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Here’s a 4.5% yield I’d avoid and what I’d buy instead

The stock market reacted to this morning’s full-year results report from FTSE 250 housebuilder Bellway (LSE: BWY) by marking down the shares. They’re around 6% lower as I write.

Yet the headline figures look pretty good. Revenue rose 8.6% compared to last year, and earnings per share lifted by 3.4%. The directors pushed up the total dividend by a little over 5%. I think the catalyst for the fall in the shares can be found in the outlook statement.

Favourable conditions

Looking ahead, the company said in the report that demand for “affordably priced, good-quality” housing in the UK is greater than the supply of new housing available in the market. Indeed, the demand for housing has been ratcheted up by the ongoing availability of the government’s Help-to-Buy scheme, which stimulates the market along with the current environment of low interest rates. 

On top of that, the land market remains “attractive” and the planning environment “favourable”. In such conditions, Bellway continues to trade well and has a “clear” strategy for long-term and disciplined volume growth.

But there’s a hitch. The directors said in the report they are “mindful” that the uncertainty of Brexit “could pose a threat to consumer confidence”. And they issued what I think reads a bit like a mild, caveated profit warning. Assuming market conditions remain favourable, they said, the strong order book, ongoing investment in land, and work in progress “should” lead to “more moderate” volume growth in the year ahead. I reckon that assessment could be what pulled the rug from the share price today.

In fairness, though, the shares shot up by more than 10% at the end of last week, along with UK-facing bank shares and the pound sterling, when the UK’s negotiations with the EU switched to a more positive tone. Such movements serve to demonstrate how cyclical the housebuilding business is and how responsive Bellway’s shares are to macroeconomic news and political news that could lead to changes in the economic outlook.

Brexit could cause a down-cycle

It’s not that Bellway is bothered by the mechanics of Brexit, though. It gets most of its materials from suppliers in the UK with a “limited number” of its supply chain partners manufacturing stuff such as electrical appliances and ceramic tiles in Europe. Those European suppliers have considered “alternative” trade routes to bring goods into the UK and have increased their stock levels to make sure they have materials available if there are delays at ports.

Meanwhile, the stock looks superficially attractive with its dividend yield running near 4.5%. However, I wouldn’t buy shares in an out-and-out cyclical company like this that has been trading with robust profits for a few years while sporting a low-looking valuation. My suspicion is the firm could be trading near the top of its earnings cycle and profits, the dividend and the share price could cycle down sometime soon. Perhaps Brexit will be the catalyst for that.

In this case, I’d rather spread my risk over many underlying companies by investing in a tracker fund such as the HSBC FTSE 250 Index Inclusive, which follows the UK’s mid-cap index, including Bellway.

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Kevin Godbold has no position in any share 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.