While Severn Trent (LSE: SVT) and Anglo American (LSE: AAL) have higher yields than Diageo (LSE: DGE) (NYSE: DEO.US), there is much more to their income appeal than just a better headline yield. Certainly, Severn Trent may not be able to grow its dividends as quickly as Diageo, and Anglo American’s business may be less certain than Diageo’s, but for long-term income investors, they appear to be worth buying ahead of the alcoholic beverages company.
Stability
When it comes to stability, few sectors can match the provision of water services. That’s because demand is very consistent, government interference is minimal (compared to domestic energy supply, for instance) and with regulatory plans being put in place for five years, income prospects over the medium to long term are very clear. Furthermore, Severn Trent’s shares also offer a very stable shareholder experience, with their beta of just 0.88 indicating that they should move by 8.8% for every 10% change in the value of the wider index, thereby providing less volatility than the average stock.
Of course, Diageo’s business is also very stable: demand for alcoholic beverages tends to be very consistent no matter what the economic weather. While this was the case for many years, last year saw Diageo’s bottom line fall by 7% and, in the current year, it is expected to fall by a further 6% as weak demand from emerging markets hits its sales and profitability. As such, Diageo, while stable, is not as stable as Severn Trent, which means that its long term dividend outlook is less certain than its water services peer.
Dividend Growth
Looking ahead to Diageo’s dividend growth prospects, its payout ratio of 60% indicates that it could afford to pay out a higher proportion of profit as a dividend. This, then, is positive for longer term income investors, with Diageo expected to increase dividends per share by 7% next year, for example.
However, Diageo’s bottom line is due to rise by a rather disappointing 7% next year, which is far lower than many other FTSE 100 stocks, with a notable example being mining play, Anglo American. It is forecast to post an increase in earnings of 29% next year and, with it having a similar payout ratio to Diageo at 63%, seems to have more scope to raise dividends at a rapid rate.
Certainly, Anglo American’s business is much more volatile than that of Diageo and, on the face of it, it has less of a competitive advantage and is more reliant upon external factors than Diageo. However, with more impressive earnings forecasts and a similar payout ratio, it could increase dividends at a faster pace than the alcoholic beverages company, too.
Looking Ahead
While Diageo remains a top quality business, its yield of just 2.9% hardly marks it out as a top notch income play. Certainly, its return to growth which is pencilled in for next year is a step in the right direction after a challenging couple of years, but it appears to lack the stability of a utility such as Severn Trent and also the growth potential of a mining company such as Anglo American. As such, it seems logical for income-seeking investors to buy Severn Trent and Anglo American before buying Diageo – especially since they currently yield 3.8% and 5.6% respectively.