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Is Persimmon the best bet among the high-yielders?

The Consumer Prices Index (CPI) rose by 9 per cent in the 12 months to April 2022, up from 7 per cent in the prior month. We will have to wait till 22 June for May’s rate to be announced, giving investors pause for thought on the wealth preservation front, with central banks' liquidity policies the prime determinant in equities markets right now.

There will be some investors whose portfolios have been designed to sail serenely though the ongoing market volatility, while others may have liquidated their growth stock positions in favour of low beta options. Beyond equities, mounting macro uncertainties are manifest in the expanding negative absolute returns on fixed income securities. Analysts at Schroders recently pointed out that this could signal that “the opportunity and yields available to investors are now more attractive than they have been at any point during the last 10 years, with the exception of the Fed hiking cycle of 2018”.

That’s encouraging in a sense. But it could be argued that it’s simply a ‘glass half-full’ scenario, partly based on the view that inflation may be peaking and that the hawkish path of central banks is already discounted into markets. The latter assumption seems reasonable enough, yet it’s hard to imagine that inflation may have peaked given the trajectory of energy and input prices, along with the tightness in labour markets. Indeed, it is probable that central banks will continue to turn the screw if unemployment remains low.

With absolute returns on fixed income in the doldrums and inflation on the loose, it’s likely that investors will be re-examining the income component of their portfolios. It’s interesting to note that a handful constituents within the FTSE 350 index come with dividend yields that are on par with the CPI increase, although any metric is meaningless in isolation and a company’s dividend yield is simply a function of the market. Tellingly, most of the stocks in question have seen their valuations march back in the year-to-date. Some even have dividend restrictions contained in their debt agreements, yet another hangover from the pandemic.

A company such as Rio Tinto (RIO) is certainly worth examining given the growth in its distributions since 2017 and apparent willingness to return 'excess' profits via special dividends. Naturally, the miner’s ability to fund further increases is largely intertwined with global iron ore demand, hardly a positive dynamic with stagflation on the horizon. Another high-yielder like Imperial Brands (IMB) has attractions linked to demand inelasticity as household budgets tighten, but its ability to maintain, let alone increase, its distribution rates must be imperilled by its huge debt overhang in a rising interest rate environment.

One seemingly unfancied stock, Persimmon (PSN) – now trading at a 10 per cent discount to its 200-day moving average – might provide surer footing on the question of distributions even as the housebuilding industry is beset by challenges on multiple fronts.

Last year, the company was caught up in a leasehold scandal and was forced to refund unfair ground rents to leaseholders following an investigation by the Competition and Markets Authority.

In April, it became the second major housebuilder to announce that it had signed the proposed cladding pledge in response to the Grenfell fire inquiry. Persimmon has historically built low-rise housing for the most part, so it anticipates that its initial £75mn remedial provision will suffice.

Add in rising interest rate and construction costs, the gradual cessation of ‘right-to-buy’ schemes and some potentially unhelpful provisions within the government’s proposed Levelling Up and Regeneration Bill, and it’s not difficult to appreciate why sentiment towards the housebuilding sector is mixed at best.

Yet Persimmon closed out 2021 with a quick ratio of 1.6 and total debt equivalent to 0.4 times cash profits, or negative 0.8 on a net basis. Taken together, this points to strong optionality on discretionary payments. And the quality of the company’s earnings is reflected in a cash flow/total assets multiple of 4.9. Inflation is certainly a material issue, although strength in house prices is expected to offset 4.5-5.0 per cent build cost inflation for the year.

Things have changed slightly in the interim period. Persimmon held £446m of cash at 22 April, after returning £399m to shareholders and investing £314m in land assets. The current forward sales position stands at £2.8bn and volume growth for the full year is anticipated at 4-7 per cent on 2021 levels. In terms of valuations, the enterprise/cash profit multiple has stretched in recent years, although it doesn’t necessarily indicate that the stock is overvalued. Indeed, the shares are down by 28.7 per cent over the last year and trade at a 25 per cent discount to the FactSet consensus with a prospective dividend yield of 9.1 per cent.

Persimmon

 Dec '21Dec '20Dec '19Dec '18Dec '17
Total Cash     
Previous Balance Sheet Amt + Cash Inflows2,0071,5961,6031,7891,723
Cash Flow     
Free Cash Flow764747593639806
Net Operating Cash Flow785766620654824
Capital Expenditures-20.9-18.9-27.5-15.5-18
Interest Expense3.74.14.23.93.9
Mergers & Acquisitions0.90.80.70.50.3
Business Divestitures0.90.80.70.50.3
Purchase/Sale of Investments1.8nil0.9nilnil
Other Fundsnil-2.4-47.2-159.9-3
Cash Increase/Decrease770.3749.1551.1483.3807.2
Debt     
Debt Issuancenilnilnilnilnil
Interest Expense-3.7-4.1-4.2-3.9-3.9
Repayment of Debtnilnilnilnilnil
Cash Received (Paid) from Debt Activity-3.7-4.1-4.2-3.9-3.9
Dividends     
Common Dividends-750-351-748-732-417
Dividends Paid-750-351-748-732-417
Cash     
Net Change in Cash (FX Adjusted)19.6397.4-197-251.4389.7
Cash on Balance Sheet1,246.61,234.1843.91,048.11,302.7
Source: FactSet