Income signal

Why shares in the Wolverhampton-based group have been so weak is hard to pin down. At 281p, the price is down 13 per cent on 2013 to date and the weakness began late in February as Carillion was about to report its 2012 results. These were packed with the usual corporate-speak banalities, but contained nothing that could be labelled 'alarming'. However, from that point, trading volumes in the shares - presumably driven by sellers - rose markedly compared with the early weeks of the year and the price fell away.

It has got to the point where the shares now yield 6.2 per cent; that's assuming a repeat of 2012's payout (although City analysts expect a touch more). History indicates that's a level at which it may be wrong to sell the shares - I put it no stronger than that. On the one hand, the average yield of the past five years is 4.8 per cent, indicating that whenever Carillion's shares yield something like today's 6.2 per cent, the price bounces. On the other hand, that could be a false conclusion since the shares have spent very little time yielding more than 6 per cent in the past five years and - ominously - almost all of that has been in the past 12 months.

In other words, runs the really bearish argument, the yield is trending upwards ahead of an inevitable cut in the payout. It's a concern that Carillion's record of cash flow can't refute that proposition conclusively. Free cash flow for the past six years has averaged £63m a year, while 2012's dividend cost £74m. That's not much of a shortfall, but it could not persist forever.

Yet it's equally feasible that the future could be better than the average since the figure was depressed by 2012's contribution when there was a free-cash loss of £40m. That was chiefly due to the - hopefully one-off - need to find working capital to replace the trade creditors whose 'loans' shrank by £159m during the year as Carillion ran down its UK construction activities. Exclude 2012 from the calculation and free cash flow for 2007-11 averaged £110m a year - plenty to cover the dividend. Couple that with the security of Carillion's £18bn order book (four years' worth of work at current rates) and it seems okay to hang on in the hope that the share price will rally in the coming months.

Besides, if I sell the Carillion holding, I get another dilemma. I have already earmarked the income fund's holding in foods processor and engineer Carr's Milling for disposal, yet there is a depressing paucity of replacement candidates. Assume that the pool comprises shares where the yield on the latest full-year payout is 3.8 per cent or more and the dividend was covered at least 1.8 times by earnings. If so, then there are just 51 candidates among London's listed shares. Add in qualifying shares on the Alternative Investment Market (Aim) and the total rises to 72.

I have always been reluctant to fish in the Aim pond, chiefly because its shares are ineligible for individual savings accounts (Isas). That may be narrow-minded, partly because by this time next year Aim shares are likely to be eligible for Isas (although don't imagine that investors will be allowed to drop existing Aim-quoted holdings straight into an Isa tax shelter). In addition, there is the small matter of an annual £10,600 allowance against capital gains tax, which should cover the profit on a decent-sized holding. So perhaps I should widen the search to include Aim stocks. In which case, shares in the likes of software supplier Dillistone (DSG), telecoms services group Maintel (MAI) and Finnish packaging group Powerflute (POWR) are all possibilities, with the added attraction that I know nothing about them. It could be fun finding out.

Mr Bearbull's income portfolio