One of the best ways to protect a portfolio and lock in stable returns is to invest in companies that offer their investors a well-covered, sustainable dividend payout that can be depended upon. However, there are numerous companies out there whose dividends appear neither well-covered nor sustainable.
Listed below are three companies whose payouts look suspicious and in my opinion are unsustainable. That said, we Fools all have our own individual opinions -- that's what makes us Motley. While I believe these payouts look precarious, your own research could reveal otherwise.
A sinking ship
First up is Nordic American Tanker (NYSE:NAT). Nordic American owns and leases oil tankers around the world. As day rates for the hiring of oil tankers continue their fifth year of declines, however, Nordic American is running into trouble. Nordic American has not reported a positive operating cash flow since the third quarter of 2012, and the company has not been cash-flow positive since before 2009. What's more, the company continues to pay out a dividend that currently yields a whopping 7.8%. With a negative cash flow, it would appear that this dividend payout is being funded from the company's cash balance, which is of course finite.
Nordic's main problem stems from overcapacity in the tanker market, which has been persistent for some time. Indeed, tankers are are now cheaper to buy new, rather than second-hand -- which only increases the oversupply.
Management is committed to Nordic American's dividend payout, but it remains to be seen whether the company can continue to support that dividend. During the first half of this year, Nordic American spent $25 million in cash running day-to-day operations before a cumulative dividend payout of just more than $19 million. Nonetheless, the company issued stock to the value of $101 million, which was supposed to pay for a new ship. Management canceled this order, however, and as far as I can see, the cash is now being used to fund the company's everyday operations and dividend payout.
Nordic American has only $71 million in cash on the balance sheet as of the end of the second quarter, and so far this year the company has burned through around $80 million in cash, excluding the $100 million received from stock issuance. Therefore it does not appear the company can sustain its payout.
Desperately trying to fend off cuts
Pepco Holdings (UNKNOWN:POM.DL) is another company that makes the dividend cut list. Pepco has sustained its dividend payout at $0.27 per share since 2008. Over the same period, the company's revenue has declined 53%. Net income has remained fairly constant during this time, only declining 5% over the five-year period. However, what concerns me is the fact that Pepco's free cash flow has not been able to cover the dividend at all since 2008 -- in fact, over this period, free cash flow has not even been positive. Additionally, during fiscal 2012, interest on the company's debt already consumed about 40% of earnings before interest and taxes, and as a result growth is being held back.
High levels of debt are commonplace among utility companies, as infrastructure requires a significant investment to begin with. However, Pepco has not committed to pay down this debt, which it could do if it cut its dividend slightly. Less debt would mean lower interest costs and a higher future payout.
Still, the company's profit margins and debt levels have remained static over the past five years. Having said that, debt has been kept under wraps with asset and investment sales of $1.8 billion and secondary stock issuance of $200 million. Without this, the company's level of debt would be around $7.3 billion, or around 40% above its current level of $5.3 billion.
While Pepco's dividend payout appears sustainable now, this is only because asset disposals and stock issuance have kept its debt low. Without assets to divest in the future, the company's negative cash flow could start to become a serious issue.
Mining is a risky business
Next up is Cliffs Natural Resources (NYSE:CLF). After cutting its dividend payout once this year already, the company has not been able to catch a break. The prices of coal and iron ore have hardly recovered since the initial payout cut, putting Cliffs under even more pressure. The price of thermal coal is still sitting around five-year lows of $50 per ton, and iron ore prices have bounced in a range from $120 per ton to $150 per ton. The price has not stayed at a sustainable price long enough for Cliffs to make a profit. What's more, the cash cost per ton of iron ore production at Cliffs' Wabush Mine surged as high as $200 during the second quarter, a totally unsustainable level.
The cumulative $23 million dividend payout per quarter is payable, given the company's current cash balance of $260 million, so Cliffs should be able to support the payout for some time yet. That said, capital expenditures and dividend payouts cost the company more than $550 million during the first half of the year; this was equal to more than 140% of cash flow from operations. Cliffs did bulk up its first-half cash flows with a $1 billion stock issuance, although this should be a one-off occurrence. Collapsing commodity prices, which Cliffs has no control over, make me wonder about the company's ability to maintain its payout.
All in all, the dividend payouts of Cliffs, Nordic American, and Pepco all look to be under pressure based on my analysis. However, if you're looking for rock-solid dividend stocks to secure your future, then check out the free report below.
Fool contributor Rupert Hargreaves has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.