Why this 18% high yield may not be as attractive as it seems

Dividend giant Steppe Cement offers investors a high yield, but can it be trusted? Dr James Fox explains why all might not as good as it seems.

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Investors choose high-yield stocks for multiple reasons. But first among these is that such stocks offer the potential for greater income through dividends.

This can be especially attractive for income-focused investors, such as retirees or those seeking consistent cash flow.

While it’s not always the case, high-yield stocks also tend to be more mature companies, and often less volatile that their growth-focused peers.

So, what about this 18% yielding stock? Why do I think its payout can’t be trusted?

Steppe Cement’s dividend yield

Steppe Cement (LSE:STCM) is a UK-listed Kazakh cement manufacturer. In 2022, it paid a huge 5p dividend, which currently represents an 18% yield.

In fact, I remember considering buying the stock in 2022 and the dividend yield fluctuated between around 12% and 18%, depending on the share price.

Many investors thought it was just too good to be true. And I feel that’s the right position to take. We need to interrogate high yields because, in many case, they’re a warning sign. Double digits are rarely sustainable.

It’s important to highlight that this high yield is influenced by the company’s a modest valuation. Steppe trades at just 3.9 times its 2022 earnings, making it one of the cheapest UK-listed stocks.

As we know, falling share prices inflate dividend yields. And the same can be applied to broadly under-appreciated stocks. Low valuations tend to translate to higher yields.

However, I can see why investors would be hesitant to invest in Kazakh cement stock. It’s not exactly blue-chip. Currently, its market value sits at just £57m.

Still affordable?

While Steppe declared that 5p dividend for 2022, which was covered 1.64 times by earnings, it’s unlikely to do the same this year.

Normally, a solid coverage ratio is deemed to be two times and above. In this context, Steppe’s coverage ratio falls below the preferred threshold.

Compounding this is that fact that 2023 has been a less profitable year for Steppe than 2022.

Despite a promising Q3 performance, earnings are down year on year. In early October, Steppe reported Q3 revenue of KZT14.1bn (£24m), an 8% increase.

However, the first half of the year saw a 13% decline in revenue due to decreased volumes and lower prices.

Consequently, for the first nine months of the year, total revenue contracted by 5%, and gross profit in H1 was down 47%.

As such, it seems highly unlikely that a Steppe will be able to maintain its 5p dividend. Given the trajectory of earnings, the coverage ratio would likely be around or below one.

In turn, a coverage ratio below one means the company’s net income doesn’t cover its dividend obligations. As such, if it did maintain a 5p dividend, it may need to eat into its $6m of cash to fund it — this would be risky.

Nonetheless, it may prove a solid investment opportunity for the medium term. In broader terms, the company is experiencing growth driven by a construction boom in Kazakhstan.

The economy grew by 5.1% in H1 2023, partially driven by Russian migrant. New business registrations jumped by 20% in June. Steppe may offer exposure to this relatively buoyant economy.

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.

James Fox 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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