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Warning: Avoid These 4 High-Yielding Stocks At All Costs

Wednesday, November 6, 2013 - 1:00pm

Short sellers love to focus on major themes, and one of their favorite themes involves unsustainable dividends. The shorts know that any time a dividend must be cut or eliminated, shares can drop sharply as the primary appeal of such high-yielders disappears.

Case in point: Frontier Communications (NYSE: FTR), which currently has a short position in excess of 200 million shares. (I recently discussed this telecom's impending dividend woes.)

But Frontier's not alone. A few of its peers in the telecom industry are also at risk of a painful dividend cut, and it's unwise to focus on their current unsustainable dividend yields.

1. Consolidated Communications (Nasdaq: CNSL)
Current yield: 8.3%
This local and long-distance phone company has supported an impressive $1.55 a share annual dividend since 2006. Trouble is, over the years, business has steadily deteriorated as its client base slowly defects to large wireless service providers.

In years past, Consolidated typically generated around $15 million in annual operating cash flow, which was just enough to support the dividend. But operating profit fell 40% in 2012 to below $10 million, and of greater concern, free cash flow turned negative for only the second time in the past eight years.

Though Consolidated's year-over-year growth looks impressive thanks to acquisitions, organic growth remains negative. And as is the case with Frontier, this company carries a hefty amount of debt ($1.2 billion as of June), and an eventual rise in interest rates will lead to surging interest costs. Management would be wise to conserve cash now by slashing the dividend before that happens.

2. CenturyLink (NYSE: CTL)
Current yield: 6.5%
This is another operator of legacy telco services, which like Frontier and Consolidated Communications, is making a belated and costly move into broadband. CenturyLink already slashed its dividend earlier this year, so it's curious that short sellers continue to hold a fairly large 38 million-share position in the stock, which equates to eight days' trading volume.

CenturyLink is also the largest holding in the AdvisorShares Ranger Equity Bear ETF (Nasdaq: HDGE), which "seeks to identify securities with low earnings quality or aggressive accounting which may be intended on the part of company management to mask operational deterioration and bolster the reported earnings per share over a short time period."

At first glance, it's hard to see what this exchange-traded fund has identified. CenturyLink is in the midst of a massive $1 billion share buyback while also aiming to pare debt by a significant amount over the next few years. And it presumably intends to stand by its current $2.16-a-share annual dividend (down from $2.90 a share in years past). Meanwhile, a $2.5 billion purchase of data center operator Savvis in 2011 has also led to a considerable spike in capital spending.

Simply put, this isn't a company that can meet all of those obligations if it faces ever-tougher pricing trends. This isn't necessarily a candidate for an imminent dividend cut, but the long-term plans to support debt paydowns, stock buybacks, robust dividends and high capital expenditures look awfully ambitious. CenturyLink will deliver quarterly results Nov. 6, at which time investors will have a fresh chance to get under the hood and see how all of these moving financial parts will interoperate.

3. Windstream Holdings (Nasdaq: WIN)
Current yield: 11.7%
With a current yield of nearly 12%, this stock practically screams out for a dividend cut. After all, Windstream's dividend has remained constant at $1 a share since 2007. Yet the company doesn't make enough money to support that dividend. Per-share profits remain below $0.50 these days, and free cash flow is on track to be negative for the third straight year.

Of greater concern is the massive debt load, which stood at $8.9 billion. This is another company that has been able to borrow at low rates in recent years, but as debts get rolled over at higher rates in coming years, then the decision to spend precious cash on dividends now will have looked foolhardy. Short sellers aren't betting that Windstream absolutely must cut its dividend soon, but they are anticipating that management will come to that wise decision anyway.

Risks to Consider: As an upside risk, these companies could starve their capital spending programs to boost free cash flow, thought that would harm them in the long term.

Action to Take --> The telecom industry continues to face stiff headwinds, yet these companies are operating as though it's business as usual. Consolidated Communications' and Windstream's dividends look especially vulnerable, though all three of these firms will likely need to trim payouts to preserve cash in the face of high debt loads.

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David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.

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