Hunting for attractive income shares I can add to my portfolio, I have been considering the pros and cons of housebuilder Taylor Wimpey (LSE: TW). With a 7.4% dividend yield, the firm might tick the income box. Taylor Wimpey shares have been steadily rising since the end of September. They are up over 40% in that time.
However, that still leaves the shares 20% below where they were a year ago and trading on a price-to-earnings ratio of just 8.
So, could they be a bargain to snap up for my portfolio?
Shifting cash flows
To pay dividends consistently, a company needs to generate excess cash.
Taylor Wimpey has been solid when it comes to profits. In its interim results, profits were flat at the operating level but pre-tax profit rose 16% compared to the prior year period. At £335m, they were substantial.
The cash flow picture was less pretty, however. The period saw negative free cash flows of £193m.
Some £151m of that covered the cost of share buybacks. But even without those, the company did not generate enough free cash flow in the first half to cover its dividend. On a short-term basis that is fine, but over the long term, negative free cash flows can signal a risk that a dividend may be cut.
Future outlook
However, the negative free cash flow at the interim stage may not be a sign of things to come. In 2021, the company generated around £100m in free cash flows even after paying out £300m in dividends. The buyback programme last year exacerbated the negative free cash flows, but that could be a one-off.
The buyback might unlock long-term value for shareholders if the firm was able to buy at a low price and reduce the number of shares in circulation. That could boost earnings per share and also free cash flow per share in future years, setting the stage for dividend increases.
Dividend prospects
Indeed, at the interim stage the company raised its dividend by 12% compared to the year before. Given its resilient post-tax profit performance, I think the dividend could see further rises in coming years, probably starting with the publication of last year’s final results early next month.
But one red flag at the interim stage was that, even though profits grew, there was a 5.4% year-on-year decline in revenue. If house prices fall, revenues at homebuilders could follow them. That could be bad news for both profits and cash flows. That might lead to a lower payout for owners of Taylor Wimpey shares.
My move
I have to admit, I do like the look of the shares. The business is well-established, it trades on an attractive valuation and has a juicy, growing dividend.
But I remain nervous about the prospects for the housing market. Taylor Wimpey shares have risen sharply, but they are still 35% lower than five years ago – and more than two-thirds below their peak in 2007 before the financial crisis hit. So for now, I will wait and see how the housing market performs in coming months and beyond before making any move.
