The Motley Fool

Two 4%+ yields I wouldn’t touch with a bargepole

Over the past few years, Devro (LSE: DVO), a manufacturer of collagen products for the food industry and best known for its sausage casings, has struggled to grow. 

Many different factors have helped contribute to the company’s lacklustre performance. These include increased competition, rising prices and the group’s operational issues. Thanks to these issues, City analysts expect the firm to report earnings per share of 15p for 2018, down by around a quarter from 2013’s figure of 20p.

Claim your FREE copy of The Motley Fool’s Bear Market Survival Guide.

Global stock markets may be reeling from the coronavirus, but you don’t have to face this down market alone. Help yourself to a FREE copy of The Motley Fool’s Bear Market Survival Guide and discover the five steps you can take right now to try and bolster your portfolio… including how you can aim to turn today’s market uncertainty to your advantage. Click here to claim your FREE copy now!

Time to grow? 

Over the past decade, Devro has undergone a significant transformation. It has moved from being a series of regional subsidiaries into a single, globally-focused, organisation, concentrating on the production of edible collagen. However, it is not the only business operating in this market and competition has been a severe headwind to the group.

It looks to me as if the hostile operating environment is going to continue for some time, based on a trading update published by the group today. Specifically, while the update does say that the company is on track to meet management expectations for the full year (based on Q1 trading), it lacks any quantitative information. It finishes with the conclusion that “the board remains confident that Devro is well placed to make good progress in 2018.

Personally, this announcement does not fill me with confidence and leaves me concerned about the company’s ability to hit the City’s target to grow earnings per share by 20% for 2018 to 14.9p

So overall, even though Devro’s 4% dividend yield might look attractive to income investors, I would steer clear of the shares for the time being until management can prove that the business is expanding again.

Rising debt 

Another 4% dividend yield I’m wary of is that of John Wood (LSE: WG). Like Devro, its trading fortunes have been mixed over the past five years as the oil services company has struggled with broader sector headwinds. And while it now looks as if the oil industry is in recovery mode, this is not enough to convince me that the firm’s dividend outlook has improved. 

Even though the dividend is set to be covered 1.6 times by earnings per share in 2018, assuming the group can hit City growth targets, the acquisition of Amec Foster Wheeler in October has pushed debt up to 2.4 times EBITDA, reducing fiscal flexibility. Management’s principal goal is now to reduce debt while trying to integrate the two businesses. 

Plenty of companies have failed at this stage of integration, and I’m not entirely convinced that John Wood will be able to pull it off without any mistakes, especially when earnings are hostage to the highly volatile oil and gas industry.

Considering all of the above, I would avoid the shares. The dividend yield of 4.5% isn’t enough to convince me this is a good income play. Meanwhile, the valuation of 13 times forward earnings looks too demanding, especially considering the uncertainties facing the business.

There’s a ‘double agent’ hiding in the FTSE… we recommend you buy it!

Don’t miss our special stock presentation.

It contains details of a UK-listed company our Motley Fool UK analysts are extremely enthusiastic about.

They think it’s offering an incredible opportunity to grow your wealth over the long term – at its current price – regardless of what happens in the wider market.

That’s why they’re referring to it as the FTSE’s ‘double agent’.

Because they believe it’s working both with the market… And against it.

To find out why we think you should add it to your portfolio today…

Click here to read our presentation.

Rupert Hargreaves owns no share mentioned. The Motley Fool UK owns shares of and has recommended Devro. 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.