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Thursday, April 10, 2014 - 12:15
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Thursday, April 10, 2014 - 12:15

Is This Popular 8.2% Yielder A Dividend Trap?

Thursday, April 10, 2014 - 12:15pm

Like people, companies sometimes fail to adequately manage their finances for so long that something eventually has to give. And that's just what I think is happening with one well-known company with a reputation for safety, reliability and far-above-average dividend yields.

Right now, the firm's payout is $3.50 a share, which is good for an 8.2% yield based on a recent stock price of around $42.50. The stock's yield has averaged 7.5% annually for a decade.

I wouldn't rush to invest just yet, though, because I strongly suspect this dividend party can't last much longer. Investors who buy now thinking they'll get yields north of 8% might soon be in for a nasty shock in the form of a major dividend cut.

I'm referring to Suburban Propane Partners (NYSE: SPH), a leading national fuel distributor with 1.2 million residential, commercial, industrial, and agricultural customers and annual revenue of $1.7 billion. Propane is the firm's main business, accounting for about 70% of revenue. However, fuel oil, natural gas, and electricity also generate substantial sales, as do the installation and servicing of heating, ventilation, and air conditioning systems.

In January, analysts at Goldman Sachs actually downgraded Suburban to from "neutral" to "sell" for a few reasons, a key one being the secular decline of the propane industry. Propane demand has been waning, they pointed out, because of increased fuel efficiency and widespread conservation. Climate change has generally been hurting demand, too, in recent years.

Along with these broader trends, several other factors specific to Suburban suggest the company may have no choice but to cut its dividend in the near future:

Excessive payout ratios: At this point, Suburban's dividend is 2.6 times earnings per share (EPS) of $1.35, so the firm is now paying out far more than it's bringing in. And that's not just in the past 12 months. In 2012, dividends totaled $3.41 a share -- 68 times that year's EPS of $0.05. Dividends began exceeding earnings in 2010 and 2011, when Suburban paid out 103% and 106% of EPS, respectively.

Flickr/Daniel Oines
Suburban Propane Partners is a leading national fuel distributor with
1.2 million residential, commercial, industrial, and agricultural customers and annual revenue of $1.7 billion.

Insufficient profits: For Suburban to have a more reasonable payout ratio of, say, 65%, it would have to be earning $5.39 a share right now. But it could be a decade or more before the company is bringing in anywhere near that much, assuming it manages to maintain the 13%-a-year EPS growth rate analysts are currently projecting.

And that doesn't seem likely. Since peaking at $4.96 in 2009, the firm's EPS have fallen nearly 73% to their current level -- an attrition rate of nearly a 15% a year. Revenues have expanded solidly since 2009, though, climbing about 10% a year from $1.1 billion to the current $1.7 billion. However, rapidly shrinking margins have more than offset the growth in sales.

Not enough cash: All this means Suburban better have plenty of cash on hand just to maintain its dividend, let alone raise it. But the company comes up short in this department, too.

With 60.3 million shares outstanding and free cash flow of $127 million, its free cash flow per share is just $2.11. The per-share cash total only rises to $3.03 -- still not enough to cover the dividend -- if you throw in the $0.92 a share in cash that's currently on Suburban's balance sheet.

Of course, all this assumes the firm will devote every penny in available cash to its dividend, but in reality that just isn't possible. Besides operating expenses, there are plenty of other big bills to be paid such as current liabilities of $234 million and $1.25 billion of long-term debt that will start coming due in 2018.

Thus, Suburban's finances seem stretched far too thin for it to keep up with its current dividend payments. To have a shot at this, it would need to raise cash by increasing debt or issuing more stock, neither of which is desirable. The company has already nearly quadrupled its debt during the past four years, and more stock offerings would likely result in substantial dilution anyway.

In retrospect, Suburban probably should have been gradually reducing its payout to more sustainable levels over years. But since it's now pretty much backed into a corner financially, a few large cuts compressed into a year or so is probably the more likely outcome at this point.

Risks to Consider: Besides the issues I've already raised, there's a risk of Suburban losing customers because of aggressive cost-cutting that might compromise service. This would put even more downward pressure on the company's dividend.

Action to Take --> Prospective investors should know they're probably not getting the higher-yielding stock Suburban appears to be. I suspect its payout will have to be greatly reduced -- perhaps by a third to a half (or maybe even more) -- very soon. If that happened today, the yield would drop into the 4.1% to 5.5% range, assuming no stock price change in response to the cut.

Yes, those are still nice yields, but even they may not be sustainable for very long as the secular decline in propane marches on and Suburban's financials continue to deteriorate. Considering this, investors may want to look outside the propane industry for dividends they can count on for the long haul, since most other industry players may not fare much better than Suburban.

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Tim Begany 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.