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2 cheap FTSE 250 income stars I’d buy today

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Domestic retailers of all stripes have fallen out of favour with many investors in recent months, but for contrarian investors this fear has created what appears to me to be a slew of bargains across the FTSE 250. One of the most glaring is big box home furnishings retailer Dunelm (LSE: DNLM), whose shares trade at just 13.5 times forward earnings while offering a dividend yield that was over 9% last year.

And while Dunelm has had its rough patches in recent quarters, a 2.2% year-on-year (y/y) decline in like-for-like (LFL) sales in Q3 caused a big sell-off, the company’s dividend is well-covered by earnings, debt levels are low and the company has surprisingly solid growth prospects.

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On the dividend front, the company paid out 25.1p in ordinary dividends last year and threw in an additional 31.5p special payout at year-end thanks to surplus cash balances. We won’t know until early September what level of special distribution will be made this year but the fact that pre-exceptional profits this year are expected to be around £110m, or £18m less than last year, does suggest a smaller payout. That said, last year’s ordinary dividend alone represents a solid 4% yield, so there’s little reason to panic if the special payout is slightly lower.

And unlike many large retailers, Dunelm isn’t swimming in debt. Management targets a net debt level between 0.25 and 0.75 times EBITDA, which provides plenty of freedom to spend the majority of free cash flow on store expansion and shareholder returns without threatening the health of the business.

Store expansion is one way the company is growing, but management isn’t solely relying on new stores to boost growth. In fact, a renewed focus on online sales and sprucing-up stores led to LFL sales rising 3.8% in Q4. This, along with profitability and free cash flow metrics, becomes more impressive once the newly-acquired Worldstores brand that management is revitalising is stripped out.

All told, with its shares cheap, good growth prospects and a huge dividend yield on offer Dunelm is one income share I’d keep my eye on.

Diversification is the name of the game 

Another high yielder trading at a great valuation that’s caught my eye is banker and asset manager Investec (LSE: INVP). The dual London- and Johannesburg-listed firm trades at a sedate 10.7 times forward earnings and provides investors with a 4% dividend yield.

Driven by double-digit growth from its specialist banking services and asset management arm the firm’s operating profits last year rose 18.5% y/y to £599m at actual exchange rates and 8% at constant currency rates. Earnings per share rose in line at 16.9% to 48.3p, which allowed for a 9.5% rise in dividends to 23p per share.

In the years to come this level of growth looks to be quite repeatable as the company invests heavily in new IT infrastructure and additional personnel to support future growth, particularly in the UK. The fact the company has been able to post very impressive growth rates in South Africa despite the weak economic environment is also encouraging over the long term.

With a valuation measurably lower than historic levels, impressive growth potential and a growing dividend, Investec looks like a very good income option to me.

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Ian Pierce 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.

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