I think that Forterra (LSE:FORT) is a stock with a really good outlook. The UK brick manufacturer looks like a great investment to me at today’s prices.
There’s a lot to like about the stock. It trades at a price-to-earnings ratio of around seven, the company has a sound balance sheet, and the dividend yield is approaching 8%.
This makes it an obvious candidate for investors seeking passive income. But is it too obvious?
Investment returns
Right now, Forterra pays a dividend of 14.7p per year to its shareholders. That means that for £500 in annual passive income, I’d need 3,401 shares.
At today’s prices, that would set me back around £6,700. That’s a significant outlay, but it’s within the realm of what I could manage as part of a broader investment portfolio.
Forterra’s dividend has been up and down over the past five years. And that illustrates the main risk with the stock.
The brick industry is highly cyclical. In other words, demand tends to be strong when house prices are high and fall away when the housing market is weaker.
Over the last 10 months, house prices in the UK have been falling steadily. So it seems likely that the effects of this will bear on Forterra’s earnings in the near future.
As a result, the dividend is likely to be unsustainable at these levels. But there is one big reason this doesn’t worry me from an investment perspective.
Cyclicality
The first reason is that I believe the long-term outlook for the company is broadly positive. As an investor, I tend to look beyond the near future and think about the next 20-30 years.
Importantly, UK housebuilding operates at a significant deficit when it comes to brick supply. That means a couple of things for Forterra – both of which are positive.
First, it means that the company has scope to expand its manufacturing without needing to compete too much with other local brick companies. This gives it scope for growth.
Second, a supply deficit means that there should still be decent demand even in unhelpful economic conditions. This should mean the company still does okay in tougher times.
In other words, I think Forterra’s earnings will continue to be cyclical. But over time, I expect the imbalance between supply and demand to lead to higher returns on average.
A stock to buy
I think investors are overly pessimistic about Forterra shares at the moment. The economic outlook looks like a headwind and I don’t expect the dividend to grow continually.
But investing is about looking beyond the next few months and years at the longer term. And the underlying trends for Forterra look very positive to me.
If I were looking for a cheap passive income stock, I’d be buying Forterra. There will be ups and downs, but I think the company will do well and prove rewarding for investors.
