The last few years have been rough for many traditional retailers. And the reason for that is pretty simple — the continued dominance of e-commerce king Amazon.com. (ticker: AMZN).
Consider that in April, the Census Bureau’s retail sales report showed a modest increase of 4.5 percent in overall receipts from last year, yet featured a stark divide between traditional merchants and online retailers. The department stores category posted a decline of 5.2 percent compared with 2016 while non-store retailers who operate online posted a 10.7 percent increase as a group.
That reality makes the going quite tough for a typical retailer in 2017.
“E-commerce is usually margin dilutive for retailers, and they are all pursuing it aggressively because that’s where the customer is going,” says Peter Dixon, the portfolio manager of the Fidelity Select Consumer Discretionary Portfolio ( FSCPX) mutual fund. “And another thing to consider is that brick-and-mortar retailing is a high fixed-cost business, so when a company is actively shifting their sales online … you can see why some of them would want to close some of their stores or see shares decline.”
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A case study in this trend is J.C. Penney Co. ( JCP), which has seen shares drop almost 40 percent in the last 12 months and recently announced it will close more than 130 stores in an effort to stop the bleeding.
Smaller profits, but big dividends. But as the old saying goes, in every crisis there is opportunity. And for income-oriented investors, that opportunity is found in some tremendous dividend yields across the retail sector.
While share prices have slumped at many retailers, those retailers also have fought tooth and nail to defend their cash distributions to shareholders.
A few of the highest-yielding retailers right now include:
— Bookseller Barnes & Noble (BKS) yielding 8.5 percent.
— Iconic department store Macy’s, (M) yielding 6.5 percent.
— Men’s Warehouse and JoS. A. Bank operator Tailored Brands (TLRD), paying 6.6 percent.
— Once-dominant apparel retailer Abercrombie & Fitch Co. (ANF), paying 6.4 percent.
— Video game merchant Gamestop Corp. (GME), yielding 6.3 percent.
With 10-year Treasury bonds paying an annualized yield of about 2.3 percent and the Standard & Poor’s 500 index offering an average dividend yield of about 2.2 percent, retailers clearly are way ahead of the pack when it comes to dividends.
High yield may mean high risk. On the surface, a 6 percent dividend yield is great. But it’s important to note that every one of those high-yielding companies listed above has seen its shares drop dramatically in the last year or so.
So is the big dividend worth the big risk? Kim Forrest, vice president and senior analyst at Fort Pitt Capital Group in Pittsburgh, says no.
“We think buying stocks solely for dividend, as a fixed-income replacement, is a spectacularly bad idea,” Forrest says. “Picking retail stocks to do this with is an even worse idea.”
That’s partially because these stocks offer the risk of big declines, but also because the high yields are “far from safe.” Forrest points to embattled department store Macy’s as a prime example, forced to “slash its store count” without a clear plan to replace that lost revenue.
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The results of fewer stores and a behind-the-curve e-commerce operation showed up in living color in the latest Macy’s earnings, which showed an ugly 5.2 percent decline in same-store sales that was even worse than the 3 percent decline Wall Street expected. Macy’s stock lost about 20 percent in just a few days as a result.
The dividends hardly make up for share declines like that, Forrest says, and investing in retail solely because of yield alone could cause investors to suffer similar losses in the future.
What’s the best way to trade retail? Balancing the risk and rewards of retail is difficult, but an overall consumer tailwind for the sector does make it possible for shrewd investors, says Peter Dixon at Fidelity.
“The U.S. retail consumer is healthy and spending money right now, and I do think that also provides a favorable backdrop for investing in the consumer discretionary sector,” Dixon says. “There will always be room for (investing in) strong brick-and-mortar retailers that gain share and grow profitably.”
To capitalize on this, Dixon recommends looking beyond just yield and instead focusing on “categories and brands” — that is, brands that connect strongly with consumers and can “command full price” instead of discounts, and categories with unique strengths such as home improvement and furniture retailers benefiting from a robust U.S. real estate market.
Josh Elman, a retail analyst at Nasdaq Advisory Services, agrees with the idea of being tactical. One subsector of the market he is bullish on now includes “cosmetics and beauty names” that have a strong connection with consumers, posting strong results and outperforming the sector at large.
Of course, that may mean passing over high-yield retailers if you favor growth. Ulta Beauty ( ULTA) is a thriving a cosmetics and hair care retailer that has jumped 20 percent year-to-date, but doesn’t pay a penny in dividends. And as for home improvement, segment leader Home Depot ( HD) yields just 2.2 percent at present.
That makes for a hard balancing act right now, and dividend-oriented investors may have to tread lightly in retail for the time being. However, Elman adds that even a modest shift in overall investor sentiment could make retail fertile ground again.
[See: 9 Ways to Buy Stocks That Everyone Needs.]
“An investor in retail should be cognizant in the back of his or her mind that there’s a lot of volatility in the environment right now,” Elman says. “But I do think the rhetoric and the attention on the space has been contributing to some of the doldrums in the space. If some of that subsides and we start to see a pickup in spending … there will be opportunities out there for investors to take a stab at.”
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Is Retail Safe for Dividend Investors? originally appeared on usnews.com
