It may be a surprise to read that Rolls Royce (LSE: RR) (NASDAQOTH: RYCEY.US) has delivered a return that is only 5% less than that of the wider index over the last year. While the FTSE 100 is up 1%, Rolls Royce is down 4%, although after a significant fall following a profit warning earlier in 2014, that level of underperformance is perhaps better than it could have been.
Having had a difficult start to 2014, with the company releasing a disappointing update, is now a good time for income-seeking investors to buy Rolls Royce? Is it a super income stock?
Despite shares falling by over 20% so far in 2014, Rolls Royce still offers a yield that is below that of the wider index. While the FTSE 100 currently yields around 3.5%, Rolls Royce yields just 2.2%. While this is slightly ahead of current levels of inflation and is better than the interest rate on a typical high-street savings account, it is behind many of the yields offered by Rolls Royce’s FTSE 100 peers.
However, Rolls Royce is forecast to increase dividends per share at a brisk pace over the next two years. Indeed, it is expected to increase at an annualised rate of 7.3%, which is considerably above the FTSE 100 average. Although such growth is unlikely to result in a yield that is higher than that of the index in the short term, it shows that Rolls Royce could be a better income play than at first glance.
A More Generous Payout?
Clearly, Rolls Royce needs to invest heavily to replace plant and machinery, with an industrial company such as it requiring relatively high levels of capital expenditure. However, paying out just one-third of earnings as a dividend (which Rolls Royce currently does) seems rather low. This means that there could be scope for the company to remain generous when it comes to reinvesting in the business, but also increase the proportion of earnings paid out to shareholders. The result could be a faster growing dividend than is currently priced in.
With a yield of 2.3% being considerably below the yield of the FTSE 100, Rolls Royce may not seem like an attractive income stock at first glance. However, the pace of dividend growth and the scope to increase payments further mean that, while not a super income stock at present, it has the potential to become one over the medium term.
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Peter does not own shares in Rolls Royce.