Top fund manager Neil Woodford recently said that the fact he’s able to build a portfolio with a 5% yield for his new fund is proof that the UK equity market still offers value. I agree and would like to suggest a couple of potential starter stocks for the new tax year.
Dig deep for a profit
FTSE 100 miner Anglo American (LSE: AAL) was one of last year’s big winners. But the firm’s current share price of 1,250p only takes the stock back to where it was at the start of 2015. This was when Anglo and the wider mining sector were already four years into a five-year decline.
Strong market conditions have led the company to place on hold last year’s plans to dispose of its coal and iron ore mines. But the group is still working to improve the profitability of its portfolio by eliminating lower quality assets. One example of this is the £134m sale announced on Monday of a group of coal mines in South Africa.
Although it’s not a large sum of money relative to Anglo’s net debt of $8.5bn, it does eliminate some of the geopolitical risk associated with the group’s operations in South Africa. It also marks a gradual shift away from thermal coal, which is used for power stations — a sector where long-term demand is likely to fall.
I expect Anglo’s management to continue making incremental improvements to improve the attraction of the group’s portfolio. Meanwhile, strong free cash flow and much lower costs should mean that debt levels continue to fall this year.
The shares currently trade on a forecast P/E of seven with a prospective yield of 3.6%. I think further gains are likely, and continue to hold the stock in my personal portfolio.
Essential for income?
Housebuilder Persimmon (LSE: PSN) has risen by 245% over the last five years. Amazingly, the firm’s shares are now worth 45% more than they were at the peak of the last housing boom in 2007.
You might think that this is a good reason to take profits and sell. Until recently, I’d have agreed. But Persimmon’s profits no longer seem to be dependent on rising prices or major growth.
The number of houses sold by the firm only rose by 4% in 2016, and the average selling price was only 3.8% higher. But this modest growth left Persimmon with an operating margin of 24.8% and lifted the group’s underlying pre-tax profit by 23% to £782m.
This cautious approach to growth has also led to record cash generation. Persimmon ended 2016 with net cash of £913m. That’s equivalent to 13% of its market cap, or about 370p per share. This net cash is enough to cover the 2017 and 2018 dividends, without any contribution from this year’s profits.
It seems likely to me that Persimmon’s profits and dividends would remain safe even in a flat housing market. The only real risks, in my view, would come if interest rates, inflation or unemployment start to rise, triggering a downturn.
There’s no sign of this at the moment, so I think it makes sense to continue buying housebuilding stocks for their income. With a 6% yield backed by surplus cash, Persimmon is one of my top picks in this sector.
