This FTSE 250 6%-yielder could harm your retirement savings. Here’s what I’d buy instead

This big FTSE 250 (INDEXFTSE:MCX) dividend could face the axe, says Roland Head.

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The market seemed moderately impressed by this morning’s full-year results from construction and outsourcing firm Kier Group (LSE: KIE). But to be honest, I think some of the 3% gain seen at the time of writing is probably relief that things aren’t worse.

In recent weeks, some investors have suggested that Kier could be the next Carillion — a total failure. Having looked at today’s figures, I think the comparison with Carillion is probably unfair. But I can see a number of areas which concern me.

Good news and bad news

Underlying revenue at Kier rose by 5% to £4.5bn last year, while underlying pre-tax profit rose 9% to £137m.

This increase in profits generated adjusted earnings of 116.7p per share for the year, a 9% increase on last year. The dividend will rise by 2% to 69p, giving the stock a tempting dividend yield of 6.5%.

The firm ended the year with a record order book of £10.2bn and a £3.5bn housebuilding pipeline. That’s the good news.

The bad news is that year-end net debt rose by 69% to £186m last year. Daily average net debt for the year was £375m, up from £320m in 2016/17.

Chief executive Haydn Mursell is now on a mission to cut debt. He’s targeting average net debt of £250m, and a year-end net cash position by June 2021.

The company is aiming to deliver a £20m increase in free cash flow in 2019/20, and hopes to raise £30m-£50m by selling non-core businesses. Capital expenditure is also expected to fall by about £25m this year, as a major IT upgrade programme has been completed.

A dividend cut may be needed

My concern is that despite these savings, the group may not generate enough cash to reduce debt and support the current dividend. My sums suggest that excluding acquisitions, free cash flow available to shareholders was just £11.3m last year. However, last year’s dividend cost £66m.

When I wrote about this stock nearly a year ago, I was fairly positive. My view has changed. Although Mursell may manage to cut debt and improve profitability, I think he may need to cut the dividend to achieve this goal.

My top construction pick

My favourite stock in the construction and services sector is Morgan Sindall Group (LSE: MGNS). It’s run by founder John Morgan, who retains a 10% shareholding in the business.

Although Morgan Sindall carries out a similar mix of work to Kier, the smaller firm benefits from a much stronger financial framework.

During the first half of 2018, Morgan Sindall’s revenue rose by 9% to £1,423m. Pre-tax profit rose 29% to £29.9m and the group ended the period with net cash of £97m. The firm maintained an average daily net cash balance of £113m throughout the half year.

Morgan Sindall’s stronger balance sheet means that it generates a much higher return on capital than its larger rival, despite having similar profit margins:

Company

Operating margin, 12 months to 30 June

Return on capital employed, 12 months to 30 June

Kier Group

3.0%

10.7%

Morgan Sindall Group

2.6%

19.1%

A higher return on capital suggests to me that Morgan Sindall is more likely to generate real wealth for shareholders, outperforming the market.

This stock currently trades on a forecast P/E of 9.5 with a safe-looking dividend of 3.7%. At this level, I rate Morgan Sindall as a 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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