Dividend stocks are often considered safe due to their regular dividend payouts. However, they carry the risk of dividend cuts if the business faces a cash crunch. A warning sign of a cash crunch is the dividend payout ratio. When this ratio crosses the 90% range, it means the company is using 90% of its cash flow to pay dividends, leaving little cash to reinvest in the business or for contingencies. When it comes to dividend yield, a high yield need not always be dangerous.
Yield is the dividend per share as a percentage of the share price. If the share price has dipped due to short-term headwinds while the cash flows remain healthy, it is a value stock opportunity to buy the dip and lock in a high yield. However, not all high-yield stocks are buys.
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This 10% yield seems dangerous
Timbercreek Financial (TSX:TF) stock fell 12% in October after reporting weak third-quarter earnings. The stock has partially recovered, and the dip has inflated the yield to 10%. This high yield seems dangerous as Timbercreek’s payout ratio crossed 100% in the third quarter. This ratio has been above 95% for more than a year, with the hope that it will decrease to 90%.
Timbercreek provides short-term variable rate loans to income-generating REITs. In 2023, the lender reported record interest income as its loan portfolio generated interest of 10% because the Bank of Canada hiked interest rates. The high interest rates reduced loan turnover and increased credit risk, which increased Stage 2 and 3 loans and expected credit loss provision.
When rate cuts began in 2024, there were hopes for a recovery in loan demand. However, headwind after headwind – first inflation and then the tariff war – delayed the recovery in loan demand. These delays are now becoming dangerous as the weighted average interest on the loan portfolio continues to fall from 11% in the third quarter of 2024 to 8.3% in the third quarter of 2025.
The interest income is falling faster than the increase in the loan portfolio. The dividend as a percentage of earnings per share (EPS) is 169%, which is not sustainable. The distributable cash flow was higher than EPS because of loan repayment. All these signs hint that Timbercreek might have to resort to a dividend cut if loan demand doesn’t improve. So far, the management sees strong demand in the fourth quarter.
A safer alternative
Instead of Timbercreek, a safer high-yield alternative is Telus Corporation (TSX:T). Telus has a dividend yield of 9.2% as the stock price has dropped to a 52-week low. Few investors fear dividend cuts. However, the company has been reducing its leverage by selling non-core assets. It has reduced net debt to Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA) to 3.5 times from 3.8 times. It aims to reduce the ratio to its target range of 2.2 times to 2.7 times.
Telus has slowed its dividend growth rate in light of price competition triggered by regulatory changes. It has also reduced its capital spending and will channel that amount towards debt reduction. While Telus’s high debt presents risk, its lower payout ratio hints at the company’s financial flexibility to sustain the current dividend per share and even grow it.
