Is Micro Focus International plc the hottest dividend stock around after today's update?
International software company Micro Focus(LSE: MCRO) has released a brief AGM statement today adding further evidence to its status as a long-term income stock. But is it a superior one to index peers including Shell(LSE: RDSB)?
Micro Focus's trading in the current year has been in line with management's expectations. It anticipates that revenue for the year to 30 April 2017 will be in the range of flat to minus 2% on a constant currency basis when compared to the previous year. Its bottom line is due to rise by 8% in the current year and by a further 6% next year.
In terms of dividend appeal, Micro Focus may appear to be somewhat disappointing. It currently yields a lowly 2.5%, which is around 100 basis points lower than the yield of the FTSE 100. However, it has superb long-term growth potential thanks to its planned merger with HPE Software. This will position it as a dominant player within the software space and could lead to improved margins and top line growth opportunities in the coming years.
As well as the prospect of fast-growing profit causing dividends to increase, the dividend payout ratio indicates that brisk dividend growth lies ahead. Dividends are currently covered 2.4 times by profit. This means that dividends could easily rise at a much faster pace than profit over the medium-to-long term.
For example, Micro Focus is forecast to raise shareholder payouts by 9% in the next financial year. If the combination with HPE Software pays off then a much faster rate of growth could be on the cards. That's especially the case since Micro Focus has strong cash flow and a relatively stable earnings outlook.
In fact, in the last five years it has delivered double-digit profit growth in every year. This should provide its investors with confidence in the future performance of the business, as well as in its reliability when it comes to making dividend payments.
Of course, this is in direct contrast to Shell. Its outlook is extremely uncertain thanks to a highly challenging outlook for oil and gas prices. Although they've recovered to some degree in 2016, there's no guarantee that this trend will continue. Therefore, Shell's dividend isn't as secure as that of Micro Focus. Given the poor rates of return on other assets such as cash and bonds, the reliability of dividends has taken on greater importance among many investors.
However, where Shell has an advantage over Micro Focus is in terms of its yield. Shell yields 7.5%, which is three times the yield of Micro Focus. Furthermore, Shell's synergies from the BG merger are expected to be higher than previously anticipated and its cash flow is due to increase rapidly in the years ahead. This provides scope for rapid dividend growth.
While Shell is a riskier dividend play than Micro Focus, its higher yield and potential for dividend increases from the integration of BG mean that it's still a more appealing income stock. Micro Focus has the potential to become a top notch income play, but Shell is already at that stage.
But is this a better income stock than Shell?
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Peter Stephens owns shares of Royal Dutch Shell. The Motley Fool UK has recommended Micro Focus and Royal Dutch Shell B. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.