A stock yielding in excess of 6% usually grabs my attention, but then I worry that such a high dividend payment may be unsustainable, or perhaps it’s a sign of trouble ahead for the underlying business.
However, in the cases of printer St Ives Group (LSE: SIV) and distributor Connect Group (LSE: CNCT), City analysts watching the firms collectively rate the stocks as ‘strong buys’, so it’s worth digging a bit deeper.
Robust dividend records
I can’t fault either firm on its dividend record. Over the last five years, St Ives has raised its dividend by 49% and Connect by 32%. Forward estimates are for Connect to increase its payout by 2.4% for 2017 and 2.8% in 2018. Analysts expect St Ives to hold the dividend flat for the next two years.
Forward earnings will likely cover Connect’s 2017 dividend just over twice and the St Ives dividend around 2.3 times. So no concerns about support from profits. But firms pay dividends with cold, hard cash and not with profits that can disappear at the stroke of an accountant’s pen.
On that front the news is good. Connect has a record of generally rising operating cash flow per share, which supports earnings per share well. The St Ives cash flow is a little more patchy but averages out to decent support for earnings.
Are these stocks cheap?
At first glance, both firm’s share prices put a low valuation on the underlying businesses. There’s that tempting 6%-plus yield in each case, but also a low-looking forward price-to-earnings (P/E) rating. At a share price of 159p, Connect’s forward P/E ratio for 2017 runs around eight and at 129p, St Ives’ is just above seven.
However, I’m not getting too excited about that because both firms have a high level of cyclicality to their operations and deserve their low ratings, in my opinion. The market as a whole will likely be trying to anticipate the next cyclical collapse in earnings for these firms. So I’m not expecting a valuation re-rating with these two.
Borrowings seem to be manageable in each case with Connect’s net debt sitting almost three times the level of operating profit and that of St Ives around 2.5 times operating profit. However, I would be happier if debt levels were lower at this mature stage in the macroeconomic cycle. Right now, when business is good, I reckon cyclical firms should be well on the way to paying down all of their debt so that they’re financially strong in order to survive the next downturn.
Back in October, Connect’s chief executive said that 2016 had been a year of both strategic and operational progress and he had confidence in the firm’s ability to succeed in the click-and-collect market in 2017 onwards.
Meanwhile, the St Ives chief executive said the firm is alert to possible deterioration in business confidence as an outcome of the Brexit process. However, assuming no change in current market conditions St Ives is well positioned to make further progress with its growth plans.
Overall, I reckon these two firms are interesting dividend payers, but their cyclical operations mean I would keep a close eye on them for signs of a deterioration in trading if they were in my portfolio.
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Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.