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The 7 Best Undervalued Retail Stocks for Dividends

Published January 13th, 2017 by Bob Ciura

Physical retailers took it on the chin last year. The retail industry is being disrupted at a rapid pace, due to a shift in consumer buying preferences.

Shopping malls are losing a great deal of customer traffic to online retailers like (AMZN) and others. Internet retailers often have the same products for lower prices, all while offering consumers the convenience of shopping at home.

This has taken a steep toll on share prices of brick-and-mortar retailers, particularly those that rely on shopping malls.

Although it might seem like Amazon is unstoppable, there are still physical retailers that remain highly profitable. Many of them are aggressively investing in e-commerce to fight back against Amazon and internet retail more broadly.

This could set the stage for a retail rebound in 2017…

With that in mind, the following 7 retail stocks are cheap, generate solid profits, and offer high dividend yields to boot.

The Gap (GPS)

The Gap is a specialty clothing retailer. It sells its products in more than 90 countries around the world. Its store-count consists of approximately 3,300 company-operated stores, 450 franchised stores, and its e-commerce sites.

The company operates four reporting segments, which are as follows:

The other category includes the Athleta and Intermix brands.

The Gap has badly lagged the overall market for an extended period. In the past five years, shares of The Gap have risen 30%. Compare that with the S&P 500 Index, which is up 77% in the same time frame.

The reason for The Gap’s struggles is that its fundamentals are deteriorating. In 2015, comparable sales declined 4% from the previous year. Comparable sales growth is a hugely important metric for retailers, which shows sales performance at stores open at least one year.

Banana Republic really dragged the company down in 2015, with a 10% decline in comparable sales for the year.

Earnings-per-share declined 22% in 2015. This prompted the company to close 150 stores that were not meeting expectations.

Unfortunately, The Gap’s performance did not improve much in 2016.

Total sales declined 2.8% through the first three quarters of 2016. And, higher costs associated with the company’s turnaround resulted in a 32% drop in diluted earnings-per-share though that period.

The decline in sales and earnings was once again mostly because of underperformance at Banana Republic. Banana Republic posted a 7% decline in comparable sales in December.

This was a huge disappointment, as retailers like The Gap rely on the holiday shopping season.

The good news is that comparable sales at Old Navy rose 12% for the month, and The Gap Global’s comparable sales increased 1% year over year.

Overall, The Gap’s net sales were up 1% and comparable sales rose 2% for the November and December 2016 holiday season.

This is modest growth, but any growth in this climate is a positive for a retailer.

For the full year, management expects full-year adjusted earnings around $1.92 per share. Moving forward, continued earnings growth will be supplemented by inventory and cost control procedures.

The Gap ended last quarter with a 4% inventory decline. Management expects fourth-quarter inventory to decline by a similar rate.

Capital expenditures declined by 24% through the first three quarters of the year.

These measures should help the company reach its full-year profit goals. With its profits, the company returns cash to investors through dividends and share repurchases.

The Gap’s management is shareholder friendly.  In fact, the company is one of 272 Dividend Achievers – stocks with 10+ consecutive years of dividend increases.

Based on this, The Gap stock trades for a price-to-earnings ratio of just 12. And, the stock has a 3.9% dividend yield.

Wal-Mart (WMT)

Next up is Wal-Mart, the king of discount retail, Wal-Mart

Wal-Mart is also a legendary dividend growth stock. It is one of only 50 Dividend Aristocrats. These are stocks in the S&P 500 that have raised dividends for 25 consecutive years or more.

You can see the entire list of all 50 Dividend Aristocrats here.

Wal-Mart has increased its dividend for the past 43 consecutive years.

This is a challenging time for Wal-Mart. The company is investing more to renovate its stores, raise employee wages, and boost its e-commerce platform.

Higher spending caused the company’s earnings-per-share to decline 9.5% in fiscal 2016. Wal-Mart’s strategic investments are putting downward pressure on margins.

Wal-Mart expects to open 35 new Supercenters, 20 Neighborhood Markets, conduct 500 store renovations, and create 500 new online grocery locations in fiscal 2018.

Wal-Mart is already seeing signs of progress. While in-store traffic numbers are still declining, comparable sales and customer satisfaction are on the rise.

WMT Investments

Source: 2016 Investment Community Meeting presentation, page 5

The biggest growth catalyst for Wal-Mart moving forward is e-commerce. It is aggressively investing in expanding its digital capabilities, both internally and through acquisitions.

For example, Wal-Mart acquired for $3.3 billion.

This strategy is already paying dividends. Wal-Mart’s global e-commerce sales increased 20% last quarter. E-commerce accounted for 0.50% of its 1.2% growth in comparable sales last quarter.

This was the e-commerce platform’s largest contribution to total comparable sales yet. is expanding at a rapid pace—it added 8 million SKUs over the last three months alone.

Wal-Mart is also taking its e-commerce ambitions global. It acquired a 10% stake in China e-commerce giant

This deal should help boost Wal-Mart’s online sales, as well as its presence in one of the most attractive emerging markets in the world.

Within e-commerce, Wal-Mart is expanding its grocery offerings. Online grocery shopping is now available in approximately 400 locations.

Separately, international growth is another compelling growth catalyst for Wal-Mart going forward. Thanks to its massive scale and financial resources, Wal-Mart has the ability to rapidly expand in new markets.

WMT International

Source: 2016 Investment Community Meeting presentation, page 6

Again, this investment is starting to pay off. Constant-currency sales increased 2.4% in the international markets last quarter, which was well above the overall company’s growth rate.

Furthermore, 10 of Wal-Mart’s 11 international markets posted positive comparable sales for the quarter, with seven of those growing by more than 4%.

Finally, Wal-Mart’s small-store banner is growing at a high rate. The Neighborhood Market realized 5.2% growth in comparable sales last quarter.

Growth from all these areas should help Wal-Mart return to earnings-per-share growth. In the meantime, the stock rewards investors with a 2.9% dividend yield.

Target (TGT)

Target is another discount retailer like Wal-Mart. Similar to Wal-Mart, Target is a Dividend Aristocrat with a long history of annual dividend increases.

Target has raised its dividend for the past 45 years.

Target’s impressive dividend history is thanks to its highly profitable business model. The company has generated steady growth over the past several years.

TGT Financials

Source: 2015 Annual Report

Going forward, Target is making similar investments in e-commerce to fuel growth. This investment is paying off in a major way: Target’s digital sales rose 26% last quarter, and have grown more than 20% through the first three quarters of 2016.

To help finance this investment, Target employed a significant cost-cutting program. Over the past two years, the company eliminated more than $2 billion in costs.

Target stock isn’t the most exciting pick, but it offers both value and income. Shares trade for a price-to-earnings ratio of 12.

This is an attractive valuation, since the S&P 500 Index holds an average price-to-earnings ratio of 26.

And, thanks to its strong profitability, Target returns loads of cash to shareholders. It does this with a high dividend yield and share repurchases.

Target stock has a solid 3.6% dividend yield. Plus, the company typically raises its dividend at a high rate. For example, Target’s 2016 dividend raise was a healthy 7.1%.

Target is a rock-solid dividend stock. It has paid 197 consecutive dividends, ever since the company went public in October 1967.

Moreover, in 2016 the company announced a new $5 billion share repurchase authorization. This is a sizable buyback, which represents approximately 12.5% of the company’s current market capitalization.

So, all things being equal, investors can expect the buyback to boost earnings growth by roughly 12%.  Target’s combination of a reasonable valuation, above average dividend yield, and solid growth prospects make the company a favorite of The 8 Rules of Dividend Investing.

GameStop (GME)

GameStop is a specialty retailer that sells video game hardware, software, and related accessories.

The stock suffered throughout 2016. Investors fear that physical video game stores will become obsolete, as digital downloads replace physical video games.

Indeed, GameStop’s same-store sales declined 6.5% last quarter, which caused a 2.8% decline in total sales for the period. The sales declines were due to weakness both on the software and hardware sides of the business—software and hardware sales fell 8.6% and 21% last quarter, respectively.

But the negativity may have gone too far. GameStop has transformed its business model to adapt to the new realities of the video game business. It now has a diversified business, spread across several different consumer categories.

GME Brands

Source: 2016 Bank of America Conference, page 3

First, GameStop has built its Technology Brands segment. In this segment, GameStop owns 70 Simply Mac stores, which sell and repair Apple (AAPL) devices. GameStop also owns 70 Cricket stores and more than 1,400 Spring Mobile stores, which sell AT&T (T) products and services.

Technology Brands revenue soared 54% last quarter, and operating profit jumped 262% year over year. This segment alone now represents 23.8% of GameStop’s total operating profit.

Separately, GameStop has invested in a collectibles business. Sales of collectibles products increased 37% in the third quarter.

All of these initiatives are helping the company expand beyond traditional video games. By 2019, management expects 50% of its annual operating profit will be derived from businesses that have nothing to do with physical gaming.

GME Roadmap

Source: 2016 Bank of America Conference, page 4

Lastly, there is still hope for GameStop’s video game business. The company isn’t sitting idly by and letting digital downloads put it out of business.

GameStop has its own digital platform, which saw a 12% increase in revenue last quarter. On an annual run-rate basis, GameStop’s digital segment is a $1 billion business by revenue.

GME Digital

Source: 2016 Bank of America Conference, page 13

Plus, investors selling the stock are forgetting that when it comes to GameStop’s physical retail business, the company still has an ace up its sleeve—trade-ins.

GameStop earns a huge margin on its trade-in business. This seems ripe for disruption by digital downloads, but there is a critical factor protecting GameStop’s trade-in business: consumers still like it.

Gamers don’t get much when they trade-in video games, but they get a decent amount of their original purchase back, which they can use to purchase a new game. There is no such ability when downloading games online.

The declines in video game software and hardware make GameStop’s revenue numbers look very ugly. The company expects comparable sales to decline 6.5%-9.5% for 2016.

But GameStop’s new businesses like collectibles, digital downloads, and trade-ins carry much higher margins, which is why the company will remain highly profitable.

GameStop expects to generate earnings-per-share $3.65-$3.80 in 2016, which is more than enough to sustain its dividend.

Investors don’t seem convinced in GameStop’s turnaround plan, but the stock may be a bargain.

GameStop shares trade for a price-to-earnings ratio of 6, and the stock offers a 6% current dividend yield.

With this kind of value and income, the company does not need to generate high growth in order to deliver satisfactory returns.

Simply put, stabilization and modest growth could result in strong returns, when combined with GameStop’s hefty dividend.

Bed Bath & Beyond (BBBY)

Bed, Bath & Beyond is another specialty retailer, which offers a host of household wares. The stock has been nothing but trouble for an extended period.

Shares have lost approximately 32% of their value over the past five years. Bed Bath & Beyond is arguably the embodiment of a retailer that has been ‘Amazon-ed’.

Household furnishings and related products are very susceptible to the ‘show-rooming’ effect. This is when a consumer goes into physical stores, inspects products in person and asks questions to staff, only to go home and purchase the item online for a lower price.

This brought Bed Bath & Beyond’s growth to a screeching halt. Fiscal 2015 was a modestly successful year; earnings-per-share inched up 0.6% for the year. Total revenue rose 2.3% after excluding currency effects, to $12.1 billion.

Conditions have worsened throughout 2016. Total revenue was flat over the first nine months of 2016. Earnings-per-share declined 14% in the same period, due to higher costs of goods sold and SG&A expenses.

Comparable-store sales fell 1.4% last quarter, which is a bad sign that the company’s established stores are not bringing in enough traffic.

The company is trying to close the gap by investing in its e-commerce platform, which is gaining traction. Digital channel sales rose more than 20% last quarter.

But the lion’s share of annual revenue is derived from its physical locations.

The good news is that Bed Bath & Beyond is still a very highly profitable company. Management expects full-year earnings-per-share to come in at the low end of the $4.50-$5.00 range.

And, earnings-per-share could begin to grow next year and beyond. This is a time of heavy investment for the company, mainly in its e-commerce business.

Bed Bath & Beyond stock trades for a price-to-earnings ratio of 8. And, it offers a 1.2% dividend yield.

The stock isn’t a high-yielder, but it has only been paying a dividend since last year. Over time, the company could easily raise its dividend at a 10% compound annual rate.

Bed Bath & Beyond has a payout ratio of just 10%, which leaves plenty of room for significant dividend growth going forward.

Macy’s (M)

Macy’s has suffered from the deterioration of department stores. Sales and profit have been stuck in neutral for several years.

Financials image

Source: 2015 Annual Report, page 19

Sales continued to decline in 2016, which forced the company to make difficult decisions about its store count.

The company posted a 2.1% decline in comparable sales over the final two months of 2016, which was toward the low end of its guidance. This was a major disappointment, as November and December are the most important months for department stores.

Furthermore, Macy’s believes full-year 2016 comparable sales are expected to decline 2.5%-3%.

This prompted the company to announce approximately 100 store closures and 10,000 layoffs.

That being said, Macy’s is doing what it needs to do to right-size its cost structure and invest in new growth initiatives.

Macy’s store closures are projected to result in annual savings of $550 million. The company will use these proceeds to invest

And, while sales are set to decline this year, the company still expects full-year earnings-per-share of $2.95-$3.10 per share.

Based on the midpoint of this forecast, Macy’s has a price-to-earnings ratio of just under 10. And, the stock now sports a hefty 5% dividend yield which makes it a member of the high dividend stocks list.

Going forward, Macy’s hopes its investments in new opportunities will restore growth.

First, the company is devoting significant resources to building its e-commerce platform. It will use $250 million of the cost savings generated by its store closures to further invest in its digital business.

In 2015, Macy’s began direct-selling in China, through a joint venture with Fung Retailing Limited. Macy’s owns 65% of the joint venture, which stands to accomplish two goals—growth in e-commerce and growth in China, a premier emerging market.

Next, Macy’s is investing in international growth. It plans to open a new Bloomingdale’s store in Kuwait in 2017. Macy’s also plans to open new Macy’s and Bloomingdale’s stores in the United Arab Emirates in 2018.

Macy’s can also monetize its vast real estate holdings, and has begun to do so. The company has $7.1 billion of property and equipment on its balance sheet. For context, its entire market cap is just over $9 billion.

The company is also in sound financial condition. Macy’s has a trailing-twelve month EBITDA to expense ratio of 6.8, which is above the company’s target of 6.4-6.6.

Kohl’s (KSS)

Last but not least is Kohl’s, another department store that is suffering from the “death of shopping malls”. Kohl’s is a specialty department store with more than 1,100 stores in 49 U.S. states.

Like Macy’s, Kohl’s comparable store sales declined 2.1% in November and December. Kohl’s was hoping the crucial holiday shopping season would bring good news, but it was not a Merry Christmas for department stores.

Kohl’s now expects diluted earnings-per-share in a range of $2.92-$2.97, which would fall well short of its previously issued guidance of $3.12-$3.32 in earnings-per-share.

Kohl’s followed Macy’s lead and reduced its own earnings forecast for the full year, based on many of the same difficulties. Namely, lower customer traffic at shopping malls and being under-cut by Internet retail competition.

But Kohl’s is still doing many things right. The company is still highly profitable, and is working to transform its business to better respond to consumer preferences.

For example, in the past few years Kohl’s has emphasized in national brands versus private brands, because national brands help to drive traffic.

KSS National Brands

Source: 2015 Annual Report, page 3

One example of this is that Kohl’s will be adding Under Armour (UA) to its active and wellness category in early 2017. This is a great move, because health and wellness is an emerging trend among U.S. consumers.

The active and wellness category itself is now 18% of Kohl’s total business, and this should only grow once Under Armour is part of Kohl’s offerings. Active-wear has been one of Kohl’s fastest-growing categories.

Furthermore, Kohl’s has a very popular membership program, including Kohl’s Cash and credit offers, which helps to retain customers.

Lastly, the company is effectively managing costs and inventories to help keep profits intact. Kohl’s gross margin increased 53 basis points last quarter, thanks largely to a $19 million cut in selling, general, and administrative costs.

It also cut capital expenditures by 10% year over year.

Management has also deployed inventory management controls, which resulted in a 6% drop in inventory dollars per store last quarter.

Kohl’s generated almost $450 million in free cash flow over the first three quarters of the year, which supports the company’s hefty 5% dividend yield.

Based on its revised forecast for 2016, Kohl’s stock trades for a price-to-earnings ratio of 13. The stock is cheap, and the high dividend yield helps pay investors to wait for the turnaround.

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