Are these 6% FTSE 250 dividend yields beautiful bargains or value traps?

These FTSE 250 (INDEXFTSE: MCX) dividend stocks deserve a closer look, says Roland Head.

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I spend much of my time looking for high-yield dividend stocks with sustainable payouts. Today I want to look at two FTSE 250 companies that have come onto my watch list recently.

Both are out of favour with investors, but neither is in serious distress. With dividend yields of more than 6% on offer, I’ve been taking a closer look to find out more.

This defence firm is under attack

Shares in defence and engineering contractor Babcock International Group (LSE: BAB) have fallen by 45% over the last year. One reason for this is that the firm has been subject to a shorting attack by a mysterious group called Boatman Capital Research.

Babcock has strongly denied the allegations made by Boatman, which include suggestions that it has a poor relationship with the Ministry of Defence and that it may have overpaid for a recent acquisition.

As outside investors, we can never be completely sure of such things. But in my view, Babcock’s latest annual results suggest that the company’s financial performance is stable and consistent with management commentary.

Is the outlook improving?

Despite these reassurances, it’s clear that Babcock is struggling to deliver any kind of growth. Last year’s results showed that underlying revenue fell by 3.8% to £5,161m, with underlying pre-tax profit rose by just 1.1% to £518m.

However, there were some positives. Improved cash generation enabled the company to reduce debt levels while supporting a full-year dividend of 30p per share.

The outlook for the year ahead can best be described as downbeat. As major contracts wind down, revenue is expected to fall by around 5% while operating profit is expected to be about 10% lower.

However, this bad news is already known and reflected in the stock’s valuation. Babcock shares currently trade on just 6.2 times 2019 forecast earnings, with a forecast yield of 6.6%. The business is expected to return to growth in 2020/21. In my view, this could be a good opportunity to build a long-term position in this unloved stock.

Going nuclear

Oil services firm John Wood Group (LSE: WG) has a pretty decent reputation among investors. The dividend has risen every year since its flotation in 2002, delivering 17 years of income growth.

This rising payout has been backed by solid operational performance, good cash generation and a strong balance sheet.

However, the firm’s decision to acquire rival Amec Foster Wheeler in 2017 required it to take on a big chunk of debt. Chief executive Robin Watson promised to make repaying this borrowed cash a priority. But Wood’s latest results show that this could take a little longer than expected.

I’d normally be suspicious of a situation like this. But given Wood’s track record I’m prepared to trust Mr Watson to deliver on his promise.

The Amec deal has enabled the company to expand into areas such as nuclear energy, while consolidating its core oil and gas business. Wood Group returned to growth last year, delivering results that were slightly better than expected. Further improvement is expected in 2019 and debt continues to fall.

WG stock currently trades on less than nine times forecast earnings and offers a 6.9% dividend yield. I reckon that’s too cheap.

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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