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Why I’d sell this 5% yielder to buy this FTSE 250 income stock

While Pendragon (LSE: PDG) may be packing the sort of yields to embarrass much of the broader London market, I for one wouldn’t touch the business with a bargepole right now.

With new car sales falling off a cliff I think that investing in the vehicle retailer is extremely risky business, and conditions do not look likely to improve any time soon as the economic and political malaise engulfing the UK continues. What’s more, ongoing uncertainty over the future of the diesel engine is likely to keep the market under pressure as well.

Latest data from the Society of Motor Manufacturers and Traders showed registrations for new vehicles in Britain plummet 15.7% year-on-year in March, to 474,069 units. This also marked the 12th monthly drop on the spin and takes the total decline in new car sales for the first quarter to 12.4%.

The difficulties in the new automobile market have encouraged Pendragon to harden its resolve in the used car segment, and the company has targeted a doubling of annual revenues from pre-owned vehicles by 2021.

Still, the used car market will surely not prove immune to the broader pressure on consumers’ spending power either — these vehicles still remain ‘big ticket’ items for most people, after all.

Car crash

Current City forecasts do not reflect this severe toughening in market conditions, in my opinion, with analysts tipping the company to bounce from the rare 15% profits slide last year with a 7% advance in 2018.

I believe this estimate could be chopped down in the months ahead given the pace at which car sales data is deteriorating. And next year’s predicted 10% earnings improvement could come under serious scrutiny too. And as a consequence I would ignore Pendragon’s ultra-low forward P/E ratio of 8.3 times and stay away.

I also wouldn’t be surprised to see monster dividend projections also fall short of current estimates. Forecasters are expecting the full year payout to remain stable at 1.55p per share through to the close of 2019, resulting in a gigantic 5.3% yield.

But with Pendragon battling an uncertain earnings outlook and a ballooning net debt pile, which jumped to £32.4m last year from £12.1m previously, I reckon investors should be braced for disappointment.

Box it up

I believe those hunting for bright dividend stocks would be much better selling out of Pendragon today and splashing the cash on Safestore Holdings (LSE: SAFE).

The FTSE 250 self-storage giant has seen dividends balloon by triple-digit percentages over the past five years. And although another painful earnings drop is forecast for the year to October 2018 — by 29%, and the third on the spin if realised — thanks to its strong cash flows, City analysts expect shareholder rewards to keep rising. Free cash flow leapt 19% last year to £50.3m.

Last year’s dividend of 14p per share is predicted to rise to 15.9p this year. And this figure yields a chunky 2.9%. The good news doesn’t stop here, however, and an anticipated 7% earnings rise in fiscal 2019 underpins expectations of a 17p reward. As a result the yield steps to an even better 3.1%.

Safestore might be expensive, the firm dealing on a forward P/E ratio of 20.7 times. I reckon the company’s robust position in an expanding market merits this premium, though.

Buy-And-Hold Investing

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