Are these two small-caps the cheapest high yield stocks around?

Rupert Hargreaves analyses two income plays that the market seems to be overlooking.

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At the end of October last year, shares in Pendragon (LSE: PDG) one of the UK’s largest car dealers, slumped by more than 20% after the group warned on profits due to falling sales of new vehicles.

Even though the company achieved underlying operating profits of £48.5m in the first half of the year, it struggled to break even in the second half of 2017. When the results for the full year were eventually released, it reported a decline in earnings per share for the year of 4.2%.

Unfortunately, analysts are expecting earnings to decline a further 14% this year, but growth is expected to return in 2019 thanks to the company’s efforts to rebuild the business around used vehicle sales, automotive after-sales services and software. 

Software sales 

Pendragon’s Pinewood Technologies is a leading software provider in the motor industry, providing dealer management software for dealerships all over the world. Even though this division is relatively small compared to the overall group, it generates a disproportionate amount of profit and is still growing steadily. Software sales accounted for less than 0.4% of revenue in 2017 but 13% of operating profit. 

That being said, even though software sales will pick up some of the slack, there’s no getting away from the fact that the firm’s income is set to fall in 2018. Still, even with earnings due to come in 14% lower, City analysts believe the group’s dividend of 1.55p per share will continue to be covered twice by earnings per share. 

Management is also trying to sell Pendragon’s US dealerships, which could fetch £100m, wiping out almost all of the company’s debt.

These figures lead me to believe that the firm’s dividend yield of 6.2% is not going to be slashed anytime soon and the stock is a steal, changing hands at just seven times forward earnings.

A great opportunity 

Another income stock that I believe is too cheap to pass up right now is Photo-Me (LSE: PHTM)

Last month, shares in Photo-Me slumped after the company issued a profit warning thanks to slower than expected growth in one of its most important photo booth markets, Japan.

Part of the reason why the shares fell so heavily after its warning is that they looked quite expensive heading into the update. After years of explosive growth (net profit has more than doubled over the past five years), investors were expecting the good times to continue. The market was not expecting a profit warning. 

However, even though City analysts now expect to the company’s earnings per share to remain stagnant for the next two years, I believe this is an excellent opportunity for investors to snap up a high-yield share at a bargain price.

Indeed, right now shares in Photo-Me support a dividend yield of 7.1% and trade at a forward P/E of 12.6, the lowest valuation awarded to the stock since 2013. Management has already stated its commitment to the dividend following the profit warning, and with net cash of approximately £26m at the end of April, it really does look as if this market-beating dividend yield is here to stay.

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.

Rupert Hargreaves owns shares in Pendragon. The Motley Fool UK has recommended Pendragon and Photo-Me International. 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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