Today I’m looking at two FTSE 250 dividend stocks which I think are undervalued compared to their long-term earnings potential.
Both companies operate in the retail sector, but they enjoy advantages which I think put them ahead of the crowd in this difficult market.
My first company is homewares retailer Dunelm Group (LSE: DNLM). Dunelm’s share price was up by nearly 6% at the time of writing, after the company reported a 4.2% increase in like-for-like sales for the year ended 30 June.
Total sales rose by 9.2% last year and the group’s underlying pre-tax profit edged higher to £93.1m. Free cash flow, historically a strong point, rose from £14.2m to £52.9m.
Unique customer numbers rose by 18% online and by 5% in-store. The Dunelm.com channel now represents 13.5% of total sales, up from 11.2% the previous year.
Only one problem is left
In 2016, Dunelm acquired the loss-making Worldstores online retail business. Worldstores is still losing money, but the technology acquired from this online-only retailer is being used to build a new online platform for the Dunelm.com brand.
This makes sense to me. By unifying its sales and supply chain, it should enjoy marketing advantages and make operational cost savings.
30% returns shouldn’t be ignored
Dunelm’s 9% operating margin is fairly impressive for a big retailer. But what’s far more impressive is the group’s track record of generating a 30%+ return on capital employed.
Although this figure has fallen from a peak of 50% in 2014, today’s figures show that even after exceptional costs, this business generated £30 of operating profit for every £100 of capital invested.
High returns of this kind usually mean that companies can fund growth and pay dividends without needing too much debt. This can be a formula for a great long-term investment.
Looking ahead, Dunelm’s 2019 forecast P/E of 12 and 5.3% yield seem too cheap to me. I’d rate this stock as a buy.
Here’s one I bought earlier
One retailer that’s already earned a place in my own portfolio is Dixons Carphone (LSE: DC). The owner of the Currys PC World and Carphone Warehouse businesses is the UK market leader in this sector. It also operates in nine other European countries, with a particularly strong presence in Scandinavia and Greece.
Dixons is still in turnaround mode under new boss Alex Baldock. In addition to the well-documented challenges facing bricks-and-mortar retailers, the firm is also facing changes in the mobile market. Customers are keeping their phones for longer and choosing cheaper SIM-only contracts, which are less profitable for the retailer.
Despite these headwinds, the group’s latest trading statement showed that revenue rose by 13% during the 13 weeks to 28 July. Like-for-like sales in the UK and Ireland were flat, cementing the group’s leading share of the UK market.
I plan to buy more
I intend to buy more Dixons Carphone shares for my portfolio over the next few weeks. Although earnings per share are expected to fall by about 20% this year, in my view this bad news is already reflected in the share price.
Dixons’ stock currently trades on 7.9 times forecast earnings, with a well-covered 6.8% dividend yield. I think now is the time to buy, ahead of an expected return to growth in 2019.
