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2 beaten-down shares with dividend growth potential

With the FTSE 100 trading at record highs, the average dividend yield offered by the big blue-chip companies is falling. However, not all shares have performed as strongly — and for those of you who are more interested in value plays that may offer outsized returns, you may want to consider these two beaten-down shares.

Trading at a discount

Pets at Home (LSE: PETS), the UK’s largest pet supplies retailer, has seen its share price fall 22% since the start of the year. This drop has left its shares changing hands at just 12.2 times its consensus forecast for full-year underlying earnings per share of 15.6p. That’s a significant discount to the sector average of 15.4 and its 3-year historical average of 16.8.

The sharp valuation compression of its shares is down to the weakness of the company’s merchandise sales in recent months. Like-for-like merchandise sales fell 0.5% in the third-quarter, down from growth of 1.7% last year. However, despite this, management still expects to be able to meet full-year profit expectations, as service revenues continue to grow robustly.

Looking forward, the group expects services — such as veterinary practices and dog grooming — rather than merchandise to be the main engine of growth, as it faces growing competition from supermarket and discount stores, which have been expanding their pet-product offerings. Revenues from services rose 47.8%, to £26.3m, in the third-quarter, with like-for-like growth of 7%.

City analysts project earnings per share will continue to climb, hitting 15.6p in 2017. With higher profits, this should mean dividends will likely grow this year too. The stock already carries an attractive yield of 4%, but with a payout ratio of just over 50% forecast for 2017, there’s plenty of room for future growth as well. With an above-average dividend yield and solid long-term dividend growth potential, Pets At Home seems to me like a dividend growth machine that income investors should take a good look at.

Turnaround potential

Berendsen’s (LSE: BRSN) share price has slumped by almost 10% since the company warned about the cost of legacy issues from its UK textiles businesses earlier this month. As a result of increased levels of machine downtime, and bottle necks caused by inefficient machinery relating to its UK operations, adjusted operating profit for 2017 is expected to be approximately £150m, down from £161m in 2016.

However, looking forward, I’m optimistic about its longer term growth prospects despite recent setbacks. Revenue continues to grow as Berendsen continues to expand into new markets, and the company has a turnaround plan for its lagging UK business — it intends to invest some £450m in improving its operational efficiency. The company has a strong track record in delivering earnings growth, with a five-year compound annual growth rate (CAGR) in earnings per share of over 13.2%.

At a current price of 842p, its shares trade at 12.9 times its consensus forecast for full-year earnings per share of 65.1p. That’s a big discount to the sector average of 17.2 times, and seems unfair given its turnaround potential and above-average dividend yield. Shares in Berendsen yield 4.0%, with a dividend payout ratio of 52%.

Before you decide for yourself

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Jack Tang has no position in any shares mentioned. The Motley Fool UK has recommended Berendsen. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.