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Is it time to buy shares in this Neil Woodford-backed 5%-yielder?

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I wrote about Topps Tiles (LSE: TPT) in October when the firm released its positive full-year trading update. The shares were up around 10% on the day and I speculated that Neil Woodford would have been pleased because he had a  chunk of the shares in his Woodford Income Focus Fund.

Today, the firm revealed its full-year results report, which puts meat on the bones of the last update. In the period between the two news releases, the share price has been volatile, which isn’t surprising given the convulsions in the wider market. However, despite bouncing up and down a bit, the stock has held its own and is close to the level it was at the beginning of October. I see that as positive because many small-cap shares have plunged by 30% or more.

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Operational and share-price volatility

Topps Tiles is perhaps one of the most cyclical firms you could invest in. I reckon tiles would be on the list of the first things that people will remove from their domestic budgets in tough economic times. It’s often easy to postpone the refurbishment of a kitchen or a bathroom, which means the incoming cash flow and profits for the firm can ebb and flow. Looking at the firm’s financial record reveals the operational volatility. Adjusted earnings per share rose 22% in the trading year to September 2014, 23% in 2015, 8% in 2016, and the declining trend continued into 2017 with a 14% fall. Today, the firm reported another fall at 13% for 2018 and City analysts following it expect a further decline of 2% in earnings for the year to September 2019.

It has been a case of two steps forward and then two back again, which has led to the stock languishing where it is. But one outcome is that the valuation looks low and the dividend yield high, at 5% or so, which seems to be one of the main things that attracted Neil Woodford. He said recently that he believes domestic companies are unloved and undervalued because they are already pricing in an overly bleak scenario for the UK’s economic future. My guess is that he would consider Topps Tiles as fitting that category.

The chief executive Matthew Williams said in the report that the firm had doubled its market following the September 2017 acquisition of Parkside Ceramics, which operates in the commercial sector rather than in the domestic sector. The overall market has been challenging during the year, but Williams points to “market-leading” gross margins in the retail division as one of the positives, although sales were flat year-on-year.

Mixed outlook

Looking forward, he is “cautious” and said that the new trading year has been “challenging” so far. Like-for-like sales in the first eight weeks “have been negative against a strong prior year comparator.” However, he is optimistic about the longer-term outlook for expansion in the commercial division.

The business looks like it is under strain to me. Whereas the dividend and valuation look attractive at first glance, I’m mindful that out-and-out cyclical firms ‘always’ look at their most attractive when they are at their most dangerous. I don’t share Neil Woodford’s enthusiasm for the stock and I remain cautious on Topps Tiles.

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Kevin Godbold 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.

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