Jackpot? A FTSE 100 stock with a whopping 12.3% dividend yield. To top it off, shares in Evraz (LSE: EVR) are climbing. Currently selling around 381p, they’ve provided a 50% return over the last six months.
But I’m not fooled by the high numbers, because things are not all that they seem with the Evraz share price.
The uncertain market for steel
Admittedly, Evraz is one of the world’s biggest steel producers. The integrated nature of its business means it’s involved in all aspects of steel production from mining coal and iron ore to selling steel products. This enables it to deal with the cyclical nature of the steel industry more effectively than operating in only one part of it.
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However, Evraz is mainly reliant on demand for its steel in Russia, the rest of Eastern Europe and North America. In all three regions, demand for its products has dropped. Consequently, operating profits plunged by 38% in its 2019 results. And this was before the global pandemic-related economic shutdown pulled its share price further into the depths.
Indeed, I suspect it’ll be a while before Evraz sees demand significantly improving again. Moreover, the bullish period around 2018 looks like an outlier, correlating with high steel and vanadium prices.
Evraz share price fundamentals
Incredibly, the 12.3% forward dividend yield on offer is what remains after Evraz’s dividend cut in August following a poor first half-year performance. This was blamed on “restrictive“ government measures being imposed in many of its geographic markets, causing steel prices to drop. To help cash flow, it also reduced it payouts from four times per year to two.
Although the dividend yield remains relatively high, the recent cut appears to reflect the current state of the business. Declining revenues have resulted in Evraz upping its levels of debt to see it through the recent downturn. Moreover, even with the cyclical nature of the steel industry, an 80% gross gearing ratio is substantial. It illustrates the large amount of debt on the balance sheet as a percentage of shareholder funds. If the downturn continues, this may increase even more.
However, the business coverts profits to cash efficiently. But it appears that Evraz uses debt, in addition to the hard cash generated, to fund its whopping dividend. Moreover, I think the business is used as a cash-cow for its shareholders. In the short term, this could benefit an investor, but it’s not a long-term wealth-building strategy for either the business or a shareholder.
In summary
To look at its last financial year in isolation, Evraz appears to be doing quite well. However, it’s the general trend of the business over the last few years that concerns me. Despite the cyclical nature of steel production, as I said, the most recent peaks appear to be outliers.
In addition, its debt pile is a concern and I’m not convinced it will manage to hold its showboating dividend at current levels. If demand for its products doesn’t improve, limited revenues mean the debt will have to be serviced by shareholders. Consequently, I’m looking out for less risky stocks than Evraz to add to my portfolio.
