BP Prudhoe Bay production coming down the Alaska Pipeline funds the royalty trust's distributions. Image source: Flickr user Dan.
Retirees need investment income, and dividend stocks are a great source of cash in a low-interest-rate environment. But some dividend stocks aren't worth the risk, and few retirees are in a position in which they can afford to take a big hit to their investment portfolios. To help you avoid potential red flags, let's look more closely at three dividend stocks that retirees should think twice about before buying shares.
Could BP Prudhoe Bay run out of gas?
Royalty trusts often have high yields, and BP Prudhoe Bay (BPT +0.00%) is among the top-yielding royalty trusts in the market right now. In the third quarter of 2015, BP Prudhoe Bay paid a distribution of about $0.703 per unit, working out to a yield of about 8% based on current prices.
The problem with royalty trusts is that their dividends are tied to energy prices and production levels. BP Prudhoe Bay gives investors just less than a one-sixth working interest on the first 90,000 barrels of daily production from the BP Prudhoe Bay field on Alaska's North Slope. If production falls below 90,000 barrels per day, the proceeds fall, and as oil prices decline, the royalty trust gets less in sales. That's a big part of why BP Prudhoe Bay's last distribution was down by nearly two-thirds from last year's third-quarter distribution of more than $2 per unit.
With the eventual termination of the trust when royalty payments decline below $1 million per year for two straight years, investors will eventually be left with nothing. The question is whether the distributions that investors will receive in the interim will be enough to make up for the eventual decline in the share price, but that adds a level of risk that many retirees won't want to take on.
Will PDL BioPharma stay healthy?
You can find a similar business model in the healthcare industry, where PDL BioPharma (PDLI +0.00%) gets the majority of its revenue from licensing royalties on its monoclonal antibody patents. The company recently sported a 15% dividend yield based on its $0.15 per share quarterly payments, which it has made consistently for years.
The problem ahead for PDL BioPharma is that it can only reap licensing revenue on its patents for as long as the patents remain protected. Once they expire, PDL BioPharma's ability to keep paying dividends will be in jeopardy.
The company expects to make investments to find new sources of revenue, but its ability to replace lucrative licensing-income streams from its now-expired Queen patents is highly uncertain. Going forward, PDL BioPharma will rely much more on the success of potential treatments in development, and that will introduce risk that dividend investors haven't had to take on previously.
Can Windstream stay connected?
Telecom company Windstream (WIN +0.00%) has a long reputation for high dividend yields, with the stock currently sending shareholders almost 10% of its share price in annual payouts. In addition to its dividends, Windstream has also embarked on a share-repurchase plan, buying back about $20 million in stock during the third quarter of 2015.
Skeptics have long feared Windstream's dividend getting cut, but the company has been obstinate about maintaining its payout at levels it sees as sustainable. The spinoff of its hardware and real-estate assets allowed Windstream to reduce some of its debt, but it has taken on a long-term lease obligation with the spun-off entity in exchange.
With nearly half its balance-sheet assets in goodwill and other intangibles, Windstream will need to work hard to avoid letting its financial condition deteriorate as it pays out high-yield dividends. If it fails, then its stock could continue to sink, more than offsetting the income that retirees receive.
Retirees need income without inordinate amounts of risk. These three stocks aren't doomed to failure, but their dividend yields could mislead you about their future prospects. Make sure you understand all the risks and potential rewards in making your decision about whether to invest in them.
