Slow economic growth could cramp UK firms’ ability to deliver dividend growth. Do income investors need to start looking at companies that make most of their money overseas?
In today’s article I’ll compare results from UK retailer Halfords Group (LSE: HFD) with those of fast-growing US construction equipment firm Somero Enterprises (LSE: SOM). Both companies have strong balance sheets, attractive dividends and decent cash flow. But which looks the better buy?
Cycling saves the day
Halfords has managed to squeeze out like-for-like growth of 1.2% during the first 20 weeks of its financial year, which starts on 1 April. The group reported total sales growth of 4.8%, thanks to new openings and cycling-related acquisitions.
Cycle sales continue to be a key element of Halfords’ growth. Like-for-like sales of two wheelers rose by 1.9%, versus just 0.6% for motoring. The Olympics helped to boost cycling sales too, while collapsing sat nav interest put pressure on motoring results.
Halfords’ dividend payments have been consistently covered by free cash flow for at least the last five years, suggesting that the business is good at converting profits into cash. This is usually the hallmark of a good quality business.
In my view, Halfords remains a fairly attractive option for income investors. This morning’s statement confirmed the firm’s full-year guidance, putting the stock on a forecast P/E of 12.1, with a forward dividend yield of 4.5%.
The only real risk I can see is that Halfords’ profits will continue to stagnate. Earnings per share are expected to fall by 7.5% this year and to be broadly flat next year. The group’s operating margins have fallen from a peak of 13.9% in 2011 to just 8.1% last year.
To justify a stronger share price, management needs to find a way of arresting this decline. I’d hold the shares, but would prefer to wait for another dip before buying.
Is Somero still cheap?
Shares in equipment firm Somero Enterprises have risen by 40% so far this year. The firm’s operating profit rose by 24% to $10.3m during the first half, lifting adjusted earnings by 30% to $0.13 per share.
Somero makes equipment that’s used to produce perfectly flat concrete floors for warehouses and distribution centres. A flat floor is essential for the very high racking that’s used in modern ‘big box’ warehouses.
Somero’s growth is heavily linked to the construction market, principally in the US, where the business is based. Sales in North America rose by 24% to $29.8m during the first half, accounting for 75% of the group’s total sales.
Somero also operates in a number of other territories, but the company’s big hope for long-term growth is China. Flat floors of the kind produced by Somero equipment are relatively new in China, and the group’s market share is low. The potential for expansion into the Chinese market is significant, in my opinion.
Somero has no debt and net cash of $11m. The shares trade on 9 times forecast earnings and offer a well-covered forward dividend yield of about 3.6%.
I believe that Somero remains a buy, as long as investors keep a close eye on the health of the US property market.