Pssst: Are Your High-Yield Dividend Stocks Actually Safe?

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Written by Puja Tayal at The Motley Fool Canada

On one side, the Bank of Canada shows signs of a pause in an interest rate hike. On the other side, higher interest rates are making it difficult for companies to service debt. Several high-yield, mid-cap dividend stocks have announced dividend cuts, mergers, and divestitures as high-interest expenses strain their cash flows. It is often in crisis that risks are triggered. It is time to revisit your portfolio and see if your high-yield dividend stocks are safe.

Mid-cap stocks that slashed dividends 

This year, several mid-cap stocks slashed their dividends. A dividend cut doesn’t mean that there is no scope for growth. Sometimes, downtime is for a brief period. A company slashes dividends to withstand that period. In such cases, a stock price dip after a dividend cut is an opportune time to buy the stock.

TransAlta Renewables

But I went bearish on TransAlta Renewables (TSX:RNW) when it announced plans to get acquired by its parent TransAlta Group. RNW did not slash its annual dividend per share of $0.94 but directly announced the acquisition. TransAlta Renewables has been piling up debt and servicing it from the cash flows generated from power generation. This flow was going smoothly till the interest rate was below 2.0%. But the accelerated interest rate hike from 0.25% in February 2022 to 5% in July 2023 is too much for TransAlta Renewables to take.

RNW’s parent, TransAlta Group, is more resourceful and can absorb the interest. Hence, RNW’s decision to merge with the parent was strategic to sustain the crisis. However, shareholders who purchased RNW for its +7% yield will have to part ways, as the parent pays a 1.66% yield.

Algonquin Power & Utilities 

Another power company, Algonquin Power & Utilities (TSX:AQN), slashed its dividend by 40% in January 2023 after reporting a loss in November 2022. I was bullish on it until last year, hoping the Kentucky Power acquisition cancellation could give some financial flexibility. The company even resorted to asset sales to pay down debt. I turned bearish on the company when it announced plans to sell its renewable energy unit and removed its chief executive officer (CEO) abruptly ahead of the second-quarter earnings.

Running under interim CEO, Algonquin aims to efficiently run its regulated utility business, which has a lower capital cost, a strong balance sheet, and a growing rate base. While these decisions are strategically apt, I am bearish and would adopt a wait-and-watch approach until the renewable energy business is sold and debt is reduced.

Rebalancing dividend portfolio 

It is a good idea to have a diversified portfolio of stocks of different sizes and sectors. Mid-cap stocks tend to give higher dividend yields and boost your upside. Large-cap, resilient stocks have lower volatility and reduce the risk of downside. If you own TransAlta Renewables or Algonquin stocks, it is time to sell them and buy Dividend Aristocrats instead with robust cash flows and manageable debt.

Large-cap dividend stocks 

The rising interest rate has created turmoil in the energy space and even pulled down the stock price of Dividend Aristocrat Enbridge (TSX:ENB) to its 52-week low. Enbridge stock came under pressure after TC Energy announced it is splitting its oil pipeline and gas pipeline business. In its second-quarter earnings, Enbridge reaffirmed its 2023 guidance, reported a 1% increase in distributed cash flow and assured it has no plans to split its business.

Enbridge has sustained the worst crisis without a dividend cut and can do so even now. Its leverage ratio is within its target range, so debt is manageable. Now is the perfect time to buy Enbridge stock, as you can lock in a 7.55% dividend yield.

Unlike TransAlta Renewables and Algonquin, Enbridge’s fundamentals are strong, and it has enough cash flow to continue paying dividends for several more years.

If you do not have contribution room in your Tax-Free Savings Account, you can sell any mid-cap dividend stocks and buy Enbridge stock. In times of uncertainty, large caps provide a cushion of sustainable profits.

The post Pssst: Are Your High-Yield Dividend Stocks Actually Safe? appeared first on The Motley Fool Canada.

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Fool contributor Puja Tayal has no position in any of the stocks mentioned. The Motley Fool recommends Enbridge. The Motley Fool has a disclosure policy.