3 High-Yield Retailers To Benefit From Tax Reform

By Bob Ciura

The tax reform package that recently passed through Congress has major implications for investors. The tax plan is a major piece of legislation that will directly benefit large U.S. corporations, such as those that comprise the S&P 500. There are many components of the bill, perhaps the most significant of which is a permanent lowering of the corporate tax rate, from 35% to 21%.

A sharply lower corporate tax rate is a huge tailwind for large companies. Specifically, the retail industry is set to benefit, as many large U.S. retailers carry tax rates of 30%+. Meaningfully lower tax bills could result in much greater earnings to be distributed to shareholders, in the form of share repurchases and dividends.

With that in mind, we have identified 3 dividend-paying retail stocks that should benefit greatly from tax reform.

Retail Tax Winner #1: Target Corporation (TGT)

Dividend Yield: 3.8%

As previously mentioned, less money paid in taxes means more money available for shareholder distributions. Therefore, Target is an ideal choice for this list, because it is already a Dividend Aristocrat, which have increased their dividends for 25+ consecutive years You can see all 51 Dividend Aristocrats here.

Target has paid 200 quarterly dividends in a row, and has increased its dividend for 46 consecutive years. A corporate tax rate of 21% would greatly improve Target’s bottom line, since the company had an effective tax rate of 32%, according to ValueLine.

Target has had to spend aggressively to fight off online retail competition, led by Amazon (AMZN). As a result, Target’s earnings-per-share declined 6.2% over the first three quarters of 2017. The good news is, Target has surpassed analyst expectations for both revenue and earnings-per-share, in all three quarters to start the year. In the most recent quarter, Target’s comparable store sales increased 0.9%, while traffic rose 1.4%.

Target has launched several initiatives to return to growth. First, it is in the process of redeveloping hundreds of stores. To do this, it is modernizing layouts, and adding new product categories.

Source: Earnings Presentation, page 84

Target expects it can achieve a 2%-4% lift in sales for each store it renovates. By 2018, the company expects to have completed reimagining on over 350 of its stores. By 2019, it will have reimagined over 600 stores, representing one-third of its total store count.

Another major growth catalyst for Target is its small stores, under the CityTarget and TargetExpress banners. These are stores with much less square footage, in places that cannot provide the necessary space to build a large store, such as urban areas and college campuses.

By 2019, Target expects to open over 100 small stores, triple the number of small stores currently in operation.

Source: Earnings Presentation, page 77

Lastly, Target building its own e-commerce platform. Target’s comparable digital sales increased 24% last quarter. Target expanded its next-day delivery of essential items to eight new U.S. cities. And, Target recently acquired Shipt for $550 million in cash. Shipt is a same-day delivery service that will help Target improve its digital fulfillment, and compete better with Amazon.

Target has a secure dividend, with a 55% payout ratio using expected 2017 earnings. Its turnaround initiatives should return the company to growth, aided by tax reform. That means Target should have little trouble maintaining its Dividend Aristocrat status moving forward.

Retail Tax Winner #2: Macy’s (M)

Dividend Yield: 6.0%

Macy’s stock has declined approximately 30% year-to-date. This is no doubt a difficult period for Macy’s, but it has been through many ups and downs during its history. Macy’s has been in business since 1858. The combination of more than 100+ years in business, and a 3%+ dividend yield, earns Macy’s a spot on our list of “blue-chip” stocks. You can see our entire list of blue chip stocks here.

But with high dividend yield and low valuation, Macy’s could be a value and income opportunity for 2018. Macy’s declining share price has elevated its dividend yield to 6%. We believe stocks with 5%+ dividend yields to be especially attractive yields for income investors. You can see our entire list of all 397 stocks with 5%+ dividend yields here.

Macy’s would be a huge winner from tax reform, as it has a tax rate of 37% according to ValueLine. As a result, tax reform would be a major boost to Macy’s bottom line, and it could not come at a better time for the company. Department stores like Macy’s have been among the hardest-hit companies by the rise of e-commerce. In turn, Macy’s has had to invest huge sums of money into its core turnaround initiatives.

Macy’s earnings-per-share declined 38% in 2016. Over the first three quarters, adjusted earnings-per-share declined another 14%. For 2017, management expects comparable sales to decline 2% to 3%. However, the declines have slowed throughout 2017, which potentially positions Macy’s to return to growth next year.

Macy’s Backstage and Bluemercury stores are compelling growth catalysts. Last quarter, Macy’s opened eight new freestanding Bluemercury stores, bringing the total to 135. It also opened seven new Macy’s Backstage stores within existing Macy’s, and how has 45 locations. These store openings will help Macy’s expand in the beauty and off-price channels, which are growing categories.

In addition, Macy’s has a huge amount of real estate value on the balance sheet. Activist investor Starboard Value once pegged Macy’s real estate value at more than $20 billion. Starboard is no longer an investor, but even if its valuation was too aggressive, Macy’s could still be a bargain. The company has a current enterprise value of just $13.5 billion.

Macy’s annualized dividend payout of $1.51 represents a payout ratio of 48% to 52%, based on 2017 earnings guidance. As a result, Macy’s is appealing for value, and income.

Retail Tax Winner #3: Kohl’s (KSS)

Dividend Yield: 4.1%

Kohl’s has an attractive dividend yield slightly above 4%. Kohl’s is one of 674 stocks in the consumer cyclical sector that pays a dividend. You can see our list of all 674 dividend-paying consumer cyclical stocks here.

Like Macy’s, Kohl’s has a high tax rate, of 37.5%, which means it would also be a huge winner from a significantly lower tax rate. Kohl’s bottom line could use a boost—earnings-per-share declined by 10% in 2016.

Kohl’s has implemented several initiatives to restore growth, which appear to be gaining traction. With regard to Amazon, Kohl’s seems to have adopted a policy of “if you can’t beat ‘em, join ‘em.” In October, Kohl’s announced it will dedicate roughly 1,000 square feet inside its stores for Amazon smart-home spaces.

In these areas, consumers can purchase Amazon devices, such as the Echo and Fire tablets, along with accessories and smart home devices and services, directly from Amazon. The program initially launched in 10 stores, in Los Angeles and Chicago.

In addition, Kohl’s added Under Armour (UA) products to its active and wellness category earlier this year. This helped Kohl’s by adding one of the most popular brands, in a growth category.

As a result, Kohl’s results have improved over the course of 2017. Comparable sales declined 1% over the first three quarters of 2017, but this was far better than the 2.4% decline in the same nine-month period in 2016. Adjusted earnings-per-share were flat in the first three quarters of 2017. For the full year, Kohl’s expects adjusted earnings-per-share of $3.60 to $3.80, which easily covers the annualized dividend of $2.20.

Final Thoughts

Target, Macy’s, and Kohl’s all have dividend yields ranging from 3%-6%.

And, they all appear to be undervalued. They all have price-to-earnings ratios is the low teens. Investors became much more pessimistic toward these retailers over the past year, due to the intense competitive threats facing brick-and-mortar retailers.

However, Target, Macy’s, and Kohl’s are still highly profitable, and can easily cover their hefty dividends. Plus, they are each implementing strategic initiatives to return to growth moving forward. Tax reform could be just the catalyst needed to improve their valuations and earnings growth.

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Disclosure: I am/we are long TGT, M.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.