Why BAE and Pennon could offer long-term income investing appeal

While the Bank of England is widely expected to continue raising interest rates, dividend shares such as BAE (LON: BA) and Pennon (LON: PNN) could remain popular among income-seeking investors.

After all, their dividend payouts are likely to offer a significantly higher income return relative to other mainstream assets such as cash and bonds – even if further interest rate rises are ahead. Meanwhile, their prospective growth in shareholder payouts over the coming years could mean that they offer a positive after-inflation rise in dividends.

Pennon

Pennon’s shares have been relatively unpopular over recent months; falling by 14% in the past six months versus a 5% decline for the FTSE 250 index. Possible reasons include uncertainty regarding the company’s future prospects following the sale of its waste management business, Viridor, in 2020 and the ongoing efforts it is making to reinvest part of the sum raised in Bristol Water.

The firm’s share price decline means that it now yields a more attractive 3.3%. While this is still lower than the income return of many other FTSE 350 stocks, Pennon’s dividend growth rate could make it a relatively attractive income proposition. It is aiming to raise dividends per share by 2% above the rate of inflation over the coming years. With inflation recently reaching a 30-year high, this could make the stock a useful ally should the cost of living continue to rise.

Moreover, Pennon is a relatively resilient business that is less likely to be affected by the wider economy’s outlook than many other FTSE 350 stocks. As a result, it may offer a degree of defensive appeal at a time when the stock market is experiencing heightened volatility.

Certainly, the stock’s forward price-earnings ratio of 23 suggests that it does not offer a wide margin of safety. But, at a time when dividend growth could be a priority for income investors, it could perform a useful role in combating higher inflation over the medium-to-long term.

BAE

BAE’s share price has also lagged its index over the past six months. While the FTSE 100, of which the company is a member, has gained 6%, BAE’s stock price is flat. A likely reason for its underperformance is heightened economic uncertainty regarding the new Covid-19 variant, Omicron, since BAE’s shares fell heavily in the latter part of 2021 but have since responded positively to an improving economic outlook over recent weeks.

In terms of income appeal, BAE is forecast to raise dividends by around 4% per annum over the next two years. While this may prove to be lower than the rate of inflation during that time, investors are compensated by the firm’s 4.3% dividend yield. This is slightly higher than the FTSE 100’s yield of 3.4% and appears to be sustainable since it is due to be covered 1.8 times by net profit in the current year.

Meanwhile, the company’s latest trading update showed that it is making encouraging progress in delivering on its strategy. Recent acquisitions and new client orders suggest it could be in a strong position to capitalise on an improving economic outlook that may strengthen the prospects across its key end markets.

Certainly, the ongoing pandemic may yet cause volatility in the firm’s share price over the short run. However, with BAE trading on a forward price-earnings ratio of 13, it seems to offer good value for money relative to its FTSE 100 index peers.