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.
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Roland Head owns shares of Dixons Carphone. 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.