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Can investors afford to miss this future FTSE 100 5% yielder?

Portrait of elderly man wearing white denim shirt and glasses looking up with hand on chin. Thoughtful senior entrepreneur, studio shot against grey background.
Image source: Getty Images

With panicking investors sending stocks firmly in the wrong direction, plenty of FTSE 100 firms are offering lucrative dividend yields. While the index as a whole seems to have recovered from last year’s volatility, not every constituent has been so lucky. And one company in that group that’s particularly caught my attention is DS Smith (LSE:SMDS).

Shares are still down by over 20% since their last high in September 2021. And yet, looking at the latest results, the business seems to be firing on all cylinders. So much so that if analyst forecasts are accurate, a 5% dividend yield could be just around the corner.

Turning cardboard into income

As a quick reminder, DS Smith is one of the largest manufacturers of corrugated cardboard in Europe. While its product is hardly the most exciting in the world, demand has skyrocketed over the last decade. Why? Because e-commerce adoption has been accelerating.

Shipping products purchased online requires appropriate packaging solutions. And with this FTSE 100 company using sustainable raw materials with the capacity to fulfil rising demand, it’s become the go-to supplier for many leading retailers.

Looking at the latest interim results, the firm’s performance was pretty spectacular, even with the recent slowdown in online spending. The boring cardboard company delivered 28% revenue growth, with pre-tax profits up by 80%! Core operating margins jumped from 8.2% to 9.7%, steadily trending back to pre-pandemic levels of 11%. And with free cash flow bolstered, shareholder dividends enjoyed a 25% boost.

As such, analyst forecasts indicate the dividend per share for 2023 will reach 17.64p. Based on today’s share price, that’s a forward yield of 5%. Compared to the FTSE 100’s current average yield of 3.5%, that sounds like a bargain opportunity for income investors.

Even FTSE 100 stocks have risks

As promising as this potential income seems, there are a few risk factors to consider. Upon closer inspection of DS Smith’s recent performance, a potentially troublesome issue emerges. Despite delivering double-digit growth, none of this came from increased demand. In fact, the volume of cardboard sold actually dropped by 3%.

Management successfully offset this decline along with the rise of input costs through product price hikes. However, customers will only pay so much before finding cheaper alternatives. And suppose the economic conditions continue to worsen in the UK and Europe? In that case, demand could fall significantly more than just 3% in the future. In this scenario, its revenue, earnings, and shareholder dividends could come under pressure.

The bottom line

DS Smith has shown remarkable resilience in an uncertain operating environment. And it’s even using its new-found cash flow to finance internal investments to pursue long-term future growth. In my experience, seeing a business continue to invest when most companies are cutting back is an excellent sign of strength.

So while the 5% dividend yield from this FTSE 100 stock isn’t guaranteed, it doesn’t seem too ambitious either.

The post Can investors afford to miss this future FTSE 100 5% yielder? appeared first on The Motley Fool UK.

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Zaven Boyrazian has no position in any of the shares mentioned. The Motley Fool UK has recommended DS Smith. 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 2023