3 Stocks Ready for a Big Dividend Hike

David Sterman's picture

Wednesday, May 4, 2011 - 1:00pm

by David Sterman

Investors tend to place a strong emphasis on growth. If a company is boosting sales at a fast clip, then its stock may be lavished with a rich multiple. Yet the top-line focus causes many to overlook a much more important metric: cash-flow growth. It's easy to miss, especially when the stock offers up a ho-hum dividend yield. If you dig a little deeper, you can come across these companies that may look fairly unappealing at first blush, but on a deeper look, they actually look quite attractive in relation to their cash flow.

The stocks in the table below offer up dividend yields in the 3% to 6% range. But if management chose to do so, these companies could hike their dividends so high that the yield would move up into double-digit territory. And in many instances, the company would still have ample funds left to buy back stock or take other steps to boost earnings-per-share (EPS).

1. Grocery store chain Supervalu (NYSE: SVU), which I recently discussed, is a cash-flow powerhouse. Investors have been concerned about a large amount of debt parked on the balance sheet and management is currently using much of the company's cash flow to reduce debt. Yet when the debt load becomes more manageable, perhaps in a year or two, a large dividend hike may result. By my math, Supervalu could triple its dividend, which currently yields 3.1%, and still have plenty of cash flow left for store remodeling or stock buybacks.

2. That's also the case with Aircastle (NYSE: AYR), which buys planes directly from manufacturers and then leases them to airlines and other customers. The company continues to trade below book value, even though book value is rising quickly, thanks to robust cash flow. [ See my previous take on Aircastle.]

Here again, the dividend could be boosted by 200% -- or more -- right out of cash flow.

3. Perhaps the most impressive stock on this list is Foot Locker (NYSE: FL), which has really been a balance sheet play for much of the last three years. The footwear retailer has seen its sales shrink from $5.7 billion in fiscal (January) 2007 to around $5 billion in fiscal 2010. The only reason investors have stuck around was due to the company's hefty $500 billion net cash balance.

Now, investors are taking a fresh look as sales start to rebound and Foot Locker again becomes a prodigious producer of cash flow. In retail, a little sales growth goes a long way due to the high fixed costs of running a store network. Foot Locker's top-line results have been modestly ahead of plan, but EPS topped forecasts by 94% in the October quarter and around 8% in the fiscal fourth quarter ended January. Recent channel checks by analysts at Citigroup have them predicting Foot Locker will handily exceed estimates for the current quarter as well.

The sales turnaround is really boosting the bottom line. Operating cash flow is expected to nearly double from the most recent fiscal year (ended in January) to fiscal 2013. Much of the company's internal growth projections are based on continued improvements at existing stores and not on a rapid expansion of the store base. As a result, working capital needs will be fairly modest.

Analysts at Citigroup predict Foot Locker will be able to hike its dividend by 50% to $0.95 a share by fiscal 2014. Even that looks too conservative. After all, the company is on track to generate $4 a share in cash flow by fiscal 2014. If the retailer sought to maintain the current payout ratio of 35%, then the dividend would rise to $1.50 by then. That's good for roughly an 8% dividend yield by then.

Action to Take --> All of these stocks carry greater downside protection than most stocks. After all, those strong cash flow metrics are likely to attract value investors in the event the economy cools and the broader market turns south. Relative safety plus the promise of a potentially bigger payout down the road puts these dividend payers in good standing.

P.S. -- If you're an income investor, why would you buy a stock yielding 2% when you can find one paying 26% right here? Watch this presentation for more.

David Sterman does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.