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Best FTSE 250 shares to buy in September 2022

Diversified Energy, Direct Line, Royal Mail, and Abrdn could be top FTSE 250 shares to buy next month as dividend yield takes centre stage.

ftse 250 Source: Bloomberg

With global recession seemingly a foregone conclusion, the criteria for selecting the best FTSE 250 stocks are rapidly changing. Instead of growth, the priority now is decent defensive qualities that make a company resilient in times of depressed spending.

Quality stocks with a dampened share price that consequently yield above-average dividends are becoming particularly attractive, especially if the market has already priced in the negatives.

FTSE 250: energy emergency

These changing criteria are being driven by the metamorphosis of the investment landscape. CPI inflation is at 10.1%, and Citi predicts it will strike 18.6% in January.

Of course, this inflation is being driven by the skyrocketing cost of energy. From October, the average UK household’s annual energy bill will be a whopping £3,549 a year. And in its latest forecast, Auxilione has predicted this will rise to £7,700 by April.

Worse, as demand for gas continues to outstrip the limited supply, there is no upper limit to how high prices will go. The only limiting factor remains demand destruction, where the upcoming recession becomes so severe that it causes energy demand to fall below the newly limited supply.

Also worth noting — there is no price cap for businesses. Many smaller companies will collapse this winter unless there is government intervention on the scale of the covid-19 pandemic response.

Further, with the base rate already at 1.75%, the markets are pricing in an increase to 4.1% by mid-2023.

Best FTSE 250 shares

1) Diversified Energy (LON: DEC)

Up 28% year-to-date to 141p, Diversified Energy could be an excellent FTSE 250 stock pick for September.

The US-based company specialises in buying up old oil and gas wells in the Appalachian Basin, Louisiana, Oklahoma, and Texas. Diversified Energy then applies its ‘smarter asset management’ program that allows it to optimise production and reduce operating costs.

Because the wells it acquires are almost always non-core, neglected, or even an outright liability for the seller, it can acquire these older wells at excellent prices relative to future profitability. Accordingly, it’s spent just $2.5 billion on roughly 70,000 oil and gas wells.

It’s unlikely to be a target of any windfall taxes, unlike oil majors BP and Shell. And it offers a significant and sustainable 9.7% dividend yield, delivered on an expansive hedging strategy, while still expanding its portfolio.

Key risk: Diversified Energy could be hit hard by future demand destruction when recession hits, while overvaluation is possible as investors flood to energy assets.

uk indices Source: Bloomberg

2) Direct Line (LON: DLG)

Down 27% year-to-date to 207p, Direct Line's dividend yield of 11% makes it another superb FTSE 250 dividend stock. The insurance and financial services group has long been popular with passive income investors due to the predictable returns offered by general insurance.

Of course, recent headwinds are challenging this thesis. In half-year results, CEO Penny James warned that the ‘uniquely complex motor market conditions...due to significant regulatory changes, heightened claims inflation and macroeconomic uncertainty, have challenged our short-term profitability.’

Adjusted gross written premium was down 2.6% compared to the same half last year. Meanwhile, policies in force fell by 9.2% to 13, 231, and pre-tax profits were down by a whopping 31.8% to £178.1 million.

However, James argues ‘the longer-term fundamentals of the business remain strong’ and she remains ‘confident in the sustainability of our regular dividends.’ Looking at the external factors, Direct Line is arguably a quality company going through a storm.

Key risk: Aforementioned regulatory changes aimed at unfair renewal premiums and soaring claims costs may not yet be fully priced in.

3) Royal Mail (LON: RMG)

Down 48% year-to-date to 272p, Royal Mail shares were unceremoniously demoted from the FTSE 100 earlier this year. This has had a depressive effect on the already underperforming stock as it means that millions of FTSE 100 index investors have exited their positions.

Recent Q1 results weren’t encouraging either. Revenue fell by 11.5% year-over-year, leading to an operating loss of £92 million, as letters declined, covid-19 test kits sent fell, and retail spending shrunk. Chair Keith Williams has warned investors that the company is now losing £1 million a day.

While subsidiary GLS did far better, the group has warned the FY22-23 full-year outlook is for a weaker parcels market and lower than anticipated efficiency savings in-year, with it ‘now likely to be around breakeven at adjusted operating profit level.’

With strikes ongoing, it’s easy to be pessimistic in the near term. However, the group declared £8 billion of assets as of March, against a £2.6 billion valuation. And it still controls 40% of the domestic parcel market revenue share, after investing heavily into modernisation.

Moreover, it has a price-to-earnings ratio of just 4.4, and an attractive 6.2% dividend yield.

Key risk: 115,000 Royal Mail workers affiliated with the Communication Workers Union (CWU) have rejected a pay rise offer ‘worth up to 5.5%’ after three months of talks. With strikes ongoing, the union has demanded Royal Mail increase wages to a percentage that ‘covers the current cost of living.’

This leaves the group between a rock and a hard place. While it operates on a wafer-thin 5% profit margin, the longer strikes go on, the more customers it will lose to competitors.

4) Abrdn (LON: ABDN)

Down 40% year-to-date to 150p, Abrdn shares now offer an attractive price-to-equity ratio of just 5.4, alongside a dividend yield of 9.7%.

While not technically a FTSE 250 stock at this time of writing, its relegation from the FTSE 100 seems all but certain. However, Morningstar analyst Kenneth Lamont believes a further demotion-related dip is unlikely as it has already been factored in.

Abrdn’s ejection has been a long time coming. When Aberdeen merged with Standard life in 2017, the combined group was worth more than £11 billion; but it’s now collapsed to £3.2 billion as investors deserted and it struggled to integrate back-end systems.

It was also widely mocked for its April 2021 rebranding to Abrdn from Standard Life Aberdeen, giving up a well-recognised brand name for an unpronounceable, vowel-less aberration of the English language.

First-half results saw an 8% drop of fee-based revenue to £696 million, while operating profit fell by 28% to £115 million. And it suffered a total net outflow of £35.9 billion, including £24.4 billion transferred out by Lloyds.

But there are positives to be found. It bought Interactive Investor for £1.5 billion in May as part of CEO Stephen Bird’s turnaround plan. And despite the weak track record, it still has £386 billion in assets under management. A recovery to growth under the right CEO remains very possible.

Key risk: Long-term declines can only be revered by exceptional management. With the turnaround ongoing, the jury is still out on Bird’s performance.

The information on this page does not contain a record of our trading prices, or an offer of, or solicitation for, a transaction in any financial instrument. IG Bank S.A. accepts no responsibility for any use that may be made of these comments and for any consequences that result. No representation or warranty is given as to the accuracy or completeness of this information. Consequently any person acting on it does so entirely at their own risk. Any research provided does not have regard to the specific investment objectives, financial situation and needs of any specific person who may receive it and as such is considered to be a marketing communication. Although we are not specifically constrained from dealing ahead of our recommendations we do not seek to take advantage of them before they are provided to our clients. See full non-independent research disclaimer.

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