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Is this 12% yield a dividend trap or an unbeatable buy?

Roland Head
A person holding onto a fan of twenty pound notes

Dividend yields of more than about 6% are often expected to carry a higher risk of cuts. So a dividend yield of 12% must surely be doomed? Not necessarily. Today, I want to look at two stocks with dividend yields of between 11% and 13%. I’ll explain why I would buy at least one of these shares, despite the risk of a cut.

A bargain in plain sight?

Tobacco stocks have a bad reputation with responsible investors. The Imperial Brands (LSE: IMB) share price has fallen by 55% over the last three years as the company has struggled to gain a foothold in the US vaping market.

However, it’s worth remembering that Imperial’s profits haven’t changed much over this period. The group’s operating profit has hovered between £2.2bn and £2.4bn over the last four years. The dividend has risen.

The fall in the share price has been driven by a devaluation of the stock. In my view, this has been investors selling out of tobacco stocks and by fears that profits could fall, triggering a potential dividend cut.

New boss faces problems

Imperial’s outgoing chief executive Alison Cooper will leave some problems behind for new boss Stefan Bomhard. In the firm’s latest trading update, Cooper admitted the backlash against vaping in the US has led to a slump in sales of Imp’s Blu product. Adjusted earnings are now expected to fall by 10% during the first half of this year.

What about the dividend?

Bomhard, meanwhile, will have to decide what to do with Blu. He’ll also face some tough decisions about the dividend.

Cooper has already abandoned the firm’s previous commitment to increase the payout by 10% each year. The current payout is affordable, in my view, but doesn’t leave much spare cash to repay debt or invest in new products.

I suspect Bomhard will cut the payout when he starts work. However, as a shareholder, I’m not too concerned. Even if the payout was cut by 40%, Imperial stock would still offer a yield of 7.4% at current levels. That’s attractive to me, given the group’s strong cash generation.

Imperial Brands isn’t without problems. But at current levels, I think the shares are likely to be a bargain for patient buyers.

Time to go shopping?

The slump in demand for retail property has hit landlords all over the UK. One interesting choice in this sector is NewRiver REIT (LSE: NRR), whose shares currently offer a forecast dividend yield of 11.4% for 2020.

I should be clear — NewRiver’s dividend hasn’t been covered by cash from the group’s operations since 2017. The company has held an uncovered payment through 2018 and 2019. Management says this has been done because the company can see “a clear path to dividend cover.”

The group’s speciality is local community property, such as convenience stores and pubs. The argument in favour is these facilities can’t easily be replaced by online shopping.

NewRiver has been making regular acquisitions over the last couple of years. Management reckons they offer good value in this difficult market. This may be correct, but this spending has also increased the group’s loan-to-value ratio to more than 40%.

I can see the bull case for NewRiver, but I can see risks too. I’m not sure how to call this one, so I’m staying on the sidelines for now.

The post Is this 12% yield a dividend trap or an unbeatable buy? appeared first on The Motley Fool UK.

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Roland Head owns shares of Imperial Brands. The Motley Fool UK has recommended Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

Motley Fool UK 2020