Investors Chronicle dividend of the week - 28/10/2013

This week we are going to continue to be sector based and have a look at the support services sector in the U.K. This is one of the largest sectors and has an interesting array of companies. Our initial selection criterion is the support services sector and this throws up some thirty four companies that are covered by DividendMax.

The support services sector has provided rich pickings for Dividend of the week in the past and so we can eliminate former dividends of the week, Carillion, Smiths News and RPS Group immediately. From there, we will look at the recent dividend paying history and look for a CADI (consecutive annual dividend increases) of greater than 5, which after eliminating the aforementioned three stocks reduces our list to 15 stocks. Next we look for solid dividend cover of greater than 2 and our list is further reduced to thirteen.

So, our long list is MITIE, Interserve, G4S, Diploma, WS Atkins, Bunzl, Capita, Serco, Babcock, Experian, Aggreko, Intertek and Ashtead. It is interesting to note that seven of these stocks are in the FTSE 100, which gives you some idea as to the importance of this sector.

We are going to eliminate Intertek and Ashtead on yield grounds as both currently have an annualised yield of under 2%. Having said that, this week we are not necessarily chasing yield; We are looking for companies with excellent track records who look well set to continue with good dividend increases into the future.

MITIE have a very good track record, but the past two years has seen a marked slowdown in dividend growth into single digit percentages. Interserve have a slow steady record of increases, but nothing over 7.9% over the past 5 years. Similarly, this is the case with WS Atkins. G4S, like MITIE is showing a slowdown in dividend growth in the past two years. So too, is Capita.

Diploma meet our criteria of an excellent track record that runs through to the last dividend. Bunzl, also scrape through, but not so convincingly. Serco get through easily with a superb record since 2006. Similarly, with Babcock, Experian and Aggreko.

So our short list is quite a long list, but a good look at the fundamentals will hopefully point us to a good value play at a time in the markets when finding value is becoming increasingly difficult with the relentless surge in the indices.

At this point we can look at the fundamentals:

This goes to show how expensive the market has become and at this stage we are going to seek help from the brokers to see if we can get our shortlist down to three. The table below represents the number of brokers in each of the recommendations categories of buy / hold / sell:

In spite of what the brokers think, Experian look too expensive to me on 21x earnings and yielding barely above 2%. Forecast earnings growth over the next two years is 10% and to me that is not enough to justify the rating.

Serco look good enough value to warrant further investigation.

Aggreko just released an interim management statement which was well received by the market and in spite of their current rebasing of the dividend cover from over 4 times to nearer 3; they do not make the cut on valuation grounds either. They also share the wooden spoon with Bunzl as far as the brokers are concerned. However, we disagree with the brokers on Bunzl and are happy to put them through to the short list. This leaves Diploma and Babcock. Diploma will announce their final results on Monday, 18^th November. Babcock is expecting another strong year and for this reason and its lower rating we are going to go with them for the final cut.

Let’s have a look at the dividends paid by each company over the past 6/7 years:

Serco

2013 interim dividend up 16.9%

Bunzl

2013 interim dividend declared at 10p goes ex dividend on 6^th November.

Babcock International

Bunzl increased its interim dividend by over 13% at the half year stage and we expect this to carry through to the interim stage.

Babcock have been very impressive performers over the past 5/6 years and have increased their dividend by 226% over the period from 2006 to 2012. They will produce their interim results on the 12^th November and another healthy dividend increase can be expected.

Serco, like Babcock have been very impressive performers increasing their dividend by 180% over the period from 2006 to 2012. A further 16.9% increase at the interim stage does make you wonder why their rating is so much lower than all of the other companies that we have looked at. It was demoted from the FTSE 100 in the latest reshuffle and has had issues with its UK government contracts that recently led to the CEO stepping down. This is not good for its reputation, but does it merit such a discount to its peer group. From a dividend perspective there is much further to go and the interim results stated:

‘Interim dividend increase of 17%, reflecting policy of accelerated growth to move to higher payout ratio.’ 

If the dividend cover were to move from its current 3.7 to a solid 2.5, then dividend increases of between 15 and 20% can be expected for the next 3 years or more.

Because of their lowly rating in the sector and their fabulous track record it is difficult to choose any other stock other than Serco which is our dividend of the week. We believe that the current steps being taken alongside the appointment of a new credible CEO will revive Serco’s fortunes and will see them promoted back to the FTSE 100 within the next two years.