With the FTSE 100’s average yield up to 4.1%, income investors are sitting pretty with plenty of high-income options available to them across the UK’s largest index. But a few of these big yielders are looking dangerous to me, including advertising giant WPP (LSE: WPP).
The company’s stock currently yields a whopping 5.37% and trades at only 9 times trailing earnings as investors have turned negative on the outlook for traditional advertisers. This fear isn’t without merit as the likes of Proctor & Gamble and Unilever, traditionally among the biggest ad spenders worldwide, have dramatically slashed their media-buying budgets due to little data regarding their effectiveness, the rising importance of online ads and efforts to improve their own margins.
In 2017 this led to WPP’s constant currency revenue rising just 1.6% year-on-year to £15.26bn with net margins flat on a constant currency basis at 17.3%. This still makes it a highly profitable business with EBITDA rising 1.2% in constant currency terms to £2.53bn.
But with signs pointing to an industry shake-up as ad spending moves to the likes of Google owner Alphabet and Facebook, with consultancies increasingly serving as the profitable middle men, I see trouble on the horizon for WPP. Previously, I was quite confident it would come out of this slump in decent shape, as it has survived previous downturns through buying disruptive agencies and co-opting their techniques.
But with founder and CEO Martin Sorrell recently forced out due to accusations of misuse of company funds, the group’s ability to repeat past success is murkier to me. Add in net debt rising to an average of £5.14bn in 2017, which will constrain big deal-making, and I’ll be steering well clear of WPP right now while it searches for a new CEO.
Not so defensive after all?
Another high income FTSE 100 giant that’s on my radar for all the wrong reasons is utility National Grid (LSE: NG). The company’s share price has fallen by over 25% in the past year, which has left its stock yielding a full 5.56% annually and trading at only 13.7 times forward earnings.
However, this valuation looks quite full to me considering the recent rise in interest rates, relatively low-growth business model of energy transmission, as well the increased political pressure on utilities as a whole in the UK. Although the industry regulator who sets prices several years out is politically independent, when both main parties are attacking the profits of privatised utilities, and with the opposition calling for renationalisation, it’s unlikely that regulators will stick their neck out to reward National Grid and its shareholders.
This is a particular worry for the firm since its main attraction to investors is its income potential. If Ofgem slashes utilities’ allowable profits, National Grid’s dividend will come under increased pressure unless management can continue to cut costs from its asset base. And then there is the fact that as interest rates rise, yield-hungry investors will have the option of moving back to safer bonds instead of equities.
Together, these worries put more than enough doubt in my mind to think National Grid will continue to erode shareholder wealth for the time being.
