Today I’m looking at two highly profitable companies with big dividend yields. Yet despite these apparent attractions, both stocks have fallen by at least 25% over the last year. This could be a buying opportunity for contrarian investors. But there’s also a risk that these falling share prices are warning of potential problems. Let’s find out more.
Shares up, profits down
Shares in satellite communications firm Inmarsat (LSE: ISAT) surged nearly 10% higher when markets opened this morning, after the company issued a solid set of first-quarter results.
Sales in the group’s aviation business rose by 39% to $56m during the quarter, helping to lift group sales by 4.8% to $345.4m.
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Inmarsat is a big player in the growing market for in-flight internet access. In June the firm plans to launch the European Aviation Network, which will provide in-flight broadband at household speeds across Europe.
However, despite a strong performance from aviation, falling revenue from high-margin government contracts meant group profits dipped. Earnings before interest, tax, depreciation and amortisation (EBITDA) fell by 4.5% to $174.9m, pushing the EBITDA profit margin down from 55.6% to 50.6%.
What’s gone wrong?
Although Inmarsat is a world-class player in this sector, it’s suffered from growing price competition while having to invest heavily in next-generation services.
Shareholders have seen profits fall and debt levels rise. As a result, the share price has fallen by nearly 65% since hitting 1,110p in December 2015.
I’d fly away from these figures
Today’s first-quarter figures suggest to me that the firm’s problems aren’t yet over. Cash generated from operations fell to $148m during the period. That’s 21% lower than the $187.2m reported for the first quarter of 2017.
This cash inflow wasn’t enough to cover $141m of capital expenditure and $21.5m of interest payments. As a result, the group saw a net cash outflow of $12.5m during the period, nudging net debt up to $2,100.7m. This represents a multiple of 2.9 times EBITDA, which is well above the 2 times to 2.5 times range I view as a prudent maximum.
Consensus forecasts for 2018 put Inmarsat on a forecast P/E of 13 and with a 5% dividend yield. This may sound cheap, but earnings are expected to fall by a further 40% next year. I think another dividend cut may be needed. In my view it’s still too soon to invest.
This could be a safer choice
Cigarette giant British American Tobacco (LSE: BATS) should be a safer choice. The firm’s business is highly profitable and requires very little investment. However, the company does face one problem — global sales keep falling as people stop smoking.
To combat this decline, it has spent heavily on acquisitions and invested in next-generation vaping products. The problem is that the market isn’t yet convinced that next-generation products can ever replace the profits provided by traditional cigarettes. And while acquiring rivals has helped to boost market share, last year’s £41.8bn acquisition of Reynolds American has resulted in net debt of £46bn.
Although this level of borrowing is higher than I’m comfortable with, I believe the firm will probably be able to gradually reduce debt over time. I don’t see any immediate threat to the dividend.
Analysts expect adjusted earnings per share to rise by 6% this year. With the shares trading on a forecast P/E of 13 and offering a forecast dividend yield of 5.2%, I’d rate British American Tobacco as a possible income buy.
