When building the income portion of my portfolio, I often look for UK shares that provide above-average dividend yields, with strong underlying fundamentals. The current FTSE 350 average dividend is now 4%, so any company offering something in excess of this level is certainly tempting.
You can understand my intrigue, then, when I discovered Ferrexpo (LSE: FXPO) was offering a dividend yield of 35.6%. The company is primarily involved in the mining and processing of iron ore, selling its pellets to the steel industry. It has struggled over the last year, down 54.4% in 2022, following a very strong 2020 and the first half of 2021.
Should first impressions count?
At first glance, the company looks to be a potentially excellent income opportunity. It has consistently paid a dividend for the last 15 years, and can comfortably cover its yield by current earnings. Furthermore, Ferrexpo has significant levels of cash generation and high-profit margins, whilst maintaining low levels of debt.
In addition to this, the company’s share-price falls have resulted in a forecast price-to-earnings (P/E) ratio of just 2.6. This appears to be extremely discounted compared to the sector. In fact, this discount can be further highlighted when compared to assets. The company has a price-to-net asset value ratio of 0.4, indicating that the current market capitalisation is less than half of its net assets. These metrics can at times represent a significant value investment opportunity, or instead indicate that something is wrong.
What lies beneath
In this particular case, as with many tempting high-yield investments, things may be too good to be true. The company’s dividend is forecast to fall by a massive 50% in the next year, resulting from a forecast decline in earnings.
Furthermore, significant headwinds from the Ukraine-Russia conflict continue to impact the share price. The price of iron ore is far below its record highs in 2021. If these factors persist, earnings are likely to suffer, and the dividend yield will continue to reduce. This lack of future dividend stability leads me to question whether this truly is a brilliant opportunity, or maybe a share best avoided.
The company’s P/E ratio is now sitting at 1.0, following the significant fall in share price over the last year. In addition to the aforementioned fall since the beginning of 2022, the share price has collapsed by over 70% since the summer of 2021. These falls have artificially boosted the company’s dividend yield and similarly reduced the P/E ratio.
Therefore, I am not tempted to add Ferrexpo to my portfolio as an income-generating investment. The massive dividend is certainly intriguing for a UK share and is considerably above the index average. However, I believe this is sadly too good to be true. As a result, I would not add this company to my portfolio.
