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Why I’d sell Conviviality plc to buy this hidden dividend stock for my ISA

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The disaster that has unfolded at Conviviality (LSE: CVR) over the past week has caught its shareholders (and management) by surprise. 

The collapse began on March 8 when it warned adjusted earnings before interest, tax, depreciation and amortisation for the current financial year would miss market expectations by 20% thanks to a “material error in the financial forecasts of the Conviviality Direct business“. 

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Following the publication of this news, shares in the company quickly lost more than half of their value. Believing the sell-off was overdone, the next day the CEO and CFO spent nearly £200,000 boosting their stakes in the business. Unfortunately, only five days after these deals, on March 14, Conviviality revealed that it had discovered an unpaid tax bill to the tune of £30m, which is due at the end of March. It seems this came as a complete surprise to the group’s CFO who spent £131,000 buying shares only a few days before. 

Trading in the company’s shares is now suspended as the firm tries to pull itself back from the brink. Management has cancelled the dividend to save an estimated £8.2m and is currently in discussion with its creditors, including HMRC. According to an update issued today, the business is having “constructive discussions” with both its creditors and suppliers and the “possibility of an equity fundraise to effect a recapitalisation of the business” is under consideration. 

Can the business be saved? 

A rights issue or placing looks to be the best solution to Conviviality’s problems assuming the company can work out an advantageous deal with HMRC and its other creditors. 

But even if management does manage to stabilise the firm, it faces an uphill struggle to rebuild investor confidence after recent events. Indeed, the group’s accounting problems show that management has clearly been asleep at the wheel and we just don’t know what else has been missed.  

Put simply, there are many moving parts here, and right now, it’s impossible to tell what the future holds for Conviviality. With this being the case, if it does resume trading, I believe investors should take the hit and sell the shares as soon as possible and instead buy dividend stalwart Pennon Group (LSE: PNN)

A wide margin of safety 

Pennon provides water and waste management services for 32,000 customers across the UK, making it one of the most defensive businesses around. Unfortunately, shares in the company have lost around a third of their value over the past 12 months as investors have become concerned about the sustainability of the group’s dividend yield, which currently stands at 6.8%. 

The threat of nationalisation from the Labour party, coupled with Ofwat’s promise to force water companies to invest more and profit less, does add some uncertainty to Pennon’s outlook. And in my view, investors should be prepared for a dividend cut in the near future. However, after recent declines, this is already baked into the share price. For example, even if the current dividend distribution is cut in half, the stock would still yield 3.2% and it’s likely management would seek to increase the payout in line with inflation as profits grow at a similar rate. 

So if you are looking for a defensive, predictable dividend play, you should consider Pennon, as right now, it looks as if shares in the company are oversold.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has recommended Pennon Group. 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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