A top UK share for income and growth

Redrow (LSE: RDW) is a UK housebuilder. It won’t be everyone’s cup of tea as this industry clearly faces some headwinds. The cladding tax, rising interest rates and the potential impact on mortgage demand and availability, a cost of living crisis, increasing materials costs and a tapered ending of government support to housebuilders. That’s quite a list of things to worry about on top of the dreadful war in Eastern Europe and all the other things dragging markets down so far this year.

Yet from a valuation and income perspective, Redrow has a lot going for it. The P/E is just seven and the price-to-earnings growth ratio – favoured by growth investors like Jim Slater – is 0.26, indicating the housebuilder is potentially very undervalued.

The dividend is covered nearly three times by earnings so has plenty of room to grow further, even though the shares already yield 5.4%.

I already have shares in FTSE 100 housebuilder Persimmon, but even so, Redrow looks compelling and I may buy the shares for the long term. It combines income and a cheap valuation, which could be a platform for strong future share price growth.

Another top share

Norcros (LSE: NXR) is exposed to some of the same risks as a supplier to housebuilders and other property companies. It owns and manufactures a range of household-related brands, such as Triton showers and Johnson Tiles, the leading manufacturer and supplier of ceramic tiles in the UK.

With Norcros there’s the political risk that comes with having significant operation in the South African market. The flip side of that is that if this emerging economy does well, Norcros should benefit.

The group has a 2025 Strategic Vision, with targets including £600m revenue by that year, having 50% of revenues derived from overseas and a sustainable ROCE of more than 15%. All of these indicate the potential for growth and ambition on the part of management. Its current revenue, for context, is £324m.

The shares are undemanding from a valuation perspective. The PEG is 0.13, while the P/E is eight. The dividend yield is just under 3.5% and is covered just under three times by earnings.

I have owned this share before, and as the shares struggle in this current market sell-off, I’m very tempted to buy them again.

A more passive route to getting more exposure to value stocks can be gained by investing in trusts or funds. These pool together investments. In my opinion, the investment trust Merchants Trust or the Fidelity Special Situations fund might be good options for me too. These professionally run investments have a strong bias towards value shares and could do well this year and beyond. All the more so if the rotation to value really takes root.

Low price and dividend growth potential

Norcros manufactures and sells branded showers and owns brands such as Triton. Similar companies have seen strong growth since the pandemic as people focused on home improvement.

This is one reason why I think Norcros half-year results, which will be out on Thursday (11 November), could be positive.

Yet wider expectations don’t seem to be that high because Norcros shares are cheap, trading on a P/E of just 10. This provides the firm with the opportunity to outperform expectations, and that could be good for the share price. The forward PEG of only 0.6 is another indication to me that the shares could be undervalued.

The dividend also has plenty of room to grow as the yield is modest at the moment at 2.5%. The dividend is covered more than twice by earnings and has recovered to a level near to what it was pre-pandemic.

I like what I see about the shares, beyond the low P/E. Norcros also has a good return on capital employed (ROCE) of 12. Return on equity is the same figure. Taken together I think these numbers show that Norcros could be a quality company. That boosts my confidence in its long-term potential.

What could go wrong?

Despite my expectations, of course, things might not go as planned for the firm. Norcros is turning around its South African business, but progress might not be as good as management hopes. In the UK tax rises and a squeeze of household budgets may limit home improvement spending too, which would likely hit the firm.

Potentially it could also overpay for acquisitions, which could hurt shareholder returns. Low organic growth, if it doesn’t improve the performance of the brands it already owns, may also hit the share price.

The pension deficit (boring and easy to overlook, I know) is also coming down but is still a drain on the company. It requires Norcros to use cash for pensions rather than spending on acquisitions, investing in its brands or other growth, or paying a larger dividend. The deficit has been massively reduced so it’s now less of an issue and requires less cash. But it’s still over £18m in deficit. 

At the end of the day, it’s hard to tell what any share price will do in the short term. But I expect that a good update this week could see the share price do very well this month if investors respond positively. And it could also provide evidence that Norcros could do well in the future too. I already own Norcros shares and for me, their low price, the firm’s decent returns on capital and growing dividend make it a long-term hold, unless something goes very wrong.

Still, even though cheap stocks aren’t guaranteed to outperform, I believe owning them introduces some diversification to my portfolio. As such, here are three cheap UK shares I’d buy today. 

Cheap UK shares I like

The first stock on my list is the utility group Centrica (LSE: CNA). This company has suffered some significant setbacks in recent years, but has overcome these challenges. 

Over the next few years, I think the company can stage a recovery. After reorganising the operation and selling off non-core divisions, it’s now better placed to make a comeback. 

City analysts forecast a net profit of £191m this year, followed by £356m in 2022. Based on these numbers, the stock’s trading on a forward price-to-earnings (P/E) multiple of 8. Based on this valuation, I’d buy the company for my portfolio of UK shares.

But while the stock may look cheap, I think it’s important to keep an eye on competition. Previously, Centrica has struggled to grow as cheaper competitors have stolen market share. This is the most significant risk facing the company today.

Defensive market

Alongside Centrica, I’d also acquire agriculture and engineering group Carr’s (LSE: CARR) for my basket of cheap UK shares. I think the agriculture side of this business is the most exciting.

This division develops and sells a range of branded animal nutrition products. This market is relatively defensive, and demand will only increase as the country’s population and the number of animals required to feed it grows.

The group’s figures for 2020 show the defensive nature of the business. Earnings per share declined by just 3% last year, despite the pandemic. 

Right now, the stock is trading at a 2022 P/E ratio of 12.3. It also supports a 3.1% dividend yield. I think these figures look attractive as Carr’s benefits from the UK economic recovery. Considering its growth potential, I think it deserves a higher multiple. 

One challenge the company could face is rising costs. Higher input costs in its feed and engineering businesses could reduce profit margins if they can’t be passed on to customers. 

Builders market

The final company I’d acquire for my portfolio of cheap UK shares is bathroom and construction components supplier Norcros (LSE: NXR). With the UK is currently experiencing a building boom, Norcros is reaping the benefits.

According to the City analysts’ projections, which are based on the company’s own forecasts, earnings per share are expected to increase 44% in its current financial year. If the firm hits this target, the stock is currently selling at a forward P/E of 9. 

Of course, these are just projections. There’s no guarantee the company will hit this target. Nevertheless, I think they highlight its potential. The stock also offers a dividend yield of 2.9%, at the time of writing. 

Like Carr’s, Norcros also faces the challenge of trying to navigate rising costs. These could hold back growth if the company can’t pass them on to consumers, or if rising prices put consumers off buying. 

One stock I’ve picked is seeing healthy growth at a good valuation. But it’s not an unprofitable tech stock. There’s no hydrogen energy here, nor electric vehicles. It’s much more boring than that. I don’t mind boring though, if I reckon there’s money to be made. 

Home improvements

Norcros (LSE:NXR) just jumped right to the top of my picks for the best shares to buy now. The £245m market cap business supplies high-end bathroom and kitchen branded products. Most wouldn’t look out of place in a posh Kirsty and Phil makeover, like Abode sinks and taps, and Johnson ceramic tiles. 

UK homeowners splashed out £39bn in the last 12 months on property improvements, according to recent surveys. It’s understandable, with more people working from home and seeing upgrades they’d like to make. 

And I really like the figures I see in the Norcros back-end. Net profit is expected to jump 72% from £15m to £25.8m in 2021. And yet the shares are trading on a forward P/E of less than 10. So there’s value plus growth potential here. 

Bosses have continually improved the company’s profitability over the past few years. Return on capital nearly doubled from 6.8% in 2020 to 12% in 2021. This shows me it’s a well-managed business. 

Some of the country’s richest investors seem to agree these are the best shares to buy now. Premier Asset Management, the company’s largest institutional shareholder, upped its stake by 773,000 shares on 16 June. It now holds more than 11% of the business.

Outlook

There are a few dampeners to consider. It’s not all sunshine and roses, and as an investor, I need to keep a calm head and not get overexcited. Group revenue for the year to 31 March 2021 dipped around 5%, to £342m. And Norcros’s South African arm pulled in a slightly lower percentage of the group’s revenue this year than than the year before. 

“Group revenue outside the UK has decreased in the year to 41.6%, reflecting the impact of Sterling strengthening relative to the Rand,” Norcros said. 

South African currency markets have experienced significant volatility over the past 12 months. And as local business reporters note, that made it bad news for anyone moving funds out of the country.  

But looking further ahead, I can see Norcros expects its revenues to keep growing, along with those tasty net profits. And earnings per share (EPS) are forecast to jump from 22.4p to 31.5p next year. That 30% EPS hike comes at good value. Price-to-earnings growth stands at less than 0.5. Anything under 1 is generally considered excellent value. 

Risk vs reward

Right now, I’m looking at top growth shares. Elsewhere, I’ve got a diversified portfolio stacked with high-dividend-yield businesses. That’s my safety angle covered. So I’m happy to take on more risk now in the hope of higher rewards. 

Of course, the best shares to buy now are different for different people. My risk profile is not everyone’s risk profile. But I think I’ve identified a great growth company that could boost my ISA and make my money go much further.

Is there a multi-year bull run on the way?

Some believe that the index is set up for a multi-year bull run after around two decades of consolidation. I think that’s a reasonable theory. Last decade’s credit-crunch was a blow that left the world’s economy and financial system in a big hole that has proved difficult to climb out of. Leading up to the crunch, many firms and individuals were engaged on a spending spree fuelled by borrowings. The world seemed to be living above its means and I see the credit-crunch as the leveller that rebased expectations. I reckon it makes sense that the world’s economy and financial system would take a decade or so to ‘repair.’ But now that the healing process is advanced, why shouldn’t we move into an extended period of prosperity and growth?

If we do, I think the FTSE 100 will do well. Many of the firms in the index operate in cyclical sectors such as finance, mining, oil & gas, retailing, housebuilding, construction and outsourcing. Macroeconomic wobbles tend to make cyclical companies’ share prices wobble too, so we often see big swings in the index. Yet the possibility of a period of prosperity suggests the potential for the cyclicals to shine and drive the index higher along with other firms in the index as their businesses grow.

Although I’m bullish about the FTSE 100, I’m even more bullish about the prospects for consumer products supplier Norcros (LSE: NXR). The firm scores well against value, quality and momentum indicators, pays a big dividend and could rally from here to outpace the FTSE 100, perhaps driven by a valuation re-rating and decent forward growth projections.

Good trading and a low-looking valuation

Today’s full-year results are encouraging. Constant currency revenue rose 8.6% compared to the prior year, underlying operating cash flow increased 4% and underlying earnings per share moved 6.1% higher. The directors expressed their confidence in the outlook by pushing up the total dividend for the year by 8.3%.

The firm supplies items such as showers, shower enclosures, trays, taps, tiles, bathroom furnishings, accessories and adhesives, and owns brands such as Triton, Merlyn, Vado, Abode, Johnson Tiles and Norcros Adhesives. During the trading year to 31 March, the firmed earned 55% of its operating profit in the UK and 45% in South Africa. There’s no doubt that operations are cyclical, but just as a period of prosperity could drive up the FTSE 100, I think Norcros could thrive too.

The stock is perky today, up around 7% as I write. But even at 213p or so, the forward price-to-earnings rating for the year to March 2020 sits below seven and the forward dividend yield is a tempting-looking 4.2%. On the face of it, there’s plenty of room for a valuation uprating and I think the stock is well worth your further research time.

The bathroom products and tiles business has been expanding steadily over the past five years, although the market seems to have ignored this growth. 

Since 2012, operating profit has grown at a compound annual rate of 9%. However, today shares in the company trade at a depressed forward P/E of only 6.3, a valuation which, in my opinion, fails to reflect the group’s outlook.

Double-digit growth

A mid-single-digit valuation implies that Norcros is struggling to grow, but that is not the case. According to a trading update issued by the firm today, for the year ending 31 March, following the significant acquisition of Merlyn — the UK and Ireland’s No. 1 supplier of shower enclosures and trays — last year, revenue increased to 10.7% year-on-year. 

On a like-for-like basis, excluding this acquisition, revenues increased 4.4% as tough trading in the UK was more than offset by growth in the South African business, which reported constant currency revenue growth of 6%.

Unfortunately, Norcros is not immune from the headwinds affecting the broader retail sector here in the UK. The group’s Johnson Tiles business suffered significantly during the second half of the year, prompting management to begin a restructuring programme. As trading continues to deteriorate, management has now unveiled a new round of cuts with the goal of saving £2m per annum at a cost of £2.1m and the loss of 50 jobs. 

Poor trading at Johnson Tiles dragged down UK like-for-like sales to a dip of 0.8% during the second half of the financial year. Excluding this business, second half like-for-like revenue grew 8.4% in the UK, following growth of 11.4% in H1. So it looks to me as if, barring this one division, Norcros is powering ahead.

With this being the case, and considering the low valuation, as well as its 4.5% dividend yield (covered nearly four times by earnings per share) I believe the stock has what it takes to outperform the FTSE 100, as the market wakes up to the opportunity on offer.

And I believe that the same is true for marketing business Communisis (LSE: CMS). 

Sector discount 

Like Norcros, shares in Communisis look cheap. The stock is currently trading at a forward P/E of 9.4 and supports a dividend yield of 4.3%, even though earnings per share have grown by 17% annualised over the past six years.

It looks as if this growth is set to continue. As my Foolish colleague Jack Tang recently pointed out, Communisis has just embarked on a three-year Value Enhancement Programme to deliver 5%-10% annualised adjusted earnings growth through to 2020, via its three critical strategic themes: Digital First, Global Reach and Empowered Organisation. 

If the company can hit this goal, then in my opinion, the shares deserve a much higher valuation. How much higher? Well, the broader media services sector is currently trading at a median forward P/E of 12 while the professional and commercial services sector is trading at a median valuation of 14.2. I think Communisis deserves a valuation between the two, around 13 times forward earnings, implying a share price of 95p based on City projections that the firm will earn 7.3p per share for 2019.

Software and IT services provider Sanderson Group (LSE: SND) is one that I think fits the bill. The share price has been a bit volatile over the past couple of years, but at 74p today we’re looking at a 55% gain over five years.

But more important from an income perspective is a dividend that has soared from 1.5p per share in 2013 to 2.65p for the year ended September 2017. That represented an 11% rise over last year, for a 3.6% yield on the current share price. It’s also almost two-and-a-half times covered by earnings per share, so it’s really not stretching the company at all.

Big 5-year jump

With the dividend having risen by 77% in four years, if you’d bought shares around the start of 2013 for about 50p, you’d be earning an effective yield of 5.3% this year on your original purchase price, and the 2.9p forecast for next year would take that to 5.8% — just a shade short of that 6%.

Revenue for the year was largely flat at £21.56m, but adjusted operating profit picked up 5.7% to £3.9m with adjusted basic earnings per share up 18% to 5.2p.

Most importantly (in my view), the firm reported continued strong cash generation which led to a year-end net cash balance of £6.18m — up from £4.34m a year previously and “well ahead of market expectations.“

Buying now could lock in some big future returns.

Superior cover

Norcros (LSE: NXR) has exhibited a slightly less spectacular dividend progression in the past few years, but it’s still impressive. From 4.6p in 2013 (adjusting for 2015’s share consolidation), the dividend has grown to 7.14p for the year to March 2017. That’s a rise of more than 55% in four years, which is massively ahead of inflation.

Forecasts suggest a 4% dividend hike this year followed by a further 5.2% next year, which is a slowdown in the rate of growth — but still beating inflation, and I’m happy with it for a couple of reasons.

First, the cash would be more than three-and-a half times covered by forecast earnings, so it’s looking pretty safe. The other thing is that this is while Norcros, which supplies showers, taps, bathroom accessories, tiles and adhesives, is facing difficult trading conditions — and if it’s looking this good in tough times, I’m optimistic about the longer term.

Acquisition

In fact, Norcros looks to be in a good state to benefit from trade headwinds by making acquisitions at attractive prices. On 23 November, the firm competed the acquisition of Merlyn Industries funded by a new £31.4m open offer, with the enlarged company now on a market cap of £145m.

On top of that, debt at the interim stage at 30 September stood at £20.8m, down 24% and not what I’d call remotely troubling, and the company saw fit to lift its first-half dividend by 8.3%.

Forecast yields currently stand at a little over 4%, with the shares on a forward P/E of only around 6.3. I reckon Norcros is a dividend and growth combination to hold for the long term.

Today the company published yet another set of upbeat figures. For the first half, management expects revenue to be 12% higher at £145m, up from £129m in the same period last year. UK revenue for the period was 8.4% higher than the previous year, while its South African business revenue was up 4.8% on a constant currency basis. A focus on cash flow has helped the business reduce debt from £27m to £21m year-on-year. 

Looking forward Norcros said: “Against the backdrop of challenging market conditions, our performance demonstrates the strength of our market positions and the resilience of our diversified business portfolio delivering revenue growth.“

Following this robust first-half performance, the firm expects results for its fiscal year ending March 31 2018 to meet its expectations.

Slow and steady 

This is one of my favourite companies. While it may not be the fastest growing business in the world, the group has reported stable double-digit revenue and profit rises year after year. Growth has come from both acquisitions and organically. Cash generation is high with the business converting around 100% of net income to free cash flow on average for the past five years. This has enabled management to pay a lucrative dividend to investors (currently 4.4%) and pay for acquisitions. Pre-tax profit has expanded fourfold since 2013. 

As long as management can maintain this course for the next decade, investors should be well rewarded. What’s more, at current levels the shares are a steal. Despite its historical growth and cash flows, the shares currently trade at a deeply discounted 6.1 times forward earnings. 

Pricey but attractive

Scapa Group (LSE: SCPA) is at the other end of the valuation spectrum. The company, which is a global supplier of bonding solutions and manufacturer of adhesive-based products for the healthcare and industrial markets, said yesterday that group revenue, trading profits, and margins are all ahead of last year. 

For the full-year, management now expects to beat analyst projections. Analysts had been expecting earnings per share growth of 11%. Off the back of this forecast, the market has awarded the company a forward P/E of 28.8. 

Scapa has managed to increase pre-tax profits threefold in the past five years. Considering the group’s leading position in its key markets, as well as the defensive nature of the healthcare industry, I believe that the business is a great long-term buy for investors. 

The one downside, however, is Scapa’s dividend yield. At the time of writing, the shares only support a yield of 0.5%. That being said, the payout is covered more than seven times by earnings per share, leaving plenty of room for further payout growth, or special dividends. 

I believe both of these potential attractions apply to the two companies I’m looking at today.

A smart acquisition

Packaging firm Macfarlane Group (LSE: MACF) has announced plans for a step change in the size of its operations. The company will pay up to £16.75m to acquire Nottingham-based peer Greenwoods Stock Boxes Limited.

The deal will be funded with a mix of cash and new shares, and as part of this process Macfarlane will raise £8m in a share placing to help fund the deal. Although this creates some dilution for shareholders, the firm still expects Greenwoods to make a positive contribution to earnings in the first full year of ownership.

This acquisition certainly seems attractive to me. Greenwoods generated an operating profit of £1.6m last year from sales of £14.1m. That gives the firm an operating margin of 11%, more than twice the 4.9% margin generated Macfarlane’s 2016 operating profit of £7.8m. So this deal should help to lift the combined company’s profit margin, boosting future returns.

If Greenwoods fails to perform as expected, Macfarlane will be able to claw back £3.25m in cash, as this will only be paid if certain trading targets are met over the next year.

Cross-selling opportunities

Management says that there is “minimal overlap” between the two companies. They expect the combined group’s shared customer base to provide new selling opportunities, which sounds positive to me.

Macfarlane stock currently trades on a forecast P/E of 11, with a prospective dividend yield of 3.2%. If Greenwoods performs as expected, I believe there’s scope for decent gains over the next couple of years. I’d rate this stock as a buy after today’s news.

Due for re-rating?

I have to admit that the performance of electric shower and bathroom fittings group Norcros (LSE: NXR) has been a little disappointing in recent years. This firm owns brands such as Triton Showers, Vado, Jonson Tiles and Croydex and operates in the UK and South Africa.

Despite generating stable profits, reliable dividends and strong cash generation, the company’s shares trade on a forecast P/E of just 6.1. One reason for the market’s caution may be the group’s pension deficit. At £62.7m, this is quite large when compared to the market cap of £104m.

However, this deficit is largely the result of ultra-low bond yields. If the Bank of England raises interest rates as expected in November, bond yields could strengthen. In common with many companies, Norcros would only need a relatively small increase in bond yields for its deficit to fall significantly.

In my opinion, this is fundamentally a good company, with a robust business and good long-term growth potential. I think it makes sense to keep the faith for a little longer yet.

Based on last year’s figures, I expect this year’s forecast dividend yield of 4.5% to be well covered by free cash flow. And as I’ve already mentioned, a low forecast P/E of 6.1 means that Norcros stock has scope for re-rating if it can deliver on growth forecasts.

However, 12 months on and the firm appears to be suffering no ill effects from Brexit just yet. Today the company reported its results for the year ended 31 March and the referendum is only mentioned three times in the release. Revenue for the period grew by 15% on a reported basis to £271m, and underlying profit rose 11.7% to £23.8m. Operating cash flow jumped by 46.1% to £29.8m giving management headroom to reduce debt by 28.6% from £32.5m to £23.2m and hike the company’s full-year dividend payout by 9.1% to 7.2p from 6.6p. Even after this hefty increase, the payout is still covered 3.9 times by earnings per share. 

Growth ahead 

Norcros is rapidly closing in on the growth goals management set out several years ago. Management is targeting revenues of £420m by 2018, and a pre-tax return on underlying capital employed of 12% to 15% over the economic cycle. ROCE is currently ahead of target and has been for the past two years at 18.4%, but revenue is still lacking. 

Excluding the negative impact of the South African rand’s depreciation against the pound, revenue for the year to 31 March would have been £304m. Still, even though the company looks as if it may struggle to meet its growth objective, management remains convinced that it can find opportunities to accelerate it over the next few years. 

And if Norcros does not meet this aim, the shares still look incredibly cheap based on current earnings. Today the company reported underlying diluted earnings per share of 27.8p for the year to March giving a historic P/E of 6.3. Even if we assume no earnings growth for next year, a mid-single digit P/E looks too hard to pass up. A payout of 7.2p gives a yield of 4.1%. 

Undervalued growth

Unlike Norcros, over the past year shares in Severfield (LSE: SFR) have charged higher, rising 75% as the firm’s recovery gathers steam. And today the company reported further progress with revenue for the year to 31 March growing by 10% to £262m and underlying profit before tax rising 50% to £19.8m.

Basic earnings per share for the period nearly doubled to 5.1p, although despite this growth, the shares still look relatively expensive at 83p. 

That being said, Severfield’s value is in its growth potential. Indeed, management is seeking to double group profits by 2020. City analysts believe this is possible and have pencilled-in earnings per share of 6.6p on a pre-tax profit of £24m for the year to 31 March 2019.

Based on this estimate, shares in the steel producer are trading at a 2019 P/E of 12.4 and could be even cheaper if additional growth emerges in the year after.