A stock yielding in excess of 6% usually grabs my attention, but then I worry that such a high dividend payment may be unsustainable, or perhaps its a sign of trouble ahead for the underlying business.
However, in the cases of printer St Ives Group (LSE: SIV) and distributor Connect Group (LSE: CNCT), City analysts watching the firms collectively rate the stocks as strong buys, so its worth digging a bit deeper.
Robust dividend records
I cant fault either firm on its dividend record. Over the last five years, St Ives has raised its dividend by 49% and Connect by 32%. Forward estimates are for Connect to increase its payout by 2.4% for 2017 and 2.8% in 2018. Analysts expect St Ives to hold the dividend flat for the next two years.
Forward earnings will likely cover Connects 2017 dividend just over twice and the St Ives dividend around 2.3 times. So no concerns about support from profits. But firms pay dividends with cold, hard cash and not with profits that can disappear atthe stroke of an accountants pen.
On that front the news is good. Connect has a record of generally rising operating cash flow per share, which supports earnings per share well. The St Ives cash flow is a little more patchy but averages out to decent support for earnings.
Are these stocks cheap?
At first glance, both firms share prices put a low valuation on the underlying businesses. Theres that tempting 6%-plus yield in each case, but also a low-looking forward price-to-earnings (P/E) rating. At a share price of 159p, Connects forward P/E ratio for 2017 runs around eight and at 129p, St Ives is just above seven.
However, Im not getting too excited about that because both firms have a high level of cyclicality to their operations and deserve their low ratings, in my opinion. The market as a whole will likely be trying to anticipate the next cyclical collapse in earnings for these firms. So Im not expecting a valuation re-rating with these two.
Borrowings seem to be manageable in each case with Connects net debt sitting almost three times the level of operating profit and that of St Ives around 2.5 times operating profit. However, I would be happier if debt levels were lower at this mature stage in the macroeconomic cycle. Right now, when business is good, I reckon cyclical firms should be well on the way to paying down all of their debt so that theyre financially strong in order to survive the next downturn.
Outlooks
Back in October, Connects chief executive said that 2016 had been a year of both strategic and operational progress and he had confidence in the firms ability to succeed in the click-and-collect market in 2017 onwards.
Meanwhile, the St Ives chief executive said the firm is alert to possible deterioration in business confidence as an outcome of the Brexit process. However, assuming no change in current market conditions St Ives is well positioned to make further progress with its growth plans.
Overall, I reckon these two firms are interesting dividend payers, but their cyclical operations mean I would keep a close eye on them for signs of a deterioration in trading if they were in my portfolio.
Another opportunity
The Motley Fool analysts have pinned down another opportunity after shares went soft forthis company.Thefirm pays a growing dividend, which is covered well by projected earnings. The directors have pushed the dividend higher for several years and that situation looks set to continue.
You can find out more about this firm by downloading the report calledA Top Income Share From The Motley Fool. It’s free to do so if youclick here.
Kevin Godbold has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don’t all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.
