IQE says that “a weak smartphone market” has resulted in reduced orders for wireless chips. The firm’s photonics division is also seeing lower forecast orders, which is likely to result in lower orders during the second half of the year.

Chief executive Drew Nelson believes that the US government restrictions placed on Chinese firm Huawei are having “far-reaching and long-last impacts” on the market in which IQE operates. In May, the company said this issue could affect up to 5% of revenue, but in today’s update, management has admitted that the total hit is now expected to be larger.

Profit collapse?

IQE now expects to report revenue of between £140m and £160m for 2019, compared to previous forecasts of £175m. Based on the mid-point of £150m, that’s a reduction of about 14%.

That may not sound too bad, but lower volumes mean that profit margins will fall too. The company says that its adjusted operating profit margin is now expected to be “significantly below” its previous guidance of at least 10%.

Management hasn’t specified how far margins are expected to fall. But based on the use of the word ‘significantly’ I’d expect a revised figure somewhere between 5% and 8%.

Using the mid-point of 6.5% as an example, my sums suggest that IQE’s adjusted operating profit is now likely to be about 45% lower than expected — I’d estimate about £10m.

It’s worth remembering that profits slumped in 2018, too.

Can the firm return to growth? It’s not clear to me. However, I thought that IQE shares looked expensive before today’s announcement, and in my view they still do.

I estimate that at 50p, the shares are probably trading on about 45 times 2019 forecast earnings. That’s too high for me, especially as this capital-intensive business has never paid a dividend. I’m going to continue to avoid this stock.

A quality engineer I’d buy

IQE’s high-tech products and jargon-filled press releases may seem exciting. But the firm appears to be struggling to convert this hype to cold hard cash.

One engineering firm that takes the opposite approach is Castings (LSE: CGS). As its name suggests, this 112-year old company makes metal parts for manufacturers, with more than 80% going to the automotive sector.

Castings has had its problems over the years. Most recently its CNC Speedwell machining division has come unstuck. But throughout the time I’ve been following this stock it’s remained robustly profitable, with a big net cash balance and a reliable dividend.

The latest figures from the firm suggest that trading is improving. Revenue rose from £133m to £150m last year, while adjusted pre-tax profit climbed from £12m to £15.3m. The firm’s foundries are said to be busier and more profitable, while new management is working hard to fix problems at CNC Speedwell.

Although a cyclical downturn is a risk, demand for commercial vehicles is said to remain strong. This is supporting Castings’ order book.

The shares trade on 12.5 times forecast earnings, with a dividend yield of 3.4%. I’d prefer to pay a little less, but this looks a fair price to me for income investors.

It was hard for me to work up enthusiasm for the share. There didn’t seem to be much scope for spectacular growth rates, and I was worried about the inherent cyclicality in the operation as well.

A worrisome, volatile holding period

The company exports much of its product to vehicle manufacturers, and I said in 2015: “Owning the shares now is fine if the economic up-leg continues, but I wouldn’t want to be holding Castings if a downturn hits the industry.” My guess back then was that many shareholders were attracted to the stock because it appeared to be cheap, but I argued that “through the lens of cyclicality, Castings might not be as cheap as it looks.”

For the record, in October 2015 the share price stood at 436p and the forward-looking price-to-earnings rating one trading year ahead to March 2017 stood at 10.5. The anticipated dividend yield was 3.4%.

Today, the share price stands close to 442p, the forward-looking P/E rating to March 2020 is almost 14 and the anticipated dividend yield is just under 3.2%. Over the past three years and eight months, revenue, earnings, cash flow, and the dividend have all been volatile and the share price dipped as low as about 350p in March 2019 before bouncing back recently.

If you’d held since my previous article, you’d have collected just under 76p in ordinary and special dividends and made about 6p on the share price for a total return of about 82p, which works out at an overall return of around 19%.

Given all the cyclical risk you’d have taken on, I think that kind of return is low for a hold of more than three-and-a-half years. And we haven’t even seen a major slump in the industry yet. As time passes, arguably, the risk involved with holding now is even greater than it was.

A lacklustre outlook statement

The company delivered its full-year results report today. Revenue increased by almost 13% compared to the previous year and earnings per share moved up around 12%. The directors increased the total dividend for the year by just over 1.9% to 14.78p and also declared a special dividend of 15p. We could look at the dividend yield as being about 6.7% this year, although special dividends are not guaranteed in the future. Indeed, the last special dividend was paid in 2016, so it’s an intermittent occurrence.

I think the outlook statement is informative and here it is in full: “It appears at the present time our order book is sound and schedules remain stable. In particular demand for commercial vehicles is currently strong and it is hoped this trend will continue.” To me, the tone and language of that statement suggest that the directors are aware they have little control over the macro-economic cycles governing the outcomes for their business. This one is not for me and I’d rather invest in a tracker fund than take the individual company risk.

The high-street fashion chain reported a 4.5% rise in full-price product sales for the three months to 27 April, boosted by an 11.8% hike in online sales while bricks-and-mortar shopping declined by 3.6%.

The company did put this better-than-expected performance mainly down to the warm Easter weather which had more people out shopping, and full-year guidance isn’t quite as rosy, but it still looks reasonable to me.

Full year

The year is now expected to bring in a modest 1.7% full-price sales increase, with an 8.5% drop in conventional retail sales offset by an 11% gain in online sales. Next stressed that quarterly comparisons with last year are difficult, as there have been some serious weather differences from year to year, and that obviously has an effect on the high street.

There’s a bottom-line 3.4% increase in EPS on the cards too, enhanced by the company’s share buyback plans, with £86m of an intended £300m of surplus cash already redistributed that way.

Next might not offer one of the biggest dividend yields, but it is progressive and very well covered by earnings — forecasts for the current year indicate cover of 2.7 times, which leaves a big margin of safety.

I’m always a bit twitchy when I see net debt, but Next’s at £1.1bn doesn’t look like a big cause for concern. And with the shares on forward P/E multiples of around 12, I still reckon I’m looking at a good long-term buy. Not a screaming bargain, but a good company at a fair price.

Price slump

I’m turning now to a small engineering company called Castings (LSE: CGS) which manufactures, well, castings. I’ve had my eye on the company for a while, but I’ve been disappointed by its poor share performance that has seen the price sliding over the past two years. There have been falls in earnings, but forecasts suggest a return to strong growth, starting with the year just ended on 31 March.

I perked up when I saw a 7.5% uptick in the share price on Wednesday after the firm released its full-year pre-close update.

Castings told us that, thanks to strong demand in the second half of the year, its full year should come out ahead of market expectations. Margins at the firm’s foundries are improving too, and management initiatives are apparently making a difference.

Dividends

But it’s the dividends that are the real attraction for me, and I can’t help feeling the market has not given them sufficient credit when marking down the share price. Dividend policy is conservative, maintaining strong cover by earnings. In 2016, before a couple of down years for earnings, the dividend (yielding 2.7%) was covered 2.7 times. That allowed the company to maintain progressive rises and still see cover at 1.5 times in the toughest year of 2018.

Meanwhile, the slipping share price has pushed the expected 2019 yield up to 4.1%, and with two more years of EPS gains on the cards, we’d be looking at cover back up to 2.1 times by 2021.

I’m seeing a small but well-managed company here, with a focus on providing long-term income for its shareholders. And I think the day’s price rise could presage a better year to come.

Within that period, the company has delivered results in line with its expectations, while continued growth looks to be ahead. As a result, it has the potential to beat the UK’s main index alongside a growth stock which reported upbeat results on Wednesday.

Simple strategy

Boohoo’s strategy is relatively simple. However, as is often the case in business, a simple strategy which is accurately executed can lead to significant financial rewards. The company has been able to deliver innovative fashion items at relatively low prices alongside high levels of customer service.

With a solely online footprint, it has also benefitted from cost advantages versus bricks-&-mortar rivals, while the continued transition of shoppers from High Street to online has also provided a tailwind for the business.

Investment outlook

The company’s results released earlier this week showed that it continues to make progress with its strategy. The decision to branch out into new websites seems to be paying off, with the company’s growth rate being exceptionally high. For example, in the current year Boohoo is forecast to post a 16% rise in its bottom line, followed by further growth of 25% next year.

Clearly, buying the stock on an ultra-low valuation would be highly desirable. But given that the FTSE 100 trades close to its record high, the company has a price-to-earnings growth (PEG) ratio of 2. This suggests that while it’s not dirt-cheap, there could be significant growth potential ahead given the positive trading conditions it’s experiencing.

Improving prospects

Of course, there are other shares that could also deliver outperformance of the FTSE 100. One such stock is iron castings and machining group Castings (LSE: CGS). It reported a positive set of results on Wednesday which showed that its foundries have seen an increase in output and improved profitability compared to the previous year.

The company’s investments in robotic handling have boosted productivity, while additional investments are expected to reduce costs yet further. With its order book being solid and schedules increasing, the company appears to have a positive outlook. In fact, in the current year, it’s expected to post a rise in earnings of 27%, followed by further growth of 10% next year.

Despite Castings’ high earnings growth outlook, the company trades on a PEG ratio of 0.6. This suggests that it could offer a wide margin of safety – especially since its strategy seems to be performing well in current market conditions. With a 3.5% dividend yield, which is covered more than twice by profit, its total return could be ahead of the FTSE 100’s future performance.

But after a big slump in 2008/09, UK manufacturing output has been steadily recovering, and the latest figures show the Manufacturing Index at its highest level in 10 years. Global economic growth has helped, and the weakening of the pound since the Brexit referendum has given Britain’s exports a significant boost.

Both of these trends tie in nicely with Rolls-Royce’s restructuring and cash-savings progressing ahead of plan, as reported at the halfway stage this year. At the time, underlying revenue was up 6% with underlying pre-tax profit up 148%.

On target

November’s update confirmed the company is on track to achieve its expectations for the year, telling us that its Civil Aerospace, Defence Aerospace and Power Systems were all performing well. The Marine division was still weak due to depressed demand from the oil and gas business, but with the black stuff getting ever closer to $70 per barrel, I can see a recovery there in 2018.

I confess I’m a little twitchy about the Rolls-Royce share price, after a one-year climb of 27% to today’s 846p. That gives us a forward P/E multiple of 24 based on forecasts for 2018, which looks a bit high. But if we really are past the bottom of the cyclical engineering downturn, the new slimmer company could be set for a return to its decades-long trend of steadily rising earnings.

The dividend is on the way back too, and though the predicted rise for this year would take it to a yield of only 1.6%, it’s a definite turn in the right direction.

Better bargain?

A smaller engineering company that impresses me is Castings (LSE: CSG) which, as its name suggests, is in the iron casting and machining business.

Thursday’s trading update confirmed that things are going as expected and spoke of “steady demand from our commercial vehicle customer base.” The firm was also able to draw a line under the costs of a couple of changes. Its new management team decided to pull out of a few projects it deemed unsuitable, which has cost £1.3m, and the reorganisation of its machining business has impacted the bottom line to the tune of £3.4m.

Full-year profit is expected to come in between £12.5m and £13.5m, with “positive” cash flows.

Current forecasts suggest P/E ratios for this year and next of 16 and 14 respectively, which is a good bit lower than Rolls-Royce’s current valuation. And I think that makes the shares a bargain at this stage in the manufacturing cycle.

Cash too

What’s more, Castings has been paying steady dividends, even while its earnings have been a bit erratic over the past few years. This year there’s a 3.2% yield on offer, with 3.3% pencilled in for the next year. It’s progressive too — around twice covered by forecast earnings, and just about keeping up with inflation.

If this is how the company has been rewarding shareholders during a downturn, I can see scope for significantly enhanced dividends in the future if the export-led manufacturing growth phase really does continue.

However, there are other companies which could do likewise. Reporting on Friday was one stock which could offer high dividend growth potential in the long run.

Mixed performance

The company in question is iron casting and machining company Castings (LSE: CGS). Its performance in the first half of the year was somewhat mixed. On the one hand, its Foundry operations continued to perform well after a period of production and productivity improvements. They have helped to deliver a rise in sales revenue of 7.9%, with profit being up 10.5% versus the previous period. Further investment is being made in order to support an automation programme that is being rolled out.

However, in the company’s CNC Speedwell Machining operation, revenue decreased by 10.9%. It also delivered a reported loss of £1m versus a profit of £0.8m in the previous period. The business has experienced major issues, such as production problems. They have resulted in a review which has identified additional short-term costs for the business. With changes being made to the Machining business, it is expected to return to profitability in the next financial year.

Dividend potential

With Castings having a dividend yield of 3.1%, it offers a real income return at the present time. However, it is the company’s dividend growth potential which could make it a worthwhile income stock for the long run. Its dividend is covered more than twice by profit. With its bottom line due to rise by 13% in the next financial year, this could provide it with scope to increase shareholder payouts at a brisk pace. And since it trades on a price-to-earnings growth (PEG) ratio of just 1, it also appears to offer capital growth potential.

Similarly, Centrica could also increase dividends in future. The company is making major changes to its business model, and they are expected to create a business which is able to deliver greater profitability in the long run. In fact, as soon as next year the company is forecast to grow its bottom line by 2%. This means that its shareholder payouts are due to be covered 1.3 times by profit, which suggests there could be scope for them to grow.

Uncertainty

Clearly, both stocks are experiencing uncertain periods at the present time. However, they both appear to have sound strategies which could lead to stronger performance in the long run. Therefore, now could be the right time to buy them while they offer relatively wide margins of safety. Doing so could mean higher income returns in the long run.

And while the headline figures were disappointing, I believe that this is the perfect opportunity for long-term investors to get involved in the group’s growth story. 

A transformational year 

For the year, Avingtrans reported sales growth of 7% to £22.7m and adjusted earnings before interest, tax, depreciation, and amortization of £0.7m, up 104% year-on-year. Adjusted profit before tax was £0.3m, compared to 2016’s figure of £0.1m. Unfortunately, after including costs, the company reported an unadjusted loss of £0.3m. 

However, during the year, it overhauled its business model and going forward I believe that the company can generate huge returns for investors. 

After selling its Aerospace division for a healthy profit in 2016, and returning £19m to investors, management has decided to adopt a strategy it calls “Pinpoint-Invest-Exit,” based on the “now proven strategy of ‘buy and build’ in regulated engineering niche markets.” This looks similar to the model used by engineering giant Melrose, which buys businesses, helps them reach their full potential, and then sells them on. 

As part of this strategy, Avingtrans made modest acquisitions of Scientific Magnetics and the assets of Whiteley Read Engineering during the financial year. After the year-end, the company acquired Hayward Tyler Group. According to management, “an unfortunate combination of ambitious investment programmes, acquisition and market down-cycle led HTG to an overstretched balance sheet position.” Avingtrans hopes to be able to get the business back on track and growing again. 

Buying, building and selling can be lucrative if done correctly. That said, plenty could go wrong with such a strategy and investors need to keep an eye out for the tell-tale signs that management has bitten off more than it can chew.

If the firm’s sales growth starts to slow, costs expand rapidly, and cash generation vanishes, these could be signs that the problems at HTG may be deeper than initially believed. On the other hand, if costs fall, sales continue to grow, cash generation improves, and margins widen, Avingtrans should be heading in the right direction.

Slow and steady 

Castings (LSE: CGS) is three times the size of Avingtrans, so the company’s growth is slower than that of its smaller peer. Nonetheless, I still believe that this business can achieve stellar returns for investors. 

Since the beginning of 2015 the shares have produced a total return of 45%, and as long as the company can maintain its operating profit margin of 14% and return on capital employed of 14%, the returns should continue. 

Wide margins and a high return on capital mean that the company has been able to invest for growth and return cash to investors at the same time. Book value per share has grown at around 6% per annum for the past six years, and at the end of fiscal 2017, Castings had net cash on the balance sheet of £27m. The shares currently trade at a forward P/E of 15.8 and support a dividend yield of 3%. 

As long as Castings’ business continues to throw off cash, I would not rule out the prospect of additional special dividends. 

But the energy giant is not the only income share I’d dump right now. Castings (LSE: CGS), for one, would also be on my ‘sell’ list today.

Worrying sales outlook

At first glance Castings’ latest trading statement on Tuesday may soothe the nerves of many investors. It commented today that “demand from our main customers remains steady which represents a continuation of the outlook reported in the Chairman’s statement in June.”

“Our efforts remain focused on developing work with both existing and new customers, with a concentration on core business that can be produced and machined within the group,” it added. Castings also reiterated its commitment to investing in production techniques and technologies to boost productivity and profits.

Still, there remains much to be concerned about over at the West Midlands business, in my opinion. It advised back in June that revenues dropped 10% in the 12 months to March, to £119m, while pre-tax profits reversed 19% to £15.9m.

And the political malaise in Britain is casting a long shadow over Castings’ revenues picture looking ahead. The company advised that “the situation concerning Brexit is creating a certain amount of concern in the manufacturing sector and the sooner the Government negotiates a deal to remove this uncertainty, the better it will be for planning the future.”

Although City brokers expect the iron castings play to endure another earnings fall in fiscal 2018, this time by 1%, the firm is still expected to keep its long-running progressive dividend policy in business. Last year’s 13.97p per share reward is predicted to improve to 14.6p in the present period, resulting in a very-handy 3.2% yield.

But given the probability that difficult Brexit negotiations will drag long into the future, and heap further pressure on Castings’ top line, I reckon investors should give the business short shrift right now despite its reasonable forward P/E ratio of 15.6 times

Switch off

Centrica’s reputation as a reliable dividend stock has gone down the tubes in recent years, of course. Against a backcloth of serious earnings weakness, the British Gas operator has been forced to slice up shareholder rewards, although the decision to hold the dividend at 12p per share in 2016 can be seen as something of a triumph as the bottom line continued to sink.

The profits pressure is not expected to cease just yet, a further 6% earnings decline being forecast for 2017. So despite its low valuation — Centrica sports a forward P/E rating of just 12.8 times — and the City expecting it to pay a 12.2p per share dividend in 2017 (yielding a mighty 6.1%), I would also  be tempted to shift out of the business right now.

Latest data from Energy UK showed 385,000 UK households switched power supplier in July, up 16% year-on-year as the strain on household budgets intensified. And Centrica’s decision to hike electricity prices for those on standard tariffs by 12.5% from next month is likely to drive even more customers into the arms of the cheaper, independent suppliers.

Given the increasing difficulties created by Britons’ growing switching culture, not to mention the additional strain created by depressed oil prices on its fossil fuel operations, I reckon investors should steer clear of the London business.

Revenue excluding landfill tax payments rose by 8.3% to £898.8m last year, while underlying operating profit rose by 18.1% to £73.8m. The figures highlighted the improving profitability of the group’s operations, with Biffa’s underlying operating margin rising from 6.7% to 7.5%.

Shareholders were rewarded with a maiden dividend of 2.4p per share, giving the stock an initial yield of 1.2%. However, this only relates to the half-year period since the group’s flotation. Consensus forecasts suggest the dividend will rise to 6.7p per share this year, giving a more appealing prospective yield of 3.5%.

A potential cash cow?

It’s this company’s potential ability to produce a reliable stream of surplus cash which attracts me. The group has used a mixture of organic growth and acquisitions to become one of the leading players in the UK waste management sector. Last year’s improved profit margins suggest to me that economies of scale are starting to come through.

My only real reservation is that net debt of £246m still seems quite high to me, relative to the group’s underlying after-tax profit of £35.8m.

However, I think Biffa offers reasonable value on a 2018 forecast P/E of 11, with good potential for long-term dividend growth. I’d consider buying at current levels.

Strong pedigree

Biffa may have potential, but my next stock has a proven record of rising cash returns. Iron casting and machining company Castings (LSE: CGS) hasn’t cut its dividend payout since at least 1998. Indeed, the last 19 years have seen the company’s ordinary dividend rise by 138%, from 5.85p per share to last year’s total of 13.97p per share.

Castings published its 2016/17 results today, confirming previous guidance for a sharp fall in profits. The group’s sales fell 9.8% to £119m, while pre-tax profit fell by 19.3% to £15.9m. Earnings per share fell by 19.7% to 29.8p, leaving the stock on a trailing P/E of 15.1.

Not as bad as it seems

These figures don’t seem great, but the company had already warned that after a “major contract” ended it would take some time for replacement work to be found.

Management appears to have been true to its word. Today’s results confirm that “replacement work has been secured and it is hoped that turnover and profitability will increase back to previous levels during the next two years.”

Customer demand is said to remain “steady” across the business as a whole, although uncertainty relating to Brexit is an ongoing concern. Much of the firm’s output is sold to car manufacturers.

In my view, these risks are worth taking, given the quality of Castings’ finances. Despite the fall in profits last year, the dividend was still covered nearly three times by earnings. Free cash flow remained positive and the group ended the year with net cash of £22.3m, despite paying a special dividend of £13m.

Earnings per share are expected to rise by 14% to 30.7p per share in 2017/18. This puts the stock on a forecast P/E of 14.7, with a prospective yield of 3.1%. In my view, this stock could be an excellent long-term income buy.

Heating up or cooling down?

The first is air conditioner, pump and heater rental firm Andrew Sykes (LSE: ASY). The company operates in the UK, Europe and the UAE and mainly targets the commercial rental market. Shares of the firm currently trade at a relatively sedate 14 times trailing earnings and come with a 4.7% annual dividend yield.

Aside from a solid valuation and attractive dividend, I’m attracted to the company’s high margin, diversified business model. Renting out equipment, particularly in stable macroeconomic environments such as now, is highly profitable and generates prodigious cash flow. This is evident in the company’s 2016 results, which showed EBITDA margins were an impressive 31% and operations kicked off £15m of net cash on £65m in sales.

It was this cash flow that allowed the company to safely pay out £10m in dividends while still improving its net cash position to £17.6m at year-end. And with operations in a slew of large, wealthy countries the company’s downside is relatively protected against a downturn in any single market. Indeed, this was clear in 2016 as the group increased sales, profits and dividends even as a mild summer in the UK dented demand for air conditioning units.

With a reasonable valuation, bumper dividend, high margins and well-managed business model, Andrew Sykes is one small cap I’ll keep my eye on in the future.

A throwback business with forward-looking management

The second stock I’ve found that might meet value investors’ criteria is iron foundry Castings (LSE: CGS). While the business of metalworking may no longer be the growth industry it was a century ago, Castings is still a highly profitable business that trades at 13.9 times earnings and returns plenty of cash to shareholders.

Last year these shareholder returns amounted to a whopping 9.3% dividend yield when including a special 30p payout to shareholders. Although this payout is unlikely to be a regular occurrence, the company’s baseline 2.9% dividend yield is nothing to sneeze at.

As for the business itself, performance over the past few years has been uneven but with earnings largely unchanged from where they were in 2012. However, this isn’t too much of a worry as the group has no debt whatsoever and is setting the stage for future growth by investing in its high-tech machining capabilities. New foundries, 3D printers and automated manufacturing have allowed the company to better serve automotive customers and maintain margins in the face of low-cost competition from Asia.

These machining operations provide higher margins than the traditional foundry business and are set to grow nicely beginning next year as new contracts that are already signed begin paying off. If Castings can continue to maintain profits in the foundry business and grow the higher-margin machining business I reckon shares could be priced for perfection at their current valuation.

Add in a great dividend that is well-covered by earnings and Castings certainly looks to me like a solid income option as long as the automotive industry continues to hum along nicely.