If you are a dividend-focused investor, the one thing you probably hate more than anything else is a dividend cut. That's understandable, given that a cut means the income stream you thought you were buying didn't pan out.
You should always consider the risk of a dividend cut when looking at dividend stocks. Right now, the risk of a cut seems elevated at Medical Properties Trust(NYSE: MPW) and Boston Properties(NYSE: BXP).
The board has the final say
Investors rightly focus on financial performance when considering the strength of a dividend. But the truth is that the board of directors makes the decision. That is an important factor to consider, because some companies operate in highly volatile sectors but still manage to increase dividends regularly.
Energy giant ExxonMobil is a good example. It keeps leverage low so it can lean on its balance sheet when times are tough to support the dividend. When volatile energy prices rise off of their lows, it uses the extra profit to pay down the debt.
Image source: Getty Images.
Other companies operate in what look like boring sectors, but they pay out so much cash as dividends that a prolonged period of weakness could put the dividend at risk. Real estate investment trusts (REITs) Medical Properties Trust and Boston Properties are examples of this, noting that leverage is material in the property sector.
To be fair, REITs are designed to pass income on to investors, so large payouts are built into the model. But that doesn't make the risk of a dividend cut any less important.
Right now, faced with tough markets, it sounds like the boards of both of these REITs are wavering on their dividend support. It doesn't take much reading between the lines to see this if you look at what the chief executive officers of both have said (or didn't say) on recent conference calls. The key is that the CEOs of both companies also hold the board chairman position.
Medical Properties Trust: No more tough talk
Medical Properties Trust invests in exactly what its name implies. The big problem for this REIT is that two large tenants have been struggling.
In one case, the REIT is helping the tenant out by lending it money, and in the other, it accepted equity in the tenant in place of rent payments. That's not good news, leading investors to worry that the dividend is at risk. That has pushed the share price down and the yield up to almost 15%.
After voicing strong support for the dividend in past quarterly updates, CEO Edward Aldag barely touched on the topic in the second-quarter call. In fact, the big commentary about uses of capital came from the chief financial officer, who said, "Our primary focus continues to be on use of capital for debt reduction."
When pressed by an analyst over the potential for a dividend cut to free up capital for debt reduction, the CFO said:
I think, our fourth quarter call back in February, I think we actually said everything is on the table, and that's at the board level. And then, again, just a few minutes ago, I said the board is constantly evaluating, considering that. And -- and we've talked already on this call about liquidity opportunities, and -- and I'll just repeat it, everything is on the table.
Notably, Aldag -- the CEO and board chairman -- didn't step in to say the dividend was safe. Given the troubles with two of the REIT's largest tenants, investors should probably sit on the sidelines here.
Boston Properties has big spending plans
Office landlord Boston Properties' first-quarter call was equally troubling. The CFO explained at the time that the company was selling assets, but that the pace was expected to slow.
REITs have to pay out 90% of taxable income to shareholders in order to retain REIT status. The CFO warned that the slowdown in asset sales would create "room" in the dividend relative to REIT requirements and that there was "flexibility" to change the dividend policy.
That sounds very much like a dividend cut could be on the table. CEO and board Chairman Owen Thomas didn't step in to change that narrative.
On the second-quarter call, meanwhile, Thomas highlighted the REIT's strong operating performance in the face of a still-difficult office market. He went on to note that Boston Properties has 13 development projects that it is working on, which will require an additional $1.6 billion in capital to get done. To save money, however, it intends to stop at least one project after putting up only part of the building.
Money seems like it is tight today, and one of the quickest ways to free up cash is to cut the dividend.
Data source: YCharts
Office peers SL Green and Vornado have cut or eliminated their dividends. That's not to suggest that Boston Properties can't sustain its payment, but it does show that the office sector is still dealing with the work-from-home trend, and material capital investment plans could make supporting the dividend increasingly difficult. Most investors will probably be better off waiting on the sidelines here despite the generous 5.7% yield.
Not great risk/reward trade-offs
It is hard to predict a dividend cut. There's a very real possibility that Medical Properties and Boston Properties both find ways to keep their dividend intact as they muddle through difficult times.
But for investors looking to live off the income their portfolios generate, the statements coming out of the companies just don't insprie confidence. It is probably best to err on the side of caution and avoid both of these high-yield REITs for now.
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Reuben Gregg Brewer has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.
