The Motley Fool

Why I’d shun this 6%-yielder an buy this FTSE 100 dividend instead

Image source: Getty Images

I don’t believe you should invest on gut instinct alone. But if my bad feeling about a company is backed up by the numbers, then I always avoid a stock.

One company that’s giving me bad vibes at the moment is cinema chain Cineworld Group (LSE: CINE). This FTSE 250 company floated in 2007 as a UK-focused business and was an outstanding success.

5G is here – and shares of this ‘sleeping giant’ could be a great way for you to potentially profit!

According to one leading industry firm, the 5G boom could create a global industry worth US$12.3 TRILLION out of thin air…

And if you click here we’ll show you something that could be key to unlocking 5G’s full potential...

However, in December 2017, management struck a deal to acquire US group Regal Entertainment for a total price of $5.8bn. At the time, Cineworld had a market cap of about £1.3bn. To fund this monster acquisition, the company raised £1.7bn by selling new shares in a rights issue and $4bn in new debt.

A high-risk bet?

From a business point of view, this deal may have been a good idea. I don’t have enough industry knowledge to be sure. But what I do believe is that this debt-fuelled deal has introduced a lot of extra financial risk for Cineworld shareholders.

At the end of 2018, the company reported adjusted net debt of $3,935.2m. That’s 3.7x adjusted earnings before interest, tax, depreciation and amortisation (EBITDA). Given Cineworld’s fairly average profit margins, I’d prefer to see this figure below 2.5x.

Operationally, things seem to be going well. So if debt repayment was management’s main focus, I’d probably give it the benefit of the doubt.

Overconfident?

Unfortunately, Cineworld’s management seem to want to have its cake and eat it.

The dividend was lifted by 17% last year and in June the firm announced an additional special dividend of $278m ($0.20 per share).

This cash represents half the $556m the firm has raised through sale-and-leaseback deals on 35 cinemas this year. The idea of the sale-and-leaseback deals was to reduce debt. But leases are a form of long-term liability, rather like debt.

Given how high Cineworld’s debt levels are, I think it’s reckless for management to use cash from property sales for shareholder returns.

CINE stock may seem cheap, on 9.8x forecast earnings and with a 6.1% dividend yield. But if growth slows, I think shareholders could be in for an uncomfortable ride. I won’t be going anywhere near this stock until the picture improves.

I’ve bought this pharma firm

I’m not completely against investing in companies with a lot of debt. One such firm I bought myself earlier this year was FTSE 100 pharma giant GlaxoSmithKline (LSE: GSK).

The shares have risen a little since I bought my shares, but I think the investment case remains strong. There are two reasons why I’m happy to own this stock.

The first is that I expect demand for modern medicines to continue to grow, as new treatments become available and emerging markets become wealthier.

The second reason is that I think Glaxo’s plan to split itself into a consumer health business and a pharmaceutical firm is likely to create value for shareholders. History suggests that two smaller, more focused businesses are likely to perform better than one larger conglomerate.

None of this is certain, but that’s how I expect things to turn out.

The market seems to agree. The rising GSK share price has now pushed the stock’s yield below 5%. I see this as a vote of confidence in chief executive Emma Walmsley’s plans. I continue to view Glaxo as a long-term buy, with long-term income potential.

“This Stock Could Be Like Buying Amazon in 1997”

I'm sure you'll agree that's quite the statement from Motley Fool Co-Founder Tom Gardner.

But since our US analyst team first recommended shares in this unique tech stock back in 2016, the value has soared.

What's more, we firmly believe there's still plenty of upside in its future. In fact, even throughout the current coronavirus crisis, its performance has been beating Wall St expectations.

And right now, we're giving you a chance to discover exactly what has got our analysts all fired up about this niche industry phenomenon, in our FREE special report, A Top US Share From The Motley Fool.

Click here to claim your copy now — and we’ll tell you the name of this Top US Share… free of charge!

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

Our 6 'Best Buys Now' Shares

The renowned analyst team at The Motley Fool UK have named 6 shares that they believe UK investors should consider buying NOW.

So if you’re looking for more stock ideas to try and best position your portfolio today, then it might be a good day for you. Because we're offering a full 33% off your first year of membership to our flagship share-tipping service, backed by our 'no quibbles' 30-day subscription fee refund guarantee.

Simply enter your email address below to discover how you can take advantage of this.

I would like to receive emails from you about product information and offers from The Fool and its business partners. Each of these emails will provide a link to unsubscribe from future emails. More information about how The Fool collects, stores, and handles personal data is available in its Privacy Statement.