The consumer sector has a long history of successful dividend stocks. Warren Buffett's Berkshire Hathaway earns an annual dividend return of more than 50% on the original cost of its Coca-Cola position, which dates back to 1988. Procter & Gamble paid its first dividend in 1890! Though some of these names are probably better to hold than buy today, new investors can still find opportunities in consumer dividend stocks.
Moreover, many pay dividends far above the S&P 500 average of 1.6% and offer prospects for further payout hikes. Given current conditions, Target (TGT -0.54%) and Advance Auto Parts (AAP -2.38%) are two dividend growth stocks that could pay off well for income investors.
1. Target
Target's current annual dividend of $4.32 brings a year return of about 2.6%. The company has increased its dividend for 51 consecutive years, making it a Dividend King. Such a long streak builds in an expectation that dividends will rise yearly. So it was notable that despite this ongoing pressure, Target hiked its payout by 20% this year and 32% in 2021.
Analysts credit Target's competitive advantages with the ability to increase the dividend to this degree. Same-day fulfillment, which leverages its 50-state store footprint, has helped to speed retail deliveries. Additionally, so-called "stores within a store," such as the Ulta Beauty locations inside many Target stores, likely also helped draw customers.
Such advantages are critical. Competition from Amazon, Costco, and Walmart remains intense. Also, Target warned in June that an inventory overhang would weigh on profits as it seeks to reduce its inventories. Like many other retailers, Target over-ordered amid supply chain concerns.
The need to liquidate product has considerably reduced its free cash flow. So far this year, Target has reported a negative free cash flow of about $2.6 billion. Over the same time frame, the dividend cost Target $842 million, a factor that may explain why its cash position has fallen to $1.1 billion, down from $5.9 billion at the end of 2021.
Still, this isn't necessarily bad news for investors. Free cash flow for the first half of 2021 came in at $2.1 billion, a level that should make Target's dividend sustainable. This and its ability to significantly raise its dividend in a competitive environment should bode well for the company.
2. Advance Auto Parts
Advance Auto Parts shareholders now receive an annual dividend of $6.00 per share, a yield of about 3.5%. However, investors should take note of its recent dividend history.
After years of paying only $0.24 per share in dividends annually, Advance raised its annual dividend to $1.00 per share in 2020. The payout subsequently grew to $4.00 per share in 2021 and $6.00 per share today. In all, the payout jumped 25-fold over a three-year period.
The auto parts retailer has benefited from the need for transportation and the current state of the car industry. Auto parts is a recession-resistant business as working cars are a top priority for most consumers. Also, according to S&P Mobility, the average age of a vehicle is up to 12.2 years, a factor that will likely keep auto parts in high demand.
Still, it must compete with AutoZone, Genuine Parts, O'Reilly Automotive, and many others. Additionally, the rise of electric vehicles (EVs) could pressure Advance Auto over time as EVs typically use fewer parts.
And like other retailers, Advance has dealt with an inventory overhang. Free cash flow in the first half of fiscal 2022 (which ended July 16) was $97 million, down from $647 million during the same period in 2021. Also, the dividend hikes have led to $246 million in dividend costs over the first two quarters of the year.
Still, the 2021 free cash flow indicates it can afford its dividend as sales return to normal. And even if the dividend hikes pause for a time, investors can still earn a significant cash return from this stock.
