Dividend investors always have to balance the desire for a high yield against the risk that the yield is unsustainable. As a dividend investor myself, I know how hard that can be. Right now, I believe the yields offered by CenturyLink, Inc. (NYSE: CTL) and Barnes & Noble, Inc. (NYSE: BKS) are simply too high to be sustainable. As a result, reduced payouts could be coming for both of these high-yield dividend stocks. Here's why their big dividend yields aren't worth the risk.
1. A highly leveraged telecom play
CenturyLink recently completed the purchase of Level 3 Communications. The goal of the acquisition was laudable, in that it expanded CenturyLink's business offerings. However, it also required the company to materially increase its debt load. Long-term debt roughly doubled from about $18 billion to around $37 billion in less than a year.
Image source: Getty Image.
Leverage has remained relatively constant, with long-term debt at around 60% of the capital structure. However, CenturyLink paid a roughly 40% premium for Level 3, so there's a fair amount of goodwill (the amount it paid that exceeded Level 3's book value) associated with this transaction.
In fact, at the end of 2017, CenturyLink reported that nearly 60% of its consolidated assets consisted of goodwill. If the deal doesn't work out as planned, CenturyLink could end up writing down the value of its goodwill, which would reduce shareholder equity and make its leverage position look much worse. That could easily push the company to prioritize debt reduction over dividends.
CenturyLink Free Cash Flow Per Share (TTM), data by YCharts.
Meanwhile, there are specific dividend issues to worry about, too. Dividends come out of cash flow, not earnings, so the fact that the company's payout ratio is greater than 100% is more a warning sign than anything else. However, CenturyLink's trailing 12-month free cash flow fell dramatically leading up to the merger and hasn't been enough to cover the annual dividend recently. The stock's nearly 11% yield reflects this concern. There are some signs of improvement, but investors should wait until this telecom provider has proven it can support its hefty debt and the dividend on a sustained basis before jumping aboard. There's simply not a lot of room for error.
2. Struggling to adjust
Barnes & Noble has managed to muddle through the internet's dramatic impact on book retailers. That's an impressive feat, given that competition from online book retailers led to the bankruptcy of peers like Borders and the closure of many mom-and-pop booksellers. However, Barnes & Noble's results haven't been pretty of late.