A “year of considerable progress” is how Dairy Crest (LSE: DGC) CEO Mark Allen described the company’s results for the year to the end of March.
Published today, the figures show that the group, which produces the Cathedral City cheese brand as well as Clover spreads, Country Life butters and Frylight oils, saw a 10% overall rise in revenue for the period. Adjusted pre-tax profits — which strip out exceptional items — increased 3% to £63m.
The company has managed to achieve this performance despite “unprecedented cost inflation in the butters market,” thanks mainly to the exploding demand for Cathedral City. In fact, demand for cheese is so healthy that management is now planning to spend £85m on an expansion programme of its cheese and whey production facilities.
Keeping up with demand
“As a result of growing demand for cheese, the company expects cheese production capacity constraints within its existing facility at Davidstow in Cornwall in the coming years,” today’s earnings release notes. The firm is tapping institutional investors for £70m to fund part of the expansion, issuing shares equal to 9.98% of its current share capital at a price of 495p.
And with demand for its flagship product outstripping supply, Dairy Crest looks to me to be an excellent income investment. Indeed, rising demand for cheese should only boost the group’s bottom line, and with an operating profit margin in the low teens, the firm should have plenty of cash left to return to investors even after funding its investment programme.
At the time of writing, the shares a support of dividend yield of 4.3%, and City analysts expect the payout to rise at around 3% per annum for the next few years, a little faster than inflation.
However, I believe there is scope for these forecasts to be revised higher as Dairy Crest expands operations. As well as the bright dividend outlook, the stock also looks slightly undervalued. The shares trade at a forward P/E of just 14 based on current City numbers, which is a discount of nearly 20% to the broader food and tobacco industry sector.
Overall, Dairy Crest looks to me to be an undervalued, defensive income champion. On the other hand, I believe income investors should avoid struggling FTSE 100 security business G4S (LSE: GFS).
Weak balance sheet
After a string of high-profile disasters, G4S’s reputation is not as strong as it once was and growth has taken a hit in recent years.
However, City analysts are expecting growth to return with a vengeance this year. Analysts have pencilled in earnings per share growth of 20% for 2018, up from just 11% year-on-year for fiscal 2017.
Still, while growth is picking up, G4S’s balance sheet is weak and the group’s operating profit margin of 6.4% (for fiscal 2017) does not give much financial flexibility, which is concerning. After stripping out cash, net gearing (total debt compared to shareholder equity) is 180%, and that’s excluding a sizable pension deficit.
In my opinion, the best dividend stocks are those with wide profit margins and cash-rich balance sheets to protect against any unforeseen developments.
So, even though G4S might look attractive from an income perspective, with a dividend yield of 3.8%, the company’s weak balance sheet is enough to put me off the business.
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Rupert Hargreaves owns no share 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.