Bus and train operator Go-Ahead Group (LSE: GOG) rose by 9% this morning after the firm said adjusted pre-tax profits rose 39% to £138.5m last year.
One of Go-Ahead’s core attractions is its strong free cash flow, which is used to fund a generous dividend. That description can also be applied to FTSE 100 consumer goods giant Unilever (LSE: ULVR).
However, while Unilever currently trades at an all-time high, Go-Ahead is down by 20% since the start of the year. Problems with its Southern Rail franchise have hit the group’s share price. Could Go-Ahead be a better dividend buy than Unilever?
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Motoring ahead
If you’re a Southern Rail passenger, you would probably expect the strikes, cancellations and engineering works that have plagued your commutes to have reduced Go-Ahead’s rail profits.
You’d be wrong.
Adjusted rail operating profit rose by 37% to £57m last year. Operating profit from the group’s bus division rose by 7.9% to £100.4m. Despite warning investors that future profit margins from the Govia Thameslink franchise (which includes Southern Rail) would be lower than expected, it was a good year for Go-Ahead.
The group’s adjusted earnings per share rose by 21% to 220.5p, while the total dividend will rise by 6.5% to 95.85p. This gives the shares a P/E of 10 and a trailing yield of 4.5%.
This dividend continues to be backed by free cash flow, which rose by 4.8% to £68.2m, or 158p per share. Go-Ahead’s net debt remained broadly unchanged, at £239.3m.
Too good to be true?
Go-Ahead’s finances look fairly sound to me. The group’s cash generation remains strong and net debt doesn’t look excessive relative to the £494.3m value of the firm’s property and fleet assets.
However, there are a few potential risks that could cause problems in the future. Go-Ahead’s bus pension plan liabilities are large, at £765.8m. If a pension deficit develops in the future, extra payments could eat up the firm’s profits, threatening the dividend. Political risks are also a potential concern, as many of Go-Ahead’s activities are regulated or influenced by government policy.
Despite these concerns, I’d be happy to buy Go-Ahead shares following today’s results.
But is Unilever a smarter buy?
Unilever shares have risen by 22% so far this year, thanks to a combination of exchange rate factors and investor demand for safe, defensive stocks.
The group’s dividend has grown by an average of 7.8% per year since 2010 and remained consistently covered by free cash flow. Unilever shares have risen by 105% over the last six years.
However, Unilever’s after-tax profit has only risen by an average of 3% per year. That’s slower than both the firm’s dividend payout and its share price. This means that Unilever is a more expensive business than it was in 2010.
At the time of writing, Unilever shares are trading at 3,590p, giving the company a 2016 forecast P/E of 23. The forward dividend yield is just 2.7%. In my view the shares are quite fully priced. Unless earnings growth rises, Unilever shares may struggle to beat the market over the next couple of years.
While I intend to continue holding my Unilever shares, I don’t plan to buy any more until they become cheaper.
