Until last year, Lancashire Holdings (LSE: LRE), a favourite of the star fund manager Neil Woodford, had one of the best dividend records in the FTSE 250.
From its IPO to 2017, the insurance group had distributed more than 100% of its earned profits to investors, giving an average annual dividend of more than 7%.
Unfortunately, a series of devastating natural catastrophes last year hit the insurer’s bottom line and, as a result, for the first time since going public, Lancashire didn’t issue a full-year special payout.
Unique dividend model
Because of the nature of the insurance business, Lancashire has adopted a unique dividend model. The company distributes a small dividend once every quarter and once a year, and (towards the end of the year) it declares a large distribution paying out any excess profits.
Last year, the group skipped the payout as insurance losses wiped out profits for the whole year, leaving little for investors. This year, however, analysts expected the company to reinstate its special annual payout. Current projections estimate a total dividend of $0.44 for 2018, rising to $0.59 for 2019. Based on these numbers, the stock could yield 5.8% and 7.7% for 2018 and 2019, respectively.
I believe these figures might be a tad optimistic, especially for 2018, as today the company revealed that catastrophe losses in the third quarter will now wipe out all of the firm’s profit for the period. While management still expects a positive result for the full-year, a Q3 loss could mean a lower distribution than the City expects for 2018.
Still, despite the short-term drop in profitability, I’m positive on the long-term outlook for this business. I think now could be a great time to buy the stock.
Indeed, right now, shares in the Lloyd’s of London insurer are trading at a forward P/E of just 11. What’s more, insurers tend to overestimate losses when they are first announced, so I’m optimistic that Lancashire’s initial losses for the third quarter will not turn out to be as bad as expected. With this being the case, I’m looking to add to my position in the next few days.
If Lancashire is not your cup of tea, another income play that currently looks cheap to me is Jupiter Fund Management (LSE: JUP).
There’s a lot to like about this City institution. For a start, the stock currently supports a dividend yield of 7.1%, and trades at a forward P/E of just 11.9. Earnings growth has allowed management to increase the firm’s payout at an average annual rate of 14.2% for the past six years.
And I’m struggling to see why the market has awarded the company such a low valuation. Earnings per share (EPS) are expected to contract by approximately 3.3% for 2018 to 32.7p, which is disappointing. But a recovery, albeit a small one, is scheduled for 2019 when EPS growth is projected to be in the region of 0.6%. Not much, but better than a decline.
The one red flag that I can see here is that Jupiter’s dividend is only covered 1.2 times by EPS, below what I’d usually consider comfortable for a dividend. Typically, I’d want to see a cover of 1.5 times, or more. However, I’m willing to overlook this weakness as Jupiter has £313m of cash on its balance sheet, enough to sustain the distribution for two years in the worst case scenario.
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Rupert Hargreaves owns shares in Lancashire Holdings. 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.