Investing in dividend stocks is the most direct path to actually profiting from a company's business. Unlike non-dividend payers -- where you just have to watch your shares go up and down from day to day -- these stocks offer regular payouts, which make stock ownership far more enticing.
Sometimes, a stock's dividend yield is so high, it seems too good to be true. In the case of mid-sized telecoms Windstream (OTC:WINMQ) and Frontier Communications (NASDAQ:FTR), as well as printing specialist Quad/Graphics (NYSE:QUAD), that's the reality: They are too good to be true.
Though they all offer dividend yields of over 7%, I believe these companies could reduce their payouts in the coming quarters.
A quick primer on dividends
I believe there are two key facets to evaluate when trying to determine the strength of a payout. The first is the percentage of free cash flow (FCF) that it takes to pay the dividend. It is from FCF that dividends are paid, and if this percentage inches too high, the dividend is likely unsustainable.
The second facet is the overall business momentum of the company in question. Even if a company has a solid payout ratio, that can only last for so long if it is in a dying industry. Having said that, here's why I think these three dividends could fall.
Windstream is a regional telecom company that got a significant boost over the past year when it decided to spin-off its networking assets into a separate company: Communication Sales & Leasing (NASDAQ: CSAL). That move helped lighten the company's debt load, and will continue to do so as Windstream keeps selling off its remaining stake.
But at its core, Windstream is a rural provider of voice, video and broadband coverage. Not surprisingly, this isn't exactly a lucrative business. It also doesn't help that almost half of Windstream's assets are classified as either good will or intangible -- in other words, they don't really represent money in the bank.
Through 2015, the number of households served by Windstream fell 5% -- following a 6% dip the year before. Its other revenue stream -- small businesses -- also fell, by 8% in 2015, preceded by an 8% dip in 2014.
Obviously, you can tell that I'm not so hot on the direction Windstream is headed, but the dividend isn't much to get excited about either. In both 2013 and 2014, over 80% of FCF was used on its payout. While the 2015 numbers are abnormal (there was negative FCF), that was largely due to the spin-off. Put all the pieces together, and I wouldn't be surprised to see a cut sometime soon.
Like Windstream, Frontier has suffered from its focus on rural customers at a time when the country's bigger players take over huge swaths of telecom's market share. Unlike Windstream, Frontier has taken a different approach to the challenge. Instead of spinning off assets, it has been making acquisitions with the goal of becoming a more mainstream player.
Over the past two years, Frontier has purchased voice, video, and broadband properties from both AT&T and Verizon. In the former case, Frontier bought rights to AT&T's customers in Connecticut -- and that didn't go so well. The Verizon deal recently closed, and Frontier bought the rights to the FiOS customers in California, Texas and Florida. It's too early to tell how that will play out.
Beyond the issue of business momentum -- which I believe is already negative -- Frontier is using a lot of FCF to pay out its dividend. In 2015, the company brought in $438 million in FCF, but paid out $576 million in dividends. The acquisitions play a part in this, and management asserts that no dividend cuts are in the future, in part because it uses an adjusted free cash flow calculation that uses operating income rather than net income as its starting point. Still, as I see it, if Frontier falters at all, it will have little choice but to cut its payout.
As a native Wisconsinite, it pains me to say it, but this Cheesehead company has seen better days. Quad/Graphics made a name for itself by being the printer of choice for some of the nation's most popular magazines. As you might've guessed, in the age of digital media, Quad/Graphics has faced some serious challenges.
While the company only used 29% of its FCF to pay its dividends in 2015 -- which means it's pretty safe for the near future -- that could be masking a long-term decline for the company. Management announced over $100 million in cuts and the closure of four plants in late 2015 amid "increased pricing and volume pressure." Management believes that FCF will come in at a midpoint of $210 million in 2016, representing a slight decline from 2015.
But as I said, it is the long-term trajectory of the business that matters. While Quad/Graphics has been doing an admirable job of trying to diversify its revenue streams, some think that the writing is on the wall. Earnings per share have fallen 70% from just two years ago, and revenue is expected to decline from $4.7 billion in 2015, to $4.3 billion in 2017.
Cuts and "efficiency improvements" can only do so much before more serious changes need to be made.