With interest rates still near record lows income investors are naturally drawn to super high-yield stocks, such as Nordic American Tankers (NAT), which until recently was offering a seemingly mouth-watering payout of 10.8%.
But one of the most important factors to successful long-term dividend investing is risk management, and the realization that Wall Street generally doesn’t offer such high-yields without a very good reason.
Let’s take a look at the cautionary tale of Nordic American Tankers to see just why this recent dividend cut wasn’t at all a surprise and actually could have been avoided by income investors.
In fact, the company is a classic high-yield “value trap,” meaning that the business model is fundamentally flawed.
Not only was this latest dividend cut predictable (and avoidable), but it may not be the last payout cut the company is forced to make in the coming quarters.
Let’s take a closer look at the factors impacting Nordic American Tankers’ dividend profile and why the stock remains an inappropriate investment for our Conservative Retirees dividend portfolio.
The Business Model Is Terrible For Paying Stable Dividends
Shipping stocks with sky-high yields are nothing new. After all, nearly a decade of massive overbuilding has resulted in a giant supply glut of ships that has caused charter day rates to crater.
This has led to many shipping companies declaring bankruptcy in the past 10 years, devastating many investors with permanent capital losses.
However, even among shippers, specifically oil tanker operators, Nordic American Tankers has always been an especially high risk dividend stock.
That’s because of its unique business model, which focuses on owning exclusively one class of tanker (30 Suezmax tankers) and operating with only short-term (i.e. spot market) contracts.
As you can see below, the spot market for Suezmax tankers is highly erratic. The reason for this extreme volatility in tanker rates is due to the inherent nature of the spot market, where prices are set at the margins.
In other words, even small changes in supply/demand relationships can have drastic swings in the price of the next tanker getting a short-term contract, making for very unpredictable business results.
For example, thanks to the recent OPEC production cuts, demand for tankers has fallen. This resulted in the spot market day rate for Suezmax tankers falling by $23,000, or 50%, in the last year.
Not surprisingly, Nordic American Tankers has very volatile revenue, earnings, cash flow, and margins. When combined with a very capital-intensive industry such as shipping, the company has never been (and will never be) a good candidate for stable or growing dividends.
Let’s take a closer look to learn how investors could have known to avoid Nordic American Tankers before its dividend cut.
Nordic American Tankers’ Dividend Safety Score
We analyze 25+ years of dividend data and 10+ years of fundamental data to understand the safety and growth prospects of a company’s dividend.
Our Dividend Safety Score answers the question, “Is the current dividend payment safe?” We look at a company’s most important metrics such as current and historical EPS and FCF payout ratios, debt levels, free cash flow generation, industry cyclicality, profitability trends, and more.
Dividend Safety Scores range from 0 to 100, and conservative dividend investors should stick with firms that score at least 60. Since tracking the data, companies cutting their dividends had an average Dividend Safety Score below 20 at the time of their dividend reduction announcements.
The chart below plots each company’s Dividend Safety Score on the x-axis and the size of its dividend cut on the y-axis. You can see that almost all companies cutting their dividends scored below 40 for Dividend Safety at the time of their announcements, and companies with lower Dividend Safety Scores generally experienced larger dividend cuts.
We wrote a detailed analysis reviewing how Dividend Safety Scores are calculated, what their real-time track record has been (including analysis of every dividend cut in the chart above), and how to use them for your portfolio. You can review this analysis and learn more about Dividend Safety Scores by clicking here.
Nordic American Tankers’ Dividend Safety Score at the time of its dividend cut announcement was 0, meaning that a dividend cut was all but inevitable as the payout security was among the lowest of any American stock.
After all, Nordic American’s dividend track record is hardly stable, meaning management is more than willing to vary the payout to match up with its latest results.
And as you can see, those very volatile results create highly dangerous payout ratios. In fact, not once in the last decade has Nordic American had a safe and sustainable payout ratio on an annual basis.
The company has either lost money or paid out more than 100% of its earnings and free cash flow each year:
Given that Nordic American’s revenue and operating cash flow in the last quarter declined by 31% and 47%, respectively, the latest dividend cut is both logical and necessary.
After all, on an EPS and FCF basis, the most recent quarter’s payout ratios were -325% and -54%, respectively.
Meanwhile, the company’s surprisingly strong balance sheet has been no help to lovers of stable and growing dividends, due to the shareholder-unfriendly way Nordic American has obtained it.
At first glance, Nordic American Tankers appears to have a pristine balance sheet, with a sky-high current ratio, very low debt, and