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Why I’d sell this dividend stock despite its 12% yield

Image source: Getty Images.

Safestyle UK (LSE: SFE) may have avoided another sharp sell-off following the release of full-year trading numbers on Thursday, but the damage was already done in late February.

Back then the business, which manufactures and sells doors and windows in the UK, warned in a trading update that it expected profits in 2018 “to be materially below 2017 levels and current market expectations.”

It said that a blend of deteriorating consumer confidence and the emergence of an “aggressive” market entrant had damaged operations and that, as a consequence, orders since the turn of 2018 had “disappointed” and fallen shy of expectations.

To the cheer of income investors however, Safestyle said that its robust cash generation and solid balance sheet would see it pay a final dividend of 7.5p per share and so take the full-year reward to 11.25p, in line with the prior year.

The company made good on this vow today and City analysts at least expect the business to pay an identical dividend in 2018, even though earnings are expected to fall 15%. Safestyle subsequently carries a monster yield of 12.3%.

The bubbly predictions do not end here however, and the Square Mile is tipping the double glazing firm to flip back with a 13% profits rebound in 2019. And this leads to speculation that the dividend will improve to 11.4p, pushing the yield to an even mightier 12.5%.

But I’m not so sure that these predictions aren’t looking just a tad giddy.

Dividends on the rack?

Safestyle advised today that while the average unit sales price rose 7.6% in 2017, the number of frames it installed last year slumped 7.9% to 265,716. This pushed revenues 0.5% lower to £158.6m and this, combined with higher costs, drove underlying pre-tax profit to £15.1m, a 26.3% year-on-year slump.

The AIM-quoted business has a mountain to climb to turn around its bottom line. Although it is taking steps to cut the cost base and to improve turnover by modernising its sales teams, the tough conditions that caused profits to tank last year look set to persist for a whole lot longer.

And this puts dividends in danger in my opinion. Dividend coverage through to the close of 2019 ranges at between 1.1 times and 1.3 times, a country mile below the widely-regarded security watermark of 2 times and above. Meanwhile, cash on the books fell to £11m by December from £13.5m a year earlier, and the investments Safestyle is about to make to improve its processes will put even more strain on its balance sheet.

Despite its low forward P/E ratio of 7 times I believe the windows giant carries far too much risk to make it a sensible investment destination. The share  has lost 70% of its value over the past year and it is not difficult to foresee a further collapse, particularly if the dividend is put through the mincer.

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Royston Wild has no position in any of the shares mentioned. The Motley Fool UK has recommended Safestyle UK. 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.