14.5% dividend yield! Should I buy this FTSE 250 income stock?

A double-digit dividend yield is usually a red flag. But is this income stock an exception, granting investors a massive passive income opportunity?

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Despite being known for growth, the FTSE 250 is filled with income stocks currently offering impressive dividend yields. In fact, one of the largest payouts available right now is Vanquis Banking Group (LSE:VANQ), seemingly offering 14.5%!

Typically, dividends of this calibre are a giant red flag to stay away. But occasionally, investors are presented with a rare opportunity to snatch up shares at a massive discount, locking in a higher yield – even a double-digit one. Is Vanquis such an opportunity? Or should I steer clear?

Investigating the yield

High payouts can be created in one of two ways:

  1. Management feels confident in financial performance and bolsters the dividend per share
  2. The stock price falls off a cliff

In the case of Vanquis, it’s the latter. The share price was already trading at depressed levels following the pandemic in 2020. But after the group published its latest results, the market-cap tumbled once again. And over the last 12 months, the stock is down 40%, sending the yield even higher.

So the questions now are, why did the share price drop? Is it a short-term problem? Or is there a more fundamental issue?

Fixing the 2021 scandal

To understand what happened with Vanquis, it’s important to know what this business actually does. As a subprime lender, the group offers loans to individuals with weaker credit scores. But in 2021, customer complaints went through the roof as loan products were being mis-sold. Consequently, management was forced to shutter its consumer credit division.

Today, the firm is in the middle of a turnaround plan. Part of this involved rebranding the group from its original name, Provident Financial. And to avoid falling into a similar trap, the company is shifting its focus to higher credit quality customers, reducing the risk profile.

Looking at the latest results, this new strategy seems to be working. Interest income has grown 5% on the back of rising receivables. It seems the increased use of credit cards and demand for vehicle financing, as well as personal loans, is creating a small tailwind.

Unfortunately, even with the credit quality of its customers improving, the latest rounds of interest rate hikes have continued to trigger impairment charges. Customers are defaulting on their loans. And in the last 12 months, Vanquis has had to write off £85.6m versus £38.5m a year ago.

What now?

With impairments jumping so rapidly, total pre-tax profits collapsed, from a gain of £46.9m in 2022 to a loss of £14.5m, triggering the sudden drop in valuation last July. However, despite this, dividends were maintained at 5p per share. And the horizon does look a bit brighter.

Providing the macroeconomic picture doesn’t deteriorate further, the group expects impairment charges to fall by the end of 2023 and continue to improve throughout 2024. And the £447.3m of cash on its balance sheet provides a liquidity buffer to weather the storm.

So while the picture isn’t pretty, does this mean the 14.5% dividend yield is sustainable? Maybe. Things seem highly dependent on the state of the British economy, which is beyond the control of management.

In other words, this income stock has a lot of risk. And that’s not something I’m keen to add to my income portfolio today.

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.

Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended Vanquis Banking 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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