One dividend stock I’d buy instead of going for BT Group plc’s 6% yield

Big dividends at BT Group plc (LON:BT.A) might be deceptive, and there could be better alternatives out there.

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BT Group (LSE: BT-A) shares have had a very mixed five years.

From late 2012 to late 2015 the price more than doubled to a high of 500p, but since then it’s slumped most of the way back again to 271p, for an overall five-year gain of just 24%.

But now, on a forward P/E of a very modest 10 and with a dividend yield forecast at 5.8%, BT looks like a screaming buy, doesn’t it? Well, looks can be deceiving, and here’s one word to explain why I’ve gone right off the idea of buying BT shares — debt.

At the end of the first quarter at 30 June, BT’s net debt stood at a pretty hefty £8.8bn, which seems like a lot for a company making $418m in pre-tax profit in the period. What’s more, BT’s market cap currently stands at £27bn, and taking that into account we’d get an effective P/E for a debt-free business of around 13, which is close to the FTSE 100 long-term average.

Pension millstone

But it’s worse than that, because of BT’s pension fund deficit, which stood at £9.2bn at the end of 2016 net of tax. That’s not the same as debt, and BT isn’t necessarily going to have to stump up for the whole amount. But if it did, that would lift the effective P/E for the business to around 17 — and that’s starting to look perhaps a wee bit stretched. 

There are estimates that BT could have to pour around £2bn into the pension scheme over the next two years, and that’s a very big chunk of expected annual profits — and that must put pressure on the dividends.

I’d look for income safety elsewhere.

Specialised insurance

I think I’m seeing that safety in Lancashire Holdings (LSE: LRE), the insurer specialising in the property, energy, marine and aviation sectors. 

What we’re looking at is a company that pays a low ordinary dividend, which has been averaging around 1.5% over the past five years. And it then tops that up with whatever special dividends it can afford, and they’ve been pretty impressive in recent years — analysts are predicting a total yield of 8% this year.

I think that strategy is exactly right for an insurance company, and that it could have saved some heartache had the whole sector adopted that approach. Insurance profits can be both cyclical over the medium term, and erratic over the short term, and going for high ordinary yields can lead investors away from that fact. Then if the dividend has to be cut, as happened to a number of firms during the financial crisis, it can lead to overblown panic and an overselling of shares.

Hurricanes

Lancashire Holdings was exposed to Hurricanes Harvey, Irma and Maria and to the Mexican earthquakes, and that sounds like it could be catastrophic. But the aggregate losses are expected to be in the range of $106m-$212m, and the company reckons that falls “well within [its] modelled loss ranges for these types of catastrophe events.”

They’re catastrophes to the people affected, but to insurance companies (and their shareholders) they should be seen as part of their regular business.

The cost of claims should hit the firm over a reasonably long period, and does not in my view damage the long-term investment prospects.

I do invest in insurance, and I’m seriously considering Lancashire Holdings.

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.

Alan Oscroft 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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