Is the Micro Focus 7.5% yield too good to pass up now?

Should contrarian investors grab this opportunity to invest in high-yield, long-term winner Micro Focus International plc (LON: MCRO)?

| 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.

After a very poor trading update released last week spooked the market, shares of Micro Focus (LSE: MCRO) now offer investors a whopping 7.8% yield on a trailing basis. For income-starved investors, the question is whether this yield is too good to pass up or too good to be true?

The bad news is that the company’s policy of paying out a dividend that’s twice covered by after-tax profit means a substantial downgrade to earnings this year could see management rightfully cut the dividend. However, Micro Focus has also made much of its record of increasing dividends annually for over a decade. So it wouldn’t be unimaginable for management to maintain payouts even without being covered by earnings, as they did in H1.

The company’s balance sheet could take the hit of one year of uncovered earnings. Although net debt was 3.1x adjusted EBITDA, as of H1 results, this was already down from 3.3x immediately following the debt and equity-funded acquisition. This shows the underlying business remains cash flow positive despite the recent problems.

On a recent conference call with lenders, its CFO also disclosed he still expects the group’s leverage to fall to the target 2.7x next year. On top of this, the group’s term loans have no covenants and it has no repayments due until 2021, which gives management some leeway in delaying reaching deleveraging targets.

Now whether this makes Micro Focus a screaming buy right now is far from clear. The group has a long history of taking mature software assets and vigorously cutting costs. It still sounds as if cost cutting at HPE is going well with the recent sales and profit warning due almost entirely to self-inflicted IT problems and the loss of salespeople.

If the group can get a handle on these issues there’s plenty of money to be made for shareholders. But with further acquisitions off the table while the HPE problems are digested, I’d urge patience while we see what management’s plan to get things back on track looks like.  

Gloomy days ahead?

Another troubled company that’s offering a knockout dividend is DFS Furniture (LSE: DFS) and its 6.6% yield. Unfortunately for shareholders, DFS’s problems don’t relate to fixable, short-term internal screw-ups. Instead, it’s rather broader industry-wide trends that include the weak pound dampening margins, sales declines as shoppers embrace e-commerce, and weak consumer confidence.

These factors collided in the group’s H1 to send pre-acquisition revenue down 3.5% to £366.5m, while pre-tax profits fell from £16.7m to £7m on the same basis. All is not lost as the CEO sounded a rather positive note about strengthening trading at the start of H2 and maintained guidance for a small uptick in underlying EBITDA for the year.

However, I see plenty of issues that will stop me from buying DFS’s shares right now. The first problem is the aforementioned headwinds facing most brick & mortar retailers. Then there are DFS’s low margins and rising net debt that hit 2.17 times underlying EBITDA at period end following a small bolt-on acquisitions. While its shares may trade at only 9 times earnings, fast-falling profits and rising debt, together with a weak outlook, leave me thinking it could be a big mistake to sink money into DFS right now. 

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.

Ian Pierce owns shares of Micro Focus. The Motley Fool UK has recommended Micro Focus. 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

View of Tower Bridge in Autumn
Investing Articles

The FTSE 100 is closing in on 8,000 points! Here’s what I’m buying before it’s too late!

As the FTSE 100 keeps gaining momentum, this Fool is on the lookout for bargains. Here's one stock he'd willingly…

Read more »

Investing Articles

3 ideas to help investors aim for a million-pound Stocks & Shares ISA

The UK has a growing number of Stocks and Shares ISA millionaires, and this plan may be one of the…

Read more »

Illustration of flames over a black background
Investing Articles

2 red-hot UK growth stocks to consider buying in April

These two growth stocks are performing well, but can they continue to deliver for investors through 2024 and beyond?

Read more »

Charticle

Is JD Sports Fashion one of the FTSE 100’s best value stocks? Here’s what the charts say!

The JD Sports Fashion share price remains a wild ride during the first quarter. Could it be one of the…

Read more »

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 »