Real estate investment trust Uniti Group (UNIT -2.01%) was spun off from Windstream to own the telecommunications company's fiber optic assets. The two companies are still tied at the hip, which goes a long way toward explaining Uniti's huge 18% dividend yield.
Here are some reasons dividend investors should tread with caution despite a modest adjusted funds from operations (FFO) payout ratio of just 34% in 2022.
Looking beyond payout ratios
Dividend investors have to consider a number of important factors when looking at a stock. One of the key figures is the payout ratio. This metric compares the dividend payment to a company's earnings, with lower percentages suggesting that the dividend is safe. The fact that the payout ratio for Uniti's adjusted FFO -- the real estate investment trust (REIT) version of adjusted earnings -- was a very low 34% in 2022 should inspire confidence in the REIT's ability to maintain its quarterly disbursement of $0.15 per share
In the first quarter of 2023, the adjusted FFO payout ratio rose a tiny bit to 38%, so the strong coverage doesn't appear to be a fluke.
Image source: Getty Images.
That said, the REIT has a fairly heavy debt load, with a debt-to-assets ratio of around 100% compared to figures closer to 60% for cell tower owners American Tower (AMT -0.26%) and Crown Castle (CCI -1.29%). Although cell towers aren't fiber optic cables, they are in the same space of connecting people digitally. So leverage is a risk, but the low adjusted FFO payout ratio suggests that there's material room for adversity before the dividend would be at risk.
Helping that view along is the fact that Uniti refinanced some debt last year. That doesn't clean up the balance sheet, per se, but it did push the company's material maturities out to 2027 and 2028. That buys the REIT time before it needs to worry about its debt again.
But these moves came at a cost, with the 2028 notes requiring an interest rate of 10.5%. The cash will be used to pay off debt with an interest rate of 7.875%. In other words, interest costs here are heading higher in 2023. This is highlighted by the company's 2023 guidance for higher interest costs and lower adjusted FFO. The fact that Uniti had to pay so much in interest is something that needs a bit more probing.
One big, troubled relationship
So why did a REIT generating more than enough adjusted FFO to pay its dividend have to pay so much to get a refinancing done? One reason is its leverage, but that alone isn't the whole picture.
Even with the higher interest costs factored in, the company's adjusted FFO guidance for 2023 of $373 million to $393 million more than handily covers the $143 million it paid in dividends in 2022. From that perspective, Uniti looks like it is on a fairly solid footing.
The rest of the story is that Windstream accounts for roughly two-thirds of Uniti's revenue. That huge concentration of risk is made even worse by the fact that Windstream's balance sheet has earned a junk rating of B3 from Moody's. So Uniti is basically reliant on a single, financially weak tenant for most of its rental income. In fact, Windstream actually went bankrupt in 2019.
But here's the thing: Windstream's lease runs through 2030, at which point the lease rate will reset to a market rate. Windstream seems to think that the market rate will be less than a third of what it is paying today, a fact it has publicly stated in a corporate presentation.
If that's the case, Uniti's rent roll is set to dramatically decline. It's unlikely that Uniti agrees with Windstream on this, which could create an increasingly contentious situation between the REIT and its largest tenant.
Meanwhile, in 2020 and twice in 2022, Uniti took one-time charges to reduce the goodwill associated with its assets. That suggests that Uniti is fully aware that its fiber cables might not be worth what they were just a few years ago. From a glass-half-empty point of view, this fact might back up the idea that some form of a rent reduction could be in the cards.
Too much risk
It doesn't look like Uniti will have too much trouble continuing to pay its dividend as long as Windstream keeps paying its rent. But the overhang related to Windstream can't be ignored since the relationship will have to be addressed by 2030, or likely sooner, and the discussions probably won't be easy. The caveat being that any trouble with Windstream could actually end up with Uniti failing to qualify as a REIT, a complication that most investors will probably want to avoid.
This is, at best, a high-risk special situation play. Only investors willing to get deep into the weeds of the relationship between Uniti and Windstream should be looking at this high yield (and high risk) stock.
