Why Taylor Wimpey plc isn’t the only cheap dividend stock that could help you retire early

Roland Head considers the outlook for Taylor Wimpey plc (LON:TW) and highlights one of his top dividend picks.

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When Taylor Wimpey (LSE: TW) published its full-year results earlier this week, the housebuilder confirmed that “low interest rates” and the ‘Help to Buy’ scheme are continuing to stimulate demand.

The figures for last year were fairly strong. Sales rose by 7.9% to £3,965.2m, completions were 4.6% higher at 14,842, and adjusted operating profit climbed 10% to £841.2m. So why did the shares fall by around 5% after these figures were released?

Profits could peak

One risk is that housebuilders’ profit margins may have peaked. Taylor Wimpey expects operating costs to rise by 3-4% this year. This happened in 2017 too, but the company was able to offset higher costs by increasing average selling prices by 3.5% as well.

If house prices deliver a flatter performance in 2018, as some experts expect, then margins could fall slightly.

That’s certainly a risk, but I think it’s worth remembering that the group generated an adjusted operating margin of 21.2% last year. That’s pretty high and was enough to lift net cash by 40% to £511.8m during the period.

More of the same, please

I believe that if Taylor Wimpey can continue cranking out houses with an operating margin of about 20%, shareholders should continue to do well.

The group’s policy of returning surplus cash to shareholders means that its ordinary and special dividends for 2017 totalled 13.94p per share, giving a trailing yield of 7.5%. A payout of 15.2p per share is forecast for this year, indicating an 8.2% yield.

These payouts are likely to fall if the housing market heads south. But the outlook for the next few years seems reasonably stable. I think Taylor Wimpey remains worth considering for dividend investors.

A dividend stock I’d buy today

Over the last year, bus and train operator National Express Group (LSE: NEX) has been a standout performer in its sector, trading broadly flat while some rivals have lost 20-30% of their value.

Today’ results provide some clues as to why the group has been able to avoid this fate. Revenue rose by 6.1% to £2.32bn last year, while operating profit climbed 7.7% to £197.9m. Earnings per share were 11.7% higher at 25.7p.

That’s a fairly creditable performance. One reason for these gains was that National Express doesn’t operate any UK rail services. Its domestic operations are restricted to bus and coach services, both of which tend to be more profitable than rail and less at risk from political interference.

A second attraction is that more than most rivals, National Express has diversified overseas. It operates bus services in North America, Spain and Morocco and rail services in Germany. In total, more than 80% of operating profit comes from outside the UK.

A cash machine

The group’s operations generated an operating margin of 8.5% last year and free cash flow of £146.4m. The board is recommending a 10% dividend increase, taking the total payout to 13.51p. My calculations suggest that this should be covered twice by free cash flow, making it affordable and suggesting that there’s still room for further growth.

The shares now trade with a forecast P/E of 11.2 and a price to free cash flow ratio of about 12. These figures look affordable to me and should provide good support for this year’s forecast dividend yield of 4.2%. I’d rate this stock as an income buy.

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.

Roland Head has no position in any of the 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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