COVID than Gilead's drug. To continue raising its dividend beyond the next few years, Gilead will need to prove it can monetize its new oncology pipeline and get a drug to market that will turn the negative sales trend around.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.