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Why I’d buy this bargain dividend stock instead of Tesco plc

According to recent reports, sales of new cars in the UK have been falling over the past few months, but there’s little sign of the pain in this morning’s interim results from Lookers (LSE: LOOK).

Good results

In the first half of the year, the UK-focused motor retail and after-sales services firm scored a revenue increase of 5% compared to a year ago and earnings per share from continuing operations lifted a healthy-looking 15%. The directors used some of the incoming cash flow to reduce net debt by more than 16% to £44.6m, and some to raise the interim dividend by 10%.

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I find the dividend decision to be interesting because it speaks volumes about how the directors perceive the immediate prospects for the business. It seems unlikely that they would raise the dividend and commit the firm to the further expense if they believed the immediate outlook for business to be poor.

Chief Executive Andy Bruce adds weight to the theory, saying in the report: Our order book for new cars for the important month of September is continuing to build in line with our expectations and the new car market for this year is still forecast to be at a historically high level.”

A reassuring outlook

The firm’s outlook statement clarifies further, explaining that the company expects the new car market to reduce slightly while remaining historically high. On top of that, Lookers is seeing further increases in used car volumes and is growing its share of that market. I reckon used car sales could help balance any further easing of new car sales if economic hardship bites any deeper into consumers’ incomes.

I can’t deny that the firm operates in a cyclical sector, which probably accounts for recent share-price weakness. But at today’s 109p, the forward dividend yield runs around 3.7% with City analysts following the firm expecting forward earnings to cover the payout almost four times. Over the past five years, the dividend has grown 67%. I think the value here looks compelling, despite cyclical uncertainties.

Long-term challenges

I’d rather take my chances with Lookers than with troubled supermarket giant Tesco (LSE: TSCO). At first glance, the numbers look quite good. Today’s 179p share price throws out a forward dividend yield of just over 2.9% for 2018 with City analysts forecasting cover from forward earnings around 2.4 times. However, after a near three-year absence, dividend payments are anticipated to restart during the current trading year – the firm’s dividend record leaves a lot to be desired.

City analysts following the firm anticipate resurging earnings this year and next year, but I think squeezing earnings out of the business can only go so far, and the longer-term prospects of the firm will depend on growth in revenues. And that’s the problem. Last year’s annual report showed revenues rising just 1% or so. Tesco seems to be struggling to maintain UK grocery market share against the onslaught of fast-growing competitors such as Aldi and Lidl. I see Tesco as a colossus in long-term decline so will continue to avoid the firm’s shares.

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Kevin Godbold 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.