Are these 5%+ yielders worth the risk?

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Shares of telecoms company KCOM Group (LSE: KCOM) dropped by as much as 5% on Tuesday after the company reported a bigger than expected fall in revenues in the six months to 30 September.

KCOM said group revenues during its first half fell by 8% to £151m, due to a continued decline in its legacy activities within National Network Services. Pre-tax profits also declined by 8% to £83m during the first half, following incurred losses of £1.7m and provisions of £4.5m relating to ongoing issues with previously identified software development contracts in its Enterprise division.

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Despite the downbeat headline performance, management is confident going forward. Chief Executive Bill Halbert said that in the context of the economic and political uncertainties, the results demonstrate “encouraging progress”. The group is seeing “particularly strong growth” in the residential market, and notwithstanding the issues affecting its Enterprise division, there was “underlying growth alongside new contract wins and renewals”.

Disruptive challenger

On the face of it, KCOM’s positioning as a disruptive challenger to the established traditional businesses, allied with the heavy investment it has made in its fibre network, should bode well for its long-term prospects.

However, I’m more concerned about the near-term headwinds affecting the company. I reckon KCOM’s recent issues with its Enterprise division could mask a deeper problem for the firm. For years, the company has struggled to drive top-line growth as the revenue from new services failed to offset the decline in legacy revenues.

These troubles are unlikely to abate any time soon, with City analysts forecasting a 12% fall in underling earnings this year, and a further 2% decline for 2018/9. This means shareholder payouts are expected to be higher than earnings for some time, with further increases in net debt likely to strain its balance sheet.

Dividend investors may still be drawn in, however, attracted by its massive yield of 6%. But I won’t be buying until dividend cover improves.

A better pick?

Shares in Royal Mail (LSE: RMG) have been out of favour with the market for much of the past year. But following the recent strong performance in its parcels business along with continued progress on its cost front, the shares have gained more than 10% over the past two weeks. Has investor sentiment towards the postal company finally shifted?

Sure, Royal Mail is doing better than previously expected, following new contract wins in the parcels business and a stabilisation in letter volumes. But on the flip side, the UK parcels market remains highly competitive and visibility over its near-term outlook remains poor.

Worth the yield?

Royal Mail’s underlying earnings are forecast to fall by 8% to 40.6p this year, although this is expected to be a low point. Analysts have pencilled in a 2% increase in earnings per share for 2018, putting the stock on a modest 10.1 multiple on its expected 2018/19 earnings.

And the group’s dividend is also expected to remain secure. Net debt has been falling steadily over the past few years and cash generation remains strong. A dividend of 24p per share is forecast for this year, giving investors a tempting prospective yield of 5.8%.

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Jack Tang 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.

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 considered, so you should consider taking independent financial advice.

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