Can These 5 Dividend Stocks Deliver?

Includes: CIM, COP, MRK, NLY, PFE, T, WIN
by: ValueMax

The following five companies all yield big dividends. To continue paying dividends at high rates, companies need to have growing or stable earnings that equate to positive cash flows. In this article, I will provide a brief analysis that should shed some light on whether these generous companies will be able to sustain these high dividends or if investors should expect a pullback in payouts.

Merck & Company (NYSE:MRK): Merck paid a $1.56 dividend at a 4.1% rate and is expected to increase that rate to 4.4% for the 2012 annualized yield. It has a payout ratio of 77%, which is on the higher end. A main competitor, Pfizer (NYSE:PFE), yielded a 3.9% dividend and is expected to increase that to a rate of 4.2%. The difference here is the payout ratio. Pfizer is more conservative with a payout ratio of 63%.

In the second quarter of 2011, dividends paid amounted to about 41% of cash from operations while in the third quarter of 2011, it only accounted for 25.7%. This shows that Merck is generating enough cash from operations to cover the dividend payment. Also, the ending changes in cash increased by 195% from the second to third quarter in 2011.

Ultimately, future sales growth is the starting point for sustainable dividend payouts. Merck does have a few promising drugs that are in the product pipeline. Merck's insomnia drug suvorexant passed two phase three trials which will put it on track for an FDA filing this year. Also, Merck is making progress with an experimental anticlotting drug called vorapaxar. Although this product increases bleeding, it was successful in reducing the risk of cardiovascular death, heart attack, stroke or certain heart procedures.

Despite a high payout ratio, Merck is still able to finance additional research products that will expectantly lead to sales. Assuming there are no major disasters concerning its upcoming products, Merck should be able to sustain its dividend.

Conoco Phillips (NYSE:COP): Conoco manages to pay a 3.7% yield with a payout ratio of only 29%. This amounted to a $2.64 annualized dividend last year and is expected to remain proportionally the same this year. Exxon Mobile (NYSE:XOM) pays a mere 2.2% yield, which is also expected to remain constant through this year. Although Exxon Mobile has a lesser payout ratio of 22%, proportionately, Conoco uses fewer earnings to maintain a higher dividend yield.

Conoco has been recognizing a decrease to cash lately in the first, second and third quarters of 2011. This is mainly due to capital expenditures, which is commonly high for the industry and the repurchasing of stock. For the second and third quarters of 2011, the purchase of stock was consistently three times that of cash dividends paid. This might suggest that Conoco sees its stock as being currently undervalued. This, increasing the concentration of shares, likely contributes to its high EPS of about 9.

Conoco has also highly increased profitability, with a year-over-year quarterly revenue growth of 21% while concurrently recognizing over 66% growth in earnings for the same period. This, coupled with a low payout ratio and confident buybacks, leads me to believe that Conoco will be able to sustain or grow its dividend in the near term.

Eli Lilly & Company (NYSE:LLY): Eli Lilly recently paid out a 4.9% dividend of $1.96 and is expected to increase its rate to 5% for this year. They will do so at a payout of 50%. Competitor GlaxoSmithKline (NYSE:GSK) yields a 4.9% dividend with an 87% payout ratio. GSK must have recognized this to be a bit extreme, because their 2012 dividend yield is expected to marginally decrease to 4.8%.

Quarterly net income steadily increased from the first through the third quarter of 2011. However, cash has been rather inconsistent while dividends remain stable. This is mainly due to the liquidation of investments in the first quarter of 2011 and a heavy reinvestment of cash in the second and third quarter.

I am considerably concerned with Lilly's margins. All margins seem to be a bit worse than the five-year average. Lilly's trailing twelve month gross margin is 30 basis points below the five-year, while operating margin is 150 basis points lower. Net margin is even more disproportionate at 480 basis points, below its five-year average. Shrinking margins suggests worsening profitability and a deficient chance of being able to sustain dividend growth.

Windstream Corporation (NASDAQ:WIN): Windstream pays a monster dividend of 8.1%, but with a frightful payout ratio of 192%. At first glance, it would seem that Windstream will not be able to sustain such a dividend. This year's annualized yield is expected to remain at 8.1%, but the 5 year average dividend yield is slightly higher at 8.4%. It has shrunken the dividend to some extent. AT&T (NYSE:T) has an even more massive payout ratio of 261%, amounting to a trailing yield of 5.8% which will expectedly lead to and even higher yield of 5.9% this year. At least Windstream doesn't have to reach as far as AT&T to pay its larger dividend.

Unfortunately, when looking at the first three quarters of the cash flow statement, Windstream has been steadily increasing accounts receivable. It could be providing customers with less stringent credit standards and improperly stabilizing revenue. Revenue actually increased from the first to second quarter by about 8% and then from the second to third quarter, revenue decreased by 2.6%.

Changes to accounts receivable and increases to cash from a surge in liabilities are both trends to watch for in Windstream's statement of cash flows. It may be using certain accounting techniques to attempt to distort the fact that it will not be able to sustain dividend growth without elevating its current payout ratio.

Chimera Investment Corporation (NYSE:CIM): Chimera has an astronomical dividend yield of 16.5%, which is expected to drop to 14.1% this year. This is sustained with a 116% payout ratio. Annaly Capital Management (NYSE:NLY), who is Chimera's wholly owned subsidiary, has a slightly lower trailing yield of 14.3% and a forward yield of 13.3%. They are paying out an even larger portion to sustain this, with a payout ratio of 124%.

Chimera, an mREIT, holds mortgage paper that is not backed by government agencies. This creates more volatility for Chimera. Although there is more upside potential, as with any risk-return scenario, there is also more downside risk. If credit further deteriorates, it may find itself in a very difficult predicament, and ultimately not be able to sustain such a high dividend.

Furthermore, from the fourth quarter of 2010 until the third quarter of 2011, Chimera's net income has been on a steady decline. During this period, net income decreased by slightly over 50%. This is in part why Chimera is recognizing an unsustainable payout ratio and will foreseeably decrease its dividend.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.