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Shopping for Dividend Growth (Part 2): Macy’s

Black Friday’s still a week away, but rather than get trampled by the post-Thanksgiving hordes, we’ve started the shopping season early here at D&I Daily. And that means early gifts for our loyal readers.

No, we’re not giving away Applebee’s gift certificates or ugly sweaters. (Sorry!) Instead, we’ve rounded up a trio of dividend-paying retailers set to benefit from the coming winter storm of consumer spending.

On Tuesday, I started it all off with a rundown on Coach (NYSE: COH). Like I said then, despite my refusal to tote a man-purse, “I sure as heck wouldn’t be ashamed to be caught holding a few hundred shares of Coach in my portfolio… This high-end retailer could very well become a high yielder in short order.”

Now, as promised, I’m back with the skinny on another mall-goer’s mecca, Macy’s (NYSE: M).

There’s no reason to delay, so let’s get to it…

A Macy’s Day Dividend-Growth Parade

The Great Recession was no walk in the park for most retailers and Macy’s was no exception. Sales slumped, the stock took a beating and the end looked all but nigh.

Luckily, getting clobbered drove the company to restructure itself for the better. The result was reduced operating expenses and a recovery more robust than the rest of the industry’s. All we have to do is look at the stock price performance for proof…

Over the last year, department store stocks gained an average of just 4.6%. Yet, Macy’s shares surged 29.6% higher. Not even close competitor, Nordstrom (NYSE: JWN) – which has both a comparable market cap and target demographic – could keep up, gaining just 12.3% over the same period.

The strong stock performance is likely to continue, too, given Macy’s latest quarterly results. Same-store sales jumped 3.7%, margins expanded and management even raised fourth-quarter guidance, underscoring our prediction of a strong holiday shopping season ahead.

But we can’t let the good allow us to turn a blind eye to the bad…

You see, as part of Macy’s effort to revamp its operations, in 2009 the company also tossed its dividend program on the chopping block, cutting the quarterly payment down over 60%, from $0.13 to $0.05.

And that’s not exactly the dividend history we’re after.

Fortunately, since then, the company’s not only been repairing its stock performance, it’s been repairing its dividend program, too.

In 2011, Macy’s doubled quarterly payments from a still-downsized $0.05 to $0.10 and then again in 2012 to $0.20, giving the stock a current projected yield of 2.05%.

That’s slightly lower than the average yield on the S&P 500, but before you balk, remember that initial yield is only half the battle. The other half is growth. And with an average dividend growth rate of 100% for the last two years, the potential yield-on-cost is enormous.

Granted, it’s unreasonable to expect Macy’s to keep up such over-the-top annual raises. But what’s not unreasonable is to look forward to a well-managed dividend program that sports consistent increases.

For one, management – which hasn’t had squat to say about dividends for years – is now indicating that increases are going to be the new norm, with CFO, Karen M. Hoguet, telling investors in the latest earnings that the company’s employing a “balanced approach” between “combination of our stock buyback, debt reduction and the increased dividend payout” going forward.

And given the barely significant dividend payout ratio of 18.7%, there’s a heck of a lot of room for growth, no matter how “balanced” management’s approach turns out to be.

Bottom line: The best time to invest in retail stocks is near the bottom of the economic cycle, like now. However, given the cyclical nature of the industry, we don’t want to make any of these investments a cornerstone of our dividend portfolio. Put simply, they’re more risky and not reliable enough.

That being said, Macy’s valuation at just 9.9 times forward earnings, compared to 14 times for the S&P 500 Index – and its dividend growth potential – make it a compelling opportunity worth considering for more speculative dividend investors. The potential capital appreciation could easily make up for the lower yield in the here and now.

Stay tuned for next Tuesday’s final installment, when I’ll take a look at another department store dividend payer, Kohl’s (NYSE: KSS).

Safe investing,

Louis Basenese