Image source: Getty Images.
Thanks to a two-year slide across the energy industry, there is a cornucopia of companies that are sporting absurdly high yields. The idea of a company paying a dividend yield greater than 15% sounds too good to be true. Well, in the case of the 10 highest-yielding energy dividend stocks, it is too good to be true. Let's take a look at the 10 highest-yielding dividend stocks in the energy industry today (caveat -- they have to have a market capitalization greater than $200 million), why their yields have been pushed so high, and why they are all probably not the best investment to make today despite that high yield.
The top 10, if you want to call them that
Data source: S&P Global Market Intelligence.
If you look at all of the names on this list, there are two common themes. Seven of the companies here are listed as master limited partnerships, which means that they are set up to pay out a set amount of their cash flow to investors. The other three that aren't structured this way -- Frontline, DHT Holdings, and Teekay Tankers -- own and operate fleets of crude-oil-carrying vessels. Typically, vessels like these operate under either long-term charters or spot contracts, and those with a high number of long-term charters typically have predictable cash flows that can make a decent dividend payout possible.
This party wasn't meant to last
Even though all of these companies are set up as businesses that are supposed to support a decently high yield, the payouts for these companies are all abnormally high, and it looks as though Wall Street is pricing in a pretty sizable dividend cut for each. There are three common reasons that in one way or another are influencing why investors have such a dour attitude with each of these companies, and why they are pricing in a dividend cut.
A company is biting off more than it can chew: The energy industry can be very cyclical, but the underlying theme is that oil and gas demand increases modestly over time. The problem for too many companies in this industry, though, is that a new growth opportunity can make companies overpursue that market and it quickly becomes saturated. A great example of this today is offshore oil tanker companies and offshore drilling equipment. For years, the underlying theory was that demand from China would continue to grow at high-single-digit rates for decades, so companies were building lots of new vessels to meet that anticipated demand. Unfortunately, Chinese growth stalled, and it has left the market for oil cargo vessels and offshore equipment oversupplied. So today, companies like Frontline, DHT Holdings, Seadrill Parnters, Capital Product Partners, Teekay Offshore Partners, and Teekay Tankers are all competing on price for contracts, all while trying to pay for new vessels or rigs still under construction.
It is overpromising on payouts: Many master limited partnerships insulate themselves from the price of oil and gas because of they are intermediaries that charge a fixed fee. This can make cash flows pretty consistent, but they aren't 100% immune from the effects of higher and lower commodity prices. The wise thing for a company to do to protect against this commodity sensitivity is to leave some wiggle room between how much cash is coming in the door and what it pays out. Unfortunately, there are too many companies that pay out all or very close to all of their cash each quarter. That makes their payouts very suspect if there is even the most modest decline in revenue or cash flow. JP Energy Partners, Midcoast Energy Partners, and CNX Coal Resources are in this position as the three aren't generating enough cash to cover all that is going out the door in distributions to their investors. The only reason that Midcoast has been able to meet its obligations is because its parent organization is covering any cash shortfalls for the time being.
It is being painted into a corner: The other issue so many of these companies face is that they are almost wholly reliant on external sources of capital to grow the business. This means that they need to issue either debt or new shares to meet their funding needs. With yields that high on their stocks, however, it's prohibitively expensive to issue new shares. There is almost no project any company can do today that would generate a rate of return greater than 16%-20%. Without equity, the only option is debt, and most of the companies already have too much debt on the books to add any more.
Data source:S&P Global Market Intelligence.
If debt is no longer an option -- the most guilty of this are Seadrill Partners, Teekay Offshore Partners, Midcoast Energy Partners, and CSI Compressco -- then the only viable options are to sell assets or cut dividends so that the dividend payments don't demand such a high return to make them viable.
What a Fool believes
These 10 companies serve as a lesson as to why high yield should be a major red flag before making any investment. Every company on this list is suffering in one way or another that suggests they will be cutting their dividends in the near future. This doesn't mean that all high-yield investments are destined to get cut, but keep in mind that the higher the yield, the deeper you need to dig to determine why the market is sour on the company or if the business fundamentals don't add up. In the case of these 10 stocks, chances are it will be best to avoid them while they work out their respective issues.
A secret billion-dollar stock opportunity The world's biggest tech company forgot to show you something, but a few Wall Street analysts and the Fool didn't miss a beat: There's a small company that's powering their brand-new gadgets and the coming revolution in technology. And we think its stock price has nearly unlimited room to run for early in-the-know investors! To be one of them, just click here.
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.