Shares of plumbing and heating distributor Ferguson (LSE: FERG) recently hit six-month highs, trading up to 5,650p. The stock, which has been beaten down due to concerns about a slowing housing market, presents a good opportunity for income investors looking for a safe dividend yield, I believe.
As reported by my colleague Peter Stephens, Ferguson recently released a quarterly trading update, the results of which were largely in line with investor expectations. Revenue grew 6.2% year-on-year, and operating profits rose 2.3% on the back of improving gross margins. Additionally, a strong quarterly operating cash flow of £502m allowed management to announce a £397m share buyback scheme.
Ferguson relies heavily on its business in the US, where it generates more than 80% of its revenues, and more than 90% of profits. In fact, it was fears about the US housing market specifically that have been the reason why its shares have been depressed over the last 12 months. Stateside economic data has been a little worrying as housing starts are down, and home sales are declining in many major urban areas. On the other hand, if the Federal Reserve decides to cut rates in the near future, that would boost mortgage applications.
In any case, predicting the housing market is famously difficult. But what I like about Ferguson is its strong balance sheet (it has a net-debt-to-EBITDA ratio of just 0.6) as well as its robust cash flow.
Activist investor takeover
Earlier in June, shares of Ferguson spiked sharply on news that American activist investing firm Trian had taken a sizeable stake in the business. Headed by billionaire Nelson Peltz, the fund is known for seeking out undervalued businesses and investing in turning them around. In a statement, the fund commented: “Trian believes that Ferguson is an attractive business that trades at a discount to comparable US peers.” The move has made Trian the second-biggest shareholder in Ferguson (behind Blackrock), meaning that we should probably expect a hands-on approach with management.
A safe dividend?
To me, Ferguson seems like a good income play because of the apparent safety of its dividend. Although it currently yields just 2.8%, its strong cash flow more than covers the payments. Moreover, it has a great history of returning excess cash to shareholders, meaning that there could be dividend hikes in the future.
Overall, the current price of Ferguson shares is more reflective of the market’s general apprehension than of any real weakness with the business itself, I think. Even in a worst-case scenario where the US housing market takes a tumble, I believe that Ferguson would be comparatively better-positioned than many of its competitors in the space. I think that the combination of safety and a real possibility of increased payouts makes Ferguson a better income play than a lot of the high-yield FTSE 100 stocks out there.
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Stepan Lavrouk has no positions in any 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.