I’m always on the lookout for high-yield dividend stocks with affordable payouts.
My aim is to find stocks that are about to come back into favour with investors, triggering a major re-rating. Today I’m looking at two possible examples.
On the cusp of a turnaround?
My first stock is specialist manufacturer Essentra (LSE: ESNT). This FTSE 250 firm makes a range of products. These include cigarette filters, specialist packaging for the health and consumer sectors and plastic components for a wide range of applications.
Cigarette filters generated £34.8m of operating profit last year — about 40% of the group’s total operating profit. Most of the remaining profit came from the components division, which generated £58.7m from a wide range of industrial customers.
Essentra has lost more than 45% of its value since 2015, when the stock peaked at over 1,000p. But the board’s restructuring programme is now largely complete. Management guidance for the year ahead is for “a return to like-for-like revenue growth and margin expansion” in 2018.
I’m tempted by this 4.9% yield
Broker forecasts for 2018 suggest that the group’s adjusted earnings will rise by 11% to 24.5p per share, with a dividend of 20.8p per share. These figures put the stock on a forecast P/E of 17.5 with a prospective yield of 4.9%.
Although earnings cover for this dividend is slim, I don’t expect the payout to be cut now that profits are rising again. With profits expected to climb a further 15% in 2019, I’d rate Essentra as a buy at current levels.
This 7% yield may be worth buying
Although the long-term decline in cigarette smoking is old news, investors are starting to get concerned that next-generation vaping products may not be able to replace these lost sales.
UK number two Imperial Brands (LSE: IMB) has seen its share price fall by more than 30% over the last year. This stock now offers a forecast yield of 7.4%, but even that hasn’t been enough to tempt dividend investors back into the shares.
It’s certainly true that high yields such as this are often a sign that a dividend cut is likely. But sometimes the market just gets it wrong for a while.
I’m turning bullish
Imperial Brands’ key attraction for investors is its free cash flow. Historically this measure of surplus cash has broadly matched the group’s earnings, providing support for a very high level of dividend payouts.
Measured in this way, the group’s forecast dividend of 187p per share looks to me like it should be affordable. The only potential problem is the high level of debt.
Because management have focused on returning free cash flow to shareholders, most of the acquisitions made in recent years have been funded with borrowed cash. This left the group with net debt of £12.1bn at the end of September 2017. That’s nearly five times forecast profits for this year, which seems a little high to me.
Net debt fell by £800m last year. If this total continues to fall this year, then I suspect the dividend will be safe. We’ll find out more when the group publishes its half-year results on 9 May. Until then, I’m going to give the stock a cautious buy rating.
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Roland Head has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Essentra. The Motley Fool UK has recommended Imperial Brands. 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.