Shares in support services company Mitie (LSE: MTO) have fallen by as much as 25% today after it released a profit warning. Clearly, this is hugely disappointing for the company’s investors. But it also provides clues as to whether there’s an opportunity for income investors that’s more appealing than that offered by National Grid (LSE: NG) and other high-yield shares.
Mitie is facing an increasingly challenging outlook. Its operating environment was uncertain before the EU referendum and is now arguably more difficult due to the reality of Brexit. Mitie’s problems include lower UK growth rates, changes to labour laws and further austerity. Although Mitie will introduce efficiency programmes aimed at reducing its cost base, the company has downgraded its outlook significantly in response to what is becoming a deteriorating future.
It now forecasts operating profit for the full year materially below previous expectations. It may have a substantial pipeline of opportunities and a portfolio of high quality, long-term contracts, but Mitie’s near-term problems are significant. Its dominant facilities management business (which makes up 84% of its sales) is struggling with many potential customers deciding to defer investment decisions and award longer contracts to existing suppliers. This trend could continue if the outlook for the UK economy remains uncertain in a post-Brexit world.
Of course, Mitie’s dividend has been a major reason to buy its shares in recent years. The company yields 6.1% after today’s share price fall from a dividend that was covered twice by profit last year. While appealing, the reality is that dividends are likely to be cut, given the scale of difficulties faced by Mitie. And with scope for a further deterioration in the UK economy, Mitie may have a standout headline yield, but the prospect of dividend growth remains somewhat unlikely.
Better income plays?
This contrasts with the stability and resilience of other income stocks such as National Grid and SSE (LSE: SSE). They yield 4.2% and 5.9% respectively from dividends that were covered 1.5 and 1.3 times respectively last year. Although these figures are less appealing than those of Mitie, the reality is that National Grid and SSE are far superior income plays compared to Mitie.
The key reason is their stability. Both National Grid and SSE are relatively low risk in terms of their businesses having predictable futures that are unlikely to be affected by challenges faced by the UK economy. So for investors seeking an income they offer a reliable income stream with the potential for dividend rises.
In fact, both companies are expected to raise dividends at a faster rate than inflation over the medium term. This means that their real returns are set to grow. In contrast, Mitie’s income returns could falter if dividends come under pressure as a result of a difficult macroeconomic outlook. As such, buying SSE and National Grid for their income returns is a better idea than buying Mitie for the long term.
