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2 beaten-down shares with bright dividend growth prospects

Photo: Tesco. Fair use.

With UK inflation rising to 2.3% in February, the outlook for retailers continues to worsen. Consumer disposable incomes are in danger of falling in real terms since wage growth may not stay ahead of inflation beyond the short run. Therefore, the near term could be a challenging period for consumer-focused stocks.

Despite this, the sector may already include a margin of safety. This could make it attractive to income-seeking investors – especially regarding turnaround stocks.

Impressive performance

Furniture and flooring retailer SCS (LSE: SCS) reported impressive results for the first half of the year on Tuesday. They showed a rise in revenue of 14.6%, with like-for-like (LFL) order intake 2.7% higher. This contributed to a rise in gross profit of 12.4%, with operating cash flow rising from £17.3m in the first half of the prior year to £22.5m in the same period of the current year.

SCS is on target to meet its expectations for the full year. It is forecast to record a rise in earnings of 3%, which would put its shares on a price-to-earnings (P/E) ratio of 7.4 if achieved. This indicates that a relatively wide margin of safety is on offer, which may help to protect investors against a potential slowdown in consumer spending.

This low valuation has been partly caused by a fall in the SCS share price of over 10% in the last six months. However, with earnings growth of 6% due next year and the company performing well in the first half of the current year, it may deserve a higher valuation.

As well as a turnaround opportunity, SCS seems to offer strong income prospects. It has a dividend yield of 9%, with shareholder payouts covered 1.5 times by profit. Therefore, even if the retail sector endures a worsening period caused by Brexit, SCS could raise dividends to boost its already impressive yield.

A return to form

The Tesco (LSE: TSCO) dividend yield is barely above zero, but it is likely to rise rapidly over the next couple of years. In fact, dividends per share are due to increase from 0.1p in financial year 2017 to 5.8p in financial year 2019. This puts the company’s shares on a forward dividend yield of 3.1%.

And since Tesco is forecast to record a rise in earnings of 69% during that time, shareholder payouts are expected to be covered 2.2 times by profit in financial year 2019. This indicates that more dividend growth could be on the horizon post-2019.

The strategy adopted by Tesco seems to be working well. It has sought to simplify its business in almost every respect. It is now focused on the UK, is seeking to dispose of assets to return to being a specialist food retailer, and even stocks a narrower range of products in its stores to improve efficiency.

While it could suffer from a slowdown in consumer spending, the integration of Booker could deliver synergies for the business. Furthermore, its turnaround plan still has some way to go, which could mean its share price performance is relatively impressive.

Brexit fears

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Peter Stephens owns shares of Tesco. The Motley Fool UK has recommended Booker. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.