Today, I’m taking a look at two deeply discounted high-yielding stocks.
Interserve
Support services and construction group Interserve (LSE: IRV) is going through a rough patch, as its troubled Glasgow ‘energy from waste’ project continues to drag on the company’s financial performance. It’s a problem that just seems to be getting worse.
On Monday, the company raised its provision for exiting the ill-fated waste business to £160m, up from the previously guided figure of £70m. The big hike was down to higher than expected litigation costs relating to the now terminated Glasgow contract and the decreased likelihood of potential recoveries from its subcontractor, Energos, which recently entered administration.
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The company is shifting its focus towards winning more support services work because of the increased pricing pressures in the construction business and recent supply chain failures. But exiting from the business won’t be a magic fix, as Interserve faces a series of headwinds, ranging from rising cost inflation to cuts in discretionary spending and Brexit-related uncertainty.
Moreover, Interserve’s balance sheet is expected to come under pressure due to the cash outflow from its energy from waste business — net debt is expected to rise to around £350m by the end of 2017. This could affect the sustainability of its dividends, and potentially force the company to raise capital.
With shares currently yielding 10.9%, Interserve’s shares seem to me like a potential dividend trap. However, Interserve’s underlying earnings is expected to only fall modestly this year, with City analysts forecasting a decline of only 8%. That leaves the stock trading at an extremely low multiple of 5.3 times its expected underlying earnings in 2017, and implies its dividends are covered by more than 2.8 times underlying earnings.
Capita
Interserve is not the only company in the sector reporting difficult trading conditions, as Capita (LSE: CPI) has issued multiple profit warnings over the past year.
The outsourcing outfit is finding it difficult to win new contracts as businesses have delayed making key investment decisions due to the uncertainty caused by the Brexit vote of last June. In addition, as a result of one-off costs incurred on a Transport for London congestion charging contract, Capita lowered its pre-tax profit expectations for 2016 by up to £100m, to at least £515m, before the impact of the latest £40m write-down to accrued income relating to legacy assets.
But despite these issues, I have more confidence that Capita will be able to maintain its dividends at current levels. That’s because although the company will no doubt take big hit to earnings, the impact on cash flow is much more muted. Also, the longer-term prospects for the company remain attractive as the underlying business is underpinned by a series of cyclical and structural growth factors.
Capita’s shares have been under pressure over the past few years, and now trade on a tempting forward P/E of just 8.9. On top of this, the shares offer a chunky 5.7% dividend yield, with underlying dividend cover expected to remain above 2.0 times.
