Is this hated 7% dividend stock a brilliant buy or an investment trap?

This unloved income stock offers monster dividend yields, but does it carry too much risk right now? Royston Wild considers the investment case for this small-cap.

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A backcloth of increasingly tough trading conditions has conspired to drive the McColl’s Retail Group (LSE: MCLS) share price through the floor.

Down 75% over the past year alone, the convenience store operator has suffered because of intense competition, broader pressure on UK consumers’ shopping power, and supply chain problems related to the collapse of wholesaler Palmer & Harvey’s in late 2017.

Surprisingly, though, investor appetite for McColl’s perked up following full-year results released last week. In this release the retailer disclosed that, although like-for-like sales had slid 1.4% in the 12 months to November, its top line had made some positive progress as the year progressed, resulting in flat like-for-like sales in the final quarter.

And promisingly it was advised that underlying sales had actually perked up in the first three months of the new fiscal year, up 1.2% to be exact.

In recovery?

So is now the time to pile in, then? Not by a long chalk, in my opinion. Sure, City analysts may be predicting an 18% profits bounceback in fiscal 2019, aided by the completed implementation of Morrisons as its supplier in 1,300-odd of its stores. I fear, though, that increasing competition in the British grocery sector and the subsequent price wars threaten to blow this forecast way off course.

Not even its cheap share price, as illustrated by its rock-bottom forward P/E ratio of 7.2 times, is enough to tempt me to invest. Chief executive Jonathan Miller claimed last month that “in approaching 30 years in the business I have never known a year as challenging as 2018.” Those wholesaler issues may be consigned to history but there are still plenty of fearsome obstacles that McColl’s must overcome to return to earnings growth.

The convenience store segment, like online, is a rare bright light for Britain’s so-called Big Four supermarkets as sales in their traditional megastores have slumped. With sales here still growing it’s unlikely that the likes of Tesco and Sainsbury’s will dial back their assault on the sector.

Other risks

Rising competition from the country’s traditional grocery heavyweights is not the only cause for concern, though, as Amazon prepares to launch its own convenience proposition on these shores. According to media reports, the US internet giant has snapped up retail space in Central London in order to roll out its Amazon Go cashierless stores. 

McColl’s is also likely to suffer indirectly from the electric expansion plans of Aldi and Lidl, and particularly so as the tough economic environment encourages more and more cash-strapped shoppers into the arms of the discounters.

In a reflection of last year’s trading troubles McColl’s chopped the dividend back from 10.3p per share in the previous year to 4p, and City analysts are expecting a similar full-year reward to fiscal 2019 for the current period. Those increasingly tough trading conditions concern me, though, and therefore I’m wary of additional dividend cuts. For this reason I’m happy to avoid the company, despite its 7% forward yield, and invest my hard-earned investment cash elsewhere.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Royston Wild has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Amazon. The Motley Fool UK has recommended McColl's Retail and Tesco. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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