Phoenix offers a juicy yield well supported by cash flows

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The stock market runs on aphorisms and golden rules. There is one for every type of situation, and many investors have been saved from costly pitfalls by being aware of them.

A widely used adage, if it sounds too good to be true, it probably is, is often applied to high-yield stocks. If you’re tempted, expect to at least do some research to make sure the return is at that level for the right reasons and seems affordable and sustainable.

Healthy levels of cash generation is a reassuring sign; a pile of expensive debt isn’t — cash may need to be funneled into interest payments. There’s little comfort in a high yield caused by a steep drop in share price, either.

This tells you that investors have concerns about the company and its ability to maintain payments. Beware of dividend cuts – they are usually severely punished. Even Shell, a strong dividend payer that cut its dividend for the first time in eight decades amid the pandemic oil crisis, has seen its share price slashed mercilessly in response, although, in the Vodafone battle, the dividend reduced earlier. this year he had long been included in the actions.

But the rules change when there is no mystery about how the dividend is funded. Phoenix, the long-term savings and pensions business, offers a juicy 10% yield, but that is well supported by the cash flows thrown in by the closed book of life insurance policies it has built up in recent years.

BUY: Phoenix (PHNX)

Adverse hedge position moves made the results reported for Phoenix difficult to interpret because the insurer uses the hedge primarily to ensure the stability of its cash and dividend. The downside is that adverse moves make the IFRS accounts read deceptively bleak, with a knock-on effect on shareholders’ equity, which management admitted was a short-term problem.

However, the results on their own terms were a qualified success as the company clearly looks on track to meet its £1.4bn – £1.5bn cash generation target for 2024, after generating £950m in the half; Organic cash generation rose 19% to £647m.

Broker Peel Hunt said: “We remain long-term positive on Phoenix as its business model transitions towards becoming a broad-based pension provider and the backbook continues to shed significant cash (yield in cash c20%).” We agree with this view, with the stock trading at 1.1 times tangible assets and a high dividend yield of 10%.

HOLD: Oxford Metrics (OMG)

A profit warning from Oxford Metrics sent shares in the smart detection and software group to a six-year low.

Executives report that customers are more cautious, which has lengthened buying cycles and pushed opportunities into the sales pipeline in the new financial year. It now guides shareholders to expect annual revenue of £40m-£42m in the 12 months to September 30, below both the consensus estimate of £48.6m and revenue of last year of £44.2m.

The life sciences and engineering segments, which account for about half of Oxford Metrics’ revenue, are performing slightly lower than last year. However, the entertainment sector has been hit by a slowdown in the global gaming industry and a contraction in content creation. The segment accounts for more than a third of the group’s revenues.

The group’s financial position remains robust. Closing net cash of £50m provides firepower to make incremental earnings acquisitions. Analysts still expect full-year earnings per share to rise 10% to 3.02p.

HOLD: Card Factory (CARD)

Shares in Card Factory fell more than 15% earlier this week after the cards and gifts retailer reported a 43% drop in interim pre-tax profits, a painful reminder of wage inflation pressures, even though management previously indicated that earnings growth would be weighted for the second half.

The size of the profit decline bothered investors as the result was hit by a 9.8% rise in the national living wage in April and freight inflation. Gross margin fell 420 basis points to 32.6 percent, hit by store and warehouse wages that accounted for 28 percent of revenue, compared with 24 percent in the same period last year.

But full-year expectations were kept unchanged, as were medium-term targets for revenues of £650m, pre-tax profit margins of 14% and 90 net new stores by 2027. A valuation of nine times consensus forward earnings, combined with a 7% forward free cash flow yield, according to Panmure Liberum forecasts, is an attractive proposition. But cost pressures remain challenging.