One dividend growth stock I’d buy and one I’d sell

Roland Head compares a new arrival with an established player.

| More on:

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Toilet rolls are big business. Accrol Group Holdings (LSE: ACRL) sold £135.1m of tissue products last year, 14.2% more than during the previous year. Pre-tax profit rose by 29.3% to £7.4m. Shareholders will receive a final dividend of 4p, giving a total payout of 6p for the year just ended. That gives a dividend yield of 3.9% at the current share price of 153p.

Accrol describes itself as a tissue converter, which means that it converts so-called primary rolls of tissue from paper mills into products such as loo paper, tissues and kitchen roll. The company’s main business is producing and supplying branded and private label products for supermarkets. A particular focus is the discount sector, where it has a market share of more than 50%.

It’s tempting to think that this recently-floated stock could become an attractive income growth play.

Why I wouldn’t buy

Last year’s financial performance was very solid. But there are a number of things about this business which concern me. One risk, in my view, is that the firm’s customers will never allow it to be too profitable. The company’s gross profit margin fell from 29.2% to 27.9% last year. The group’s operating margin, which includes a wider range of costs and expenses, fell from 10.1% to 7.8%.

In today’s results, chief executive Steve Crossley comments that input costs are rising. He notes that “we continue to seek inflation recovery”. According to Mr Crossley, retailers are increasing their prices “slower than expected”. These comments seem to confirm my view that this business’s customers will use their negotiating power to keep prices down. I suspect it will be difficult for Accrol to regain this lost margin.

On that basis, I’d argue that on a forecast P/E of 11.5, Accrol stock is probably fairly priced.

One I would buy

For consumer goods firms, the secret to pricing power lies in having strong brands. One company which understands this is FTSE 100 group Reckitt Benckiser Group (LSE: RB), which owns brands including Dettol, Nurofen, Harpic and Strepsils.

Producing these branded goods isn’t necessarily any more expensive than producing own-label products for supermarkets. However, their premium positioning and customer appeal means that prices and profit margins tend to be higher.

Reckitt has generated an average operating margin of 24% over the last five years. The group generates a huge amount of free cash flow, enabling it to invest in new products and acquisitions without excessive levels of debt. Although the group’s recent $17.9bn acquisition of Mead Johnson will result in raised debt levels, I’m confident its cash generation will enable it to repay this additional borrowing promptly.

The stock has fallen by about 5% from the all times high of £81 per share seen at the start of June. Reckitt was also hit by a recent cyber-attack and said the disruption this has caused is expected to reduce full-year sales growth from 3% to 2%.

In my view, this is just a short-term blip for this impressive growth business. Although the stock is expensive on 22 times forecast earnings, I think the firm’s defensive qualities mean that it’s worth considering as a long-term buy.

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.

Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended Reckitt Benckiser. 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.

More on Investing Articles

Investing Articles

Could the JD Sports Fashion share price double in the next five years?

The JD Sports Fashion share price has nearly halved in the past five years. Our writer thinks a proven business…

Read more »

Bus waiting in front of the London Stock Exchange on a sunny day.
Investing Articles

If interest rate cuts are coming, I think these UK growth stocks could soar!

Falling interest could be great news for UK growth stocks, especially those that have been under the cosh recently. Paul…

Read more »

Investing Articles

Are these the best stocks to buy on the FTSE right now?

With the UK stock market on the way to hitting new highs, this Fool is considering which are the best…

Read more »

Petrochemical engineer working at night with digital tablet inside oil and gas refinery plant
Investing Articles

Can the Centrica dividend keep on growing?

Christopher Ruane considers some positive factors that might see continued growth in the Centrica dividend -- as well as some…

Read more »

Smiling family of four enjoying breakfast at sunrise while camping
Investing Articles

How I’d turn my £12,000 of savings into passive income of £1,275 a month

This Fool is considering a strategy that he believes can help him achieve a stable passive income stream with a…

Read more »

Person holding magnifying glass over important document, reading the small print
Investing Articles

2 top FTSE 250 investment trusts trading at attractive discounts!

This pair of discounted FTSE 250 trusts appear to be on sale right now. Here's why I'd scoop up their…

Read more »

Smiling young man sitting in cafe and checking messages, with his laptop in front of him.
Investing Articles

3 things that could push the Lloyds share price to 60p and beyond

The Lloyds share price has broken through 50p. Next step 60p? And then what? Here are some thoughts on what…

Read more »

Young female business analyst looking at a graph chart while working from home
Investing Articles

£1,000 in Rolls-Royce shares a year ago would be worth this much now

Rolls-Royce shares have posted one of the best stock market gains of the past 12 months. But what might the…

Read more »