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One 9% dividend I’d buy, and one I’d avoid

Today I’m going to look at two retail stocks offering 9% dividend yields. If a share is priced this cheaply, there’s usually a good reason. However, high yields don’t always spell disaster.

One of these stocks is on my personal watch list, because I think there’s a chance that the group’s management may pull off a surprise turnaround.

An uncomfortable position

Sales rose by 14% to £165.9m at sofa retailer SCS Group (LSE: SCS) during the six months to 28 January. But the group’s share price has fallen and is down by 7% so far this year, putting the stock on a miserly forecast P/E of 7.1 for 2016/17.

This gradual decline has also resulted in the group’s forecast dividend yield rising to a staggering 9.5%.

One reason for this is that ScS is heavily cyclical. While consumers may continue to buy food and clothes during a recession, they generally stop buying new sofas. ScS Group’s annual revenue has risen by 52% to £317.3m since 2012 and profits have followed. But there are signs this strong run of growth is coming to an end.

The group’s adjusted earnings are expected to rise by just 2% to 22p per share this year. This forecast has been cut by 0.45p per share over the last three months. Any further reduction would leave ScS at risk of reporting a fall in profits.

In my view, the stock’s current valuation is pricing-in the likelihood that consumer spending could fall, dragging down the group’s profits.

A second concern is that ScS’s balance sheet may not be as strong as it appears. Although the group reported a net cash balance of £36.8m at the end of February, ScS receives payment for sofas sold up to two months before the firm pays its own suppliers. If sales slowed, then I believe the group’s cash balance would fall fast as supplier payments became due.

Although the 9.5% yield is tempting, I’m going to continue to steer clear of ScS.

This could be a buy

Shares of women’s value clothing retailer Bonmarche Holdings (LSE: BON) rose by 3% on Wednesday, after the struggling group issued a cautiously optimistic year-end trading statement.

Adjusted pre-tax profit for the year ending 1 April is now expected to be between £6m and £7m, towards the upper end of the £5m to £7m range quoted in September last year.

Chief executive Helen Connolly appears to have slowed the decline in sales and turned around the group’s disappointing online operation. Online sales rose by 14.8% during the final quarter of the year, compared to a 1.8% increase for the full-year period.

Like-for-like store sales remained negative during the period, falling by 2.4% during the 13 weeks to 25 March. However, this compares well with the results seen during the first half of the year, when like-for-like store sales fell by 8.6%.

There was no word today on whether Bonmarché’s 7.1p per share dividend is likely to be cut this year. I think there’s a reasonable chance of a cut, but I’m also attracted by the apparent turnaround in sales performance. If this continues into the current year, then I believe Bonmarché could be of interest to value investors.

This stock could have 44% upside

Bonmarché and ScS are both risky bets. That's why they have dividend yields of 9%. If you're looking for small-cap investment opportunities then I believe it's essential to diversify.

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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. 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.