Investing in high yield stocks can make for a very attractive proposal. Those high cash payouts can help ensure a certain rate of return regardless of what the market does over the next several years. Plus, holding high-yield stocks and reinvesting those dividends can really add up over time. Problem is, not all high-yield stocks are alike, and investing in a stock that's close to having its dividend cut is much less attractive.
With issues piling up at Alliance Resource Partners (ARLP -0.26%), Williams Companies (NYSE: WPZ), and TerraForm Power (TERP), it's looking more and more possible that these high yield stocks could be headed for a cut. Here's why.
Under (market) pressure
Most companies, even those in the commodity space, that are well managed can weather the ups and downs of commodity prices without having to make cuts to their payouts. Typically, those well-run companies were conservative enough in paying shareholders that there was a cushion to pad any fall in prices. For the past several years, Alliance Resource Partners fit that bill. Despite being in the coal business -- not exactly a growing industry -- the company had managed to remain solidly profitable with its low-cost mines by taking market share from others and not taking on too much debt. Even today, the company has a pretty clean balance sheet in an industry that has become morbidly bloated on debt.
Unfortunately for Alliance, there are external factors that continue to weigh on the coal market. Cheap natural gas continues to take market share in the electricity market, and exports of coal to places such as China haven't been what companies had expected them to be just a couple of years ago. This has led to a huge buildup of coal stocks to the point that prices for new coal production are at or below every player's ability to make money.
The company already decided that in 2016 it would keep its payout the same as last year's, halting a 12-year streak of constant increases. Still, with coal inventories continuing to build up and bankrupt producers still sending coal to market, things are looking like they will keep getting worse to the point that Alliance's payout may not be sustainable for much longer.
Dancing too close to one partner
Even if we were to ignore that the proposed merger between Williams Companies (WMB 1.03%) and Energy Transfer Equity is getting ugly and that the deal is looking less likely by the day, there are more and more reasons piling up that suggest Williams Partners will have to cut its payout to shareholders.
Sure, the company was more or less able to meet its distribution obligations in 2015 with a distribution coverage ratio of 0.99, but there are some underlying issues that could really compromise that payout. One issue to consider is that it has one client -- Chesapeake Energy (CHKA.Q) -- that makes up about 20% of total revenue. Chesapeake hasn't exactly been on the most stable financial footing as of late, even to the point that it has needed to pledge "substantially all" of its assets as collateral to back its debts. If Chesapeake were to succumb to bankruptcy, it could seriously compromise Williams' revenue stream.
Then there's the other issue of its massive backlog of projects it wants to build over the next several years. To fund all those projects, it's going to need a lot of capital. With its debt load already pushing the upper range for pipeline companies and a stock with a prohibitively high yield, it can't raise the money needed to complete these projects. By cutting its payout, it would make raising capital though equity raises more affordable, and it would allow Williams to retain some of its internally generated cash flow to find growth.
Investors probably won't like to see Williams cut its payout, but with its 14% yield today, it would seem Mr. Market has already priced a cut in. In the best interest of the company, Williams should cut its payout, but it may need to get this whole merger thing settled first.
Dragged down by a reckless parent
Owning partnerships or yieldcos that are managed by parent companies can be lucrative, because you get a more direct investment in those assets' cash flow though a distribution. To do well with these kinds of investments, though, you need to be sure the parent company managing those assets and the growth of the partnership can do so in a sustainable manner. Unfortunately for TerraForm Power, that simply isn't the case.
With a debt load that makes even the most risk-tolerant investor blush, TerraForm's parent, SunEdison, put itself in an untenable position. The company was making huge acquisitions and taking on major development projects without having a stale cash flow base from which it could pay for those projects. One way it thought it could get some quick cash for those projects while retaining some the cash stream from those utility-scale solar and wind projects was to drop them into its two yieldcos, TerraForm Power and TerraForm Global. SunEdison is teetering on the brink of insolvency, and there isn't much hope for TerraForm Power to get out from under its parent company. With debt loads piling up and the cost of equity simply too expensive today, TerraForm will probably need to cut its dividend to make equity capital affordable and clean up its balance sheet.