The Motley Fool

This FTSE 250 5% yielder isn’t the first stock I’d buy after today’s news

Today I’m looking at two highly profitable companies with big dividend yields. Yet despite these apparent attractions, both stocks have fallen by at least 25% over the last year. This could be a buying opportunity for contrarian investors. But there’s also a risk that these falling share prices are warning of potential problems. Let’s find out more.

Shares up, profits down

Shares in satellite communications firm Inmarsat (LSE: ISAT) surged nearly 10% higher when markets opened this morning, after the company issued a solid set of first-quarter results.

Sales in the group’s aviation business rose by 39% to $56m during the quarter, helping to lift group sales by 4.8% to $345.4m.

Inmarsat is a big player in the growing market for in-flight internet access. In June the firm plans to launch the European Aviation Network, which will provide in-flight broadband at household speeds across Europe.

However, despite a strong performance from aviation, falling revenue from high-margin government contracts meant group profits dipped. Earnings before interest, tax, depreciation and amortisation (EBITDA) fell by 4.5% to $174.9m, pushing the EBITDA profit margin down from 55.6% to 50.6%.

What’s gone wrong?

Although Inmarsat is a world-class player in this sector, it’s suffered from growing price competition while having to invest heavily in next-generation services.

Shareholders have seen profits fall and debt levels rise. As a result, the share price has fallen by nearly 65% since hitting 1,110p in December 2015.

I’d fly away from these figures

Today’s first-quarter figures suggest to me that the firm’s problems aren’t yet over. Cash generated from operations fell to $148m during the period. That’s 21% lower than the $187.2m reported for the first quarter of 2017.

This cash inflow wasn’t enough to cover $141m of capital expenditure and $21.5m of interest payments. As a result, the group saw a net cash outflow of $12.5m during the period, nudging net debt up to $2,100.7m. This represents a multiple of 2.9 times EBITDA, which is well above the 2 times to 2.5 times range I view as a prudent maximum.

Consensus forecasts for 2018 put Inmarsat on a forecast P/E of 13 and with a 5% dividend yield. This may sound cheap, but earnings are expected to fall by a further 40% next year. I think another dividend cut may be needed. In my view it’s still too soon to invest.

This could be a safer choice

Cigarette giant British American Tobacco (LSE: BATS) should be a safer choice. The firm’s business is highly profitable and requires very little investment. However, the company does face one problem — global sales keep falling as people stop smoking.

To combat this decline, it has spent heavily on acquisitions and invested in next-generation vaping products. The problem is that the market isn’t yet convinced that next-generation products can ever replace the profits provided by traditional cigarettes. And while acquiring rivals has helped to boost market share, last year’s £41.8bn acquisition of Reynolds American has resulted in net debt of £46bn.

Although this level of borrowing is higher than I’m comfortable with, I believe the firm will probably be able to gradually reduce debt over time. I don’t see any immediate threat to the dividend.

Analysts expect adjusted earnings per share to rise by 6% this year. With the shares trading on a forecast P/E of 13 and offering a forecast dividend yield of 5.2%, I’d rate British American Tobacco as a possible income buy.

Buy-And-Hold Investing

Our top analysts have highlighted five shares in the FTSE 100 in our special free report "5 Shares To Retire On". To find out the names of the shares and the reasons behind their inclusion, simply click here to view it immediately with no obligations whatsoever!

Roland Head has no position in any of the shares 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.