Picking dividend stocks has not been easy in recent years, but this team of City experts has built a list of income plays that could generate a blockbuster yield this year.
Income plays including Persimmon (LSE:PSN), Dunelm Group (LSE:DNLM) and Primary Health Properties (LSE:PHP) feature on a City firm's list of 27 stocks capable of producing an average dividend yield of 5.6% in 2022.
The forecast yield on Peel Hunt's pick of top income stocks rises to 6.1% in 2023, with the average dividend cover across both years being at least two times earnings.
The real estate sector is the best represented through four companies, just ahead of builders, financials, miners and retailers with three stocks each.
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Peel Hunt's 30 top income selections performed well last year, producing an average total return of 23.6% as improving profits and cash flows enabled companies to rebuild their dividend levels after the Covid-19 shock in 2020.
Peel Hunt said: “While overall market dividend levels still lag 2019 peaks, the trajectory remains positive, especially given the robust balance sheets across much of the market.
“While income stocks have not been hugely popular over the last few years, we believe careful selection can generate attractive returns.”
A top sector for building big income
The two biggest stocks on the list come from the housebuilding sector, led by Persimmon. Its current dividend payment of 235p implies a yield of 8.2% but further returns are expected given the cash on its balance sheet.
The shares rose by just 3% to 2,856p in 2021 but Peel Hunt rates the UK's second largest housebuilder at 3,300p based on expectations for a strong performance in a buoyant market.
The broker added: “Demand for the group’s products remains high, house price increases are offsetting build cost inflation, and the group continues to sit on a sector-leading land bank.”
The dividend policy of Barratt Developments (LSE:BDEV) is to pay out 40% of earnings, but with material excess cash flow expected in the next few years there's every chance that the market's second largest housebuilder by market cap could also pay special dividends. Peel Hunt has factored in 90p per share over the next three years.
Fellow builder Vistry Group (LSE:VTY), which was formed in early 2020 from the combination of Bovis and the housing and Partnerships businesses of Galliford Try, performed well last year operationally and in terms of its share price.
Its balance sheet gives the market more confidence about dividend plans, with the growth potential of the capital-light Partnerships business leaving scope to expand shareholder returns.
As the group’s dividend policy is to be twice covered through the cycle, this points to a 60p dividend from 2021 trading and rising to 75p in 2022 and 78p in 2023. The shares trade on 8.1 times 2022 earnings with a dividend yield of 6.2%.
One of the most secure income streams on the list is delivered by Primary Health Properties, based on 25 consecutive years of dividend growth for a current yield of 4%.
The owner of a £2.7 billion portfolio of primary care assets in the UK and Ireland has demonstrated its resilience over the past couple of years, with approximately 90% of its rents being backed by government bodies on long lease terms.
Peel Hunt said the company had an attractive pipeline of acquisition and development opportunities, while the prospect of refinancing historic, high-yielding debt facilities should also contribute to future income growth.
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The bank also sees income growth and security at LondonMetric Property (LSE:LMP), whose £3 billion portfolio comprises 74% distribution and 23% grocery-led long income assets.
Peel Hunt said the company is “extremely disciplined” and one of the most active in the sector when it comes to asset recycling and redeployment. Its shares trade at a 30% premium to net asset value but the broker said this is more than justified by the management's track record, attractive earnings stream and potential of its logistics-led portfolio.
Net rental income has more than doubled since 2014 and the company has delivered total shareholder returns of 140% over that time.
Don't forget these retailers
In the retail sector, Halfords Group (LSE:HFD) is favoured by Peel Hunt following a strong performance in 2021 when it won market share and defied most profit forecasts.
Management are likely to use a strong balance sheet for acquisitions rather than special dividends, but the potential for one-offs remains and the growing ordinary dividend should be of interest to income investors.
The potential for Dunelm to pay out ordinary and special dividends of £400 million over 2022/23 for an annual yield of 8% means it features on both Peel Hunt's pick of income stocks as well as its growth list.
The bank said: “First and foremost, we view Dunelm as a growth story, growing market share through a combination of new customer acquisition and increasing share of wallet.
“We see no reason why Dunelm cannot double its market share over time. Thanks to the attractive margin structures and robust cash generation, as well as strong earnings growth, the stock also offers high single-digit dividend yield, generating the potential for a sustainable mid- to high-teen total shareholder return.”
Banks, insurers and more
Peel Hunt's list includes Virgin Money UK (LSE:VMUK), which returned to the dividend ranks in 2021 and is forecast to increase payments “strongly and sustainably” in the coming years. A strong balance sheet means Virgin is expected to yield 4.4%, with the broker seeing a share price upside to 264p based on improving profitability.
Another favoured financial stock is motor insurer Sabre Insurance Group (LSE:SBRE), whose current share price is described by Peel Hunt as a “remarkable investment opportunity”.
The stock trades on 11 times 2022 earnings, leading to a 7% dividend yield and 34% upside to the broker's 255p target price. It said: “We estimate Sabre’s current share price does not assume a cyclical recovery and a return to top-line growth, which we believe is unjustified.”
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When assessing yields, income-seeking investors need to tread carefully and remember that particularly big numbers can turn out to be dividend traps.
The biggest yield on Peel Hunt's list is the 12% offered by Diversified Energy Company (LSE:DEC) following an 18% fall for shares from their 2021 high. The US-based oil and gas operator has a dividend strategy based on paying 40% of operating free cash flow.
Peel Hunt said: “Diversified Energy is a stand-out in the sector, due to its very high and sustainable dividend. This is underpinned by a low-risk free cash flow profile, owing to a low-decline production base, a comprehensive hedging portfolio, and very limited capex.”
The other stocks on the list are Atalaya Mining (LSE:ATYM), Central Asia Metals (LSE:CAML), DFS Furniture (LSE:DFS), DWF Group (LSE:DWF), Ferrexpo (LSE:FXPO), Gulf Keystone Petroleum (LSE:GKP), Headlam Group (LSE:HEAD), Hollywood Bowl (LSE:BOWL), LXi REIT (LSE:LXI), Moneysupermarket.com (LSE:MONY), Ocean Wilsons (LSE:OCN), Paragon Banking Group (LSE:PAG), Polar Capital (LSE:POLR), Rank (LSE:RNK), Redde Northgate (LSE:REDD), Regional REIT (LSE:RGL), and Telecom Plus (LSE:TEP).
These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided by third parties. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.
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