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Can this 7% yielder provide a safer income than dividend giant National Grid plc?

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Today I’m looking at 5.5% yielder National Grid (LSE: NG), plus a smaller business with a generous cash return policy that gives its shares a forward yield of at least 7%.

A 12% dividend yield!

Greetings card retailer Card Factory (LSE: CARD) saw its share price rise by 7% when markets opened this morning after the firm released its results for the year ending 31 January.

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Revenue rose by 6% to £422.1m last year as new branches and extra ranges boosted sales. However, like-for-like sales only rose by 2.9% and higher costs pushed pre-tax profit down 12.3% to £72.6m.

The group’s underlying operating margin fell from 22% to 19.7%. Full-year underlying earnings fell by 4.4% to 18.9p per share, but were in line with expectations.

For many investors, the big attraction is the dividend. Card Factory’s ordinary dividend rose by 2.2% to 9.3p last year. When combined with December’s special dividend of 15p per share, shareholders will receive a total payout of 24.3p for last year.  That’s equivalent to a yield of 12%, at the last-seen share price of 200p.

What could go wrong?

Card Factory’s board plans to pay a further special dividend of 5p-10p per share later this year. This implies a forecast yield of between 7% and 10% for the current year, including the ordinary dividend.

Buying the shares for this high yield could be a successful strategy. Fund manager Neil Woodford has done exactly that. But I think it’s worth noting that the Wakefield-based retailer’s special dividends are partly being funded with debt.

Free cash flow fell from £68.9m to £57m last year, but total dividend payments rose from £81.1m to £82.9m. To fund the shortfall, net debt rose from £135.8m to £161.3m.

Although the resulting leverage of 1.72 times EBITDA isn’t especially high, I’m not keen on using debt to fund dividends. It’s often unsustainable and in my view adds unnecessary risk to an investment.

I don’t see any signs of serious problems here at present. But with earnings expected to be flat this year, I think the stock’s current forecast P/E of 10.6 is probably high enough for now, despite the tempting dividend.

A safer 5.5% yield?

Like many utility stocks, National Grid has fallen by around 25% from the highs seen last year. These falls appear to have been driven by fears of political intervention and by rising interest rates, which usually lead to higher dividend yields.

The firm’s latest results suggest that it-s business-as-usual at the moment, and highlight the growing appeal of the group’s US business. US profits rose by 19% during the first half of the year, accounting for nearly 40% of group profits for the period.

Can profits keep growing?

Adjusted earnings from continuing operations rose by 19% to 56.9p per share in 2016/17. Profits for the year ended 31 March are expected to have been boosted by a stronger performance from the US business, where new rates were agreed in several territories last year.

Analysts expect 2017/18 earnings to have risen by 3.5% to 58.9p per share, while the dividend is expected to rise by 1.3% to 46.2p per share.

These figures put National Grid on a forecast P/E of 14.2, with a prospective dividend yield of 5.6%. Although I expect growth to remain limited, I believe this could be a good level for income investors to buy the shares.

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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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