One of the most popular dividend stocks is Duke Energy (NYSE: DUK).

Duke provides electricity and gas to more than 7 million U.S. customers, mostly in the Carolinas.

With its 4.1% yield, strong fundamentals and position as a leading utility, it’s seen as the model of stability for dividend investors. But is that image deserved?

Let’s take a closer look at its dividend…

Over the past year, Duke Energy generated $7 billion in cash flow from operations.However, as is the case for most utilities, its capital expenditures are huge.

It takes a lot of money for utility companies to maintain facilities and add new ones. Duke’s capital expenditures totaled $7.1 billion.

So the company is already in the hole by $100 million.

Negative free cash flow of $100 million means Duke is spending $100 million more than it brings in.

This kind of scenario is very common with utilities. They generate lots of cash from running their businesses but, when capital expenditures are taken into account, they’re often free cash flow negative.

So how do they pay their ample dividends?

Debt.

Utilities live on mountains of debt. Low interest rates have been extremely helpful to the sector.

Utilities survive by borrowing, and they can borrow cheaply when rates are low. It’s one of the key reasons the utility sector is up 18% this year while the S&P 500 has gained 5%.

Over the past 12 months, Duke Energy has grown its long-term debt to $40 billion from $37.4 billion. But its interest expense has climbed too. Last quarter, Duke paid $500 million in interest expense versus $403 million a year earlier.

When interest rates rise, borrowing becomes more expensive. Interest expenses rise, and the stocks often underperform.

We may not have higher rates for a while, so that may not be an immediate concern. But it should be in the back of any utility investor’s mind.

The immediate concern is that Duke (and many other utilities) simply doesn’t generate enough cash flow to pay its dividends.

It uses debt, and that’s a dangerous situation for dividend investors – particularly with the chance of rising rates.

Next year, Duke Energy’s free cash flow is expected to fall off a cliff, to negative $2.6 billion. But the company pays out more than $2 billion a year in dividends.

With negative free cash flow and just $676 million in cash in the bank, Duke will either have to borrow more money or sell stock to afford its dividend.

Duke completed a $1.5 billion stock buyback last year, so it’s unlikely that it will sell stock to fund its dividend. Borrowing more money is the likely avenue.

Duke has raised its dividend for 12 straight years. That track record is the only thing keeping it above SafetyNet Pro’s lowest rating.

Since the company doesn’t generate enough (or any) free cash flow, it must borrow funds to pay shareholders, and therefore its dividend cannot be considered safe.

I’m not necessarily expecting a dividend cut right away… but long-term investors shouldn’t feel too secure, particularly once rates start rising.

Dividend Safety Rating: D