Private equity firm 3i Group (LSE: III) may not be the most obvious choice for income investors, but I believe it has a lot to offer. The group invests in two kinds of assets — mid-sized businesses in Europe, Asia and the Americas, and infrastructure projects in the UK, Europe and North America.
Thursday’s half-year results show that the value of this portfolio rose by 16% to £6,584m during the six months to 30 September. This increase reflected new private equity investments totalling £514m, plus £830m of new infrastructure assets.
What’s good
Under current chief executive Simon Borrows, 3i has developed a reputation for strong financial management and for choosing successful investments. The group sold assets worth £374m during the half year, delivering a 20% gain over their book value.
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Some £78m of this cash was returned to shareholders via the interim dividend, while the remainder was used to help fund new investments.
Although the group made £572m of cash investments during the first half, most of this was funded by surplus cash. At the end of September, net debt was just £48m.
What could go wrong?
3i has had an impressive record of growth in recent years. But there are some risks. One is that the shares currently trade at 920p, 41% above their book value of 652p.
This valuation implies that the market expects the group to continue booking healthy profits on future asset sales. If this proves difficult — for example in a market crash or major recession — then the shares could fall sharply.
A second risk is that in pursuit of growth, the company will overpay for new assets or allow debt to rise to unsustainable levels.
3i’s dividend yield of 2.9% isn’t that exciting. But investing in the group provides exposure to a wide range of businesses and assets that aren’t usually available to stock market investors. This could prove a good way to diversify a long-term income portfolio.
A 5.8% yield I’d trust
Telecoms giant Vodafone Group (LSE: VOD) may finally be emerging from a period that’s seen its earnings collapse and its share price lag the FTSE 100 since March 2014.
The Newbury-based firm’s recent half-year results suggested to me that chief executive Vittorio Colao’s plan to invest in new technology and expansion is now starting to pay off.
Although group revenue fell by 4.1% to €23.1bn, operating profit rose 32% to €2bn. The group returned to the black with an after-tax profit of €1.2bn, generating earnings of 4 cents per share.
Another encouraging sign is that cash generation is improving. Net debt fell by 15% to €32bn, while free cash flow was €415m, compared to €428m for the same period last year.
Looking ahead
The group also tweaked its guidance higher for the current year. Full-year adjusted earnings before interest, tax, depreciation and amortisation (EBITDA) is now expected to be 10% higher than last year, versus a previous forecast of 4-8%. Free cash flow before spectrum expenses is expected to “exceed €5bn”, rather than just being “around €5bn”.
Earnings are expected to rise by 17% next year. And it looks to me like Vodafone’s 5.8% dividend yield should soon be covered by the group’s profits. I think this could be a good income buy at current levels.
