The outlook for the UK retail sector is highly uncertain. Brexit has already caused a depreciation in the value of sterling, which is likely to make inflation rise. This could hurt consumer confidence if wage growth fails to match inflation, which in turn may cause spending levels to come under pressure over the medium term. In such a scenario, should investors avoid convenience store operator McColl’s (LSE: MCLS), even though it has a whopping 5.8% yield?
Today’s full-year trading update from McColl’s shows that it’s making good progress in a challenging market. Although revenue increased by 1.9% for the full year, on a like-for-like (LFL) basis it fell by the same amount. However, recently acquired and converted stores fared much better, recording LFL sales growth of 0.8%. This shows that if the company can roll out its store conversion programme and successfully integrate the 298 stores acquired from the Co-op, its top-line performance could improve.
In fact, in the new financial year the convenience store operator is expected to record a rise in earnings of 18%. This improved performance hasn’t yet been factored-in to the company’s valuation, since it has a price-to-earnings growth (PEG) ratio of just 0.6. As such, it has a wide margin of safety that could mean that even if Brexit causes a difficult period for the retail sector, McColl’s could significantly outperform its peers.
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Furthermore, a yield of 5.8% is well-covered by profit. In the current year earnings are expected to cover shareholder payouts 1.7 times, which indicates that there’s room for dividend growth even if profit growth stalls. As such, it seems unlikely that McColl’s dividend will come under threat by Brexit, although its growth rate may be hurt somewhat over the medium term. Still, with such a high yield it remains a top notch income play.
Growth opportunity?
One retailer that lacks appeal at the present time is Sports Direct (LSE: SPS). Although its value proposition may prove popular if Brexit causes a squeeze on disposable incomes, Sports Direct continues to offer lacklustre growth forecasts. In the current year, its bottom line is due to fall by 45%. This could severely damage investor sentiment and send the company’s shares downwards.
While Sports Direct is expected to return to growth next year, its PEG ratio of two indicates that its improved outlook is already adequately priced-in. It also lacks a dividend, so it’s difficult to see how its share price will be positively catalysed in future.
As such, at a time when the retail sector is enduring a tough period that could worsen due to Brexit, it seems logical to buy McColl’s and avoid Sports Direct. The former’s dividend outlook is highly positive, although it’s as much a growth opportunity as an income one as its acquisition programme continues.
