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Dividend-growth stock Taylor Wimpey plc seems to be Neil Woodford’s best income stock

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Neil Woodford’s Woodford Investment Management LLP is the largest single shareholder in homebuilder Taylor Wimpey (LSE: TW), owning 3.04% of the group. The company is one of the top 10 holdings in Woodford’s Income Focus fund too, which, as its name suggests, is focused on finding top income stocks. And I believe that Taylor is the best dividend stock in the portfolio overall. 

The main reason why I believe Taylor is a better income play than Woodford’s other top holdings is its simplicity. The company buys land, builds houses and then sells them, it’s as simple as that. Cash generated from sales is then reinvested into new land and excess funds are returned to investors. 

Still, as my Foolish colleague, Roland Head pointed out at the beginning of March, Taylor’s outlook is not as bright today as it has been in previous years as costs are starting to creep up. Management expects operating expenses to rise by 3% to 4% in 2018, following a similar rate of growth in 2017.

However last year, the company was able to offset higher costs by increasing average selling prices by 3.5%, which implies that the firm will be able to do the same again for 2018. According to Hometrack, house price inflation across the UK’s top cities accelerated to 5.2% at the beginning of this year, from 4% a year ago.

Cash cow 

Even if Taylor can’t fully pass on higher costs, it’s clear the firm can afford to absorb lower profit margins without being forced to slash its dividend. The group generated an adjusted operating margin of 21.2% last year, which was enough to lift net cash by 40% to £511.8m, even after the distribution of profits to investors. 

City analysts certainly seem to believe that the company can keep up its current growth rate. Analysts have pencilled in a net profit of just under £700m for 2018, up 26% year-on-year. Earnings per share are projected to rise to 21.2p, giving a forward P/E of 8.7.

What about the dividend? 

So, Taylor is expected to continue to grow in the years ahead, and the company is throwing off cash, which indicates to me that the dividend yield is safe. It also implies that the distribution should be held at the current level and possibly increased going forward. 

With this being the case, Taylor’s current dividend yield of 8.2% looks too good to pass up. There are few (if any) other companies on the market today that offer the same level of income backed up by a cash-rich balance sheet. Indeed, according to my calculations, Taylor currently has enough cash to continue with its current dividend policy for a whole year if profits vanish altogether. If the payout is cut by 50%, the company could continue to reward shareholders for a full two years without selling a single house. 

Overall, Taylor looks to me to be Neil Woodford’s best dividend stock due to its simple business model, low valuation, 8.2% dividend yield and cash-rich balance sheet.

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Rupert Hargreaves owns no share mentioned. The Motley Fool UK has no position in any of the shares mentioned. 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.