Are These 3 Retail Stocks Dividend Traps?

The retail apocalypse could cause up to 12,000 store closures in the U.S. this year, according to Coresight Research. Traditional malls are withering as superstores, warehouse retailers, and discount retailers pull away shoppers, while Amazon and other e-commerce marketplaces are digitizing the entire shopping experience.

As a result, many retail stocks plunged over the past year, and their dividend yields inadvertently soared. Investors might be wondering if these stocks are now undervalued dividend plays or high-yield traps, so let's dig deeper into three high-yielders: Macy's (M -1.42%), Kohl's (KSS -3.41%), and L Brands (BBWI).

Image source: Getty Images.

Macy's

Macy's lost half its market value this year as its comparable store sales declined, its margins contracted, and its turnaround efforts failed to attract shoppers. The stock now trades at just seven times forward earnings and pays a forward yield of nearly 10%.

Macy's hasn't raised its dividend since 2016. Over the past 12 months, it spent 113% of its free cash flow (FCF) on its dividend, and its FCF declined nearly 50% during the same period -- which suggests that a dividend cut could be in the cards. Macy's comps growth (on an owned-plus-licensed basis, which factors in the growth of its store-in-stores) withered over the past year, and its gross margins remain shaky.

Source: Macy's quarterly earnings. *Owned-plus-licensed basis.

Macy's expects its total comps to decline 1%-1.5% for the full year, and for its gross margin to "moderately" decline. Wall Street expect its revenue and earnings to decline 2% and 37%, respectively, this year, which explains why investors are still shunning the stock.

Kohl's

Kohl's stock tumbled nearly 30% this year as it sacrificed its margins to squeeze out anemic comps growth. The stock now trades at ten times forward earnings and pays a forward yield of 5.5%.

Kohl's has raised its dividend annually for eight straight years. It spent just 45% of its FCF on its dividend over the past 12 months, but that ratio is rising due to a near-40% decline in its FCF in the same period. Kohl's comps growth turned positive again last quarter, but its gross margin still contracted at a much faster rate than Macy's as it relied more heavily on markdowns.

Source: Kohl's quarterly reports.

Kohl's main turnaround plan is to accept Amazon (NASDAQ: AMZN) returns at its stores. But that plan requires Kohl's to repackage and deliver the products back to Amazon on its own dime, and hope that those customers buy some products at Kohl's to offset those costs. That desperate strategy might bring people back to its stores, but it isn't guaranteed to boost actual sales.

Kohl's didn't provide any full-year revenue guidance, but it expects its full-year earnings to decline 12%-15%, which would cause its FCF to decline and its dividend to become less sustainable.

Image source: Kohl's.

L Brands

L Brands, the parent company of Victoria's Secret and Bath & Body Works, shed 30% of its value this year as the ongoing decline of Victoria's Secret offset the stronger growth of Bath & Body Works and crushed its margins. It now trades at just eight times forward earnings and pays a forward yield of 6.5%.

L Brands cut its dividend in half last year, but it still spent just over 50% of its FCF on its dividend this year. However, its FCF improved 9% as the company closed Victoria's Secret stores, shuttered its Henri Bendel banner, and sold its Canadian lingerie brand La Senza. Unfortunately, L Brands' comps growth still crumbled over the past year, and its gross margin contracted as it tried to boost its sales and fend off rivals -- like American Eagle Outfitters' Aerie -- with markdowns.

Comps growth, Source: L Brands quarterly reports. *Stores plus direct sales.

L Brands didn't offer any full-year comps guidance last quarter, but it expects its full-year earnings to decline 7%-15%. That downbeat forecast, along with its myriad challenges, indicate that L Brands still isn't an undervalued dividend stock.

Avoid these high-yield traps

There are plenty of solid dividend stocks to choose from, but these three retail stocks don't make the cut. These companies aren't doomed yet, but they face fundamental challenges which could make it tough to generate earnings growth -- and thus keep paying their dividends -- over the long term.