2 inflation-busting dividend stocks you may not have considered

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Biffa

Waste management firm Biffa(LSE: BIFF) reported "a good half-year performance" in a pre-close trading update this morning and said it "remains confident in the Group's strategy, commercial opportunities, and outlook for the full year."

The shares moved modestly higher in early trading, before dropping back a bit below yesterday's closing price of 234p, valuing the FTSE SmallCap firm at £585m.

Solid performance

Investor interest in Biffa has been solid since its IPO last year at 180p and I can understand why. It is a relatively defensive, cash-generative business, with good prospects of providing shareholders with annual inflation-beating dividend increases.

Today's update told us the company has "continued to deliver solid organic and acquisition revenue growth," as well as underlying profit growth "driven by a strong operational performance and cost control, including the delivery of acquisition synergies."

Management is actively exploring further acquisition opportunities and advised: "The Group's balance sheet remains strong, with cash generation and net debt also in line with our expectations."

Dividend prospects

Biffa has set a progressive dividend policy, with a conservative payout ratio of approximately 35% of profits. This looks a sensible balance to me at this stage, as it provides shareholders with a decent initial cash return, while also allowing management to invest for future growth.

After a 2.4p maiden dividend last year (covering the short period from the IPO), the City consensus is for a 7p payout this year, followed by an inflation-busting increase of 8.6% to 7.6p next year. The prospective yield is a handy 3%, rising to 3.25%, and with an undemanding forward 12-month P/E of 12.5, the stock looks very buyable to me.

Income stream

Many dividend investors probably don't look beyond FTSE 100 firms United Utilities and Severn Trent in the water sector. However, the table below suggests it may be worth considering FTSE 250 peer Pennon(LSE: PNN).

 Forecast P/E 2017/18Forecast dividend yield 2017/18Forecast dividend growth 2017/18Company annual dividend growth-rate policy to 2020
United Utilities20.54.4%2.4%At least RPI inflation
Severn Trent19.43.8%6.3%Upgraded from at least RPI to at least 4% above RPI from 2017/18
Pennon17.14.7%7.2%4% above RPI

The P/E, dividend yield and dividend growth figures are based on analyst consensus forecasts for the companies' financial year ending 31 March 2018. Pennon offers the best value on all three counts and also looks set to deliver the highest dividend return through to 2020, which marks the end of the current five-year regulatory period.

Well positioned

There looks to be a fair chance regulator OFWAT's pricing review for the 2020-25 period will be less generous to water companies than in the past. But here, too, Pennon appears relatively well positioned. In addition to its water businesses (South West Water and Bournemouth Water), it owns waste management firm Viridor. This diversification could help it keep dividends advancing ahead of inflation post-2020, even if profit growth in water businesses is crimped by OFWAT.

With a sector-low P/E, sector-high starting yield, inflation-busting dividend growth through to 2020 and diversification via its ownership of Viridor, I rate Pennon a 'buy'.

5 best blue-chips

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G A Chester has no position in any of the shares mentioned. The Motley Fool UK has recommended Pennon Group. 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.