I love buying high-yielding dividend stocks. They enable me to generate lots of passive investment income, which I reinvest to buy more income. I should eventually generate enough to completely offset my living expenses.
However, as much as I love collecting dividend income, I've learned the hard way to avoid the high-yielding payouts of companies with deteriorating finances, because they put the dividend at a high risk of a future reduction. That's the fate I see ahead for real estate investment trust (REIT) Brandywine (BDN -0.21%) and its eye-popping 16.8% yielding dividend. Because of that, I won't go near that stock.
On the other hand, the 9.7% yielding payout of Energy Transfer (ET -0.55%) is on very solid ground. That's driving me to buy it hand over fist.
A cut seems inevitable
Brandywine Realty Trust currently makes quarterly dividend payments of $0.19 per share ($0.76 annually). The office REIT declared its latest dividend in May, which it will pay to shareholders next month.
Given the headwinds facing the office sector and its funding requirements, I don't believe the REIT can maintain its current rate for much longer. The company will pay out $99 million in dividends this year. That gives it a dividend payout ratio of 95% to 105% of its cash available for distribution. Because of that, the company isn't able to retain much, if any, cash to fund capital projects. The REIT plans to invest $211 million in capital this year, leaving a huge hole to backfill.
On a positive note, Brandywine has the funds to cover the shortfall. The company received $120 million in asset sale proceeds earlier this year to enhance its liquidity, which at the end of the first quarter included $96.6 million of cash on its balance sheet and an undrawn $600 million unsecured line of credit. While that gives the company lots of liquidity, it still has balance sheet issues in the form of upcoming debt maturities. With interest rates rising, its borrowing costs are increasing.
For example, in December, the company issued $350 million of 7.55% notes due in 2028 to refinance a similar amount of 3.95% notes maturing earlier this year. With more debt maturing, its interest expenses will rise, further cutting into its cash available for paying dividends.
While Brandywine has several development projects on track to finish construction and start generating lease income in the coming years, it still might have to join several of its office REIT peers and cut the dividend to help fund those investments and reduce debt.
This big-time payout is heading higher
Energy Transfer was in Brandywine's shoes a few years ago. The energy midstream company made the hard choice of slashing its distribution to retain more cash to fund its expansion projects and pay down debt. That strategy worked. The master limited partnership (MLP) reached its targeted leverage ratio last year. That gave it more financial flexibility, allowing it to return its payout to its former peak.
Energy Transfer is now generating more than enough cash to cover its reset payout and capital program. It produced $2 billion in cash during the first quarter, covering its distribution with $965 million to spare. That left plenty of money to cover growth capital spending ($407 million). Because of that, it has had excess cash to continue reducing leverage, which is on track to be at the lower end of its target range.
That's giving Energy Transfer the financial flexibility to make value-enhancing acquisitions. The company recently acquired Lotus Midstream for $1.45 billion. The deal will increase its free cash flow, enhancing its ability to pay dividends.
With a strong balance sheet and growing cash flow, Energy Transfer is now in a position where it can start returning even more money to its investors. The MLP plans to increase its already high-yielding distribution by 3% to 5% annually. That growing payout makes it a very attractive income investment.
A much more sustainable income option
Brandywine Realty Trust is paying out nearly all its available cash flow to cover its dividend, which isn't sustainable. While the company has some development projects coming online that should grow its cash flow, it's also battling headwinds from rising office vacancies and interest rates. These issues could eventually force the REIT to slash its eye-popping payout. That's why I wouldn't touch the stock right now.
Energy Transfer offers a big-time payout that it can easily support. Because of that, the company expects to grow its payout in the future. That sustainable and rising income stream is driving me to buy Energy Transfer hand over fist.
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June 29, 2023 at 08:08PM
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