The Motley Fool

Why I’d bin this 8% yielder and what I’d buy instead

Car reseller Lookers (LSE:LOOK) has some really attractive headline figures. A dividend nearing 8%, trading at an excessively cheap four times price-to-earnings ratio and the share price has gained 15% after an all-time low. So is it worth a punt?

As they say in the used car game: always look under the bonnet. You might drive away with what you think is a great deal before it craps out on you and you’re left stranded.

Margins remain tight at 111-year-old Lookers. In 2018, revenue was £4.87bn and profit before tax was £53m. The year before? Revenue was £4.69bn and pre-tax profit £58m.

Higher revenue and lower profits is never good news but the shares tanked 20% in June on news that the Financial Conduct Authority watchdog was probing sales processes for the first six months of 2019. It could mean large fines and a costly restructuring. In response, management spent £10m on an internal review, including £3m on staff retraining, changing sales processes and a detailed review of past business. 

Opportunity costs

Falling pre-tax profits of nearly 30% for the first half of 2019 represented “an ongoing backdrop of challenging UK market conditions“, according to chief executive Andy Bruce. The UK car market is weak and Lookers’ rivals have been feeling the pain of sales slumps too. Prospects of a no-deal Brexit means less spending by big companies on fewer fleet buys, which make up a large proportion of the leasing side of the business.

Earnings per share are slated to plunge from 15.1p to 8.3p per share between now and 2020. Declining profits and falling EPS will put serious pressure on that headline 8% dividend. Buyer beware.

Energy boost

FTSE 100 stalwart Royal Dutch Shell (LSE:RDSB) is currently trading at under 10 times earnings, with a 6.4% dividend on the cards. The energy giant reports its earnings in dollars, which means it is less likely to be affected by a plunging pound in the wake of October’s potential no-deal Brexit.

Dividends per share have been rock solid over the past 10 years, as well as increasing year-on-year. Payouts haven’t dropped below 6.5% since 2014 and cover is better than any time over the last five years with analysts expecting it to rise from 1.3 to 1.6 times earnings.

Shell is almost exactly the same age as the century-old Lookers, but operates with much more efficiency. The future looks bright too. Falling natural gas prices are an issue, but Shell is transitioning away from fossil fuels at a rapid rate. A takeover of First Utility in early 2019 saw it switch 700,000 UK households to 100% renewable energy, including biomass. This shows that chief executive Ben Van Buerden knows which way the wind is blowing.

There’s a reason Shell tends to show up in the UK’s most popular funds. Its valuation looks attractive to me as it trades near its 52-week low. While it’s no small-cap rocket, growth prospects are strong at 6.6% year-on-year and management has indicated it will keep up with $10bn a year of share buybacks to increase shareholder value.

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Tom holds no position in 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.