3 Retailers With Outstanding Dividend Growth Prospects

Costco, CVS, and Macy's are three high-quality retailers with outstanding dividend growth prospects.

Jan 18, 2014 at 4:00PM

The retail environment has been notoriously challenging and competitive lately. For this reason, investors need to be particularly selective when investing in the sector. Dividend growth is a clear and transparent sign of fundamental strength, and companies like Costco (NASDAQ:COST), CVS (NYSE:CVS), and Macy's (NYSE:M) have what it takes to deliver growing dividends for years to come.

Costco is smart and effective
Costco has a smart and effective business model: The company makes most of its profits from membership fees, as opposed to margins on sales, and this allows it to charge competitively low prices for its products. In addition, Costco prioritizes efficiency and low prices over product variety when it comes to sourcing and inventory decisions.

Customers seem to be quite happy with the company. Renewal rates have been consistently above 85% over the last several years, and the last quarter was as strong as usual. The global renewal rate remained 87%, and key markets like the U.S. and Canada performed particularly well, with renewal rates of more than 90%.

The company continues delivering healthy sales growth in spite of the challenging retail environment, and comparable sales excluding the impact of foreign exchange fluctuations and gasoline prices increased by 5% in the U.S. and 7% in international markets during December.

The dividend yield is quite modest at 1.1%, but payments have increased materially from $0.10 in 2004 to $0.31 currently. The company has a resilient business model and a conservatively low payout ratio in the area of 25% of earnings, so Costco is well positioned to continue raising dividends in the coming years.

CVS for healthy dividend growth
CVS is both one of the leading U.S. pharmacy retailers and a major pharmacy benefit manager. The company benefits from its vertically integrated operations and scale advantages, which generate cost efficiencies and negotiating power with suppliers.

Factors like an aging population, technological advancements in the health care industry and the broadening of medical insurance coverage represent considerable tailwinds for the company over the medium and long term.

CVS is firing on all cylinders from a financial point of view; the company expects to deliver adjusted earnings-per-share growth of between 10.25% and 13.75% during 2014, and CFO Dave Denton is quite optimistic about the future of the business:

CVS Caremark has a strong track record of meeting or exceeding our financial targets. The outlook for 2014 is bright, and we are focused on strategies that will lead to solid, long-term enterprise growth. We continue to generate a substantial amount of free cash flow and we remain committed to disciplined capital allocation practices that drive value for our shareholders.

The company announced a whopping dividend increase of 38% in December, and it still has a lot of room for dividend growth considering its fundamental strength and safe payout ratio near 25%. The dividend yield is 1.6%.

Macy's is outperforming
While most department stores are reporting dismal sales figures for the key holiday season, Macy's is performing materially better than its peers thanks to its omnichannel strategy, its focus on private-level offerings, and its price optimization initiatives.

The company has delivered growing earnings per share over the last 15 consecutive quarters, and it recently announced a healthy increase of 4.3% in comparable sales, including departments licensed to third parties during the holiday shopping season. Management is expecting comparable sales growth between 2.3% and 2.5% in the fourth quarter and comparable sales growth in the range of 2.5% to 3% for 2014. 

Macy's is implementing a series of initiatives aimed at reducing $100 million in annual expenses starting in 2014, so the company is not resting on its laurels and remains focused on maximizing efficiency and generating profitability for shareholders.

The company had to cut its dividend and restructure operations because of the recession in 2009, but it has emerged stronger than ever and has been delivering outstanding dividend growth since then. What was a $0.05-per-share dividend in 2010 has now grown into $0.25 per share, and the comfortably low payout ratio of 26% means plenty of potential for further dividend growth. Macy's pays a dividend yield of 1.8%. 

Bottom line
Growing dividends don't only provide income for investors, they also reflect a sound and healthy business. Even in a challenging economic scenario for retailers, Costco, CVS, and Macy's offer outstanding dividend growth prospects, and that says a lot about the fundamental quality of these companies.

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Fool contributor Andrés Cardenal has no position in any stocks mentioned. The Motley Fool recommends Costco Wholesale. The Motley Fool owns shares of Costco Wholesale. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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