One dividend stock I’d buy with Lloyds Banking Group plc

Roland Head highlights the appeal of a 6% yielder he’d buy along with Lloyds Banking Group plc (LON:LLOY).

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Shares of bus and train operator Stagecoach Group (LSE: SGC) fell by 11% this morning, after management said that pre-tax profits fell by 82% to £17.9m last year.

This slump was caused by an £84.1m charge the company has made to allow for expected losses on its Virgin Trains East Coast contract over the next two years. This business isn’t expected to be profitable until 2019. But the picture was brighter elsewhere. As I’ll explain, I believe that Stagecoach could now offer good value for income investors.

A cash machine

Last year was clearly a tough year. Group revenue rose by 1.8% to £3.9bn, but underlying operating profit fell by 15.7% to £192.8m, as rail profits halved and bus profits came under pressure.

Bus operations provide the majority of the company’s profits. In 2017, UK regional and London buses contributed 72% of underlying operating profit, up from 69% in 2016. Profit margins on these services are relatively high, at 12% for regional buses and 7% for London buses. Bus services also make an important contribution to Stagecoach’s strong cash generation.

My interest in this stock is as a dividend share. So I’m more interested in free cash flow than profit, as cash is needed to fund dividend payouts. Looking at Stagecoach’s accounts for the last two years, I can see that free cash flow was £100m in 2016 and £131.4m in the 2017 financial year which ended on 29 April.

There’s obviously a risk that cash generation will fall next year, due to pricing pressure on bus services and the expected rail losses. But as this year’s figures show, cash flow doesn’t always mirror falls in accounting profits.

The shares now trade on a price-to-free cash flow ratio of just 7.9. This is very low, and means that the group’s 6.5% dividend yield is comfortably covered by last year’s surplus cash. I believe this stock could be worth a closer look for long-term income investors.

Lloyds could outperform

Lloyds Banking Group (LSE: LLOY) may not be the most original choice of stock, but its popularity is probably well deserved. The bank is one of the strongest and most profitable in the UK, thanks to its CET1 ratio of 14.5% and low cost-to-income ratio of 47%.

The bank’s first-quarter results showed continued improvement in most areas. After-tax profit rose by 68% to £890m compared to the same period last year. Net interest margin, a key measure of profitability, rose to 2.8%, up from 2.74% for the same period last year.

In my view, the main risk facing investors in Lloyds is that it’s heavily dependent on the UK housing market and on UK credit card spending. These are areas where profits could be hit hard next time the economy falls into recession.

Opinions vary about the likely outlook for the UK economy at the moment. I’m not going to venture an opinion, but it’s worth noting that fund manager Neil Woodford has recently put domestic stocks — including Lloyds — at the heart of the investment strategy for his new high-yield income fund.

Mr Woodford believes the outlook for the UK economy is fairly benign. If he’s right, then Lloyds’ forecast P/E of nine and dividend yield of 6% could prove to be very good value.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Roland Head owns shares of Stagecoach. The Motley Fool UK has recommended Lloyds Banking Group and Stagecoach. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

More on Investing Articles

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »

Investing Articles

3 ideas to help investors aim for a million-pound Stocks & Shares ISA

The UK has a growing number of Stocks and Shares ISA millionaires, and this plan may be one of the…

Read more »

Illustration of flames over a black background
Investing Articles

2 red-hot UK growth stocks to consider buying in April

These two growth stocks are performing well, but can they continue to deliver for investors through 2024 and beyond?

Read more »

Charticle

Is JD Sports Fashion one of the FTSE 100’s best value stocks? Here’s what the charts say!

The JD Sports Fashion share price remains a wild ride during the first quarter. Could it be one of the…

Read more »

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »