Should you buy this FTSE 100 giant for its mega 9.5% dividend yield?

G A Chester discusses a FTSE 100 (INDEXFTSE:UKX) mega-yielder and a mid-cap flying high after its results today.

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There are some cracking dividend yields available in the market today. But few are as high as the 9.5% offered by FTSE 100 housebuilder Persimmon  (LSE: PSN). With the company also trading on a bargain-basement forward price-to-earnings (P/E) ratio of 9.1, it appears to offer outstanding value.

Elsewhere, FTSE 250 plastic piping specialist Polypipe  (LSE: PLP) reported half-year results this morning and said its performance was “driven by continued strong growth in new housebuilding.” Its shares are up 5.6% at 375p, as I’m writing, and I’ll come back to this stock after first looking at Persimmon’s prospects.

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History

I turned bearish on housebuilders last autumn, rating Persimmon a ‘sell’ in October at 2,800p and again in January at 2,710p. With the shares now down to 2,470p, are today’s cheap earnings rating and whopping yield simply too tempting to ignore?

Housebuilders have enjoyed almost a decade of booming profits. The problem for investors in this historically boom-and-bust sector is that the market begins to price-in the next bust even while fundamentals appear robust. Back in February 2008, Persimmon posted a record profit of £414m and was confident that there remained “an underlying demand and desire for new homes.” However, the shares had already lost 50% of their value by then and the P/E had fallen to 5.5. A year later, the company posted a £625m loss and ditched the dividend. The peak-to-trough decline in the share price over two years was more than 85%.

Things that can’t go on forever, don’t

The market correctly predicted the last housebuilding bust and now appears to be starting to price-in the risk of the next. I see potential for demand and pricing for new homes to plummet. Interest rates are now entering a rising cycle (not generally good for housbuilders), there’s political risk (e.g. an early withdrawal of the government’s Help to Buy scheme) and Brexit presents a range of potential headwinds (availability of skilled labour and rising labour and materials costs) and even the risk of a full-blown economic recession.

Now, there may not be a perfect storm, but the scale of the likely collapse of housebuilders’ share prices should there be, leads me to take a cautious view. I believe selling Persimmon and banking profits at this stage is a prudent course.

Exposed pipework

Polypipe manufactures plastic piping systems for heating, plumbing, drainage and ventilation. It has some geographical diversification (little more than 10% of first-half revenue came from outside the UK) and it supplies the commercial and infrastructure sectors as well as residential. Well over half of H1 revenue and two-thirds of operating profit came from residential.

Residential revenue was 5.9% higher than in the same period last year, with new housebuild more than offsetting weakness in the repair, maintenance and improvement markets. Revenue in commercial and infrastructure was down 6.6%. The company expects the outlook to remain mixed in the second half but to deliver full-year results in line with expectations.

At the current share price, the forward P/E is 13.2, based on forecast 5% earnings growth, and the prospective dividend yield is 3.1%. For a company with significant indirect exposure to the risks faced by Persimmon, I don’t see the earnings rating as offering anything like a big enough margin of safety. As such, I also rate this stock a ‘sell’.

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G A Chester 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.

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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