Shares of bus and rail operator Stagecoach Group (LSE: SGC) rose by 2% today after the group published its half-year results. But investors were less impressed with the latest news from construction and outsourcing firm Carillion (LSE: CLLN), whose shares fell by 5% following a trading update.
If you’re a dividend investor, you’ll probably recognise both of these companies as popular high yield picks. Stagecoach offers a prospective yield of 5.6%, while Carillion’s forecast yield is a chunky 7.7%.
Does today’s news provide us with a chance to lock in these high dividend yields, or is a more cautious view required?
Is this business changing?
Carillion shares fell by about 5% this morning, after the firm said that lower margin support services work would continue to drive growth. Profits from construction work and the sale of public private partnership (PPP) projects are expected to fall further in 2017.
This shift in focus towards support services — or outsourcing — may be the reason why investors aren’t very enthusiastic about Carillion. This kind of low margin work generates a lot of revenue, but profit margins are slim. Major outsourcing groups such as G4S, Serco and Mitie have all come unstuck over the last couple of years, thanks to lossmaking contracts and shifts in customer spending patterns.
A second problem is that while net debt is expected to be lower at the end of the year, Carillion expects average net debt across the whole year to have risen in 2016. This more meaningful figure was £540m in 2015. That’s quite high, relative to this year’s forecast net profit of £149m.
Is Carillion an income buy? The stock’s forecast P/E of 7 and prospective yield of 7.3% reflects the market’s sceptical view. Bulls will argue that Carillion’s shares are already cheap enough to reflect the risks facing the firm. I’m not sure this is true, but for now, I’d hold.
Rising oil prices could boost sales
Stagecoach reported a pre-tax profit of £89.5m for the six months to 29 October, down from £90.4m last year. First-half sales rose by 1.6% to £2,002.1m, while the interim dividend climbed 8.6% to 3.8p.
The group’s operating margin fell from 7% to 5.4%, but much of this decline was offset by lower finance charges. The main area of weakness was the group’s rail division. Operating profit fell by 53% to £20m, as weak passenger growth failed to offset rising costs. Stagecoach says that low fuel costs have encouraged more travellers to drive or fly, instead of taking the train.
Net debt rose from £399.3m to £484.m over the period, mainly because of investment in new buses. I’m comfortable with this level of borrowing, which gives a net debt/EBITDA ratio of 1.4, and represents about one-third of the value of Stagecoach’s property and fleet assets.
In my view, one of Stagecoach’s main attractions is its strong cash flow. Last year’s dividend was comfortably covered by free cash flow. Today’s interim results suggest to me that the dividend should be covered by surplus cash again this year.
Stagecoach currently trades on a forecast P/E of 8.2, and offers a prospective dividend yield of 5.8%. In my view the stock is attractively priced and backed by strong fundamentals. I remain a buyer.
