Investing in dividend stocks can be tremendously rewarding because they offer a steady stream of cash flow. With the S&P 500's average yield hovering around 1.96% today, it is not surprising that many investors are turning to stocks with sky-high dividend yields for added income.
But chasing dividend yields can be a dangerous game, because a high yield can sometimes signal that a company is in financial turmoil. Below, three Motley Fool contributors explain why Emerge Energy Services (NYSE:EMES), Freeport-McMoRan (NYSE:FCX), and Windstream (NASDAQ:WIN) are three stocks whose respective dividends may not be built to last.
Dan Caplinger (Emerge Energy Services): The plunge in oil prices has had a huge effect throughout the energy industry, and some of the hardest-hit companies are those that have played a supporting role in oil and gas exploration and production. Emerge Energy Services enjoyed huge profits in 2014 from providing sand for hydraulic fracturing operations to oil and gas producers, and those profits have helped the master limited partnership pay massive dividends that now equate to a nearly 12% dividend yield.
The big question facing Emerge Energy Services is whether drillers will continue bulking up their use of fracking sand. On one hand, even as drillers cut back on capital expenditures for new projects, they'll still need sand in order to keep the production of their existing wells up. So far, Emerge Energy hasn't seen a big drop in purchases despite the drop in oil. At some point, though, many fear that drillers will actually cut production, and that would send sand demand falling.
Moreover, Emerge's $5.09 in per-share dividend distributions over the past year already exceeds its net income by almost $1.40 per share. Admittedly, the company can afford to make payments beyond earnings because of the finances of the energy industry. But in the long run, Emerge Energy's dividend will likely have to fall if energy prices don't rebound soon.
Bob Ciura (Freeport McMoRan): Freeport McMoRan is a high-yield dividend that is unlikely to last. Freeport is a copper and gold miner, and recently added a large oil and gas business. Despite its diverse market interests, however, the operating climate for commodities is terrible, Freeport is losing a ton of money, and its balance sheet is bloated with debt. Combined, these factors put the company's dividend at risk.
No company can pay a dividend without the supporting cash flow. Last year, Freeport generated $5.6 billion in operating cash flow, but spent $7.2 billion in capital expenditures. That means it was free cash flow negative to the tune of $1.6 billion -- and it's important to note the commodity crash didn't take place until about halfway through the year.
To help raise cash, Freeport is cutting 2015 capital expenditures by $2 billion. But this isn't going to be enough. As a result, it's very likely the company will be free cash flow negative again this year, and its internal forecasts suggest the same. Freeport expects to generate $4 billion in operating cash flow in 2015 based on its production forecasts, and spend $6 billion on capital expenditures this year, which means it will likely generate $2 billion of negative free cash flow.
Freeport's dividend cost approximately $1.3 billion in 2014, but if it's free cash flow negative, something has to give. The dividend is the most likely culprit, since raising debt to cover the dividend probably isn't an option for Freeport. It's already saddled with a lot of debt as a result of its $19 billion acquisitions of Plains Exploration and McMoRan Exploration two years ago. At the end of last quarter, Freeport held over $18 billion in long-term debt.
As a result, barring a commodity rally in 2015, Freeport's dividend is at risk of being cut.
Tamara Walsh (Windstream): It's easy to fall in love with Windstream's dividend at first glance. The rural telecom giant boasts a dividend yield of 13% at its current share price of $8.07, thereby making it the largest yield of any company in the diversified telecom industry today. However, a closer look reveals various risks that could force Windstream to cut its dividend in the future.
Windstream spent more than $602 million on dividend payments in fiscal 2014, an increase of more than $8 million over the prior year. Specifically, the company paid $1 per share in dividends last year, yet only generated full-year adjusted earnings of $0.14 per share. As basic logic would dictate, paying out more in dividends than a company earns isn't a trend that is sustainable over the long haul. Moreover, the future doesn't look much better, as analysts now expect Windstream to generate a loss of $0.02 per share in fiscal 2015. The company's balance sheet is also being weighed down by debt. In fact, Windstream's current operating profits and assets are not enough to offset its ongoing debt obligations.
Up to this point, Windstream has been able to keep its dividend afloat by generating just enough free cash flow. However, with mounting competition from cable companies now offering phone services, Windstream may need to beef up its capital expenditures going forward. Ultimately, this could force Windstream to cut its dividend altogether in the year ahead as it puts more cash back into its business.