Companies with strong dividend credentials often outperform the market over time, as their ability to generate surplus cash provides support for a rising share price.
Today I’m going to look at two very different companies which I believe are capable of producing a reliable 5% yield.
A contrarian buy?
High street retailers are out of favour with the market. But this widespread sell off has left some stocks looking cheap, in my view. Cycle and car parts retailer Halfords Group (LSE: HFD) is one example.
The group’s shares now trade on a forecast P/E of 12.3 with a prospective yield of 5.4%. This dividend looks reasonably well supported to me. Having been covered by free cash flow in recent years, I expect this to be the case again for the year which ended on 1 April.
The other factor supporting Halfords dividend is its low level of debt. Management expects to end the year with net debt of just 0.8 times earnings before interest, tax, depreciation and amortisation (EBITDA).
Although debt and cash flow problems are two of the most common reasons for dividend cuts, I don’t see any serious concerns here for Halford. My only concern is whether the group can deliver reliable profit growth.
Although sales rose by 2.2% on a like-for-like basis during the first half of the current year, Halfords’ underlying pre-tax profit fell by 12.1% to £40.8m, due to lower profit margins. The firm says this was largely the result of changing exchange rates and deeper discounting on cycling products.
Consensus forecasts suggest Halfords’ underlying earnings will have fall by 9% to 30.2p per share during 2016/17. A further decline of 2% is expected in 2017/18. For the group’s dividend to be truly safe, this trend needs to be reversed in the next couple of years.
A pure dividend play
Strictly speaking, FTSE 250 wind farm investment group Greencoat UK Wind (LSE: UKW) is a financial investment. The firm doesn’t build and operate wind farms, it simply buys into existing farms.
However, for dividend investors, I think it’s fair to consider Greencoat UK Wind as an alternative to traditional utility stocks. Indeed, this company has some potential advantages, in my view.
It’s hard to imagine renewables falling out of the energy mix in the future and Greencoat doesn’t have retail customers either, removing a possible source of political pressure.
The main downside is the firm’s focus purely on wind power. Although pricing and financial benefits for green energy production are subject to regulation, this could change, impacting the group’s ability to pay a dividend. Lower gas prices could also harm profits, as these could also drive down the market price for electricity.
However, the financial picture seems attractive at present. The stock currently trades on about 11 times forecast earnings, with a prospective yield of 5.2%. Dividends since the group’s flotation in 2013 have been covered by free cash flow, and I’d expect this to continue due to the predictable nature of the group’s cash flows.
The only risk is that the shares currently trade at a 14% premium to their net asset value of 108.6p per share. I’d rather pay less of a premium, but given the yield on offer I think the overall picture rates as a buy.
