When evaluating dividend stocks with high yields, it's tempting to get caught up in the allure of substantial payouts. A 9.9% yield, like that offered by Allied Properties Real Estate Investment Trust (TSX:AP.UN), can feel like a golden ticket to financial success. However, it's crucial to dig deeper into the numbers and context to understand what's truly on offer. A high yield can be a double-edged sword, sometimes signalling opportunity and at other times hinting at trouble.
What to consider
High dividend yields can be the result of a falling stock price. This isn't always a red flag, but it's a sign to proceed with caution. A declining share price can reflect broader market conditions or company-specific issues. For AP.UN, the stock trades significantly below its book value, with a price-to-book ratio of 0.43. While this may signal a bargain, it also prompts questions about why the market values it so low.
One of the first factors to consider is the payout ratio, which measures the percentage of earnings allocated to dividends. Ideally, companies retain enough earnings to reinvest in their operations. AP.UN's payout ratio of nearly 400% is a red flag, as it means the dividend stock is paying far more in dividends than it earns. This could signal an unsustainable situation unless supported by strong cash flow or asset sales. However, Allied Properties has been proactive in managing its portfolio, exceeding its non-core property sales target for 2024 by generating $231 million in sales. This provides some short-term financial flexibility but raises concerns about the long-term impact of shrinking its asset base.
Cash flow is another critical component of dividend sustainability. Allied Properties reported $218.2 million in operating cash flow over the trailing 12 months. While this indicates some ability to fund dividends, it must be weighed against its high debt levels. The trust carries $4.4 billion in total debt, resulting in a debt-to-equity ratio of 74.3%.
Broadly speaking
Past performance offers valuable insights, but Allied Properties' financial track record has seen some turbulence. The dividend stock reported a net income loss of $584.2 million over the trailing 12 months, translating to a diluted earnings per share decline to $4.18. While real estate investment trusts (REITs) often prioritize cash flow over earnings, such a substantial loss cannot be ignored. It may reflect asset write-downs or operational challenges that could linger into the future. Despite these challenges, Allied Properties continues to distribute a monthly dividend of $0.15 per unit, signalling its commitment to shareholders.
The broader real estate market also plays a significant role in Allied Properties' outlook. REITs are heavily influenced by the health of their sectors, and Allied's focus on urban office and mixed-use properties makes it particularly sensitive to demand for downtown real estate. As hybrid work remains popular, the recovery of office space utilization has been uneven. However, Allied's portfolio includes high-quality properties in desirable urban areas. This could position it for a rebound if demand for such spaces strengthens.
Looking forward, Allied Properties' valuation metrics suggest some optimism about its earnings potential. With a forward price/earnings (P/E) ratio of 10, the market expects improvements in profitability. The challenge lies in balancing this optimism with its financial constraints and sector headwinds. The trust's ability to navigate these challenges will depend on effective management, prudent use of cash, and continued success in asset repositioning.
Bottom line
Ultimately, the decision to invest in AP.UN depends on your risk tolerance and investment objectives. While the 9.9% yield is enticing, it comes with significant risks tied to its payout ratio, debt load, and uncertain market conditions. For income-focused investors with a higher tolerance for volatility, AP.UN might offer an attractive opportunity. However, it's essential to weigh these factors against the possibility of dividend cuts or further declines in the share price. As with any high-yield investment, due diligence and a clear understanding of the underlying risks are key.
