Today, I want to look at two FTSE 250 dividend stocks that I believe have the potential to provide an attractive long-term income.
My first company could be a controversial choice. Engineering group Babcock International Group (LSE: BAB) has come under attack from short sellers recently. The company disputes most of these allegations, but today’s half-year results have left the shares down by 5%, at the time of writing.
Good and bad news
Investors fear that Babcock will turn out to be another outsourcer with loss-making contracts, shrinking profit margins, and too much debt. In my view, today’s figures justify some of these concerns, but certainly not all of them.
The good news was that the group’s underlying results were in line with expectations. Exiting low-margin businesses helped to lift underlying operating profit rose by 1.4% to £279.6m, even though revenue fell by 2.3% to £2.577bn.
A significant improvement in free cash flow provided the cash needed to reduce net debt by £159m, to £1.132bn. This reduced the group’s net debt to EBITDA (earnings before interest, tax, depreciation and amortisation) multiple from 1.9x to 1.6x.
Looking ahead, the group’s combined order book and pipeline expanded by 3% to £32bn, including £650m of new orders from the Ministry of Defence.
Unfortunately, today’s figures also included some bad news. The firm’s contract to decommission Magnox nuclear reactor sites ends next year. Management now expect revenue to fall by about £250m, more than double previous guidance of £100m. The loss of the contract is expected to wipe £20m off the group’s operating profits.
Guidance unchanged
Chief executive Archie Bethel says that the outlook for the 2018/19 financial year is unchanged. He’s expecting single-digit revenue growth and improved profit margins.
Broker forecasts put the shares on a 2018 forecast price/earnings ratio of 6.6, with a dividend yield of 5.2%. If the outlook remains stable, I believe these shares could be an income buy.
A safer option?
If you’re concerned about the outlook for Babcock, one alternative I’d consider is FTSE 250 engineer QinetiQ Group (LSE: QQ). This business is focused on developing its own products and technology, which should give it a stronger competitive edge.
QinetiQ’s business mainly operates in the defence and aerospace sectors. Historically, it’s worked mostly for the UK Ministry of Defence, but this is changing. International customers accounted for 31% of revenue during the first half of the year, up from 26% during the same period last year.
One reason for this changing strategy is that profit margins on UK government contracts are falling. As a result, analysts are forecasting a 10% fall in underlying earnings per share this year, with a modest return to growth in 2019/20.
The group’s half-year results supported this view. Underlying operating profit fell by 11% to £51.1m, despite sales rising 7% to £420.3m.
Falling profit margins aren’t ideal. But I believe the firm should be able to continue winning attractive new work. In the meantime, a net cash balance of £250m means that management has money available to invest in new opportunities.
QinetiQ shares have risen by 15% so far this year. This has left the stock trading on a forward price/earnings ratio of 15.5, with a 2.4% dividend yield. This isn’t cheap, but I think the long-term potential of this business means the price is fair.