Our latest Research - 14/10/2014

Our latest research 10/10/14

In this piece we are going to widen our net and look at the FTSE 350. The initial criterion is for a CADI (consecutive annual dividend increases) of greater than 5 years. This throws up 117 stocks, which is far too many to list. Interestingly, the last time we started with this criterion, about 3 years ago, there were only 74 companies in the FTSE 350 that met it, which gives you some idea of how important dividends have become to both companies and investors.  A second criterion of forecast dividend increase greater than 10% is added and this brings our list down to a much more manageable 24 companies (9 last time). Again this list is too long so we need to consider the safety of the dividend and take a look at dividend cover. The higher the cover, the safer the dividend pay-out is the general rule and this time the selection is for very strong dividend cover of more than 3 times. This gives us our short list of stocks including The Paragon group of companies, John Wood Group, Weir Group, Pace, Ashtead, ARM Holdings and Shire.

Easyjet would have made the cut easily had it been paying dividends for longer, but our fondness of Easyjet is well documented and there is no need to write about them again. This also goes for John Wood group so we will also eliminate them at this stage. We still remain firm fans of both companies.

Finally, we will tighten our yield criteria to greater than 1.5%. This eliminates Shire (0.37%) and ARM (0.97%). You don’t get a lot from companies with high growth prospects and cover over three. Shire has double digit dividend cover, which does mean at some point in their future, they will start to increase the dividend dramatically. This brings our list down to 4 stocks:

The Paragon group of companies, Weir Group, Pace and Ashtead.

Looking at the fundamentals we have

For its higher Price Earnings ratio and lower yield it is necessary to eliminate Ashtead on valuation grounds.

Before we go any further, let’s have a look at what the brokers are saying about each of our final three:

Now, let’s have a look at the dividends paid by each company over the past 6/7 years:

Paragon

Paragon has paid an interim dividend of 3.0p for 2014. Its final dividend is expected to go ex in January.

Weir

They have just gone ex-dividend for a 15p interim, (up 70% in a rebasing exercise) last Thursday 9^th October.

Pace

They have declared an interim dividend of approximately 1.389p which was up 23% in dollar terms. (16% in sterling) They go ex-dividend on the 6^th November.

Three very good companies with very good track records and with good dividend growth expected. For me though, there is a clear winner and that is Pace. Paragon have recovered well from the financial crisis and have been in the process of rebuilding their dividend ever since. They are about half way there, which is pretty good considering that some of the banks (Lloyds, RBS) have not even started. Weir look quite expensive in spite of their track record and the surging dollar will hurt them. Pace look like a gem to me at this price on a low price / earnings ratio and with very high dividend cover. They could multiply the dividend four times and still have a level of cover that most investors would be happy with (two times). Profits can be variable as with so many tech stocks, but you are not overpaying on this multiple. They also pay their dividend in US dollars so there is some uplift to be expected there.

Their interim results statement read very well and is reproduced in part below:

Momentum building through the year: gross margin up 3.9ppt to 21.6%, adjusted EBITA up 9.9% to $106.3m, free cash flow of $108.9m up 18.4% and interim dividend increased 23.0%. Strong H2 anticipated, full year profits and cash flow guidance increased.

Financial highlights

Revenue down 13.6% to $1,138.9m (H1 2013: $1,318.4m), in-line with management expectations.

Gross profit up 5.4% to $245.8m (H1 2013: $233.1m), gross margin 21.6% (H1 2013: 17.7%).

Adjusted EBITA up 9.9% to $106.3m (H1 2013: $96.7m), operating margin 9.3% (H1 2013: 7.3%).

Profit after tax up 9.3% to $55.4m (H1 2013: $50.7m).

Basic Earnings per Share ("EPS") up 8.5% to 17.8c (H1 2013: 16.4c) with adjusted basic EPS up 15.4% to 25.5c (H1 2013: 22.1c).

Interim dividend 2.25c per share, a 23.0% increase on H1 2013 (H1 2013: 1.83c).

Free cash flow up 18.4% to $108.9m (H1 2013: $92.0m).

Closing net debt $167.6m (Pro forma net debt of $279.2m immediately following Aurora acquisition).

Operating highlights

Increased operating profit on reduced revenues, due to Aurora contribution, improved revenue mix, improved supply chain efficiency and increased operational efficiency.

Significant further progress made against the Strategic Plan laid out in November 2011:

Continue to transform core economics:

o Underlying operating costs reduced by 6.1% whilst continuing to further invest in growth opportunities.

o Integration with Aurora complete and committed synergies, both cost and working capital, achieved ahead of plan with further opportunities for savings identified.

o Fifth consecutive half of strong cash flow generation (102.4% conversion of adjusted EBITA to free cash flow). Aggregate free cash flow of $500.6m over last five halves.

Maintain PayTV hardware leadership:

o Reconfirmed market leader; global number 1 in Media Servers, Set-top boxes ("STBs") and Advanced Telco Gateways.

o Strong uplift in Customer Premise Equipment ("CPE") revenue in H2 2014 anticipated due to new product launches with key customers.

o A number of new wins and deployments have been achieved across all regions with customers including Sky Italia, Oi, GVT and BeIn Sports.

Widening out:

o 213.8% increase in non-CPE revenue (H1 2013: 4.3% increase) to $167.9m (H1 2013: $53.5m) driven by the acquisition of Aurora Networks.

o Pace achieved a number of key wins across all areas of our Software, Networks and Services offerings and has made good progress on major product and customer project launches for this period and H2 2014.

o Demand for network products is stronger than anticipated; revenue and profit growth expected in H2 2014.

Outlook

Revenue momentum has increased as the year has progressed. We have good visibility and anticipate strong revenue growth in H2 2014 driven by new product launches across a number of markets, regaining leadership with several key customers plus increased demand for network products.

As such the outlook for the remainder of the year has improved and as a result we anticipate that full year profits and cash flow for the Group will be higher than previous guidance:

Revenues for 2014 expected to be c. $2.7bn (2013: $2.47bn)

Operating margin for 2014 is expected to be no less than 8.5% (2013: 7.8%).

Strong cash flow will continue, and Pace expects to generate in excess of $200m of free cash flow (2013: $209m). Ends

We are estimating the next three dividends to be 1.39p (declared), 2.68p and 1.49p. They are at 298p at yesterday’s close. At 298p, this will generate a return of 1.75% annualised over an approximate 13 month period.

Pace yield calculation:

1.39 + 2.68 + 1.49 = 5.56p between now and 5/11/2015 (approximate ex-dividend date of the third dividend)

Ergo 5.56p / 298 = 1.86% 1.86% annualised = (1.86 x 365) / 387* = 1.75%

*Number of days until theoretical ex-dividend of the third dividend.

Note that if the dividend forecasts are correct, the actual yield (which DividendMax calls the ‘Optimized yield) is affected by two factors; the share price and the proximity to ex-dividend dates. DividendMax performs these calculations daily against hundreds of stocks in the U.K. and overseas producing new lists every day as prices change, dividends change and ex-dividend dates approach. 

Please note that after their 73% dividend increase today Bellway would make this analysis and yield 5.22% on the optimizer.