Stockwatch: A 7% yield and robust financials

Is a yield over 7% too good to be true? Combined with an AIM listing it initially suggests a dubious enterprise i.e. the stock priced for a high yield to compensate for risks. Yet the five-year table for Andrews Sykes shows robust if variable financials, with cash flow significantly above earnings - the typical profile for a group of mature businesses.

Capitalised near £140 million, it principally combines two long-established equipment hire operations: Andrews air conditioning and heating, and Sykes pumps for de-watering in situations like mining and construction.

Stretching criticism, the group appears rather well-consolidated in this structure, possibly due to majority ownership by the Murray family - with Tony Murray as chairman and his son as vice-chairman. Yet the accounts are clean, capable management is in place, and the board prioritises shareholder returns - so this stock has use in a diversified portfolio.

Weather surprises are the chief variable

In principle, the Andrews heating and air conditioning sides help smooth seasonal performance; in practice a mild winter or cool summer can impact it. Since pumps relate to mining and construction, their demand tends to follow business cycles. Notes to the accounts don't separate performance of the Andrews and Sykes sides, but note 5 in the 2014 annual report shows nearly 80% of revenues deriving from European hire & sales, the UK not specified, 14% Middle East hire & sales, with the remaining 6% "installation".

So European weather and trend of business cycle are key influences; it becomes quite tricky to judge what may be a mature cycle in the UK as some indicators turn down, versus the beneficial effects of monetary stimulus by the European Central Bank - and how this pans out for equipment demand.

Ideally, hot summers would follow cold wet winters, but the weather may not oblige: a good example being the first half of 2014, when a mild winter hit demand for heaters and more than offset UK wet weather boosting demand for pumps. A weak construction market in the Netherlands also weighed, explaining last year's revenue/profit fall.

Dividend supported by cash flow and reserves

The table also shows how subtracting capital spending of 7.6p per share from cash flow of 27p means the 23.8p total dividend was uncovered by operations i.e. cash reserves being used. And cash is reducing: the end-December balance sheet cited cash down to £24.1 million from £27.4 million, and the last interim results showed £19.7 million cash at end-June.

An 11.9p interim dividend has recently been paid and "the board continues to adopt the policy of returning value to shareholders whenever possible". The 2014 results noted it had returned £17.6 million cash to shareholders over the previous two years, so the culture is well-established and justified.

Maintaining the current 23.8p total dividend requires a cash distribution just over £10 million so the operations would need a more substantial hit to jeopardise this in the medium term. Debt totals a modest £6 million, mainly long-term, so arguably cash should continue to be returned: the board is opting to pay a very full ordinary dividend where other firms might declare a special dividend.

Recovery in Benelux, improvements in UAE

The first half of 2015 saw good operational progress with a strong recovery across the Benelux region and new continental businesses trading in line with expectations. Sykes improved in Dubai and Abu Dhabi and Andrews' UK operation was slightly ahead, such that pre-tax profit rose 15% to £4.7 million - albeit still down on the £6.7 million achieved in the first half of 2013.

Third-quarter trading has been helped by early-July hot weather boosting demand for air conditioning, which persisted on the continent despite being short-lived in the UK. "The board remains cautiously optimistic that the group will return an improved performance for the full year."

No forecasts appear published, but weather can sway them anyway. There has been speculation of a harsh winter, yet autumn has been exceptionally warm.

Despite these uncertainties the group's five-year record is fairly stable; it has strong industrial brands and low debt, so a 7% yield should be a genuine support for the stock. Even in a worst-case scenario of the UK economy weakening under Osborne's budget-balancing austerity, another warm winter and an emerging markets crisis as US interest rates and the dollar rise, Andrews Sykes looks set to maintain its 23.8p total dividend. UK interest rates are unlikely to rise meaningfully for a long while, so the yield is attractive.

Chart reflects typical consolidation pattern

The five-year chart shows a re-rating during 2013 as Quantitative Easing (QE) boosted stocks generally, then sideways trading in a 278p to 378p range. The price slid with operating profit towards the end of 2014, yet management continued to safeguard its operating structure by investing in the hire fleet and the group is able to draw on this currently.

At about 330p, the stock still looks to be drifting sideways, lacking new elements in the story as catalysts. Admittedly, this is not a situation to excite growth investors: news flow tends to be sparse apart from results reporting, and the price/earnings (PE) multiple looks high in the mid-teens, yet this lack of interest also explains why the stock ends up priced for high yield.

Another reason for being off-radar is the Murray family's controlling position meaning low liquidity. Yet the 95-year-old executive chairman, Tony Murray, has done a good job overseeing Andrews Sykes since he gained control some two decades ago. The story shows how AIM does not necessarily mean "high-risk" - while you can't account for fickle weather, Andrews Sykes is a sound operation. Ultimately, one's stance depends on investment objectives: for income, well worth considering.

For more information see their website.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.