Is this Woodford-backed income star simply too cheap to pass up?

With a P/E ratio under 12 and dividend yield over 3.5% is this Woodford holding a top buy?

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Image: Forterra: Fair use

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While many of Neil Woodford’s holdings are well-known blue-chips, the star fund manager is also known for buying up huge stakes in small-caps he likes. One such company he’s just taken a 19% stake in is clay brick and concrete block manufacturer Forterra (LSE: FORT). With a major backer such as Woodford, what analysts expect to be a 3.6% yield in 2017, and a valuation of 11.8 times forward earnings, is this relatively unknown income star too good to pass up?

Well, at its heart the company is a play on the health of the domestic housing market as new builds accounted for 63% of turnover and remodelling a further 32% of revenue in 2016. This makes the company a bit risky for those who see troubles ahead for the housing market in the near term, but over the long term, there’s plenty to like about the business.

The company has racked up four consecutive years of sales and margin improvements as new home builds have continued apace and management actively managed production output to minimise excess inventory and concentrate on production from the most efficient facilities. This led to EBITDA margins hitting 23.7% in H1 and cash flow ramping up significantly.

The company was taken public in 2016 by private equity fund Lone Star and, as is normal with these types of deals, was highly leveraged at the time of its IPO. This means that for the time being, a large chunk of the company’s cash flow is being diverted to interest and principal payments. However, net debt at the end of H1 had fallen to one times EBITDA, already significantly lower than the 2.2 times leverage profile at the time of the IPO.

As the company’s balance sheet improves, there’s very high income potential in its future. Last year pre-exceptional operating cash flow was a very healthy £69.8m, of which only £4m was used to fund dividend payments. And even after accounting for IPO costs, interest payments and capex, the company still produced £24.7m in net cash flow.

If you believe the domestic housing market is in good shape then this high level of cash flow and reasonable valuation could make Forterra a very interesting income option.

A safer option?

Another income option that’s flown under the radar is payment solutions business SafeCharge (LSE: SCH), which offers a 5.2% dividend yield and trades at 16 times forward earnings. The company started off providing payment and fraud solution services for the online gambling industry that allow clients to receive and dispense payments in a slew of different countries.

While these gaming clients still provide a large chunk of sales, the firm has wisely sought to diversify its client base in recent years into safer sectors. This move is paying off so far with full-year core revenue rising 11% in 2016 to $101m and adjusted EBITDA hitting 14%.

While SafeCharge offers investors high margins, solid growth prospects and impressive dividend streams, it’s one company that is well worth doing an extra level of due diligence on before investing. The online gaming industry is one that’s always at risk of incurring the wrath of regulators and with a full 70% of SafeCharge’s shares held by insiders, minority shareholders will need to have a very high degree of trust in management’s intentions in order to feel safe.   

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.

Ian Pierce has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.

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