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Why I’m still avoiding this cheap FTSE 100 stock yielding 10%

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A house being constructed in the countryside
Image source: Getty Images.

The interminable bore that Brexit has become — combined with the uncertainty generated by a forthcoming election — suggests the UK property market is unlikely to gallop for some time. That said, none of the aforementioned political wrangling appears to be impacting housebuilder Persimmon (LSE: PSN), at least not yet.

Today’s Q3 statement from the £7bn-cap said trading between the beginning of July and 6 November had been in line with management expectations, helped by the “usual pick-up in customer activity” seen over this part of the year.

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Indeed, in spite of our planned EU departure and other economic headwinds, Persimmon reflected that consumer confidence had “remained resilient” thanks to factors such as high employment and low interest rates. In addition to hitting targets for the current year, it had roughly £950m of forward sales reserved beyond 2019. Prices had also remained firm across its regional markets.

Elsewhere in the statement, Persimmon commented on how it was addressing concerns with the quality of its houses and its dealings with customers, something that’s previously made me avoid the shares like the plague.

The company’s care improvement plan — which included the decision to stem the release of new homes for sale in higher demand areas until construction had reached “the appropriate advanced stage” — has sent H1 sales volumes 6% lower than last year. Notwithstanding this, the FTSE 100 member was quick to reassure existing investors that “the normal seasonality of the market” would likely see numbers improve in H2. 

Given that the shares were only trading on 8.5 forecast earnings before markets opened, it’s perhaps no surprise Persimmon’s shares were posting a healthy gain this morning. I remain wary, though, and not simply because of prevailing political and economic concerns.

Increased investment in its customer services, while no doubt desirable given recent negative publicity, could have a knock-on effect on margins over time. Despite boasting a huge net cash position, the scarily-high 10% dividend yield is also covered just 1.15 times by profits (far below the desired 2 times). For a company operating in a highly cyclical industry, that’s simply not enough protection for me.  

Robust performance

Also reporting today was kitchen supplier Howden Joinery (LSE: HWDN) – a business I’ve been far more positive on over the years.

Despite strong comparators from last year, the £3.5bn-cap reported delivering a “robust” performance over the period covering 16 June to 2 November with total revenue at its depots increasing by 4.9%. Gross margin — the difference between revenue and the cost of goods divided by revenue — was in line with what management had predicted.

The outlook is also encouraging. In addition to looking likely to hit its expectations on FY revenue and profits, Howdens declared it was aiming to have opened 40 UK depots in 2019, bringing its total estate to 734. 

The shares have been in superb form over the last couple of years (+65%), helped no doubt by two recent buyback programmes (one of which has now been completed). That said, its current price-to-earnings (P/E) ratio of 17.3 is only slightly above the 16.5 average over the last five years.

This suggests the stock, while not a screaming ‘buy’, might still be worth grabbing. The 2.1% yield, while nowhere near Persimmon’s monster payout, also looks far more secure, covered as it is 2.7 times by profits. 

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Howden Joinery Group. 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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