As UK indices surge to record highs and traditional dividend champions such as banks and miners slash their shareholder returns, income investors haven’t had the easiest time lately. But digging deeper into lesser-known stocks reveals a couple of companies offering sustainable competitive advantages, high cash generation and dividend yields that already top 5% and are still growing.
Growing through acquisitions
One of these is McColl’s Retail Group (LSE: MCLS), whose shares currently yield 5.27% and is forecast by analysts to raise dividends in each of the next two years. This looks completely achievable for the tiny £200m market cap newsagent and convenience sore chain thanks to the defensive characteristics of the business and growing revenue as it acquires new locations.
The latest acquisition was of 298 convenience stores that the Co-op was divesting. These stores are already profitable and management believes they will increase annual sales by 33% and EBITDA by 40% in 2017. Needless to say, the increased cash flow from the newly expanded estate will eventually find its way into the pockets of investors.
Now, there are some red flags potential investors need to be aware of. In 2016 total newsagent like-for-like sales fell 3.3% due to grocery price deflation and changing consumer habits. However, the company is addressing this situation by converting tired old newsagent locations into more premium fresh food and alcohol-centric stores. This appears to be working with like-for-like sales from these converted locations falling a more reasonable 1% year-on-year.
And while converted store sales are still falling, the shift towards these locations drove gross margins up 70 basis points during the year. The company also boosted growth by adding 30 additional food-to-go locations that posted double-digit like-for-like growth in 2016. Expect this rollout to continue in 2017.
While headline like-for-like sales continue to fall, the shift towards higher margin premium offerings is good news in the long term. Add-in low debt and the expected 40% rise in EBITDA from the newly integrated Co-op stores and there’s plenty of room for McColl’s to boost already substantial dividends in the coming years.
As reliable as they come in the oil & gas sector
A larger company that’s offering up an unbeatable 5.9% yielding dividend is Middle Eastern oil services firm Petrofac (LSE: PFC). Despite low oil prices the company is still pumping out huge amounts of cash as its state-owned clients continue to retain its services for the downstream jobs that are its bread and butter.
In 2016 the reliable revenue from these contracts as well as an increased focus on cash generation boosted free cash flow to $386m, which comfortably covered the $224m paid out in dividends. And while last year was the fourth in a row for which dividend payments stayed level at 65.8¢ there is considerable room for them to improve in the coming years
That’s because, after a questionable foray into new business lines, the company is refocusing on its core competencies. This is freeing up extra cash by both cutting capex needs and improving group margins. Indeed in the past year these efforts already began to bear fruit as EBITDA rose from $312m to $704m. This helped drive the company’s net debt to a very manageable 1.1 times EBITDA.
As the balance sheet improves, cash flow picks up and capex needs fall, I believe income investors will find Petrofac a very attractive dividend option over the long term.
