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Here’s why I’m avoiding the Royal Mail share price and buying this dividend stock instead

Since announcing in May it would be slashing its dividend by 40% to help fund CEO Rico Back’s Journey 2024 turnaround strategy, shares in Royal Mail (LSE: RMG) have been treading water. That suggests many investors are giving the stock a wide berth until they see clear signs of an improvement in trading.

Based on the market’s rather lacklustre response to today’s short company update (released to coincide with its AGM), I can’t see this situation changing anytime soon. 

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According to management, Royal Mail’s performance in the first quarter of its financial year had been as expected. The outlook for 2019/20 was reiterated and all targets left unchanged. Considering the ongoing decline in letter volumes and the recent fall in advertising revenues as a result of GDPR, I suppose that’s the best existing holders could have hoped for. 

Today, Royal Mail’s shares can be picked up for just 9 times forecast earnings. That’s certainly cheap relative to the market as a whole, but I’m not inclined to think it represents a ‘bargain’ for prospective investors

Aside from ongoing problems in the business and the threat of a Jeremy Corbyn-led government seeking to renationalise it, I don’t think the chances of a further cut to the dividend can be easily dismissed either.

Royal Mail has said it will pay 15p per share to holders in the new financial year. This gives a forecast yield of 6.9% — still rather high for a company going through such a sticky patch.

Moreover, the extent to which this payout will be covered by profits is already looking rather low. A slight deterioration in trading will be all that’s needed to put the payout at risk of being cut further. And as things stand, there’s nothing to reassure me that this won’t happen. Put simply, I suspect there are far better opportunities for generating income elsewhere.

Coincidentally, one such company also reported to the market today.

Rising dividends

It may not have the lure of some stocks, but I continue to believe kettle safety control supplier Strix (LSE: KETL) is a great option for dividend hunters. Today’s trading update for the six months to the end of June showcased the kind of stability Royal Mail can only dream of.

Strix’s management is confident the company has traded in line with market expectations for the full year, despite ongoing political and economic uncertainty.

In addition to saying it had maintained its global share of the kettle control market, the firm also remarked it hadn’t suffered “any material impact” from US/China trade tariffs, thanks to the flow of goods being maintained between the Isle of Man and China.

Perhaps most importantly for holders, the £300m-cap disclosed that recent performance and strong cash generation would allow it to pay a total dividend of 7.7p per share for the financial year just gone (a 10% increase on FY2018). Based on today’s share price of a little under 160p, that gives a trailing yield of 4.8%. 

Yes, the shares might be slightly dearer than those of Royal Mail, but a forecast price-to-earnings (P/E) ratio of just 10 looks great value to me, considering the healthy dividend increase and the prospect of new appliance launches later in the year further supporting earnings growth. 

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Paul Summers owns shares in Strix. 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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