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A dividend cut isn’t the only reason I’d steer clear of this small-cap stock

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It’s not easy being a retailer of, well, anything these days. Just ask bike and car accessories seller Halfords (LSE: HFD).  

Despite decent numbers from its car services division, a 3.8% reduction in sales at its retail arm (blamed on a difficult backdrop and poor weather compared to last year) meant overall revenue dropped 2.9% to £582.7m over the six months to 27 September. While “in line with expectations,” pre-tax profit also declined 2.5% to £27.5m. 

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Given the above, you might be asking why Halfords shares were up earlier this morning. The fact the company chose not to alter its guidance on profit for the full year (£50m-£55m) is likely to have helped. However, I believe a chunk of today’s early gains can probably be attributed to plans to focus even more on its Autocentre business through investment in more garages and mobile vans. This, management believes, will ultimately lead to “higher and more sustainable financial returns.”

Considering that people must keep their cars in good working order whatever the weather, this strategy makes sense (although I remain sceptical on how inclined drivers will be to switch mechanics). Nevertheless, becoming a market leader will require sacrifices.

As I speculated in September, the company announced today its final dividend this year would be reduced to 8p. The total dividend will then be lowered to 12p per share from FY21 onwards. While unsurprising, this development will clearly disappoint those invested for income.

Of course, you might argue that, at just 7 times forecast earnings, Halfords is simply too cheap to pass up. There might be something in this. However, with no certainty its strategy will work and sales of big-ticket discretionary products likely to remain under the cosh for a while thanks to Brexit, I think there are less risky options elsewhere.

One example would be vehicle marketplace Auto Trader (LSE: AUTO). As luck would have it, the FTSE 100 member also released half-year numbers this morning. And what great numbers they are.  

Motoring ahead

Revenue accelerated 6% to £186.7m in the six months to the end of September, along with a 12% increase in pre-tax profit to £127.7m. A quick glance at the stats helps explain why.

Cross-platform visits per month, at 51.2m, were 4% higher compared to over the same period in the previous financial year. The average revenue generated per retailer climbed 7% to £1,951 and the amount of physical stock jumped 10% to 481,000.

Although the vast majority of the latter was made up of used vehicles, CEO Trevor Mather pointed out that the site now lists “over 30,000 brand new cars” which were “viewed by 1.6m people in September alone.” To be clear, Auto Trader remains the clear market leader at what it does.

Looking ahead, the £5bn-cap said it was likely to meet growth targets for the full financial year, “despite ongoing market uncertainty.” As a sign of confidence — and in contrast to Halfords — it also raised its interim dividend by a little over 14%. 

The only downside to all this is that tapping into Auto Trader’s success comes at a hefty price (almost 25 times earnings before markets opened). Considering the company’s dominance, seriously high returns on capital employed, and improving finances, I’d be far more likely to buy a slice of this quality stock than the aforementioned market minnow.

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Paul Summers has no position in any of the shares mentioned. The Motley Fool UK has recommended Auto Trader. 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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