2 surprising stocks from Neil Woodford’s new income portfolio

AA breakdown cover

Newly-released details of fund managers’ portfolio holdings are not usually met with much excitement, but Neil Woodford’s latest picks could prove an exception.

Mr Woodford’s impressive track record means that the stocks chosen for his new Income Focus Fund — which takes a very positive view of the UK economy — are likely to attract some comment.

Details of the portfolio were published on Wednesday. Although there are some familiar names, such as AstraZeneca and Imperial Brands, many of the stocks represent Mr Woodford’s view that people have been “too downbeat” about the UK.

The cream of the crop?

Barratt Developments (LSE: BDEV) is one of the more attractive stocks in the housebuilding sector, in my opinion. It’s a view Neil Woodford seems to share. Barratt is the ninth-largest holding in the new Income Focus Fund, which is targeting a 5% initial yield.

Barratt shares have risen by 422% in five years. You might think this means that it’s too late to invest in the UK’s housing market. I have some sympathy with this view, but recent results from Barratt suggest that it may not be correct.

As things stand, demand for new housing remains strong. The big housebuilders are still reporting rising prices and increasing completions. In Barratt’s case, this means record forward orders worth £3,205.7m, and expected net cash at the end of June of £600m.

The firm’s 2017 forecast dividend yield of 6.3% looks safe to me, as it should be covered by both free cash flow and net cash.

Barratt shares now trade slightly above the level seen before last year’s referendum sell-off. Both profit and performance have improved since, so the current price tag seems reasonable. The only hesitation I do have is that Barratt stock now trades at twice its tangible book value of 309p. As and when the market does slow down, the shares could fall sharply towards this level.

For this reason I’d only buy Barratt for income, not for value.

A future cash machine?

The second one of Mr Woodford’s recent picks I’d like to highlight is AA (LSE: AA). The breakdown operator needs no introduction. Yet high debt levels means it’s not an obvious income buy, due to the risk that dividend cash might be needed for debt repayments.

However, I think Mr Woodford may have looked further ahead than other investors and spotted a potential income goldmine. AA’s net debt has fallen from £3.2bn to £2.7bn since its flotation in 2014. During this time the group has invested in IT and other improvements designed to make it fit for the future. The results are starting to come in — the firm’s recent results showed a 2.5% increase in membership revenue during year to 31 January.

AA stock trades on a forecast P/E of 10 and offers a forecast yield of 4% for the current year. But the group’s free cash flow has been consistently strong since its return to the market. If trading remains stable and debt continues to fall, I think that its dividend and share price could rise strongly to reflect the increase in surplus cash available for shareholder returns.

In my view, this is potentially a smart pick by Neil Woodford.

These dividend champions could surprise

Mr Woodford’s investing style is bold and long term. Many of his past contrarian bets have paid off handsomely for investors in his funds.

If you’re interested in building a portfolio of stocks with the potential to beat the market over long periods, then I’d urge you to take a look at 5 Shares To Retire On. Our exclusive new investing report focuses on five income growth stocks we believe could help fund your retirement.

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Roland Head has no position in any shares mentioned. The Motley Fool UK has recommended AstraZeneca and Imperial Brands. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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