The Income Investor: upbeat dividend prospects at FTSE 100 stock

The FTSE 100 has risen by 11% since the start of the year and now trades at a record high. As a result, many income investors may naturally assume that it’s now difficult to find large-cap stocks offering attractive yields.

However, the FTSE 100 has a relatively respectable dividend yield of 3.4% even after its recent gain. This is much higher than the yields on offer from other major indices such as the S&P 500, which has an income return of just 1.2%. Moreover, 41 FTSE 100 members have higher yields than the index. This means investors can build a portfolio which pays a substantially higher income return than the UK’s large-cap index.

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Of course, the continued income appeal of the FTSE 100 is largely due to its relatively poor performance over recent years. The FTSE 100 is up just 51% in the past five years, for example. Over the same period, the S&P 500 has gained 89%. This suggests that, alongside a relatively attractive yield, investors in UK large-cap shares may benefit from capital gains as today’s undervalued stocks are gradually rerated upwards.

Mainstream income options

Clearly, some income investors may question whether the FTSE 100’s dividend yield is, in fact, all that appealing. It’s currently possible to obtain a 4.5%+ income return from easy access cash savings, for example, without the risk of permanent capital loss that comes with investing in equities.

Similarly, the yield on 10-year gilts currently stands at 4.5%. Given that government bonds are far less risky than a portfolio of stocks, both in terms of the reliability of their income stream and the potential for permanent capital loss, some investors may feel that gilts represent a superior income opportunity vis-à-vis the FTSE 100.

However, falling interest rates mean that the outlook for cash and bonds is set to drastically change. The income return on cash, for example, is set to decline as Bank Rate moves lower. Investors who rely on savings accounts for their income are therefore likely to find that it falls in absolute terms over the coming years.

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While bond prices should benefit from interest rate cuts, thereby providing capital gains for their holders, the fixed nature of their coupon payments means holders are set to experience a real-terms decline in their income. The scale of this could be relatively high while inflation remains 160 basis points above the Bank of England’s 2% target. Furthermore, holders of government bonds would not participate in the benefits of an improving economic outlook that is likely to have a positive impact on dividend growth as monetary policy easing continues.

Global focus

Indeed, the FTSE 100 offers an upbeat outlook for income investors due to its combination of a relatively attractive yield and strong dividend growth potential. The index’s international focus means its members are likely to benefit from recent monetary policy easing across developed economies, as well as further interest rate cuts as sticky inflation gradually subsides. In fact, over 80% of the revenue generated by the index’s members is derived from abroad.

While time lags mean there is likely to be a delay in the effects of a looser monetary policy being fully felt, the long-term outlook for FTSE 100 dividend growth is highly upbeat.

Certainly, short-term risks such as increasingly protectionist trade policies could cause elevated volatility in both the financial performance of large-cap stocks and their market valuations. However, with the potential for inflation-beating dividend growth and a relatively attractive yield, as well as upbeat capital growth prospects, the FTSE 100 appears to offer significant long-term income appeal even while it trades at a record high.

Dividend growth

While FTSE 100 member Intertek Group (LSE:ITRK) has a dividend yield that is only in line with that of the wider index, its long-term income investing prospects appear to be encouraging.

The company, which provides inspection, testing and assurance services to a wide range of sectors to ensure safety and regulatory requirements are met, raised its dividend by over 40% last year. This rapid rate of increase was largely due to a rise in its dividend payout ratio, which now stands at 65% versus 50% in the previous year. Alongside this, the company produced earnings per share (EPS) growth of 7.9% last year that further boosted its shareholder payouts.

The firm’s recently released half-year results showed a continuation of last year’s trend. The company’s EPS rose by 6.3%, for example, with dividends increasing at the same pace.

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Given that the company is relatively cyclical, in terms of demand for its services being closely linked to the global economy’s outlook, it is well placed to benefit from the impact of falling interest rates and subdued inflation across developed economies. And with a pre-determined dividend payout ratio, which is highly sustainable at its current level, investors are set to directly benefit from any rise in profitability via higher payouts.

Potential catalysts

Acquisitions could act as a further catalyst on the company’s financial performance, and dividends, over the long run. It has made several purchases over recent years, with the company’s interim results stating that it continues to have a pipeline of potential acquisitions.

Given that the firm has a solid financial position, it has the means to engage in further M&A activity. For example, its net debt-to-equity ratio currently stands at 92%, while its net interest costs were covered 13.6 times by operating profits in the first half of the current year. Both figures suggest that Intertek could increase borrowings without compromising its sound financial standing.

Separately, the company’s profit margins continued to improve in the first half of the year. They rose by 60 basis points to 16.5% at the operating level, with cost control, productivity improvements and price increases proving beneficial. The firm is on track to meet its target to raise operating profit margins by a further 200 basis points to 18.5% over the medium term. This should boost its bottom line growth rate, and dividend payouts, over the coming years.

Risk/reward ratio

The company’s shares currently trade on a price-to-earnings ratio of 19.6. This appears to represent fair value for money given the firm’s recent financial performance, with its EPS rising at an annualised rate of 8% over the past three years. The stock could even merit a modest upward rerating given its solid fundamentals and improving competitive position amid a rising profit margin.

Of course, Intertek’s financial and share price performance could prove to be volatile in the short run. As mentioned, the imposition of tariffs may have a detrimental impact on the world economy’s performance. Given that the firm is highly reliant on the global economy’s outlook, it may be affected to a greater extent than some of its index peers by near-term economic uncertainty.

However, the stock’s long-term outlook appears to be upbeat. It is well placed to capitalise on growing demand for its services as falling interest rates prompt an improving economic outlook, while further acquisitions could bolster its bottom line growth rate. This should equate to a rising dividend that increases at a faster pace than inflation. Alongside an attractive yield, this suggests the stock has income investing appeal.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.