Dividend growth investors are constantly looking for the holy grail of stocks, companies so dependable that their dividends will rise every single year. Luckily for Canadian investors, they don’t have to look very far.
Names like Royal Bank, Bank of Montreal, and BCE have all raised dividends annually for decades. There are many other names that may not have a track record that can compare to Canada’s oldest companies, but have the benefit of a bright future and dominance in their sector.
This article isn’t about any of those names. Instead, let’s take a look at three companies where the future doesn’t look so bright. Each of these stocks pays a handsome dividend, except when we take a closer look, we’ll see risks of dividend cuts going forward.
1. AGF Management
First up is AGF Management (TSX: AGF.B), one of Canada’s largest mutual fund managers. The stock currently yields an enticing 8.5%, paying out a 27-cent quarterly dividend.
AGF investors have to deal with one major headwind affecting the company, mutual fund investors fleeing high fee mutual funds for low-cost exchange traded funds. Investors are figuring out that paying AGF fund managers 2-3% each year in fees to underperform the market is a pretty crummy deal.
Revenue keeps falling as assets under management shrink. Revenue was down more than 5% last year, leading to lower profits, even though the company instituted an aggressive cost-cutting plan. This isn’t new for AGF, as the company hasn’t made enough from operations to cover its dividend since 2010.
The company is sitting on a mountain of cash from selling its mortgage division to Laurentian Bank in 2012. It currently has more than $380 million in the bank and the dividend is about $95 million per year. On the surface, it appears to be adequately covered. But the company is also sitting on $307 million worth of debt, meaning there’s only enough net cash to cover the dividend for another year.
2. Just Energy
Just Energy (TSX: JE) is engaged in the sale and delivery of electricity and natural gas to both residential and commercial customers. The company also rents tankless hot water heaters, heating oil furnaces, and air conditioners to customers in Ontario and Quebec.
Unfortunately for the company, it often gets a lot of bad press as customers sign up for a service, find out that an overzealous salesperson may have overstated the benefits of the service, and then the wronged customer tells everyone who will listen. Energy costs are a touchy subject for Canadian consumers, and they will get unreasonably upset if they feel like they’ve been overcharged.
Just Energy just isn’t the type of company that should have such a generous dividend. The balance sheet is levered up considerably, as the company has more than $1 billion worth of debt on $1.5 billion worth of assets. The debt to equity ratio is actually negative, as the company’s book value is negative $1 per share.
Just Energy is currently profitable enough to cover its 9.6% dividend yield, but that’s thanks to terrific results last quarter. Those results came after the company lost money the previous two quarters. Earnings just aren’t stable enough for investors to have confidence in the dividend over the long term.
3. Veresen Inc.
Don’t be fooled by the strong performance of Veresen Inc.’s (TSX: VSN) shares over the past few months. The company’s dividend of nearly 6% still isn’t in great shape.
The company trades at 65 times trailing earnings, continues to issue shares, and has more than $1.2 billion worth of debt on its balance sheet. The company was also just downgraded by Scotiabank analysts.
The company’s debt has increased over the last two years, some $400 million. At this point, Veresen shareholders would be better served if the company slashed the dividend in half, which would save $100 million per year, money which would be much better spent minimizing debt.
Foolish bottom line
Whenever a stock’s yield is much higher than other similar names in the market, investors must be wary. Research could uncover a hidden gem, but there’s typically a reason the dividend is so high. The last thing investors want is to invest in a company that cuts its dividend.
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Fool contributor Nelson Smith has no positions in any stock mentioned in this article.