Put a cap on it

As a Centrica shareholder myself, I think there’s a good chance that the payout will be held. Today, I want to explain why.

One of the factors putting pressure on utility share prices over the last year has been the government’s planned price cap. Details of the cap were published earlier this month and, in short, about 11m households are expected to save an average of £75 each year. This implies a loss for utility sector revenue of about £825m.

Centrica’s share price rose after this news, suggesting it was no worse than expected. Management guidance has also remained unchanged, so far.

Still a cash machine

At the core of forecasts for Centrica’s dividend is the group’s cash flow guidance. Management expect to generate adjusted operating cash flow of between £2.1bn and £2.3bn this year. To help achieve this, cost savings of £200m are planned.

Capital expenditure for the year is expected to be limited to £1.1bn. The difference between operating cash flow and capex gives us an adjusted free cash flow figure of around £1bn, perhaps a little more.

Once interest costs of about £300m have been paid, this should leave just enough surplus cash to cover the cost of the dividend, which I estimate at about £675m.

In my view, this suggests the dividend will remain safe this year, and probably next year too. But earnings forecasts for 2019 are flat. In my view, a return to growth will be required to support the current payout beyond 2019.

This situation isn’t without risk, as my colleague Rupert Hargreaves explains. But I believe a turnaround is still likely and rate the shares as a buy.

Is this 8% yield safer than Centrica?

Another stock offering a forecast dividend yield of 8% is legal services and personal injury specialist NAHL Group (LSE: NAH), which runs the National Accident Helpline business, among others.

This £55m firm has been hit by regulatory changes in recent years and forced to change its business model. As a result, the group’s dividend has already been cut from a high of 19.1p per share in 2016 to a forecast level of 9.5p per share this year. This gives a forecast yield of 7.8%.

Today’s half-year results confirmed that the interim dividend will be cut from 5.3p to 3.2p. This seems to match up with the full-year forecasts, but the group’s share price is 4% lower at the time of writing.

I suspect investors are concerned that this business is still struggling to generate any growth. Today’s figures show revenue unchanged at £24.9m, and pre-tax profit unchanged at £5.3m.

However, net debt has risen by almost 50% to £17.4m over the last year. In my view, we need to see some growth as a result of this spending — otherwise this debt burden could become problematic.

What I’d buy

I believe the best company for investors in this sector is rival Redde, about which I wrote recently.

I’m not yet convinced by the turnaround at NAHL. In my view, there’s still a fair risk that growth will disappoint and another dividend cut will be necessary. I’m going to steer clear for now.

Accidental profits

Legal services firm NAHL Group (LSE: NAH) operates in the personal injury market, generating leads for solicitors who handle claims. It also works with critical injury cases and has an unrelated service providing conveyancing leads.

The business has two parts — marketing and legal services. The structure of the legal operations has changed in recent years due to regulatory changes. This highlights a major risk with this type of company — it’s vulnerable to political and regulatory interference.

However, my impression is that NAHL is quite a well-run firm. Despite dealing with a changing regulatory environment it’s been consistently profitable and cash generative in recent years, operating with very little debt.

On track to deliver an 8% yield

In a trading statement today, the firm said that trading during the first half of the year had been in line with expectations. According to chief executive Russell Atkinson, “earnings are in line with our plans”.

Based on the group’s revised dividend policy of paying out half the group’s earnings each year, analysts expect a full-year dividend of 9.5p per share, giving the stock a forecast yield of 8%. Trading on a forecast P/E of 6.2, the shares seem cheap.

Overall, my view is that the stock’s valuation reflects the risks facing investors in this business. If NAHL continues to perform well, then I think the shares could be a good income buy at this level.

A potential bargain?

With a market cap of under £60m, NAHL might be too small for some investors. One larger company offering a super-sized dividend yield is housebuilder Crest Nicholson Holdings (LSE: CRST).

Crest’s forecast dividend yield of 8.5% is one of the highest in the FTSE 250. But the firm’s shares have fallen by 28% so far this year, as investors have taken fright at the firm’s falling profit margins.

Expensive houses are harder to sell

The Surrey-based firm’s main focus is on London and the south of England. Prices are flat in these markets, according to management, but the cost of building houses is still rising. As a result, Crest’s operating profit margin fell from 19.1% to 17.2% during the first half of this year, compared to the same period last year.

It’s worth noting that some company insiders have seen the stock’s decline as a buying opportunity. And to be fair, the company still appears to be in good financial health.

Earnings are expected to be broadly flat this year, at about 65p per share. The company has indicated plans to pay a dividend of about 33p for the full year. These figures put the stock on a forecast P/E of 6, with a prospective yield of 8.5%.

Despite this tempting price tag, I’m uncomfortable investing in a firm with falling margins after such a long housing boom. I believe there are better opportunities elsewhere in the property sector.

Indeed, over the period, the shares have returned 100% excluding dividends. Including dividends, shareholders have seen a return of 125%.

And it looks as if these returns are set to continue as today the company announced, alongside its final results for the period ending 30 November, a 25.9% increase in adjusted diluted earnings per share and a 10% increase in the proposed full-year dividend of 26.6p per share. 

Successful year 

This dividend hike follows a healthy year for the supplier of technology and resources to the education sector. Overall, revenues for the period increased by 11% to £185.9m and adjusted operating margins increased from 11.2% to 11.9%. These operational improvements helped the company deliver adjusted operating profit growth of 17.4%. 

RM’s performance received a substantial boost in the year after the company acquired the education & care business of Connect Group plc for £59m. The acquisition contributed revenues of £27.8m for the period. Even though the group did borrow to acquire this growth, robust cash generation is already allowing it to pay off creditors. Before the acquisition, RM’s net cash balance was £40m. By year-end, net debt had fallen to £13.4m implying a reduction in net debt of £5.6m over the past few months. 

Going forward City analysts are expecting further growth from the company. Following this year’s strong performance, earnings per share growth of 9.1% is projected for 2018 indicating that the shares are trading at a discount forward P/E of only 8.3. A market-beating dividend yield of 4.3% is also on offer. 

So overall, if you’re looking for a cheap growth stock with a dividend growing at a double-digit percentage every year, RM could be the company for you. 

Changing with the times

Another dividend stock that’s on my radar today is NAHL (LSE: NAH). This personal injury-focused law firm has fallen out of favour with investors over the past few years, due to government attempts to clamp down on the sector. However, management has been trying to diversify, and so far this strategy is succeeding, with the group’s critical care division and residential property arm producing steady results.

These efforts are expected to help the company continue to grow in a harsh environment. Over the next two years, City analysts expect revenues to expand by around 9%, although net profit is expected to slide by 25% over the same period. 

Still, NAHL’s discount valuation and high-single-digit dividend yield more than make up for this earnings decline. The shares currently trade at a forward P/E of 9.3 and support a dividend yield of 7.3%. The payout is covered 1.5 times by earnings per share, and the group has a relatively stable balance sheet with net gearing of just 16.2%, leaving plenty of room for manoeuvre. 

It could also be the case that City expectations for the company’s outlook turn out to be too pessimistic. Indeed, only a few weeks ago the firm announced to the market that trading during the fourth quarter had exceeded expectations and, as a result, earnings for the full year would beat City estimates. With this being the case, I’m optimistic about NAHL’s future.

Today I want to look at two stocks with 7% yields that I believe could be quite safe.

Better than expected

Shares in personal injury specialist NAHL Group (LSE: NAH) fell by nearly 4% today, despite the firm advising investors that its full-year underlying operating profit for 2017 should be in line with expectations.

In fairness, this stock has put on a spurt in recent months, having risen by 40% since September. I wouldn’t be surprised if some traders had decided to take profits after such a strong run.

For longer-term investors, this business still seems attractive to me. Unlike some rivals, debt levels are low and the group doesn’t have a lot of money tied up in unpaid bills. Cash generation is strong. Previous years’ dividends have generally been paid out of genuine surplus cash.

As such, the shares look cheap to me, with a 2018 forecast P/E of 9.5 and a prospective yield of 7.2%.

What’s the catch?

The main risk here seems to be that the legal regulations which govern NAHL’s business are changing. Management have already taken steps to restructure the business to work within the new rules, which are expected to come into force no earlier than April 2019.

However, it’s not yet clear how large the eventual impact on profits will be. Earnings are expected to have fallen by around 8% in 2017, and are forecast to drop a further 20% in 2018.

NAHL’s dividends are also falling to reflect this lower level of earnings. So although the stock is cheap, investors have to take a view on future earnings growth. Overall, I think this unusual stock is probably worth a closer look.

This Woodford pick looks cheap to me

Fund manager Neil Woodford’s focus on belief in the UK economy has led him to invest in a number of housebuilding stocks. One of these is Crest Nicholson Holdings (LSE: CRST), a FTSE 250 firm with a focus on the south of England.

The group’s shares currently trade on a relatively modest valuation compared to some rivals, with a forecast P/E of 7.3 and a prospective yield of 6.9%. This payout should be covered twice by earnings this year and looks entirely affordable to me in the current market.

The group’s balance sheet also seems healthy enough, with just £30m of net debt versus forecast profits of £167m.

What might go wrong?

The obvious risk is that the housing market could crash. However, low interest rates and government support through Help to Buy seem likely to delay this. I suspect a crash could still be some way off.

I also think that Crest’s focus on “the southern half of England” could help to make it more resilient in a downturn. Historically, the south has recovered more quickly from housing slumps than most other parts of the UK.

The group’s forward sales were up by 13.6% at the end of October, and total sales are expected to rise by about 13% to £1,205m this year. In my view, this 7% yielder could be a rewarding buy in 2018.

However, not all dividend stocks may be worth buying at the present time. Some stocks may offer high yields, but have relatively uncertain growth outlooks. With that in mind, here is one dividend stock which appears to be worth selling, followed by another that could be a sound buy.

Falling profitability

UK consumer marketing business NAHL (LSE: NAH) released an update on Friday. The legal services-focused business announced that it has established its second Alternative Business Structure (ABS) in partnership with Lyons Davidson. The ABS will trade under the name National Law Partners and is expected to commence in November.

This forms part of the company’s strategy to advance its business model following the Personal Injury reforms announced by the government. In the long run, the ABS could help the company to grow its share of the Personal Injury market.

However, in the next couple of years the company is forecast to post a significant fall in its bottom line. For example, in the current year its earnings are due to fall by 11%, with a further decline of 20% expected next year. This means that dividends are expected to be cut from 19p per share last year to 13p per share in 2018.

While this still means that NAHL has a forward dividend yield of 8.9% and shareholder payouts should be covered 1.5 times by profit, the stock may struggle to make gains. Investor sentiment could decline in response to falling profitability, which means that its high income return may be more impressive than its total return.

Growth potential

In contrast, FTSE 100-listed Smurfit Kappa (LSE: SKG) is expected to post impressive earnings growth next year. The paper-based packaging specialist is forecast to grow its bottom line by 15% in the next financial year. When combined with a modest price-to-earnings (P/E) ratio of 12.5, this gives the stock a price-to-earnings growth (PEG) ratio of just 0.8. This suggests that its share price could move higher.

As well as growth potential, Smurfit Kappa also appears to have dividend appeal. The company has a dividend yield of 3.4% from a shareholder payout that is covered 2.4 times by profit. This suggests that dividends could grow at a much faster pace than profit without reducing the reinvestment potential available to the business.

With relatively solid profit growth over the last five years, Smurfit Kappa could prove to be a sound buy for the long term. Since the outlook for the UK economy is uncertain, it could provide a mix of defensive attributes, dividend growth potential and capital gains over the long run. As such, now could be the perfect time to buy it.

The business in question is personal injury-focused legal services group NAHL Group (LSE: NAH). In its half-year results today, the company confirmed that its performance so far this year is in line with expectations.

The group’s dividend policy remains unchanged, which means that the full-year payout should be covered 1.5 times by earnings per share. Based on forecasts for full-year earnings of 24p per share, that gives a total dividend of 16p. Today’s interim dividend of 5.3p supports this forecast, as NAHL’s final dividend is usually twice the size of its interim payout.

At the current share price of 132p, a dividend of 16p gives a yield of 12.1%. So what’s the catch? Why aren’t income investors buying as much stock as possible?

2 possible problems

NAHL is a business in transition. Changes to the regulations regarding personal injury claims have forced the group to reshape its business. It’s too early to say how successful this will be or whether profits will be sustained at historic levels.

The company expects 2017 and 2018 to be transition years. Analysts’ forecasts are for the group’s profits to fall by around 20% in 2018. I’d expect a similar cut to the dividend next year. But this still gives a prospective yield for 2018 of 9.9%.

Buy or sell?

There’s considerable risk here. But the group’s management has generally delivered well in the past, and its finances remains strong.

I’d argue that if NAHL can maintain profits at next year’s forecast level of around £9m, the shares could rise by about 50% from their current level. However, failure to deliver could result in permanent losses for shareholders.

How safe is this 6.6% yield?

Another company with a very high yield is men’s formalwear specialist Moss Bros Group (LSE: MOSB). This business hires and sells suits to customers and has, for several years, offered a generous yield of about 6%.

This dividend has not been covered by earnings since 2014. But the company’s strong net cash position, boosted by advance payments on hired outfits, has meant that this generosity has been affordable.

However, shareholders will know that the value of Moss Bros shares has fallen by more than 15% since May. While this has lifted the yield on the stock, I believe it’ also highlights growing risks to the dividend.

Clouds gathering?

Moss Bros’s trading update for the 15 weeks to 13 May warned of a 0.5% reduction in retail margins due to a midseason sale. This was introduced in response to “a much tougher trading environment”.

The update also revealed a 3.8% fall in hire orders, while like-for-like hire sales on a ‘cash taken’ basis fell by 14.2% during the period. This was due to the firm reducing the deposit it takes from each customer when hire orders are placed.

Pressure on both cash flow and profit margins appears to be growing. And with the stock already trading on 16 times forecast earnings, I think the dividend is the only thing supporting the share price. If the payout falls, I’d expect the shares to plummet. I’m not tempted at current levels.

The company has done remarkably well recently as rising property values and solid economic growth have led homeowners to upgrade to double-glazed windows and doors or add a conservatory to their homes. This has driven demand for the rigid plastic frames that Eurocell makes and distributes.

By acquiring competitors and expanding its retail presence across the country, this growth has continued in the six months to June despite a flat remodelling market in the UK. Year-on-year (y/y) revenue rose 11% to £108.1m as the company opened up 15 new branches and also made inroads into the new build housing market that continues to grow steadily due to restricted supply.

It wasn’t all good news though as rising materials costs due to inflation and the weak pound did send gross margins down from 52.1% to 51.4% y/y, which led to adjusted earnings per share rising by just 8%. However, with net debt falling to just £20.8m, or less than one times EBITDA, management was still able to increase the interim dividend payout by 7% to 3p per share.

If last year’s final dividend payout of 5.7p per share rises by a similar amount, investors could be looking at around a 9.1p payout for the full year that would yield roughly 4% at today’s share price.

That said, the markets it targets are very reliant on continued economic growth and rising property values. And the fact that companies such as Safestyle UK that operate in the same sector have recently warned on profits is not a good sign. Eurocell continues to grow nicely and offers a healthy dividend yield, but the cyclical nature of the sector scares me and I reckon there are safer income stocks out there.

Too good to be true?

While Eurocell looks cheap and its dividend yield is impressive, both figures pale in comparison to those posted by NAHL Group (LSE: NAH), which offers a 14.6% dividend yield while trading at just 5.4 times forward earnings.

These figures may look incredibly appealing but when something looks too good to be true, it generally is. I believe this holds true in the case of NAHL. The group’s core business is operating the National Accident Helpline that connects those injured in accidents with a lawyer in exchange for a small fee.

This was a tidy little business for a long time but proposed regulatory changes have the potential to damage it. The main alterations would be an increase in the maximum claims ceiling that could be sought in small claims court, which would mean less need for lawyers, and changes to how personal injury cases are compensated. The market has understandably reacted negatively to these proposals and sent the share price of NAH plummeting 45% over the past year.

There’s still hope for NAH as it is diversifying its revenue streams, remains highly cash generative and has low debt. But until we see for sure what effect these proposed changes will have on NAH’s bottom line, I won’t be picking up its shares.

Earnings before interest, tax, depreciation and amortisation in the nine-month period hit £34.1m, up from the £23.2m reported for the prior 12-month period.

Cash is king

On a pro-forma basis that compares the nine months to the end of 2016 versus the nine months to the end of 2015, revenue was up 27% to £115.6m from £91.6m while EBITDA was up 57% to £17m from £10.8m.

Unfortunately, due to higher amortisation charges of £64m, compared to just £18.8m for the prior 12-month period, Vectura’s pre-tax loss ballooned to £40.1m. But in many ways this accounting loss is irrelevant. What really matters is its cash generation. During the nine-month period, the company generated £28.2m of cash, taking the cash balance to £92.5m at the end of the period, almost 9% of Vectura’s market capitalisation. 

As it shortened its financial year after merging with Skyepharma, these results should be interpreted as the group’s full-year 2016 results. Analysts had been expecting a loss from the company but going forward they believe its earnings will surge. For 2017 earnings per share growth of 27% is pencilled-in and for 2018 growth of 48% is expected as the firm continues to roll out new products. 

Even though shares in Vectura currently trade a forward P/E of 25.4, this growth is certainly worth paying for, especially considering its cash balance. The company does not currently offer a dividend although considering the cash pile it holds, I wouldn’t rule out a dividend in the near future. 

Dividend champion 

As well as Vectura, shares in National Accident Helpline (LSE: NAHL) are also rising today following an upbeat set of results from the company. 

For the year ending 31 December, underlying revenue declined 2.6% to £49.4m but underlying operating profit rose 15.1% to £18m thanks to an improvement in the firm’s operating profit margin from 30.8% to 36.4%. Profit before tax increased 13.3% to £15.8m and basic earnings per share rose 1.4p to 27p. Off the back of these results, management has increased NAHL’s dividend payout for the year by 1.6% to 19.1p giving a dividend yield of 11.4%. 

City analysts are not optimistic about NAHL’s outlook but today’s results should alleviate concerns about the company’s future. Falling revenue but rising profitability shows that NAHL can adapt to the changing regulatory environment, which is good news for shareholders. 

And even if earnings collapse as predicted over the next two years (analysts have pencilled-in a 30% decline in earnings per share) the shares still look cheap. Based on 2018 forecasts, shares in NAHL currently trade at a forward P/E of 8.2 and support a dividend yield of 8.6%. 

In today’s low-interest-rate environment dividends are even more important as they can give a new lease of life to your savings. So, here are three of my favourite dividend stocks for 2017. 

Slow and steady 

Furniture and flooring group SCS (LSE: SCS) may not be the most exciting company around, but it is an income champion. 

Indeed, for the year ending 31 July 2016, City analysts expect the company to pay a dividend to shareholders of 14.5p per share, which equates to a yield of 8.5% at current prices. The shares currently trade at a forward P/E of 7.9 and the payout is covered 1.5 times by earnings per share.

Unfortunately, analysts aren’t expecting any fireworks from the group this year. Earnings per share growth of zero is pencilled-in for the year ending 31 July. Still, SCS’s low valuation and 8.5% dividend yield appear to make up for the lack of growth. 

Putting shareholders first 

Shares in DX Group (LSE: DX) lost around 75% of their value last year when the company warned on profits and ever since the shares have struggled to return to their former glory. Nonetheless, even though DX’s earnings per share have fallen by 50% since 2015, the company’s dividend payout of 2.5p is still covered twice by earnings per share indicating that the payout is safe for the time being. 

A dividend payout of 2.5p per share equates to a dividend yield of 13.9% at current prices. What’s more, just like SCS, shares in DX trade at a highly attractive valuation. City analysts are projecting group earnings per share of 4.8p for the year ending 30 June 2017, meaning that the shares currently trade at a forward P/E of 3.8. 

Cloudy outlook 

Legal services group NAHL (LSE: NAH) will be glad to have put 2016 behind it. Concerns about the company’s business model knocked 47% off the share price during 2016 as investors fled the stock. However, City analysts aren’t predicting doom for the firm any time soon. 

For the year ending 31, December 2016 analysts are expecting the group to report earnings per share growth of 16% although these gains are expected to disappear next year. For the year ending 31, December 2017 earnings per share are projected to fall 21% back to the level reported for 2015. Analysts are also expecting management to reduce the company’s dividend payout in line with declining earnings. From a payout of 19.2p for 2016, analysts have pencilled-in a full-year dividend payout of 15.9p per share for NAHL during 2017, down 17.2% year-on-year but still equal to a dividend yield of 11.8%. 

Further, NAHL’s shares currently trade at a forward P/E of only 5.7, which is cheap even considering the market’s concerns about the company’s outlook. 

Personal injury profits

NAHL Group (LSE: NAH) is perhaps not a familiar name, but its National Accident Helpline brand is — and that, along with the rest of the firm’s marketing services provided to the legal profession, looks like good business to me. I wasn’t surprised to see first-half pre-tax profit up 17% to £7.5m, as reported in Wednesday’s interim figures, together with a 5.6% rise in earnings per share. Cash conversion of 95.7% helped the firm hike its interim dividend to 6.35p per share.

But what does surprise me is the valuation of NAHL’s shares, priced at 263p. Forecast EPS growth of 19% this year and 33% next gives us low P/E multiples of 8.9 and 8.6. That results in PEG ratios of 0.5 and 0.3 respectively — anything around 0.7 or lower is usually considered a good sign by growth investors.

This low valuation has come about through fears of changes to personal injuries regulation — plans to curtail whiplash claims were announced last autumn by George Osborne, but he’s history now. But even when changes do come, NAHL seems to be on top of it, with chief executive Russell Atkinson speaking of the firm’s diversification and its “deliberate strategy to reduce volumes and focus on higher value case types,” which is helping to improve margins.

And on top of that, NAHL is expected to pay dividend yields of around the 7.5% mark, which should be well enough covered by earnings. It’s a risky investment, but I see over-reaction in the low share price and I think it could be a winner.

Building on services

Another tempting combination of share price growth and dividends I see is Interserve (LSE: IRV), whose shares are down 29% over the past 12 months to 402p. But they’ve been recovering of late, having picked up 80% since early July, and that includes a 4% hike on the day the services firm announced a new contract. Interserve’s construction joint venture Khansaheb is set to expand the City Centre Ajman mall in the United Arab Emirates under an £81m deal.

August’s first-half results revealed modest improvements all round, with the interim dividend lifted by 2.5% to 8.1p per share. Net debt was reduced to £275.6m, from £308.8m at the end of 2015, though that should rise again by the end of this year to £300m-£320m — and that does concern me a little.

The firm’s guidance was unchanged, so we should see a full-year EPS fall of around 5%, but the City folk have a return to growth on the cards for next year. And with what chief executive Adrian Ringrose described as a “healthy future workload” (which stood at £7.6bn at the interim stage), I can see further years of steady earnings growth.

On valuation terms, we’re looking at P/E ratios of just 6.3 this year and 5.8 next, and on top of that we have dividend yields of 6.3% and 6.6% pencilled-in. I was previously concerned that a cut might be needed, but strong forecast cover and the confidence the firm has shown by increasing its halftime payment have allayed that concern.