The Income Investor: upbeat about this FTSE 100 dividend stock

Income investors may naturally seek to avoid retail stocks at present. After all, the sector faces an uncertain near-term future that could negatively impact on profitability and dividends in the short run.

Indeed, the Bank of England’s recent interest rate cuts could yet take several months to have their desired impact on the economy’s performance due to the existence of time lags. Sticky inflation also means that the pace of future interest rate cuts could prove to be somewhat pedestrian.

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In the meantime, economic factors including an unemployment rate that has risen by 40 basis points to 4% in the past three months and 0% GDP growth in the third quarter of last year, could weigh on the financial performance of retailers. The prospect of higher costs resulting from an upcoming rise in the minimum wage, as well as changes to employer national insurance contributions announced in the Budget, may also inhibit profit growth within the sector.

An upbeat long-term future

While this could mean that the near-term prospects for dividend growth, and even the affordability of shareholder payouts, are somewhat precarious among retailers, the sector’s long-term income investing outlook remains upbeat.

After all, the Bank of England forecasts that inflation will fall to its 2% target within the next three years. This should prompt improved GDP growth, with even a gradual pace of interest rate cuts likely to ultimately have a positive impact on levels of economic activity.

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This could catalyse employment opportunities and wage growth, thereby raising demand across the retail sector. And with UK consumers having already experienced increasing spending power since April 2023 as a result of wages rising at a faster pace than inflation, their financial position may be more robust than many income investors realise.

International opportunities

Higher consumer demand within the UK retail industry could provide a positive catalyst for the profitability of sector incumbents that allows them to raise dividends.

A similar outlook could be ahead for UK-listed retailers that have exposure to mainland Europe. Although the eurozone faces similar challenges to the UK, including flat economic growth and sticky inflation, the European Central Bank is implementing monetary policy easing that should ultimately bolster the consumer outlook.

The central bank has already cut interest rates by 125 basis points to 2.75%. And with inflation likely to also fall in the eurozone over the medium term, the prospects for consumers could improve vis-à-vis the recent past.

Fundamental appeal

Alongside an improving outlook, the retail sector may offer income investing potential due to the generous yields that are currently on offer. Downbeat investor sentiment in response to near-term challenges means it is possible to purchase retail stocks that have dividend yields significantly higher than those of the wider stock market. This provides a margin of safety in case dividend growth proves to be somewhat disappointing amid an uncertain near-term operating environment.

Additionally, several FTSE 350 retail stocks have solid fundamentals that further reduce their overall risk. For example, they may have modest debt levels that mean they are able to withstand a period of lacklustre profit growth in order to service their borrowings. Similarly, they may have a competitive advantage, such as through brand loyalty or a lower cost base than competitors, that means they are well placed to capitalise on an improving industry outlook.

Source: Refinitiv as at 11 February 2025. Bond yields are distribution yields of selected Royal London active bond funds (as at 31 December 2024), except global infrastructure bond which is 12-month trailing yield for iShares Global Infras ETF USD Dist as at 7 February. SONIA reflects the average of interest rates that banks pay to borrow sterling overnight from each other (6 Feb). *Data prior to May is based on 3-month GBP LIBOR. Best accounts by moneyfactscompare.co.uk refer to Annual Equivalent Rate (AER) as at 11 February.

Risk/reward opportunity

Clearly, the share prices of retailers could prove to be relatively volatile over the coming months. Their dividends are also unlikely to be as reliable as firms operating in more defensive sectors that are less impacted by economic undulations. And with the prospect of substantial dividend growth being somewhat limited in the short run, investors may fail to experience a real-terms rise in their income in the near term.

However, higher dividend yields compared with the wider stock market, alongside the potential to grow dividends at a relatively brisk pace as their operating environment improves, means that income seekers may still wish to consider the retail sector on a long-term view.

An attractive dividend yield

Home improvement retailer Kingfisher (LSE:KGF) could prove to be a worthwhile income investment over the long run. The FTSE 100-listed company currently has a dividend yield of 5%, which is 150 basis points higher than the wider index’s income return. Shareholder payouts, meanwhile, were covered nearly 1.8 times by profits in its latest financial year. This suggests that the business can afford its current level of dividends even if operating conditions remain challenging in the short run.

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Indeed, the firm’s latest trading update showed that like-for-like sales growth was -1.1% in the third quarter of the year. However, it was able to make market share gains in the UK, which accounts for around half its sales, and Poland, which contributes 13% of revenue. The company’s operations in France, which represent a third of sales, continued to act as a drag on overall growth.

A wide margin of safety

This performance represented a continuation of the trends witnessed in the first half of the firm’s 2025 financial year. In that period, Kingfisher left dividends per share unchanged versus the same period of the previous year. While this is disappointing, the potentially positive impact of falling inflation and interest rate cuts on the company’s operating environment means that its financial performance, and dividend growth rate, could improve over the medium term.

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Indeed, the company’s status as a discretionary retailer means it is arguably more cyclical than many of its sector peers. Consumers typically delay the purchase of many of its goods, particularly big-ticket items such as kitchens and bathrooms, until they feel they are in a solid financial position.

This could mean that the company’s shares offer greater scope for capital gains than other retailers which are more focused on staple items. And with them trading on a price/earnings ratio of just 11.3, they appear to offer a wide margin of safety.

A sound financial position

Encouragingly, Kingfisher has a sound financial position through which to navigate an uncertain operating environment. At the time of its half-year results in July last year, for example, it had a net debt-to-equity ratio of 30%. And in the first six months of the 2025 financial year, its net finance costs were covered a healthy 7.7 times by operating profits.

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Furthermore, the company is seeking to reduce costs in order to strengthen its competitive position and financial performance. In its latest half-year results, the firm said it was able to cut operating costs in its French division by 3%. As a result, it is on track to make £120 million of total cost reductions in the 2025 financial year.

Long-term potential

Clearly, Kingfisher could face an uncertain operating environment for a sustained period. Even though inflation in the UK and the eurozone is expected to decline, while monetary policy easing may persist, their respective timelines remain unclear. This could mean that a lack of profit growth and an absence of dividend increases persist over the coming months.

However, the company is well placed to overcome short-term challenges, as well as capitalise on upbeat long-term industry prospects, as a result of its solid fundamentals. Moreover, its well-covered dividend, wide margin of safety and attractive dividend yield compared with the FTSE 100 index suggest it has a favourable income investing outlook.

Robert Stephens is a freelance contributor and not a direct employee of interactive investor.