Why I’d buy the Next share price plus this hidden dividend stock

I reckon this small-cap income provider shares a similar management quality to Next plc (LON: NXT).

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If the retail sector is hurting, you’d hardly know by looking at Wednesday’s first-quarter update from Next (LSE: NXT).

The high-street fashion chain reported a 4.5% rise in full-price product sales for the three months to 27 April, boosted by an 11.8% hike in online sales while bricks-and-mortar shopping declined by 3.6%.

The company did put this better-than-expected performance mainly down to the warm Easter weather which had more people out shopping, and full-year guidance isn’t quite as rosy, but it still looks reasonable to me.

Full year

The year is now expected to bring in a modest 1.7% full-price sales increase, with an 8.5% drop in conventional retail sales offset by an 11% gain in online sales. Next stressed that quarterly comparisons with last year are difficult, as there have been some serious weather differences from year to year, and that obviously has an effect on the high street.

There’s a bottom-line 3.4% increase in EPS on the cards too, enhanced by the company’s share buyback plans, with £86m of an intended £300m of surplus cash already redistributed that way.

Next might not offer one of the biggest dividend yields, but it is progressive and very well covered by earnings — forecasts for the current year indicate cover of 2.7 times, which leaves a big margin of safety.

I’m always a bit twitchy when I see net debt, but Next’s at £1.1bn doesn’t look like a big cause for concern. And with the shares on forward P/E multiples of around 12, I still reckon I’m looking at a good long-term buy. Not a screaming bargain, but a good company at a fair price.

Price slump

I’m turning now to a small engineering company called Castings (LSE: CGS) which manufactures, well, castings. I’ve had my eye on the company for a while, but I’ve been disappointed by its poor share performance that has seen the price sliding over the past two years. There have been falls in earnings, but forecasts suggest a return to strong growth, starting with the year just ended on 31 March.

I perked up when I saw a 7.5% uptick in the share price on Wednesday after the firm released its full-year pre-close update.

Castings told us that, thanks to strong demand in the second half of the year, its full year should come out ahead of market expectations. Margins at the firm’s foundries are improving too, and management initiatives are apparently making a difference.

Dividends

But it’s the dividends that are the real attraction for me, and I can’t help feeling the market has not given them sufficient credit when marking down the share price. Dividend policy is conservative, maintaining strong cover by earnings. In 2016, before a couple of down years for earnings, the dividend (yielding 2.7%) was covered 2.7 times. That allowed the company to maintain progressive rises and still see cover at 1.5 times in the toughest year of 2018.

Meanwhile, the slipping share price has pushed the expected 2019 yield up to 4.1%, and with two more years of EPS gains on the cards, we’d be looking at cover back up to 2.1 times by 2021.

I’m seeing a small but well-managed company here, with a focus on providing long-term income for its shareholders. And I think the day’s price rise could presage a better year to come.

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.

Alan Oscroft 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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