Can this 10% yielding FTSE 250 stock make you a million?

Is this FTSE 250 (INDEXFTSE: MCX) an undervalued gem, or is it cheap for a reason? Roland Head has taken a closer look.

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Shares in housebuilder and construction group Galliford Try (LSE: GFRD) are up by 6% at the time of writing, after the company released a positive trading update.

Bullish investors appear to be betting that the firm’s problems — which have seen the shares halve over the last two years — are now over. If this view is correct, then these shares, which yield 10%, could be a real bargain.

I’ve been taking a fresh look at Galliford to find out more.

What’s new?

Today’s trading update from Galliford covered the year ended 30 June. Chief executive Graham Prothero is confident that pre-tax profits will be in line with expectations. Based on forecasts for earnings of 130.4p per share, this prices the stock at just five times earnings.

There was no comment on the dividend, which suggests to me that the broker forecast figure of 65.6p per share is probably realistic. That gives a 10% yield at the last-seen share price of 656p.

Trading is said to be stable across the group. In housebuilding, the average sale price was down by 4.3% to £351,000 as management targets mid-range houses away from central London. But the year-end order backlog was up by 10% to 2,564 units, which suggests to me that demand is healthy.

Would I buy?

The main problem area for Galliford has been its construction division. This has been restructured, but in my view the main area of concern remains — construction work generally carries high costs, low profit margins and the risk of unexpected complications.

For example, shareholders are waiting to learn about the cost of a “significant claim” on the now-completed Aberdeen ring road project. Cost estimates have risen for Galliford’s Queensferry Crossing joint venture.

As a result of these problems and others, Galliford expects to report £40m of exceptional costs for 2018/19. I estimate that including these costs in the firm’s profit calculations could reduce earnings by as much as 25%.

Although the firm’s housebuilding business appears to be performing well, so too are others. I’d rather buy a housebuilder that doesn’t have a construction business attached to it.

I don’t think this is an undervalued gem. I’d suggest that Galliford’s 10% dividend yield represents the risk attached to these shares. I’d rate GFRD as a hold, at best.

Happy holidays

One company that will be hoping for a trouble-free summer is FTSE 100 travel group TUI (LSE: TUI), which owns a number of European package tour and cruise ship businesses.

The company has been hit by the grounding of Boeing 737 MAX aircraft and by weaker pricing and rising costs on holiday bookings. Profit margins are down and the company expects adjusted profits to fall by as much as 26% this year, depending on when the 737 MAX returns to the skies.

The shares have fallen by more than 50% over the last 12 months, leaving TUI stock offering a tempting forecast yield of 6.6% for the current year. However, I think it’s too soon to get involved here.

TUI isn’t the only company in this sector reporting tough trading. Although broker forecasts suggest that profits will bounce back next year, I think it’s a big risk to price in such a strong recovery so quickly. I plan to watch from the sidelines for now. I’ll only get interested if trading improves, or if the shares get cheaper.

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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