One 9% yielder I'd buy today and one I'd avoid
Shares of construction and housebuilding group Galliford Try (LSE: GFRD) fell by nearly 20% on Wednesday morning after the group announced a dividend cut and said it would raise £150m by selling new shares.
This news overshadowed an otherwise sound set of half-year results, which showed revenue up by 14% to £1,495m and adjusted pre-tax profit up by 29% to £81.3m.
Galliford's shares are now worth almost 50% less than one year ago. But fresh cash should strengthen the balance sheet. Is it time for contrarian investors to get interested?
The curse of Carillion
Galliford's housebuilding business is doing quite well. But its construction division faces tougher conditions.
In January, management admitted that Carillion's failure had left the group liable for £30m-£40m of spending on a road-building project near Aberdeen. Today's figures reveal that the true figure is much higher. Cost overruns mean that Galliford will actually need to find "in excess of £150m" to complete the project.
To avoid cutting funding to its more profitable housebuilding business, the board has decided to raise new money from investors. They will also bring forward a planned policy to maintain dividend cover at two times adjusted earnings.
This year's interim dividend will be cut from 32p to 28p per share. But if the capital raise goes ahead, I expect the increased share count to result in a much bigger cut to the final payout.
My estimates suggest that the full-year dividend might fall from a forecast figure of 98p to about 67p per share, giving a potential yield of 8.4% at a share price of 800p.
Buy, sell or hold?
I'm pleased that Galliford's management is taking proactive steps to strengthen its financial position. But it's still only reporting a profit margin of 0.9% on construction work. The risks and low profitability of this business seem to detract from the group's more appealing housebuilding activities.
Although the shares look cheap and could still support an 8%+ yield, I think there are better buys elsewhere.
Political risk could pay off
The threat of renationalisation is hanging over transport operator Stagecoach (LSE: SGC), which operates a number of rail franchises in the UK.
Reports suggest this would probably be done by putting franchises under public management when they expire. I believe the resulting loss in profit for Stagecoach might not be as big as you'd expect.
Rail operations are the company's least profitable activity and only generate about 20% of operating profit. The rest comes from bus services and the group's US business. Exiting the rail sector would probably reduce overheads and might free up cash for new expansion opportunities. I don't see this as a big worry for shareholders.
An 8.5% dividend ticket
I'm more concerned about the risk of a dividend cut. In December's interim results, the board confirmed full-year earnings guidance and reiterated their support for the dividend.
Based on City consensus forecasts, this guidance puts the stock on a forecast P/E of 6.9 with a prospective yield of 8.5%.
Last year's figures suggest to me that the dividend could still be covered by free cash flow in 2018, but only just. However, with the shares at 137p, even a 30% dividend cut would still give a tempting 5.9% yield. I believe Stagecoach could be worth considering for income investors.
Roland Head has no position in any of the shares mentioned. The Motley Fool UK has recommended Stagecoach. 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.