Today I’m looking at two mid-cap dividend growth stocks that I believe could provide a profitable mix of income and capital gains for investors. Up first is specialist equipment hire firm VP (LSE: VP).
VP’s share price is up by more than 5% at 990p at the time of writing, following a strong set of results. Sales at this £400m company rose by 22% to £303.6m last year, while adjusted pre-tax profit climbed 16% to £40.6m.
Adjusted earnings per share rose by 18% to 81.8p. The dividend was also increased by 18%. This lifted the total payout to 26p per share, while maintaining a conservative three times dividend cover.
These figures put the stock on a trailing P/E of 12.1 with a yield of 2.6%. That looks a reasonable valuation to me, but do today’s figures support an optimistic outlook?
Too much debt?
VP paid £68.8m in cash and debt to acquire rival Brandon Hire Group in November. Management plans to combine Brandon with VP’s Hire Station business to deliver economies of scale.
In total, the firm spent just over £80m on four acquisitions last year and invested a further £64.9m in its rental fleet. This spending resulted in year-end net debt of £179.2m, up from £98.9m one year earlier.
This level of borrowing represents 74% of the value of the firm’s fixed assets, such as property and its rental fleet. I’d normally look for debt to stay below about 50% of fixed assets, to leave room for depreciation and the risk of a market slowdown.
However, the group generated a return on capital employed of 14.8% last year and an operating margin of 11%. Both figures are roughly double those of rival Speedy Hire. These higher returns reflect the group’s specialist focus and suggest to me that this borrowing should be manageable for a short period.
I’d still buy
Analysts expect VP to deliver earnings growth of about 15% in 2018/19, as Brandon contributes a full year’s earnings.
This puts the stock on a forecast P/E of 10 with a prospective yield of 3.1%. Despite my reservations about debt, I’d be happy to keep buying at this level.
My top pick
Although I rate VP highly, my top pick in this sector is construction and regeneration specialist Morgan Sindall Group (LSE: MGNS). There are three reasons for this.
This group has regularly beaten expectations over the last couple of years, and this trend looks set to continue in 2018. Broker consensus earnings forecasts for 2018 have risen from 106p per share in June last year to 138p per share today.
This well-run firm is also operating without debt. A trading update in May confirmed that average daily net cash for the current year is expected to be at least £70m.
The final attraction for me is that the firm is run by part-founder John Morgan, who has a 10.1% shareholding. Having skin in the game means that Mr Morgan’s interests should be well aligned with those of his investors.
I’d buy
Analysts expect the firm’s adjusted earnings to climb around 15% to 139p per share this year. This puts the stock on a forecast P/E of 10.8, with a prospective yield of 3.3%.
Although Morgan Sindall would be exposed to a slowdown in the UK construction sector, my view is that the group’s owner-management and strong financial performance make it a buy at today’s prices.
