How would you like to earn a 6% income and enjoy some growth? Today, I’m going to be looking at two stocks, both offering 6% dividend yields. One falls firmly in the income camp, while the other is an out-of-favour growth stock which I think looks cheap at current levels.
Income + growth
Shares in hostel-booking travel website Hostelworld Group (LSE: HSW) have halved in value over the last year. In part, this seems to have been due to heavy selling by fund manager Neil Woodford. But investors have also been concerned by an uncertain outlook for growth.
The company operates in a very competitive market. It also faced tough trading last summer, due to the hot weather and the football World Cup.
Figures released today show that bookings made under the core Hostelworld brand rose by 4% last year, while the average value of each booking rose 3% to €11.90.
The proportion of bookings made with the group’s mobile app rose from 33% to 40%. I see this is good news. I’d expect app bookings to cut advertising costs and lead to higher levels of customer loyalty, compared to website bookings.
Do the numbers stack up?
Revenue fell by 5.3% to €82.1m in 2018, but this was mostly due to the €2.9m impact from the introduction of a cancellation policy. This means that some revenue can’t be recognised until the bookings it relates to can no longer be cancelled.
Given the modest decline in sales, you might be worried to learn that Hostelworld’s adjusted net profit fell by 19% to £17.5m last year. However, the problem with adjusted profits at software companies is that they can be calculated in many different ways. In my view, a more reliable guide to profitability is cash generation.
Free cash flow fell by just 3.3% to €20.8m last year — a pretty stable performance. This surplus cash covered the group’s €16m dividend payout and helped to lift net cash by 21% to €26m.
Based on its cash flow, Hostelworld looks cheap to me, with a price/free cash flow ratio of just 10.3.
The challenge for chief executive Gary Morrison is to return this business to growth. The risk is that he’ll fail and it will gradually be crushed by larger competitors.
I remain optimistic about this stock, which is modestly priced and loaded with cash. In my view, the shares remain a buy.
A safe and boring 6.8%?
My next stock is FTSE 100 utility group SSE (LSE: SSE). The group is expected to make its first ever dividend cut this year, reducing the yield on offer from 8.4% to 6.8%.
Oddly enough, I think this is good news. The old dividend was no longer affordable. Reducing pressure on the group’s cash flow by cutting the payout makes sense.
The problem is that investors are very nervous about utility stocks at the moment. The utility business is changing, as western economies move towards a heavier mix of renewables. In the UK, the situation is made more complicated by the possibility that a Labour government might choose to renationalise utilities.
In my view, firms such as SSE (the UK’s largest renewable generator) are likely to adapt and survive. I see this uncertainty as a good opportunity to lock in a high dividend yield. As a pure income investment, I’d buy SSE at current levels.
