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One FTSE 250 dividend stock I’d buy ahead of this 7% yielder

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Shares of housebuilder Crest Nicholson Holdings (LSE: CRST) fell by 12% when markets opened on Wednesday. The slide was triggered by the company’s warning that rising costs and flat prices are putting profit margins under pressure.

Management now expect the group’s operating margin for the full year to be “around 18%”. That’s below last year’s margin of 20% and is at the bottom end of the group’s target range of 18%-20%.

What’s gone wrong?

Housing completions rose by 17.6% to 1,251 units during the six months to 30 April, while average open market selling prices rose by 5% to £439,000. These figures seem positive, but they hide two problems.

The first is that it’s taking longer to sell more expensive houses, due to “a slow second-hand market” in the south of England. The group’s sales rate excluding private rental sector (PRS) projects fell from 0.77 sales per outlet per week last year to just 0.72 during the six months to 30 April.

The second problem is that the £439,000 average selling price excludes homes built for private rental sector (PRS) projects. PRS housing forms a growing part of the group’s business, but the pricing of these cheaper properties is failing to keep up with rising costs.

We can see this from the information the group provides about its order book. Total forward sales rose to 2,079 units with a value of £441.7m during the first half. This works out at an average selling price including PRS of £212,500.

That’s only 1% more than the average of £210,400 reported at this point last year. But Crest says that the cost of building houses is expected to rise by 3%-4% this year. So it’s easy to see how rising costs could be cutting into the group’s profit margins.

Is the 8% yield safe?

After today’s fall, the stock trades on a 2018 forecast P/E of 6.1 with a prospective yield of about 8%. I don’t think the dividend will be cut this year, but if current trends continue, next year’s payout could come under pressure.

In my view, now probably isn’t the right time to buy these shares. After such a long housing boom, I think it’s important to focus on companies whose profitability is improving. I’d avoid weaker players with falling margins.

My top housing pick

The only housebuilding stock I own at the moment is FTSE 250 firm Redrow (LSE: RDW). During the first half of this year, the Flintshire-based firm said operating profit rose by 22% to £175m. Redrow’s operating profit margin rose to 19.7%, compared to 19.5% last year.

The profitability of these two groups is similar, but they appear to be moving in opposite directions. In situations like this, I believe the trend is your friend. I don’t think it’s the right time to be making contrarian bets on housebuilders, as the whole market remains quite highly priced in my view.

Still a buy for me

Redrow trades on a 2018 forecast P/E of 8 with a forward yield of 3.7%. This payout is more modest than some others but it should be covered 3.4 times by earnings this year, compared to 2 times cover for the Crest Nicholson dividend.

While housing market conditions remain stable, I continue to rate Redrow as a buy.

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Roland Head owns shares of Redrow. The Motley Fool UK has recommended Redrow. 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.