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11 safe yield shares

High yields are often accompanied by high risks and many of the UK's erstwhile dividend stalwarts have been cutting payouts. My Safe Yield screen hopes to identify stocks that will grow their dividends by not being too greedy in the level of yield it demands
July 16, 2019

The screen I’m reviewing this week attempts to hunt for safe yields. Over recent years UK investors have been given plenty of reasons to doubt the safety of many high-yielding shares. Recent examples of high-profile dividend cuts include Vodafone and Marks and Spencer. More dividend stalwarts may well follow, whether due to declining cash generation from mature capital-intensive businesses (the Vodafone example) or threats to the business from industry disruption (Marks and Spencer). 

One way investors can seek to avoid dividend disappointment is simply by not being too greedy. At a time when many government bonds around the world offer low or even negative yields, income hunters should view with extreme suspicion any share that offers a dividend yield of over 7 per cent – or perhaps even 6 per cent. Indeed, the fact that the FTSE 100 index currently yields 4.8 per cent can be interpreted more as a reflection of the challenges faced by many of its key constituents rather than an indicator of value.

While the need to treat high yields with caution seems particularly pertinent at the moment, extreme valuation has always served as an important warning for investors. That’s a key reason my Safe Yields screen does not set an overly aggressive target for the income it expects from shares. The screen’s key dividend test is that shares should offer a historical yield of 3 per cent-plus.

But despite this low bar, the results from this screen over the past two years have been far from immune to dividend disappointments. In fact, the screen has been disappointing in terms of both output and performance. 

In terms of output, few shares have passed all the screens tests, leading me to have to rely on weakened screening criteria. In terms of performance, it is lucky the criteria was weakened because those shares passing all the screen’s tests have done spectacularly badly. The four shares that passed all the criteria last year produced a torrid negative total return of 21.9 per cent compared with a negative 0.3 per cent from the broader selection and 1.6 per cent from the FTSE All-Share (the index screened).

2018/19 PERFORMANCE

NameTIDMTotal return (17 Jul 2018 - 11 Jul 2019)Criteria used
TarsusTRS48%WEAKENED
Telecom PlusTEP33%WEAKENED
Barratt DevelopmentsBDEV29%WEAKENED
UnileverULVR23%WEAKENED
Liontrust Asset Man.LIO23%WEAKENED
Sirius Real EstateSRE17%WEAKENED
Big YellowBYG10%WEAKENED
Tritax Big Box ReitBBOX8.8%WEAKENED
HeadlamHEAD7.6%WEAKENED
RPCRPC6.3%FULL
Mj GleesonGLE6.0%WEAKENED
RedrowRDW5.5%WEAKENED
Taylor WimpeyTW.1.4%WEAKENED
ForterraFORT-1.3%WEAKENED
BellwayBWY-2.1%WEAKENED
Brewin DolphinBRW-2.6%WEAKENED
ChesnaraCSN-3.0%WEAKENED
PlaytechPTEC-8.7%FULL
Morgan SindallMGNS-13%WEAKENED
RankRNK-14%WEAKENED
PersimmonPSN-15%WEAKENED
CarnivalCCL-18%WEAKENED
InchcapeINCH-22%WEAKENED
PagegroupPAGE-26%FULL
Babcock Int'lBAB-43%WEAKENED
CostainCOST-59%FULL
FTSE All-Share 1.6% 
Safe Yields -0.3% 

Source: Thomson Datastream

 

While recent years have been tough for this screen, it has a strong long-term track record. In the eight years I’ve monitored it, it has produced a 149 per cent cumulative total return compared with 79 per cent from the FTSE All-Share. The screen results are considered to be a source of ideas for further research rather than off-the-shelf portfolios. If we add in a notional 1.5 per cent charge to take account of the real world costs that would be involved in dealing in and out of portfolios each year, the cumulative return drops to 121 per cent.

The full screening criteria are as follows:

■ Dividend yield of at least 3 per cent.

■ Dividend cover of at least two times.

■ Interest cover of at least five times.

■ Dividend growth in each of the past three years.

■ Forecast earnings growth in each of the next two financial years.

■ An average return on equity over the past three years of at least 12.5 per cent.

■ Cash conversion (measured as cash from operations as a percentage of operating profit) of over 100 per cent.

■ A market capitalisation of at least £250m.

■ Beta of 0.75 or less.

This year only one stock passed all the screen’s tests, while a further 10 passed the weakened version of the screen which allows stocks to fail one test as long as it is not the dividend yield test. Details of the shares can be found in the table below and I’ve taken a look at the two of the lower-yielding stocks from the table on the basis that they may offer more reliable payouts. Both stocks have strong dividend records. All the same, I feel one makes a good safe yield option, with a caveat, but I’m more dubious about the other fitting the bill. 

 

CompanyTIDMMkt capPriceFwd NTM PEDY3-yr DPS CAGRFY EPS gr+1FY EPS gr+23-mth mom3-mth fwd EPS upgradesNet cash/debt (-)BetaTest failed
Paragon BankingPAG£1.1bn443p94.7%21%7.3%7.1%-1.7%--£5.7bn0.72CashCnv
Morgan SindallMGNS£521m1,166p84.5%22%0.6%7.8%-8.4%-£160m0.81Beta
MJ GleesonGLE£429m786p134.4%43%8.8%9.7%-0.7%-£28m0.68CashCnv
Sirius Real EstateSRE£683m67p164.3%15%5.3%13%3.0%--€296m0.13CashCnv
Polymetal Int'lPOLY£4.5bn967p113.9%32%13%9.4%21%3.9%-$1.5bn0.22DivCov
VesuviusVSVS£1.4bn515p103.8%6.8%3.1%7.6%-18%0.2%-£248m1.43Beta
NorcrosNXR£180m224p63.8%8.4%8.8%4.3%13%--£35m0.35MktCap
TBC BankTBCG£866m1,570p63.6%22%8.8%13%1.0%--GEL1.6bn0.56CashCnv
VpVP.£344m869p93.5%17%7.7%5.1%3.6%-0.1%-£168m0.32-
Liontrust Asset MgntLIO£401m794p143.4%31%18%7.2%22%12%£39m0.48DivCov
BritvicBVIC£2.3bn882p153.2%7.1%3.8%6.1%-5.9%--£683m0.59DivCov

Source: S&P Capital IQ

 

Vp

It would be a push to describe a cyclical, capital-intensive, high-fixed cost business as safe. Most equipment hire companies fit this description. That said, Vp (VP.) has a strong dividend record and held its payout during the credit crisis. A key reason for the dividend's historical resilience is the company’s focus on niche and specialist businesses, many of which serve relatively defensive infrastructure markets, such as water and rail. But Vp is also exposed to markets that are very sensitive to the economic cycle, such as construction and housebuilding. Its major £69.2m acquisition of general hire business Brandon Hire in November 2017 actually increased its exposure to more cyclical and competitive parts of the hire market. The company also has a small international business, but almost all profits and about nine-tenths of sales come from the UK.

Acquisitions have played an important role in Vp’s growth in recent years. This has meant a marked increase in debt to fund deals as well as capital-intensive organic growth (buying expensive equipment to rent out to customers). The increase in borrowings has coincided with a fall in returns (both underlying Ebit margins and returns on capital). This is a worrying sign for shareholders because it begs the question of whether the business’s long-term profitability has been reduced by the pursuit of growth. The chart below shows the recent trend in debt and returns.

There are reasons to believe trends could now reverse. Chief among these is that the Brandon acquisition has been integrated with Vp’s Hire Station business and cost savings should be evident this year. Broker Peel Hunt forecasts that this will help lift underlying operating margins (as defined by the company rather than our standard method used for the chart above) from 14.5 per cent to 14.9 per cent in the current financial year. Margins are expected to plateau at 14.8 per cent for the two years after. Net debt, which fell by £11.1m to £168.1m last year, is also expected to continue to decline. Consensus forecasts are for debt to fall to £160m by the end of this financial year, dropping to £143m in 2020 and £131m in 2021.

While the group expects growth to slow this year following a recent strong run, management will be looking to squeeze synergies from Brandon and drive organic growth elsewhere, while staying on the lookout for opportunistic acquisitions (in May it announced the purchase of excavator equipment specialist Sandhurst for £3.3m). But management has more than just this on its plate. Vp’s groundworks rental business has been under investigation for anti-competitive behaviour by the Competition and Markets Authority (CMA). Last year, a £4.5m provision was put in place for potential costs based on the midway point of outcomes from similar past CMA actions, which range from £0 to £9m. A longer-term concern is whether any changes that need to be made at the groundworks business will weigh on profitability.

But a robust balance sheet, solid operating cash generation and dividend cover means a CMA fine looks of minimal threat to the dividend itself. A Brexit-induced shock to the economy is a far more significant known unknown. These issues, coupled with the trend of debt and returns over recent years, means investors are best advised to view Vp with more caution than this screen’s 'safe yield' billing would imply, despite the strong track record.

 

Britvic

My comments about rising debt and falling returns on capital at Vp (not so much margins), could also be applied to soft drinks company Britvic. However, in Britvic’s case there are more grounds to see the trend in a favourable light. The trend reflects a period of capital investment to improve the company’s manufacturing and distribution capabilities in the UK and Ireland. The investment is now pretty much complete, which means shareholders can hope to sit back and enjoy the benefits.

Significantly, the company’s ownership of a number of strong brands and its licence to produce and sell PepsiCo products in the UK and Ireland provides it with relatively reliable income stream based on the small, frequent purchases by loyal consumers. Britvic's drinks are also exported internationally and licensed to franchise partners. When sales are relatively dependable, the returns from hefty investments tend to be a lot more dependable in turn. 

Like many of its peers in the soft drink industry, Britvic has dealt well with the introduction of the UK sugar tax and this issue should not prove such a distraction this year. Meanwhile, the first-half performance was reassuringly solid, albeit not spectacular. Net debt should start to come down this year, with broker Shore Capital forecasting a drop from £578m to £554m in the 12 months to the end of September, with £388m predicted by the end of September 2021. Over the same period, operating margins are forecast to progressively edge up from 13.8 per cent this year to 14.2 per cent. 

The recent investment provides scope for forecast upgrades as the benefits become more apparent, and the steady nature of the business and attractive yield means Britvic looks a good fit with this screen’s objectives. The shares represent pretty good value based on their earnings multiple. There is a caveat, though. A recent profit warning from rival AG Barr has highlighted, among other things, that 2019 weather has made for tough comparisons with last year’s hot summer. Britvic is unlikely to avoid industry challenges.