2 dividend-paying shares to be wary of

Sometimes attractive dividends come with risks that aren’t apparent at first glance. Here are 2 companies that I think could be at risk of cutting their dividend in the next couple of years:

Lifehealthcare Group Ltd (ASX: LHC) – yields 6.4% unfranked

Lifehealthcare is a distributor of medical devices, from disposable items on up to large surgery tables and imaging devices. The company has high-ish capital requirements, as it needs to keep items in inventory for distribution to customers. This distribution business model leads to weaker cash flows and some extra vulnerability as the company must purchase an item in advance of it being sold to customers, which means the costs come before the profits.

My concern about dividends comes because there is little buffer in the company’s financials to absorb any costs. Lifehealthcare has $1.5 million in cash. It earned $7.3 million in cash flow from operations in the last half, and spent $1.8 million on interest and tax, $3.3 million on equipment, $1.5 million on repaying debt, and a further $3.2 million on dividends.

While the second half of the year is usually stronger, it’s clear that the company can’t keep spending at the current rate.  For this reason, I place a mental question mark over the company’s dividend payments.

Telstra Corporation Ltd (ASX: TLS) – yields 6.7% fully franked

Like Lifehealthcare, Telstra Corporation paid out a dividend that does not appear sustainable based on its first half, as dividend payments were greater than earnings per share – the company paid more than it earned. This is not as concerning as it might sound, as cash flows were strong, and over the full year dividend payments tend to balance out.

However, it does look as though Telstra is flirting close to the limit of what can be paid in dividends – for sure, I don’t think anybody in the market is expecting payments to increase any time soon.

The upside is that Telstra has a very stable business with reliable cash flows and attractive franking credits. While the current 6.7% dividend might not be sustainable, investors who mentally ‘marked down’ the dividend to say, 4.7%, give themselves a good margin of safety. With franking credits, 4.7% grosses up to around 6%, and there’s nothing unhealthy about that.

Of course, Telstra and Lifehealthcare are far from the only dividend shares out there. Here are 3 more that are a good opportunity at today's prices, in my opinion:

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Motley Fool contributor Sean O'Neill owns shares of LifeHealthcare Group Limited. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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