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Why I’d dump dividend dud Tesco for this underrated income champion

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Slowly but surely Tesco (LSE: TSCO) is making its comeback as a growing, profitable and healthy grocer after a few years of scandals, diminishing market share and falling profits. But while the company has resumed dividends, analysts are still only forecasting a 5p per share payout next year that at its current share price would mean an annual yield of only 2%, less than half the FTSE 100 average dividend yield.

While there is always room for the company’s earnings and dividends to provide a positive surprise, this meagre yield makes the company a dividend dud in my books. And on top of this, its growth prospects are still far from fantastic.

The main cause remains the German discounters Aldi and Lidl that have continued to take market share from the big four grocers at an astonishing pace. Over the past two years alone, they have increased their joint share from 9.6% of the UK grocery market to 12.6%. Over this same period, Tesco’s share has slipped from 28.4% to 27.6%.

Even if this trend slows down, the discounters will continue to place incredible pricing pressure on larger, higher-cost-base rivals like Tesco. This leads me to believe that its sales growth will remain low and margin pressures will continue, constraining its ability to provide bumper payouts to shareholders as it once did. 

Furthermore, at a valuation of 17.2 times forward earnings, Tesco is far from a bargain basement share. So with low dividends, continued competitive pressures and a rich valuation, I’ll be looking elsewhere for my income stocks.

A true dividend champion 

And one that I’d buy is warehouse REIT Tritax Big Box (LSE: BBOX). It owns large warehouses that are generally over 300,000 square feet in size and are located in prime spots near big cities and vital transport links.

Demand for these sorts of facilities has been off the charts in recent years as the normal needs of traditional retailers, including Tesco, have been supplemented by e-commerce firms needing the same sort of facilities to aid quick delivery to customers. For Tritax this means 100% of its properties are let on leases with a weighted average length of 13.9 years, on rental terms very favourable to the company.

In 2017 this, and the addition of new properties, led to the group’s rental income rising 26.2% to £125.95m, which alongside rising property valuations led the company’s net asset value to rise a full 10.3% during the year. Healthy rent rolls allowed management to pay out 6.4p per share in dividends for a yield of 4.32% at today’s share price.

And looking ahead, I see plenty of room for management to continue increasing dividends as demand growth for such warehouses remains well above supply growth, the e-commerce boom seems highly unlikely to slow any time soon, and Tritax is growing its portfolio by snapping up new facilities that generate more rents to fund more dividends.

The group’s shares trade roughly 5.6% higher than their net asset value per share, but this slight premium looks like a price worth paying to me for such a dividend dynamo.

Buy-And-Hold Investing

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Ian Pierce has no position in any of the shares mentioned. The Motley Fool UK has recommended Tesco. 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.