Today, I’m looking at two high-yield dividend stocks I believe could deliver a market-beating performance over the next few years.

A 7.9% yield I’ve bought

Shares in utility group SSE (LSE: SSE) are currently trading at a six-year low, with a forecast dividend yield of 7.9%.

I’m not sure this gloomy outlook is justified, having recently added SSE to my own portfolio. Although the group faces political pressure to cap prices and has lost customers to smaller rivals, the board is taking steps to address these problems.

SSE plans to combine its retail business with that of nPower, forming a new company. The new business will have a tighter focus on retail and greater scale, which should help with pricing. Meanwhile SSE should receive a share of the profits of the new business while being free to focus on its core business of gas and electricity production.

Too cheap to ignore?

My view is that SSE’s depressed share price already allows for a fair amount of bad news.

In its most recent trading update, the company confirmed earnings and dividend guidance for the current year. This puts the stock on a forecast P/E of 10, with that prospective dividend yield of 7.9%.

Although such a high yield would normally be a warning that a cut might be likely, I’m prepared to accept this risk here. Even a 25% cut would still provide an attractive 6% yield, with the potential for future gains.

I believe SSE deserves a buy rating — a view shared by 11 out of the 16 City brokers who cover the stock.

This cash-rich miner could be on a roll

Mining groups have made a stunning comeback over the last two years. But I reckon some companies in this sector could still be attractive for dividend investors. One stock I rate highly is South32 Ltd (LSE: S32), which was spun out of FTSE 100 giant BHP Billiton in 2015.

The Australia-based group published its half-year results today. Revenue rose by 8% to $3,494m during the six months to 31 December, while underlying operating profit rose by 5% to $724m.

The interim dividend will be increased by 19% to 4.3 cents and shareholders will also receive a special dividend of 3 cents per share.

These payouts look comfortably affordable to me. South32 ended the half-year with net cash of $1,431m, despite spending $426m on dividends and share buybacks during the period.

Why are the shares falling?

South32 shares have fallen by 6% following today’s results. One source of pressure could be that volumes from some of the group’s mines fell during the first half, due to technical challenges. Higher revenue and profit was mostly due to higher commodity prices, a benefit that may not recur during the second half.

However, I think it’s worth noting that the group’s cash balance accounts for 10% of its share price. On this basis, South32’s forecast P/E of 13 and 4.3% yield look good value to me. I’d be happy to buy at these levels.

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Improving outlook

For the fiscal year ending 30 June 2018, South32 is projected to report earnings per share of 17.3p giving a forward P/E of 10.3 at current prices. According to City figures, the shares offer a yield of 4%, and the payout is covered twice by earnings per share, giving plenty of room for payout growth. Thanks to rising commodity prices, analysts have more than doubled their earnings projections for it over the past year, and if prices continue to expand, I would not rule out further revisions. 

What’s more, compared to peers such as BHP and Rio Tinto, South32 looks to be undervalued by as much as 50%. Indeed, at the time of writing, shares in BHP currently trade at a forward P/E of 15.5, and Rio trades at a forward P/E of 12.8. 

Secure assets 

Shares in Berkeley Group (LSE: BKG) have been on a roll this year, but despite the gains, the stock still looks cheap compared to the wider market. Specifically, Berkeley currently trades at a forward P/E of 7.8 compared to the market median of 14.1. And as well as the low valuation, the shares also support a highly attractive dividend yield of 5.1%. 

Unfortunately, it seems as if UK investors love to hate the housebuilders. Even though these firms have recovered entirely from the financial crisis, investors still approach the sector with caution, wary of the next downturn.

Nonetheless, despite investors’ concerns, such firms continue to report steady profit growth, stronger balance sheets and improving pipelines. For example, for the year ending 30 April 2017 Berkeley reported a cash balance of £286m, after £255m of dividends and £65m of share buybacks. Meanwhile, the group’s land bank rose to 46,351 plots (up 8.1% year-on-year) with a total indicated gross margin of £6.4bn. With this tangible asset base providing a backstop to the business, it’s difficult to argue the case against Berkeley. 

Cheap growth

Over the past five years, RM (LSE: RM) has grown rapidly with earnings per share expanding 78% between 2012 and 2016 as demand for the company’s services — IT solutions for the education sector to help teachers and students alike — has blossomed.  City analysts have pencilled in further growth for the next two years with earnings growth of 5% projected for this year, and 17% for fiscal 2018. 

Still, even though RM has been able to chalk up a rate of earnings growth that most companies struggle to achieve, shares in the company trade at a relatively undemanding forward P/E of 8.6, falling to 7.5 for 2018. Compared to the group’s double-digit earnings growth rate, these multiples appear to undervalue the business. 

As well as the attractive valuation, shares in RM support an attractive dividend yield of 4%. The payout is covered nearly three times by earnings per share, so there’s plenty of room for further payout growth here, as well as headroom if revenues start to slide. A net cash balance of £40m (year-end 2016) adds further support to the group’s dividend distributions.

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Improving performance

Releasing a quarterly report on Thursday was mining company South32 (LSE: S32). It delivered record performance at Mozal Aluminium, which aided a 2% rise in total aluminium production during the year. The company’s smelters continue to operate at their maximum technical capability, which boosted production to some degree.

While impressive, the remainder of the company’s portfolio did not achieve the level of consistency which had been expected. For example, Cannington recorded a significant decrease in ore grades and metal production, while there was a 15% decrease in Illawarra Metallurgical Coal production. Despite these disappointments, South32’s alumina, nickel and manganese operations ended the financial year on a positive note.

At the present time, it has a dividend yield of 4.1%. That’s from a shareholder payout which is covered 2.5 times by profit, which suggests that dividends could increase at a faster pace than profit without hurting the company’s reinvestment prospects. Certainly, the mining industry is not the most stable sector for income investors. But with an inflation-beating yield and the potential for rapid dividend growth, South32 could be a strong investment for the long term.

Growth potential

Also offering upbeat income prospects within the mining sector is Antofagasta (LSE: ANTO). The copper mining specialist is set to deliver strong earnings growth over the next couple of years as it benefits from the results of a strategy change which saw some restructuring in recent years. In fact, in the current year the company is expected to report a rise in its bottom line of 44%, followed by further growth of 10% this year.

Such strong growth in earnings is set to lead to rapid dividend growth. That’s especially the case with Antofagasta currently having a payout ratio of just 37%. This is forecast to enable it to raise dividends per share by 9% next year, with further scope for dividend growth in future years. While this puts the stock on a forward yield of just 1.8%, it would be unsurprising for dividend growth to beat inflation and lead to a relatively enticing income return over a sustained period.

As well as its income potential, Antofagasta also appears to offer good value for money. For example, it has a price-to-earnings growth (PEG) ratio of just 1.8, which suggests that provided commodity prices remain stable, it could deliver a high rate of capital growth in the long run.

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A fast resurgence in the price of coal and iron ore led to big gains. But this rate of recovery is unlikely to continue. At some point mining stocks will transition from being value buys to being fairly priced. As a shareholder in all three of the big miners, valuation is a subject I’m paying close attention to.

We’re now in the middle of results season. Rio Tinto has already released its figures, which were better than expected. In this piece I’ll take a look at the latest numbers from BHP Billiton (LSE: BLT) spin-off South32 (LSE: S32), and consider the mining outlook for 2017/18.

Profits rise by 390%

The headline figures from South32 were certainly impressive. Sales rose by 8% to $3,221m during the six months to 31 December. The group’s first-half underlying operating profit rose by 390% to $691m.

Higher profits were backed by strong cash generation. Free cash flow rose to $626m during the half, meaning that 90% of operating profit was converted to surplus cash. The group ended 2016 with net cash of $859m.

Some of this cash is being returned to shareholders. South32 will pay an interim dividend of 3.6 cents per share, which is equivalent to a cash return of $192m.

How safe is the outlook?

South32 stock now trades on a forecast P/E of 9.2, with a prospective yield of 5.2%. These are attractive figures. But it’s worth noting that first-half earnings of 9 cents per share only represent 41% of full-year earnings forecasts for 22 cents per share. The company admits that hitting guidance will depend on “a strong finish to the financial year”.

Another point worth noting is that consensus forecasts currently suggest earnings per share will fall by 20% during the 2017/18 financial year, which starts on 1 July. South32 may outperform this guidance, but at current levels I’d view the stock as a hold, rather than a buy. It might make sense to lock in some gains at this point.

Bigger might be better

BHP Billiton benefits from a more diverse portfolio of assets than South32. But the outlook is remarkably similar. Earnings per share are expected to fall by 13% to $1.25 per share in 2017/18. This puts the stock on a forecast P/E of 13.8, with a prospective yield of 4.5%.

As we’ve seen with Rio Tinto and South32, current year performance is likely to be very strong. BHP expects to generate free cash flow of $7bn during the current year, which will be used to fund debt reduction and a big dividend hike.

Are the shares still a buy? One measure which suggests that BHP may still be cheap is the so-called PE10. That’s a P/E ratio calculated using the current share price and 10-year average earnings per share.

I’ve calculated BHP’s PE10 as 9.1. That suggests to me that the stock isn’t expensive, relative to its historic performance.

As a long-term income buy, I believe BHP remains attractive. But for investors seeking capital gains, now may be a good time to reduce the size of your holding. I suspect that further gains will be slower, with a greater risk of disappointment.

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Selling could boost growth

Manufacturing group Essentra (LSE: ESNT) will sell its Porous Technologies unit for £220m to US firm Filtration Group. The deal will reduce Essentra’s debt levels significantly and allow the group to focus on core growth areas of its business.

Shares in the group have fallen by 38% so far this year, thanks to a profit warning in June. Profits will take another hit from the loss of the Porous Technologies business, which generated an operating profit of £17.6m over the last 12 months. This represents about 17% of Essentra’s reported operating profit for the last year.

However, I suspect that the impact of this loss will be partly offset by the benefits of lower operating costs and reduced debt.

In my view, Essentra remains a hold. I estimate that the shares will trade on a forecast P/E of 12-14 after the sale, with a prospective yield of about 4%. Essentra has good growth prospects elsewhere — the shares could perform well from here.

Profits up at fashion firm

Luxury shoe retailer Jimmy Choo (LSE: CHOO) said that sales rose by 9.2% to £173.1m during the first half of the year. The firm’s adjusted operating profit rose by 13.7% to £21.6m.

However, because 89% of sales were made outside the UK, these figures were given a big boost by the recent slide in the pound. Measured at fixed exchange rates, sales rose by a more modest 3.8% during the first half.

Sales trends in Asia were encouraging. Jimmy Choo reported double-digit like-for-like growth in China and strong growth in men’s sales. Men’s shoes currently account for just 8% of Jimmy Choo’s sales, but the firm believes this figure could rise “well into double digits” in coming years.

Jimmy Choo shares are up by 3% at the time of writing, putting them on a 2016 forecast P/E of 19, falling to 16 for 2017. The shares have fallen by 30% over the last year, but earnings growth is expected to accelerate next year. Now could be a good time to pick up a few shares.

Mining spin-off digs up cash

Mining group South32 (LSE: S32) reported a loss after tax of $1.6bn last year, due to non-cash writedowns on the value of its assets. The firm’s underlying earnings fell by 76% to $138m. However, the situation may not be as bad as these figures suggest.

South32’s profits have fallen as a result of weak commodity prices. But market conditions have stabilised this year. South32 is profitable at current prices and generated adjusted free cash flow of $597m last year. This enabled the group to reduce debt and finish the year with net cash of $312m.

The firm has declared a maiden dividend of 1 cent per share, giving a yield of about 0.6%. Analysts’ forecasts suggest that underlying earnings will rise from 2.6 cents to 6.9 cents per share in 2017. This puts the stock on a forecast P/E of 22.

I’d say that South32 is priced fairly at the moment, but further gains could follow as the market recovers, or as a result of takeover or acquisition activity.

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Clearly, much of this is down to an improved outlook for commodity prices, but South32’s focus on value over volume has also helped it deliver improved financial performance. And its delivery of two major projects on budget and ahead of schedule shows that it has the capacity to operate and be successful within a difficult environment.

Looking ahead, South32 is forecast to increase pre-tax profit from around £125m in the most recent financial year to just under £400m in the current one. This is clearly dependent on prevailing commodity prices, but with South32 trading on a price-to-earnings growth (PEG) ratio of around 0.3, it seems to offer a sufficiently wide margin of safety to merit purchase now for the long term.

Return to profits

Also offering an upbeat outlook is Tullow Oil (LSE: TLW). The oil explorer has responded to a lower oil price environment by focusing to a greater degree on production and this is set to boost its profitability in the short run. In fact, Tullow Oil is expected to return to profitability in the next financial year, with its Project TEN in Ghana being a major reason for that.

Although the profitability of the project will be lower than previously anticipated due to a lower oil price, the cost per barrel of producing oil at the deepwater project is just $20. Therefore, oil could fall by up to 60% from its current level and still leave the new project economically viable.

And with Tullow Oil expected to rapidly improve its cash flow in the coming years, concerns surrounding its degree of leverage may subside and cause investor sentiment to improve. Therefore, now could be a good time to buy it – even if the oil price disappoints over the short-to-medium term.

Lagging its peers?

Meanwhile, Cairn Energy (LSE: CNE) has benefitted from a rising oil price in 2016, with its shares up 20% year-to-date. It continues to have a bright long-term future, with the company having a strong financial position through which to develop its lucrative asset base. And with the prospects for the oil price now being stronger than a number of months ago, investor sentiment towards Cairn could improve over the coming months.

However, with a number of other resource-focused companies having black bottom lines and forecast to grow their earnings at a rapid rate, the appeal of Cairn on a relative basis may be somewhat limited. That’s not to say that it’s a stock to avoid, but rather investors may prefer to buy the likes of South32 or Tullow, which may prove to be on the cusp of stunning returns thanks to their high forecast earnings growth rates over the next year.

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However, as investor sentiment has improved over the past eight weeks miners have staged a recovery, and South32 (LSE: S32) is leading the charge. Indeed, over the past eight weeks shares in South32 have risen 94%, and shares in the company’s former parent, BHP Billiton (LSE: BLT) are close behind having racked up gains of 33%.

These gains have been enough to convince some investors that the mining sector is starting to recover. But while miners have been rallying since mid-January, the underlying market fundamentals haven’t improved significantly. Key commodity markets are still oversupplied, and questions remain about China’s economic growth. What’s more, global trade growth has slowed to recessionary levels and emerging market growth is faltering.

With this being the case, it’s difficult to buy into the recent mining sector rally. Mining stocks have rallied hard and fast, although it seems as if this is more to do with short covering than anything else. So, South32’s rally could be nothing but hot air. 

On the other hand, BHP remains the world’s largest diversified miner, and while recent gains in the company’s share price may be overdone, BHP still has all the traits of an attractive long-term investment.

BHP over South32?

Why BHP over South32? Well, for a start BHP has some of the lowest production costs in the mining industry, which gives it flexibility throughout all stages of the mining cycle. Moreover, the company’s size and asset base, coupled with a relatively clean balance sheet means that banks and other creditors are happy to lend to the miner, allowing it to remain solvent during times of stress.

Also, BHP’s production profile is more diversified than that of its smaller peer. Three key commodities, coking coal, aluminium and manganese, make up around 75% of South32’s earnings before interest and tax. BHP produces four primary commodities, coal, copper, iron ore and oil.

The better long-term choice 

So, even though South32’s shares have doubled during the past eight weeks, BHP’s size and diversification mean that it’s the better choice over South32 for long-term investors. And BHP is currently trading at a more attractive valuation than its smaller peer. 

BHP is currently trading at a forward P/E of 80.2, falling to 36.5 next year. South32 is currently trading at a forward P/E of 22,106, falling to 4,104 next year. On the yield front, BHP once again looks more attractive than its smaller peer. BHP’s shares currently support a dividend yield of 3.8%; even after the recent payout cut. South32’s shares are only set to support a dividend yield of 0.3% for this year.

All in all, investors shouldn’t be misled by the recent performance of South32’s shares. Underlying market fundamentals are still signalling further pain ahead for the miners and BHP is one of the few miners with the firepower in place to survive a protracted downturn. 

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Severe cuts

That’s mostly because the company has also announced a major restructuring programme that has the potential to improve its long term financial outlook. It will include severe cuts in sustaining capital expenditure at a handful of its operations, with over 1000 jobs also due to be cut as it seeks to offset falls in sales resulting from low commodity prices. It will also seek to make productivity improvements and generate greater efficiencies, although its future remains highly dependent upon commodity prices.

With South32 trading on a price to earnings growth (PEG) ratio of 0.4, it continues to have capital gain potential. And despite being in the midst of a tough trading period and being forced into making major changes to its strategy, it remains a company which could be of great interest to less risk averse investors.

Considerable rewards

Clearly, a turnaround is very achievable, as shown by KAZ Minerals (LSE: KAZ) which released its 2015 results today. Despite experiencing a fall in revenue versus the prior year, KAZ Minerals was able to move from a red bottom line in 2014 to a black one in 2015. This was largely because of a fall in impairments, but also because the company’s drive to cut costs has been relatively successful.

Looking ahead, KAZ Minerals is aiming to become increasingly efficient and is also targeting production growth of 50% per year over the next three years. This could have a very positive impact on its profitability, with the copper miner expected to record a pre-tax profit of around £65m in the 2017 financial year.

Although this puts it on a rather rich forward price to earnings (P/E) ratio of 20.4, there is scope for share price gains over the medium to long term. That’s because, with production rising and costs having the potential to fall, KAZ Minerals could begin to deliver on its turnaround potential in the coming years.

Clearly, the company remains a relatively high risk play and continues to have rather high debt levels. But for investors who are comfortable with a relatively high level of risk, the rewards from investing in KAZ Minerals could be considerable.

Risky potential

Meanwhile, UK Oil & Gas (LSE: UKOG) continues to lead most of its resources peers when it comes to year-to-date share price growth. It is now up by 100% since the turn of the year as a result of positive news flow regarding the Horse Hill prospect near Gatwick airport, with its 20% stake in the project benefitting from the better than expected flow rates.

Looking ahead, there is the potential for further upbeat news flow from Horse Hill, although investing in UK Oil & Gas at the present time may be rather risky. That’s because it is impossible to determine the nature of future news, and there could be disappointments ahead, as well as more encouraging news.

Therefore, while less risk averse investors may be keen to invest in UK Oil & Gas, for most investors buying a slice of a less volatile business within the oil and gas sector may offer a more preferable risk/reward opportunity.

The post Are South32 Ltd, KAZ Minerals PLC And UK Oil & Gas Investments PLC 3 ‘Must-Have’ Resources Stocks? appeared first on The Twelfth Magpie.

The company believes that the changes being implemented will allow it to rebase its manganese ore production and benefit from reduced mine gate costs. When the changes are taken alongside the other initiatives being undertaken across South32’s portfolio of assets, they could lead to a strengthening of the company’s financial position as well as improved future cash generation.

Although South32 also announced a non-cash impairment charge of $1.7bn today, investors seem to be optimistic about its long-term prospects. Certainly, there’s scope for it to become more efficient and increasingly profitable, which is expected to lead to earnings per share of 3.3p in the current year. This puts South32 on a price-to-earnings (P/E) ratio of 16.1 which, given its long term potential, could prove to be a highly appealing valuation.

More appealing?

Despite this, the likes of Rio Tinto (LSE: RIO) and Centamin (LSE: CEY) may hold greater appeal. In the case of the latter, it trades on a lower rating than South32, with its shares having a P/E ratio of just 12.9. Furthermore, with production set to hit 500,000 ounces of gold within the next two years, it’s likely to deliver a significant rise in profitability over the medium term, which could positively impact on its share price.

In addition, Centamin’s focus on gold may also be a major ally for investors given the uncertain outlook for the world economy. That’s because during such periods it can be seen as a store of wealth. Also, its price has historically held up better than other commodities, thereby providing Centamin with a slightly better earnings outlook than South32.

Meanwhile, Rio Tinto continues to have a dominant position within the iron ore market, with its cost curve being among the lowest in the world. Although the price of iron ore could continue to come under pressure as Chinese demand falls, Rio Tinto’s position in the industry is likely to be strengthened relative to its rivals. This could lead to higher market share and greater profitability in future.

Furthermore, with Rio Tinto trading on a P/E ratio of 12.2, it also offers better value than South32 at the present time. So while South32 could prove to be an excellent long-term buy, Rio Tinto and Centamin seem to be preferable for investors who are unable to hold all three.

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Zinc is currently trading at multi-year lows and the firm says that cutting production now will help to “preserve the value” of the firm’s zinc reserves.

According to the FT, Glencore’s cut equates to around 6.3% of global zinc production outside of China, so it is likely to have a noticeable effect on supply and demand.

Zinc prices have risen by around 6% this morning, while Glencore shares are also up by around 6%.

The share prices of other zinc producers have also risen. Notable among these are Vedanta Resources (LSE: VED), whose shares are up by nearly 10% at the time of writing. Another firm that should also benefit is recent BHP Billiton spin-off South32 (LSE: S32), which also mines zinc. South32 shares have climbed by around 4% so far today.

Are any of these companies a buy, following today’s news?

Glencore

Glencore is under pressure from investors to reduce its high level of debt in the face of low commodity prices. In my view, today’s decision needs to be looked at in this light.

Are the zinc mines affected by the cuts currently operating profitably? Are they generating free cash flow? If the answer to these questions was yes, surely Glencore would be maintaining production to help repay debt.

I suspect Glencore is cutting production in order to improve its cash flow and operating margins. The firm reported an adjusted operating margin of just 3.5% from its zinc operations during the first half of the year. Cutting production at higher cost mines could improve this significantly.

On this basis, today’s move seems smart and cautiously improves the outlook for the firm.

Vedanta Resources

Bosses at Indian miner and oil firm Vedanta must be smiling this morning.

Vedanta owns some of the lowest-cost zinc mines in the world, and zinc accounted for 65% of the group’s adjusted operating profit last year. The boost in zinc prices seen today will help lift Vedanta’s profits.

Vedanta also has high debt levels, but generates a lot of free cash flow. Trading on around 16 times 2016 forecast earnings and offering a 7% prospective yield, I rate these shares as a potential buy.

South32

Earlier this year, BHP Billiton spun off a number of unwanted assets, including its zinc operations, into a new company called South32.

This spin-off came just before the big commodity sell-off, and South32 shares have fallen by 27% since joining the market in May. Today’s news is good for the firm, however, and I believe South32 could be a medium-term buy.

South32 was floated with a minimal amount of debt and is expected to generate net profit of $367m this year, rising to $698m in 2016/17.

The firm’s shares currently trade on just 8.5 times 2016/17 forecast earnings and at around 0.6 times their book value. There’s also a forecast yield for the current year of 2.8%.

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