Image source:Smhenry87 via commons.wikimedia.org.
For dividend investors, there is nothing worse than buying into high-yield stocks that are subsequently cut. While there are some companies with high yields that can make for decent investments, there are many out there that will lure you in with that high yield only to burn you down the road. Today, GasLog Partners , Summit Midstream Partners , and Plains All American are showing signs of being yield traps. Here's why.
You can't have bothAn investment with an extremely high yield and with a robust growth trajectory is like trying to find a Pegasus. A company can have a sustainable high-yield payout or it can have a modest payout with plans to grow it at a high rate, but it's extremely difficult to do both at the same time. GasLog Partnersis trying to be a Pegasus, but it looks more like a strong horse with cardboard wings taped on its back.
If the company were to stay put where it is, it could be a decent high-yield investment. It owns eight LNG tanker ships that have long-term, fixed-fee charters with Royal Dutch Shell, so counterparty default is pretty unlikely. The problem is that it wants to keep growing its fleet quickly. Parent company GasLog has 18 ships already being considered for purchase. To raise the amount of capital it will need to make those acquisitions, it will have to do so through the debt or equity market. Excess cash from its current operations isn't enough to make a significant acquisition. Today's yield is too high to make a share issuance worth it, and you can only raise so much capital through debt before stretching the balance sheet too thin.
Also, by pulling the growth lever, everything on the operations side of the business needs to go right. All of Golar Partners' current LNG tankers would have to have their charter options picked up. Otherwise, the company's ability to generate cash would dissipate quickly. If GasLog Partners pumps the brakes on its growth plans, then its stock could be a steady, high-yield workhorse for your portfolio. If it keeps pushing this growth plan, then don't be surprised if the wings fall off.
"Grow into our payout" hasn't worked so far, but let's try it anywayIf there is one thing that the oil and gas market's crash has taught us, it's that the phrase "grow into our..." should be a major red flag. Producers that were taking on huge debts said they would grow into their balance sheets as new production came on line, and master limited partnerships that pushed their payout rates high said they would grow into it as new projects came on line. Too many times, we have seen companies that have employed this strategy blow up, yet it looks like Summit Midstream Partnersplans on doing it anyway.
In 2015, it announced that its distribution to shareholders was more than the amount of cash it was bringing in the door. The saving grace, though, was that it made a substantial acquisition at the end of 2015 that is intended to grow distributable cash flow considerably for 2016. While that is certainly a possibility, there are some issues that aren't completely addressed that could bring the company's payout into question. One of them is the fact that most of the assets Summit acquired are natural gas gathering pipelines. Although 98% of its pipes use fixed-fee contracts, we have seen that gathering pipes can be some of the most exposed assets to volume declines from slowing production across the U.S.
Another aspect to consider is that much of the payment for these assets -- $800 million to $900 million -- is being deferred until 2020. While the current structure looks strong and will allow the company some breathing room to build up cash and lower debt, there is a big question mark as to what its finances will look like when the bill for these assets come due.
When looking for a high-yield investment, it's never a good thing when there are questions about the company's financial future. While it's entirely possible that it can pull it off, Summit, like GasLog Partners, needs a lot of things to go its way in the coming years.
Backed into a corner, financially speakingLike so many other pipeline companies, Plains All American has some pretty large financing needs for its growth plans. The challenge for Plains is that there aren't a whole lot of options for financing these growth plans. Today, the company continues to have an investment-grade rating, but just barely. With its debt-to-EBITDA ratio already at 6.32 times, it is already pushing the limits that credit ratings agencies and lenders want to see. On top of that, it has a yield of 11.7%, which is also prohibitively high to raise capital through equity issuances. Those two conditions are why the company had to tap private equity by issuing $1.6 billion in preferred equity.
According to CEO Greg Armstrong, that private equity raise was enough to satisfy its current capital spending needs and that the growth from that spending will help to boost cash flows and start covering all of Plains' payout to shareholders. Like the others listed here, though, much needs to go right for the company to be able to maintain its payout. Existing assets will need to reverse the recent declines in volumes across the system, and then there is the question of where financing will come after it has burned through its preferred share cash. There is a chance that Plains will be able to get through this rough patch with its payout in place, but it's going to be a pretty fancy high-wire act that could see investors experience a substantial cut.
The article 3 Dividend Stocks That Are Yield Traps originally appeared on Fool.com.
Tyler Crowe has no position in any stocks mentioned.You can follow him at Fool.comor on Twitter@TylerCroweFool.The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
Copyright 1995 - 2016 The Motley Fool, LLC. All rights reserved. The Motley Fool has a disclosure policy.