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Are these 6% dividend stocks about to explode?

Retailers are facing a new challenge from inflation after years of flat or falling prices. For investors, identifying companies which can pass on price increases to customers will be crucial.

One firm whose sales performance suggests that it can beat inflation is Moss Bros Group (LSE: MOSB). The men’s tailoring specialist said this morning that sales rose by 5.7% to £127.9m last year.

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On a like-for-like basis, retail sales rose by 6%, while like-for-like hire sales rose by 1.5%. Pre-tax profit rose by 20.3% to £7.1m, lifting earnings per share by 17% to 5.51p.

The group’s dividend was boosted by 6.1% to 5.89p, giving a yield of 5.9%.

How safe is this dividend?

For several years, Moss Bros has paid dividends that were equal to or greater than its earnings per share. The firm’s cash generation has supported these payouts. Moss Bros generated free cash flow of £7.4m last year, comfortably covering the £5.7m it paid in dividends.

The risk is that this situation is mostly the result of the firm collecting payments more promptly and paying bills more slowly. This is known as reducing working capital — the float of money required to run the business.

It’s a proven technique for generating cash, but can only go so far. Trade payables — or unpaid bills to suppliers — rose from £11.6m to £17.2m last year. This freed up a lot of cash, but it probably won’t be repeatable.

Moss Bros is performing very well at the moment, and the group’s net cash balance of £19.5m provides a useful safety net. But I expect dividend growth to slow over the next few years. If it does, then the P/E of 18 could start to look very expensive. For now, I’d hold.

A budget retailer with premium appeal

Moss Bros’s dividend yield of 5.9% is dwarfed by the 8.8% on offer at budget greetings card retailer Card Factory (LSE: CARD).

To be clear, this dividend is made up of a 9.1p per share ordinary dividend and a 15p per share special one. The ordinary dividend alone gives a more typical yield of 3.3%. But the company said on Tuesday that it expects to make a special payment again this year, as cash generation remains strong.

Card Factory does appear to be in good health. Like-for-like sales rose by 3% last year, while revenue including new stores rose by 4.3% to £398.2m. Profit margins were also stable. The firm’s underlying operating profit margin was 22% last year, compared to 22.4% in 2015/16.

One reason for this is that costs have been well controlled. Although the National Living Wage caused store wage costs to rise faster than sales last year, rental costs are expected to start falling this year as new leases are negotiated on older stores. Total operating expenses accounted for 7.1% of sales last year, down from 7.2% a year earlier.

It’s hard to find any serious faults with Card Factory’s 2016/17 figures. But the firm’s growth rate is low and may remain so. Analysts expect earnings per share to rise by just 2% this year. On that basis, I’d argue that the forecast P/E of 14 leaves the stock looking fully valued, regardless of dividend income. I’d hold at current levels.

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