The last thing an income investor wants is a dividend cut.
There are a number of different precautions one can take to ensure such a thing doesn’t happen. Many investors will eschew any dividend above 5%. Others will sell the minute they get a whiff of danger. And some ambitious investors will study income statements and cash flows, hoping to spot danger yields before they get slashed.
Let’s take a closer look at three of Canada’s best dividends and see if they’re sustainable over the long term.
Cominar Real Estate Investment Trust (TSX:CUF.UN) is Quebec’s largest landowner and has property in Atlantic Canada, Ontario, and a little bit in Alberta. In total, the REIT owns nearly 45 million square feet of gross leasable area spread out over 539 different buildings.
Cominar made a big acquisition in early 2015, acquiring some five million square feet of Quebec real estate worth $1.35 billion. It increased the company’s asset base by more than 20%.
What’s the problem? The company has struggled since. Cominar has been weighed down by the debt taken on with the transaction, and it also had to issue a lot of new shares to pay for the deal. It also lost Target as a major tenant when the retailer shut down operations in Canada, and Quebec’s economy has been somewhat tepid.
Thus far in 2016, Cominar has delivered $207 million in recurring funds from operations–down from $224 million in the same period last year. This has pushed its payout ratio above 100%.
Management is trying to take steps to bring the payout ratio down, including re-instituting the company’s dividend-reinvestment program. That should help, but the fact remains that Cominar is paying out a dangerously high dividend.
Alaris Royalty Corp. (TSX:AD) is an interesting company. It supplies capital to high-quality businesses in exchange for a royalty payment. This payment is usually between 10% and 15% annually.
There’s only one problem: sometimes the underlying businesses have difficulties and can’t pay their royalties. Alaris is experiencing this right now with KMH, one of its largest royalty partners. It is currently in negotiations with KMH about a settlement and has written off more than $28 million worth of its original investment. Royalty payments from KMH have also stopped.
But this isn’t all bad news for Alaris’s dividend, which currently stands at 6.8%. First of all, it had nearly $70 million worth of cash on hand at the end of the third quarter–enough to pay dividends for more than a year without earning a nickel. It has earned $1.22 per share during that time, while paying out $1.21 per share in dividends.
At this point, the company’s dividend looks to be okay, and any settlement news with KMH should be enough to send shares higher.
Case in point: take the company’s fiscal 2016, which ran through June 30. After adjusting for changes in working capital, it posted negative free cash flow of about US$4 million. It paid out US$38 million in dividends.
This isn’t a new phenomenon, either. Student Transportation paid out more than it earned in free cash flow in 2013, 2014, and 2015.
How does it maintain this? The company has issued more than US$30 million worth of new shares since 2013 and added more than US$105 million in debt. Part of that was used to fund acquisitions. The rest was used to pay investors dividends.
This strategy works until confidence evaporates. Eventually, it’ll happen. The only question is when.
The bottom line
There’s no guarantee Cominar, Alaris Royalty, or Student Transportation will cut their dividends. In fact, the exact opposite could happen. These companies could soldier on and actually end up raising their payouts in the future as business improves.
But if investors are looking for a sustainable high yield today, I’d look elsewhere. There are better choices with less risk out there.
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Fool contributor Nelson Smith has no position in any stocks mentioned.