High yield stocks likely to continue good run

Keep a hold on Fitness First; DS Smith should offer good value
Click to follow
The Independent Online

We may be only half-way through the year, but people in the City seem resigned to a third consecutive annual fall for the FTSE 100. There is too much fear and loathsome accounting around for the stock market to look like the place for the average saver to make capital gains this year.

But with almost all shares shaken by the latest growl of the bear market, cautious investors might want to pick up a portfolio of stocks with big, safe dividends. The income compares well to the local building society account.

High yield stocks have already had a good run, outperforming since the technology investment bubble hit its peak in March 2000. It seems likely to continue until corporate debt and economic uncertainty are reduced.

The tobacco stocks should remain the biggest draw for the income investor. British American Tobacco and Gallaher are both yielding more than 4.5 per cent. With the dividend covered 1.5 and 1.3 times respectively by earnings, they are highly attractive. Both are enjoying healthy profit growth and, despite having reached record levels, their shares look relatively unvulnerable. Other defensive investments with a well-covered pay-out include Arriva, the transport group, which yields 5 per cent. Of the utilities, water companies appear the best bet. They are half-way through the seven-year price regime set by the regulator, so have a high visibility of earnings. The mid-cap Kelda is yielding almost 6 per cent, and its dividend is well covered, so it is the pick of the sector. Electricity groups, many with exposure to the US and the falling dollar, are less attractive to the risk-averse.

Some analysts were yesterday suggesting the big banks as a strong long-term dividend play, but the current concerns over the solvency of their life divisions might tempt them to cut their pay-outs. That has already been rumoured at Lloyds TSB.

Despite worries of a consumer slowdown, the highest yielding leisure and retail stocks are worth a look. Six Continents, the hotels chain whose shares are still recovering from the post- 11 September downturn in tourism, yield a secure dividend. And many housebuilders also have big pay-outs, which would only be threatened by years of sliding house prices. Wilson Connolly, Crest Nicholson and Taylor Woodrow all yield at least 3.8 per cent.

Keep a hold on Fitness First

Just as gym members are prone to lose their enthusiasm for working out, investors are apt to lose their appetite for shares in gym owners. The sector has looked out of shape for some time, reflecting problems at the premium end of the market where operators such as Holmes Place and Esporta have been struggling.

Yesterday's interim results from Fitness First showed that its clubs was punching above their weight. There was no evidence the feared consumer slowdown is putting people off pumping iron. UK membership increased by 35 per cent to 270,000 while worldwide members rose 65 per cent to 632,000. Like-for-like sales in the UK and Germany – its other mature market – were 8 per cent healthier.

The group, which pitches itself at the budget end of the private fitness club operators, increased pre-tax profits for the six months to end-April by 47 per cent to £11.7m on turnover up 68 per cent to £101.8m. It continues to pour cash into expansion in the UK and overseas, aiming to open about 80 new clubs a year. At this rate it will triple its estate to 800 in the next six years across Europe, Asia and Australia.

The only blip to yesterday's numbers was in France, a new territory for the group, where unexpected opening delays to eight new clubs meant it missed the peak post-Christmas membership rush. The share price was duly punished, closing down 11 per cent to 357.5p, although the hiccup will only push the French clubs' profitability back until next year.

While the stock no longer trades on a giddy rating, there is plenty of growth to come. Earnings should rise by about 30 per cent this year and 35 per cent the year after, boosted by openings in embryonic overseas markets. With even President George Bush urging obese America to follow his example and hit the treadmills, the lifestyle pressures favouring fitness clubs are increasing all the time. Although this is not the time to be chasing consumer-focused stocks, the shares are fair value and worth holding.

DS Smith should offer good value

What is the point in investing in DS Smith? It is not meant to be a rude question. Investors have to be tempted into the market by something, and a packaging and office supplies group does not sound the sort likely to offer a sudden share price spurt, particularly given the disappointing results it posted yesterday.

Tony Thorne, the chief executive, answers the question in several ways. The group, whose activities span paper making to paper clip wholesaling, deals in "here today, here tomorrow" products. It has a solid business with a small number of growth opportunities, and it has a strong dividend. That's enough to make it a buy in these markets, Mr Thorne reckons. His analysis is entirely fair.

Results for the year to 30 April were only fair to middling, though. While turnover was up 3 per cent to £1.44bn, profit before tax, goodwill and exceptionals slipped from £72.2m last time to just £62.6m.

Improved sales and margins in the main packaging and paper division failed to outweigh the sharp downturn in office supplies. With office budgets tight, the demand for pads, pens and paper clips seems to be down about 5 per cent on this time last year. There is little sign of a pick-up, but job cuts and the resolution of some little operational difficulties should at least ensure the profit outcome for the division this year is no worse.

The main worry is that DS Smith will find it hard to pass on the rising costs of recycled paper to its cash-strapped customers. It held its dividend, but it remains well covered, and the stock, up 7p to 165p, should yield between 5 and 6 per cent this year. On 11 times prospective earnings, it is good value.

Comments