As we enter year six of this practically uninterrupted bull market, it’s easy for investors to forget the power of dividends.
After all, all major North American stock indexes ended the year in positive territory, with the S&P/TSX Composite Index lagging its American cousins by only increasing a little more than 7% during 2014. And if Canadian investors avoided the energy sector, results were likely even better. When stocks do so well dividends don’t seem so important.
But tell that to folks who endured the financial crisis of 2008-09. While big banks in the U.S. teetered on the brink of collapse, most Canadian stocks continued to pay out dependable dividends. As long as the portfolio wasn’t heavily weighted toward risky financials, the dividend income generated during that tumultuous time likely didn’t miss a beat.
Sometimes though, investors can be lured by the promise of ultra-high yields, tempted by the desire to really supercharge their dividend income. Not only do those types of stocks pose danger from an income perspective, but they can also come with big capital losses once the dividend gets cut and other investors bail.
It’s best if you avoid those types of stocks completely. Here are three that are particularly vulnerable.
Canadian Oil Sands
I think investors with a long-term focus should be looking at Canadian Oil Sands Ltd. (TSX:COS) at these levels. Based on the reserves and the investment already made in the Syncrude project, the company is trading at about a third of what it’s worth when oil is $100 per barrel. It’s just a matter of waiting until oil comes back.
But in the meantime, the company’s 10% dividend is pretty much kaput. When it came out with its 2015 capital budget, Canadian Oil Sands predicted cash flow from operations of $1.51 per share. Subtract the company’s planned capital expenditures of $1.15 per share, and we’re left with just $0.36 per share to pay a dividend that’s currently at $0.80 per share. Oh, and those assumptions were made when the price of crude was averaging $75.
Needless to say, something has to give and there’s little doubt in my mind what will be the casualty. The dividend will likely get eliminated before the next payment is due, which is the middle of February.
Pengrowth
On the surface, it looks as though Pengrowth Energy Corp (TSX:PGF)(NYSE:PGH) has a relatively secure dividend, even though the yield is an eye-popping 14.3%.
Thanks to its hedging program, Pengrowth is in line to get $94 per barrel for 63% of its oil production in 2015. That means if oil averages $60 on the open market this year, Pengrowth is still looking at a selling price on average of about $82 per barrel of oil. The company also has 59% of its natural gas production for 2015 hedged as well.
Compared to others in the sector, Pengrowth is in pretty good shape.
But the company still needs to invest extensively in its Lindbergh project, which uses steam to help loosen up heavy oil. The company plans to fund Lindbergh primarily from its untapped $1 billion credit facility, but that’s a risky move in today’s market. What if the price of crude remains under $50 for years? What if bankers start getting nervous? Suddenly, Pengrowth doesn’t look so secure after 2015.
Management could easily redirect the $250 million the company currently pays annually on its dividend towards Lindbergh, or paying use it to pay down debt.
Manitoba Telecom
Already once forced to cut its dividend in 2010, Manitoba Telecom Services Inc. (TSX:MBT) is sitting on shaky ground once again.
Through the first nine months of 2014, the company generated free cash flow of $105 million, while paying out $99.6 million in dividends. That’s enough to cover the distribution, but only barely.
And yet that’s actually the safest the dividend has been for years. Ever since the first dividend cut back in 2010, Manitoba Telecom hasn’t been able to generate the free cash flow needed to safely pay shareholders. It helped cover that shortfall by issuing 13 million new shares, which increased the float (and diluted existing shareholders) by 20%.
The market is sending a warning sign by giving Manitoba Telecom a 6.2% yield. Income investors should heed that warning.
