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This high-yield ASX industrial stock is in the green zone

Nicholas Grove  |  30 Nov 2016Text size  Decrease  Increase  |  

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There are several moat-rated, ASX-listed stocks that are currently sitting on a fiscal 2017 dividend yield above the S&P/ASX 200's yield of around 4.4 per cent, but there is only one currently trading at a substantial discount to fair value.

Spotless Group (ASX: SPO), on which Morningstar equity analyst Tim Mann currently has a fair value of $1.50, and which is on an FY17 dividend yield of 7.7 per cent, is a market leader in outsourced facility and laundry management services in Australia and New Zealand.

According to Mann, the company is a key beneficiary of a positive trend towards outsourcing services in a market that, according to Spotless, is expected to grow at about 8.2 per cent between fiscal 2013 and 2018.

"We understand Australia lags other advanced economies in outsourcing services, with only about 47 per cent market penetration," Mann says in a research note.

"Spotless Group is well positioned to benefit from the outsourcing trend, which continues to grow solidly as organisations seek to improve their productivity and lower their operational costs.

"Spotless has solid earnings streams through long-term contracts, with a large customer base and a good record of contract renewal."

Mann argues that Spotless has a narrow economic moat, which is underpinned by several competitive advantages.

"Being the largest provider of outsourcing services by revenue, the scale and breadth of services in Australia and New Zealand allows the company to benefit from economies of scale, as buying in bulk results in more efficient sourcing," he says.

And while the barriers to entry to the sectors in which Spotless operates may be low, Mann says the company has a strong relationship with its customers--highlighted by the long-dated nature of some contracts to about 27 years.

Furthermore, the company's brands benefit from a long history of operation in both the Australian and New Zealand markets, he says.

However, Mann points out that Spotless is not without its risks, being exposed to potential slowdowns in macroeconomic activity, particularly in the government and mining sectors.

"Should the incumbent government be successful in implementing its relatively tight fiscal policy, we believe there is a risk to Spotless Group achieving its forecast numbers," he says.

"While many government contracts are long-dated in nature, they are nevertheless less binding, highlighted by clauses in the contract that allows the government to walk out just for convenience purposes.

"In this environment, higher competition can also place more pressure on the pricing that Spotless Group can achieve for its contracts, adversely impacting margins."

Nonetheless, Mann still expects Spotless to achieve returns on invested capital significantly above its weighted average cost of capital going forward.

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Nicholas Grove is a Morningstar journalist.

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