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Why I’d avoid this FTSE 250 falling knife and buy the ITV share price

Some high-yield dividend stocks are genuine bargains. But some have ‘sell’ plastered all over them. Today, I want to look at one example of each, starting with a stock I own, FTSE 100 broadcaster ITV (LSE: ITV).

Why I’d buy this 6% yield

ITV’s latest results were given a cautious reception by the market. The shares fell slightly on the day but have since recovered, trading up by about 6% so far in 2019. In my view, the firm’s results reflect the changing nature of its business, as it shifts from advertising-funded television to online subscription services.

The need for this change is clear. In 2018, viewing of ITV’s conventional television channels rose by 1%. Online viewing rose 32%. To address this changing landscape, it’s teaming up with the BBC to launch BritBox, a new online streaming service.

The two broadcasters hope that their huge library of popular British drama will prove a draw for paying customers in the UK and overseas.

The numbers look good to me

Investors’ big fear is that advertising revenue will fall too fast for the ITV Studios programme-making business to make up the shortfall.

The success of BritBox remains to be seen, but personally I think ITV is already making good progress at diversifying its income.

In 2018, ad sales rose just 1%, but revenue from the Studios production business rose by 6% to £1,670m. The business now generates 50% of ITV’s revenue, and more than 30% of its profit.

Despite the growth of online streaming services, the broadcaster also remains very popular, with a 23% share of UK television viewing.

Last month’s figures didn’t flag up any major concerns for me. The group’s operating margin edged higher to almost 19% in 2018 and the 6% dividend yield remains covered by earnings and free cash flow.

With the shares trading on less than 10 times forecast earnings, I think the stock looks too cheap for such a profitable business.

I’m avoiding this flyer

The satellites owned by communications provider Inmarsat (LSE: ISAT) fly high above us. But they face tough competition and the group’s profits have fallen 63% over the last five years.

Unfortunately, heavy spending on new satellites means that Inmarsat’s borrowings have been rising. Net debt has risen from $1,900m in 2014 to $2,176m today. That’s now 17 times the company’s after-tax profits, up from 5.5 times in 2014.

What’s even worse is that broker forecasts indicate that Inmarsat’s earnings are expected to fall by a further 46% in 2019, from $0.32 to $0.17 per share.

The company’s return on capital employed, a measure of profit compared to money invested in the business, has fallen from 12% in 2014 to just 6.9% in 2018. That’s barely any higher than the 5.7% paid by the firm on its borrowings last year. In my view, the company is running to stand still at the moment.

I expect things to get worse

Chief executive Rupert Pearce has already cut the dividend, but my sums indicate the firm has had to borrow cash to afford even this reduced payout. With profits crumbling, I think the dividend should be suspended altogether.

Spending on new satellite services isn’t expected to slow until 2021. I expect debt to continue rising. In my view, shareholders face the risk of another dividend cut and might even be asked for fresh cash. I’d avoid this stock until profits start to recover.

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