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Why I’d ditch big faller Galliford Try and buy this FTSE 100 7% dividend

Shares in construction and housebuilding firm Galliford Try (LSE: GFRD) fell by more than 15% when markets opened on Tuesday after the firm issued a profit warning.

Predictably enough, the warning came from the company’s construction division, which is suffering yet more cost overruns on major projects. Management is carrying out a review of construction operations. It has warned that pre-tax profit for the year is now expected to be £30m to £40m below the consensus forecast of £156m.

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Should shareholders sit tight and hope things improve? Or should they sell now in case there’s more bad news in next month’s scheduled trading update?  This is what I’d do.

A difficult place to make money

The construction business is notorious for its slim profit margins and regular cost overruns. It’s a tough place to make money.

Personally, I’ve had a number of bad investing experiences in this sector in recent years. I’m starting to think that for equity investors, construction firms are best avoided. I reckon this kind of business is better suited to long-term private owners who are happy to accept big dividends in good years and support losses during bad years.

A turnaround buy?

Galliford boss Graham Prothero says that the firm will now scale back its construction activities and focus on sectors “with sustainable prospects for profitability and growth, where we have a track record of success.”

You might wonder why it wasn’t doing this already… Leaving that aside, the group’s housebuilding business, Linden Homes, appears to be performing well. And after today’s share price fall, I estimate that Galliford stock trades on about six times 2019 forecast earnings, with a dividend yield of about 8%.

Those figures could be attractive, if they’re sustainable. Is the stock a turnaround buy? I don’t know. But I’d prefer not to take the risk. I’d rather buy a top-performing pure housebuilder at this point in the market cycle.

Biggest and best?

As the political outlook in the UK remains uncertain, I think it makes sense to focus on big, profitable housebuilders with happy customers. One company that ticks all of these boxes is FTSE 100 homes firm Barratt Developments (LSE: BDEV).

Barratt completed nearly 18,000 homes in 2018, making it the UK’s largest housebuilder. Both profits and profit margins increased last year as well, while the company gained a five-star customer satisfaction rating in the annual Home Builders Federation survey.

Looking ahead, the group is developing new housing designs and trialling new methods of construction. These are aimed at cutting build costs while maintaining the finished quality of its homes.

In my view, increased use of modern construction technology is a big opportunity for British builders. Most houses are still built using techniques and materials that haven’t changed in my lifetime. That’s not true in any other industrial sector.

Barratt says that it “aims to use modern methods of construction” in 20% of homes by 2020. I see the firm’s focus on this area as a major positive that could put it ahead of rivals.

The right time to buy?

The shares currently trade on nine times 2019 forecast earnings, with a 4.3% ordinary dividend yield plus a special payout that should take the total yield to 7.1%. These extra cash returns will probably come to an end at some point, but I see Barratt as a stock that’s still worth buying today.

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Roland Head 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.