In general, regardless of how well or poorly the U.S. economy is performing, investors tend to flock to dividend stocks.
Dividends represent a sign of strength for companies, with a regular payout (likely) demonstrating near- and long-term growth potential. It also doesn't hurt that dividend payments can help offset the downside pain investors might be subjected to during a stock market correction, and that reinvested dividends can be one of many keys to supercharged long-term capital appreciation. As I've often said, dividends are the foundation upon which great retirement portfolios are built.
High-yield horror on the horizon?
But blindly buying a stock based on a superior dividend yield can be nothing short of dangerous. Unless there is a sustainable business model backing up a recurring dividend payment, then not only could the dividend itself be cut or eliminated in the future, but it could wreak havoc on a company's stock price, which is likely being buoyed by income seekers looking for premium dividend yields. The higher the yield, the more skeptical investors should be of sustainability.
After quickly perusing the nearly eight-dozen companies currently yielding 12% or higher with a market value of at least $300 million, three stand out as potential high-yield horrors. While there's no way to definitively predict the future, I'd opine that the following high-yield dividends could be in serious danger of hefty cuts -- or possible suspensions.
PDL BioPharma (NASDAQ:PDLI): current yield: 12%
Topping the list of dangerous high-yield stocks is a unique biotech company: PDL BioPharma. Unlike your standard biotech company, which undertakes clinical studies and attempts to bring new and innovative therapies to market, PDL instead invests in royalties that generate revenue based on the total sales of the drugs covered by the royalty. The advantage of such a system is that it's extremely low-cost beyond the lump sum cash payments needed to purchase new royalty streams or products.
The bread and butter for PDL BioPharma has been its Queen patents, which entitled it to a percentage of sales from some heavy-hitting cancer drugs, including Avastin and Herceptin, as well as ophthalmic blockbuster Lucentis and multiple sclerosis blockbuster Tysabri. In 2013, the Queen licensed products totaled nearly $23 billion in cumulative sales.
However, there's one major problem (heavy emphasis on major!): PDL's Queen patent expired in December 2014. PDL BioPharma will continue to receive revenue from the sale of warehoused drugs through early 2016, but sales are otherwise expected to drop off a cliff. An expected $631 million in revenue in 2015 is forecast to become just $73 million in sales by 2017. This means PDL's current annual dividend of $0.60 looks mighty unsustainable next to the $0.09 in full-year EPS that Wall Street is forecasting for 2017.
Unless PDL manages to pull a rabbit out of its hat and land a massive royalty stream (which would likely entail heavy dilution via stock offerings to raise the cash needed for the purchase), I personally don't see how PDL's dividend is even remotely sustainable.
Theravance (UNKNOWN:THRX.DL): current yield 13.9%
It might be hard to believe, but drug developer Theravance could be in even worse shape than PDL BioPharma when it comes to maintaining its dividend.
Theravance and its development partner GlaxoSmithKline are resting a lot of their future hope on a new line of long-lasting inhaled respiratory products. Designed to treat COPD or asthma, Glaxo is forecasting that the combination of Breo Ellipta, Anoro Ellipta, Incruse Ellipta, and Arnuity Ellipta could be responsible for completely erasing an expected $3 billion in Advair patent losses by the end of the decade. In anticipation of strong sales, Theravance wound up splitting its respiratory products business from its developing portfolio and positioned its namesake (Theravance), the respiratory products company, as a royalty stock for income investors.
Unfortunately, things have not been going well for Theravance or its partner Glaxo. Breo's and Anoro's sales, while still relatively new, have disappointed Wall Street and investors, as their higher price points have been a tough sell for insurers and pharmacy-benefit managers. Adding salt to the wound, the SUMMIT trial, which was reported last month, demonstrated only a 12.2% overall survival benefit for Breo in COPD patients as compared to the control group. This non-statistically significant result was not what investors (or the duo of drug developers) expected, and it's unlikely to provide a sales acceleration for Breo anytime soon.
The other issue for Theravance is that it took out a $450 million loan to assist in paying a $0.25 quarterly dividend to shareholders. While Breo and Anoro sales struggle, Theravance's cash on hand has been dwindling. In fact, Theravance has seen its small gross profits turned into quarterly losses all because of its quarterly interest payments. With Wall Street pushing its ability to hit $1 in EPS all the way out to 2018, I don't see how Theravance can maintain its current payout and make a dent into its debt without a substantial cut or possible suspension of its dividend.
Noble Corp. (NYSE:NE): current yield 14.3%
Last among high-yield horrors we have offshore oil and gas driller Noble, a company that's seen its stock get absolutely taken to the woodshed. As Noble's share price has floundered, its yield has soared above 14%.
It's no great secret what's adversely affecting Noble's contracted drilling business: weakness in crude oil prices. A more than 50% year-over-year plunge in crude prices have caused capital expenditures in the space to dry up, and it's made obtaining new contracts extremely difficult for Noble. Although offshore drilling costs are seemingly being reduced by the year, drilling deep beneath the ocean floor for fossil fuels is still a relatively costly procedure compared to recovering oil assets onshore. Because of this, offshore has really taken a backseat during crude's recent tumble.
Making matters worse, offshore rigs were set to flood the market long before oil prices dove. New rigs can recover oil at a much faster clip than older rigs, and they tend to be more efficient in terms of operating costs and obviously sport lower near-term maintenance costs. New rigs are also expected to command a higher daily contract rate. Unfortunately, with new rigs entering the market and little demand currently present, it's putting intense downward pressure on dayrates.
The pain offshore drillers are witnessing was clear as day in a recent presentation from Noble. Its floating rigs are scheduled to move from having 78% of operating days committed in 2015 to just 35% in 2017. Jackup rigs are poised for a similar decline, going from 80% committed in 2015 to 41% committed in 2017.
All told, Noble's full-year EPS is slated to drop from $3.01 in 2014 to a mere $0.19 per share by 2017. As my Foolish colleague Tyler Crowe recently pointed out, Noble has suspended its dividend on three prior occasions throughout the years, and based on its current profit trajectory of paying out $1.50 annually, it looks as if a massive dividend cut or dividend suspension is in the cards.
Sean Williams has no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen name TMFUltraLong, track every pick he makes under the screen name TrackUltraLong, and check him out on Twitter, where he goes by the handle @TMFUltraLong.
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