Let me put it to you simply. The City appears to believe that something is about to go wrong with the housing market. That’s why housebuilders with massive profit margins and stacks of spare cash are being priced to give 8% dividend yields.
Today’s full-year results from FTSE 100 firm Barratt Developments (LSE: BDEV) are a prime example. Despite cost pressures, the group managed to lift its operating margin from 17.2% to 17.7% last year.
Total sales rose by 4.8% to £4,874.8m, while pre-tax profit was 9.2% higher, at £835.5m. Earnings per share climbed 8.5% to 66.5p, supporting a total dividend payout of 43.8p per share — a 5% increase on last year.
By the end of June, net cash had risen by 9.3% to £791.3m, even though the firm paid out £435m in dividends last year.
Despite all this good news, the Barratt share price was unchanged at the time of writing.
The market vs. Neil Woodford
Barratt Developments is one of the 10 largest holdings in fund manager Neil Woodford’s Income Focus Fund. Woodford has taken a contrarian stance on UK stocks, buying heavily as others have been selling.
I can see his point. Perhaps the UK economy won’t crash after Brexit. But I think there are some valid reasons to be worried about the housing market.
One potential concern is that affordability metrics show house prices at record highs when compared to household incomes. Rising interest rates could worsen this problem.
Another concern is that housebuilders may have become too dependent on the Help to Buy scheme. I explained more about this in an article yesterday. But I believe these cheap homebuyer loans have boosted both selling prices and profits.
Barratt stock currently trades on a 2019 forecast P/E of 7.8, with an expected dividend yield of 8.1%. That looks cheap. But if profits start to dip, then the stock could fall from 530p+ towards its net tangible asset value of just 366p per share.
This Woodford bet looks safer
The top holding in Woodford’s Income Focus Fund is tobacco giant Imperial Brands (LSE: IMB).
Big investors have punished this stock over the last year, wiping 15% off its share price and leaving the group lagging the FTSE 100. They’re worried about a flat profits outlook and are concerned that tobacco firms like Imperial are lagging behind smaller rivals in areas such as vaping.
The City wants to know what Imperial boss Alison Cooper is going to do to solve these problems.
Selling the family jewels?
Cooper’s answer to investors appears to involve selling more assets. This could include some of its traditional cigarette brands. In her half-year results statement, the CEO said she was targeting initial proceeds from asset sales of “up to £2bn in the next 12-24 months.”
Selling some of its mature tobacco products would raise cash to reduce debt and fund share buybacks. It would also enable the group to increase its focus on next-generation products, such as the myblu vaping brand.
I don’t invest in tobacco stocks for ethical reasons. If I did, I’d almost certainly be topping up with Imperial Brands at current levels.
The group’s forecast dividend yield of 6.9% should be covered by both earnings and free cash flow. So a cut seems very unlikely. With the shares trading on just 10 times 2018 forecast earnings, I believe the stock could perform well… if profits do return to growth.