The stocks that make up the S&P 500 (SNPINDEX:^GSPC) includes hundreds of dividend-paying stocks, helping the index achieve a dividend yield of 2%. Yet for dividend investors who like much bigger payouts, S&P investors can look at three relatively small players in the telecommunications industry -- Windstream (NASDAQ:WIN), Frontier Communications (NASDAQ:FTR), and CenturyLink (NYSE:CTL) -- as the highest-yielding stocks in the S&P 500.
Yet as enticing as yields like Windstream's 11.7%, Frontier's 9%, and CenturyLink's 6.4% might be, smart dividend investors look beyond yields to determine whether high dividends are sustainable. Let's take a closer look at how these companies pay out so much money in dividends and whether they'll be able to keep doing so in the future.
Are dividend cuts inevitable?
These three companies can pay such high dividends because of the dynamics of their rural-telecom businesses. Urban customers have been quick to adopt mobile phones as their primary method of communicating by telephone, making landlines a steadily decaying business in urban areas. But Windstream, Frontier, and CenturyLink all serve rural customers, who've been slower to move away from traditional landline service as large wireless networks have made providing coverage in rural areas a low priority.
But even those favorable characteristics haven't prevented dividend cuts in the past. So far, investors in two of these three telecoms have already seen their dividends reduced from higher levels. Frontier has cut its dividend twice in the past three years, leading to current payouts that are 60% lower on a per-share basis than they were in early 2010. Frontier took on a huge amount of debt in buying up rural landline assets from Verizon, and while that added substantial revenue to Frontier's business, it also put it in a difficult position to try to retain and profit from those new customers.
CenturyLink followed Frontier's lead with a 25% dividend cut earlier this year, but the situation was somewhat different. At the same time CenturyLink cut its dividend, it also announced a $2 billion share repurchase program, essentially changing the method by which it returns capital to shareholders rather than cutting off the outward flow entirely. As part of a broader corporate shift, CenturyLink's move could actually help the company by giving it more flexibility to allocate capital as needed without fear of spooking dividend investors further.
Bucking the trend
For its part, though, Windstream has been adamant about keeping its dividend at current levels. Like Frontier and CenturyLink, Windstream has struggled against the challenges of declines in its legacy landline business, and those declines are likely to continue in the face of continued technological advances that threaten to make traditional phone service obsolete. Yet earlier this year, shortly after CenturyLink cut its dividend, Windstream CEO Jeff Gardner said that cuts in capital spending and interest expense would help the rural telecom sustain its payout. Analysts remain skeptical, though, arguing that high debt will continue to weigh on Windstream's overall business and that diverting resources away from potential growth could do more harm than good.
In general, investors need to pay close attention when highly indebted companies keep making massive dividend payouts. With low interest rates, such moves might make sense from a purely financial perspective. But in the long run, if refinancing debt becomes more difficult than the easy conditions that prevail today, dividend investors could easily get a nasty shock.