The Income Investor: a cyclical FTSE 250 stock with dividend appeal

Income investors may understandably question the appeal of cyclical dividend shares at the present time. After all, they don’t typically offer exceptional yields and, due to their high level of dependence on the economy’s performance, are generally not delivering positive real-terms growth in dividends.

Indeed, the near-term outlook for the economy remains highly uncertain. The global trade war, for example, could come sharply back into focus as we hopefully find out more about US tariff policy.

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Additionally, conflict in Ukraine and the Middle East could prompt relatively high volatility in the share prices of cyclical firms over the short run. And with inflation being sticky across the developed world, while recent interest rate cuts will take time to have their desired impact on the economy, the near-term prospects for GDP growth, as well as the performance of cyclical stocks, could prove to be somewhat disappointing.

Furthermore, given their reliance on the economy’s performance, there’s an inherently greater underlying threat that cyclical income stocks will be forced to cut shareholder payouts. Although defensive stocks still face this risk to a degree, it’s likely to be to a far lower extent due to their relatively stable financial performance. Similarly, cyclical stocks typically come with a greater risk of capital loss vis-à-vis defensive shares.

Monetary policy easing

While income stocks that are highly dependent on the economy’s performance may appear to lack appeal over the short run, they could deliver fast-paced dividend growth over the long term.

History suggests that interest rate cuts enacted in the UK and across developed economies over recent months, are likely to have a positive impact on the economy’s performance once time lags have passed. Given that inflation in the UK and US is expected to fall further towards central bank targets over the medium term, while it currently stands at 2% in the eurozone, there appears to be scope for further monetary policy easing to be implemented over the coming months.

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A more accommodative monetary policy should provide improved operating conditions for cyclical firms that are more conducive to profit growth. This could mean they are able to raise shareholder payouts at a faster pace than inflation – especially since the annual rate of price rises is forecast to moderate. This could mean that investors obtain a boost to their spending power over the coming years.

Additionally, rising profits and a more buoyant economic outlook could lead to long-term capital growth. While this may not be a key consideration for income investors, a larger portfolio by value may ultimately make the task of generating an attractive income somewhat simpler.

Self-help measures

While cyclical firms are set to continue to experience tough operating conditions in the short run, in many cases they are implementing self-help measures to boost their financial performance. For example, they may be reducing costs via efficiencies to either bolster profits or at least limit the effects of temporarily lower revenue.

Those firms with sound financial positions may also be able to make acquisitions at discounted prices to further improve their long-term prospects as the full impact of monetary policy easing becomes clear. Companies that have modest debt levels may also have a higher chance of overcoming near-term economic challenges.

Undoubtedly, cyclical dividend shares are likely to be a riskier prospect than their more defensive income peers. They could produce substantial paper losses, as well as deliver dividend cuts in the short run as an uncertain economic outlook leads to elevated share prices and financial volatility.

However, over the long run they appear to offer significant potential rewards in the form of strong dividend growth and scope for attractive capital returns. By focusing on those firms with sound strategies and solid fundamentals, income investors may be able to capitalise on economic difficulties that, history suggests, are likely to gradually give way to more prosperous conditions over the coming years.

Source: Refinitiv as at 8 July  2025. Bond yields are distribution yields of selected Royal London active bond funds (as at 31 May 2025), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 7 July. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (4 July). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 8 July. **Best rate includes 12-month bonus.

A relatively high yield

For example, Morgan Advanced Materials (LSE:MGAM) could offer long-term income investing potential. The FTSE 250-listed firm, which manufactures advanced carbon and ceramic materials used in a wide range of applications including aeroplane engines and wind farms, currently yields 5.4%. This is 200 basis points higher than the mid-cap index’s dividend yield, with the company’s shareholder payouts being covered more than twice by profits in its latest financial year.

Of course, the firm’s cyclical nature means it is experiencing a tough set of operating conditions amid an uncertain economic backdrop. This contributed to an increase in dividends per share during the company’s latest financial year of just 1.7%. This was 80 basis points lower than annual inflation over the same period and meant the firm’s investors experienced a reduction in their spending power.

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While the company’s revenue declined by 1.3% in 2024, it was able to generate a 6.7% increase in operating profits versus the prior year. This was brought about by cost reductions and price increases that led to a 90 basis point increase in its operating profit margin, which stood at 11.7%.

The company expects this figure to rise by a further 80 basis points to 12.5% during the current year as it anticipates cost savings of £16 million. Furthermore, annual cost savings of £27 million that are forecast to be delivered from 2026 onwards could mean there is scope for an additional rise in profit margins over the medium term. If achieved, this would help to mitigate some of the effects of a tough operating environment on profitability and, potentially, the rate of growth in the company’s dividends.

Solid fundamentals

Encouragingly, Morgan Advanced Materials has a sound balance sheet through which to overcome near-term economic uncertainty. For example, it has a net debt-to-equity ratio of 70%, while net finance costs were covered around 5.5 times by operating profits in its latest financial year.

The firm’s return on equity figure of 15%, which was achieved amid a tough operating environment last year, highlights its solid competitive position. This is especially the case when its aforementioned improving profit margin is taken into account.

Income investing potential

Since first being discussed in this column in January 2024, Morgan Advanced Materials’ share price has fallen by around 20%. Given that the FTSE 250 has risen by 11% over the same period, this represents a 31 percentage point underperformance of the mid-cap index.

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Trading on a price/earnings (PE) ratio of just 8.8, the stock appears to offer a wide margin of safety. Given the upbeat long-term outlook for the world economy, as well as scope for the company to deliver a further increase in its profit margin, it seems to be well placed to produce an improved share price performance over the coming years.

Clearly, its status as a cyclical firm means share price volatility is likely to be high. Additionally, its financial performance could come under further pressure amid elevated geopolitical risks and sticky inflation in the short run.

But with a relatively high yield, solid fundamentals and a sound strategy, Morgan Advanced Materials appears to offer a sound income investing outlook within a diversified portfolio.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.