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I’d avoid this Neil Woodford 7% dividend stock and buy this 5%-yielder instead

Investors in former FTSE 100 doorstep lender Provident Financial (LSE: PFG) may be wondering if things can get any worse.

Their shares have fallen by 75% over the last two years, as the firm has struggled to recover from a botched restructuring and regulatory problems. A once-generous dividend has been cut by about 90%.

This sad story has now taken an unexpected twist. As I’ll explain, I think it might be time for shareholders to move on.

Woodford backs surprise takeover

Fund manager Neil Woodford owns 25% of Provident Financial. He also owns nearly 24% of the firm’s much smaller rival, Non-Standard Finance (LSE: NSF). This company was founded in 2014 by John van Kuffeler, who was previously Provident Financial’s chief executive.

NSF has been a disappointing investment so far. Since floating on the market in 2014, it’s reported losses every year. The firm’s shares have fallen by about 40%.

Woodford appears to think that Provident and NSF would do better if they pooled their resources. Along with his former employer Invesco, he’s backed a takeover offer by NSF for Provident Financial.

NSF has a market-cap of about £183m — it’s roughly 15% the size of Provident, at £1.3bn. So the deal will be an all-share affair. NSF is planning to issue Provident shareholders with 8.88 new NSF shares for each Provident share they own.

At the time of writing, the deal valued Provident stock at 532p, a premium of less than 5% to Thursday’s closing price. The deal already has the backing of Woodford, Invesco and another firm. Collectively, they control 50% of Provident shares, so this takeover seems almost certain to proceed.

My view

Provident’s recovery hit a stumbling block in January when it warned losses from bad debts would be worse than expected. The group’s turnaround was certainly taking longer than expected, but progress was being made. Analysts had pencilled in a 10% rise in earnings for 2019, and forecast a dividend yield of about 7%.

Van Kuffeler claims that Provident has “lost its way.” But, in my opinion, combining two under-performing companies is not generally a good way to create one good company. A complicated restructuring will now be required, along with several divestments.

In my view, there’s too much risk and complexity in this deal. I’d avoid NSF and Provident Financial.

This is what I’d buy instead

I don’t own every stock I write about favourably. But one stock I do own is sub-prime lender Morses Club (LSE: MCL). Woodford Funds also has a stake in this firm, but it’s only 9.3%. Woodford’s investors may wish that the fund manager had taken a larger stake in Morses Club’s flotation. Since floating in 2016, the firm’s shares have risen by about 45%, and paid a string of generous dividends.

The business took advantage of Provident’s problems in 2017 to increase its market share. Profit margins have improved too, and it generates a return on equity of about 25%.

The shares currently trade on 11 times 2019 forecast earnings, with an expected dividend yield of 5.1%. The business has very little debt and continues to look good value to me. I hold the shares and continue to rate them as a buy.

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Roland Head owns shares of Morses Club. 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.