Dividend yields across the FTSE 350 remain elevated as many constituents have yet to recover from the recent stock market correction. In some cases, the falling stock prices have pushed yields into double-digit territory. One such example is Mobico Group (LSE:MCG).
The coach operator, previously known as National Express, is now seemingly offering a yield of just over 10%. But is this too good to be true? Or are investors secretly looking at a terrific buying opportunity? Let’s take a closer look.
Rebound in the travel market
Following the evaporation of demand during the pandemic, coach operators saw their revenue streams dry up fairly quickly. Since then, the transport market has improved drastically. And companies like Mobico and FirstGroup have further benefited from the rail strikes which have driven up demand for bus transportation.
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According to the latest results, Mobico’s bus passenger volumes have reached 97% of pre-pandemic levels. And by raising ticket prices, revenue is now ahead of 2019 levels. Yet, looking at the stock chart, things have gone from bad to worse. For reference, shares are down 60% over the last 12 months and 85% since the start of 2020. Meanwhile, rival firm FirstGroup has seen its market cap climb over 80% in the past year. What’s going on?
A profitability problem
While sales may have bounced back from Covid disruptions, the same can’t be said about earnings. The bottom line is still firmly in the red. And it seems management’s expected recovery timeline for profit margins wasn’t as accurate as they had hoped.
Short-term challenges are bound to emerge for any business trying to turn itself around. But in the case of Mobico, the lack of profits is particularly bad news because of its large pile of debt. As of June this year, the company has £1.5bn of borrowings.
With the cost of debt on the rise, the group’s interest expenses have grown by 47% year on year. And with operating profits unable to cover this expense, Mobico’s balance sheet is looking over-leveraged. Consequently, management has just announced that it is suspending dividend payments, making the current 10% yield an income trap.
A secret buying opportunity?
Investors expecting a reliable, chunking payout from this business are likely going to be sorely disappointed. However, with the share price already in the gutter, this news appears to have already been baked into the valuation. So, the question now becomes, is this a long-term turnaround opportunity?
Maybe. Management is currently looking to sell off its American school bus business to raise capital and pay down its debts. While this doesn’t solve all of its problems, the reduction in interest expenses will provide some much-needed breathing room.
At the same time, the company continues to roll out its cost-saving initiative to try to cut down annual expenses by £30m. And in its most recent trading update, the company believes a further £20m in savings can be achieved, which would be sufficient to push the business back into profitability, even with headwinds from driver wage inflation.
Therefore, I believe there is a future where Mobico can get back on track. However, a lot of things have to go right, starting with the successful disposal of its American school bus segment. But whether management can find a buyer has yet to be seen. Therefore, I’m personally keeping this stock on my watchlist for now.
