Despite an increase in returns from cash, there are plenty of options for investors wanting to beat income from bank accounts. This City broker identifies the shares to do it.
Peel Hunt’s recommendations for investors looking to offset the ravages of inflation also include Barratt Developments (LSE:BDEV), Energean (LSE:ENOG), Hilton Food Group (LSE:HFG) and Paragon Banking Group (LSE:PAG).
The average forecast yield rises to 5.9% the following year, with Diversified Energy Co (LSE:DEC) the highest across both years at above 12%.
Yields of 8% and above can be a sign that the market thinks the dividend is unsustainable, but the bank points out that it has factored in other considerations such as dividend cover and growth, balance sheet health and sector exposure.
It expects 19 of the companies to deliver dividend growth, with three unchanged over the two-year period - Barratt Developments, Ocean Wilsons Holdings Ltd (LSE:OCN) and Polar Capital Holdings (LSE:POLR). Central Asia Metals (LSE:CAML) and Ecora Resources (LSE:ECOR) are expected to moderate slightly from higher levels.
The bank’s selections had a median market capitalisation last week of £780 million, ranging from Smith (DS) (LSE:SMDS) as the largest down to Speedy Hire (LSE:SDY). The building industry has four stocks through Taylor Wimpey, Barratt, Ibstock (LSE:IBST) and Keller Group (LSE:KLR), while there are three each from financials, mining and real estate.
Last year’s picks struggled overall due to the market conditions, with returns of 57% and 42% respectively by Gulf Keystone Petroleum Ltd (LSE:GKP) and Telecom Plus offset by significant declines for housebuilders Persimmon (LSE:PSN) and Vistry Group (LSE:VTY) as well as Ferrexpo (LSE:FXPO) and Sabre Insurance Group (LSE:SBRE).
Telecom Plus is one of 12 stocks repeated from the 2022 list, although the yield for 2023 is now one of the smallest on offer at 4%.
However, Peel Hunt believes the Utility Warehouse owner should continue to thrive in the tough economic environment, with the income appeal of the FTSE 250-listed stock underlined by its predictable profit and cash flow profile.
Dunelm is also kept on the list after the bank highlighted a potential cumulative dividend pot of about £450 million over the next two years. This equates to a 24% yield split 40%-60% between ordinary and special dividends.
It said: “Dunelm has a very clear capital allocation policy that essentially sees all free cash flow paid out to shareholders. After prioritising investment needs, which are fairly limited given average capital expenditure of £40 million, Dunelm can generate £150 million to £175 million per year of free cash flow.”
As well as the attractive yield, the bank noted the potential for Dunelm to drive market share to mid-teens levels over the medium-term. It has a price target of 1,375p.
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The selection of Halfords Group (LSE:HFD) was made before last week’s profit warning, when the retailer disclosed it had not been able to hire enough mechanics in its Autocentres division.
The bank believes the FTSE All-Share stock is now very different to its 2018 incarnation and that an increased focus on motoring service made it much less cyclical and more valuable.
Peel Hunt said: “Halfords could go in our top picks for value or income: the shares do not reflect the changed face of the group nor the cash generation.”
Despite ongoing uncertainty for housebuilders, Peel Hunt believes the strength of the balance sheet at Barratt Developments means the current 8.6% yield is safe in all but the most bearish housing market scenarios. It expects the builder to maintain its dividend at 36.9p a share over the next two years.
Barratt used to lag its two main peers in terms of performance and balance sheet, but Peel Hunt said this was no longer the case.
It added: “Longer term, the housing shortage fundamentals have not changed - and while demand may be dulled as mortgage rates settle down, we do not see house prices dropping as they did in 2008/09.”
Taylor Wimpey shares fell 42% last year but with a net cash position of £800 million and the dividend 1.6 times covered the bank said, “the 9.6% yield looks safe to us”.
The largest stock on the list is FTSE 100-listed packaging firm DS Smith, with a 25% hike in interim dividend in December regarded by Peel Hunt “as a real statement of intent” in terms of capital allocation.
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Diversified Energy Company has the highest yield, but this is underpinned by one of the sector’s lowest risk cash flow profiles due to factors such as low-cost production, limited capital expenditure and a strong hedge portfolio.
Peel Hunt adds that production is all onshore in the United States and 85% gas, meaning that the company should be well placed to benefit from the surge in US gas prices following the sanctions on Russian supplies.
The other income stocks on Peel Hunt’s list are DWF Group (LSE:DWF), Hargreaves Lansdown (LSE:HL.), Hollywood Bowl Group (LSE:BOWL), LondonMetric Property (LSE:LMP), Pan African Resources (LSE:PAF), Primary Health Properties (LSE:PHP) and Sirius Real Estate Ltd (LSE:SRE).
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