This Dividend King's Hike Is Bigger Than You Think

Target (NYSE: TGT) made it official on Thursday. The mass-market retailer lived to keep its Dividend King crown another year. Target boosted its quarterly dividend rate, something that the chain operator has now done for 54 consecutive years.

It wasn't much of an increase. The new quarterly distribution rate of $1.14 a share is just a pair of pennies -- or 1.8% -- higher than the old dividend. Target stock has moved exactly 2% higher just through the first four trading days of this week, so its forward yield of 4.6% is just a smidgeon lower than it was when the week started.

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This is still a pretty big move for Target. Let's zoom in on the retailer's storefront logo to see if it hit the bull's-eye this week.

My two cents

The timing of the payout boost isn't a surprise. As I pointed out earlier this week, Target has announced its annual increase between June 9 and June 15 over the last several years. If it was going to go through with another hike it was going to happen this week.

The new rate also isn't a surprise. Target also moved its quarterly dividend two pennies higher last June. Target has the earnings wiggle room to go higher, but it's the wrong message to send when the "cheap chic" chain has some issues to figure out. Thursday's move was about checking a box, keeping income investors satisfied until it drums up a way to win back the growth investors that have meandered elsewhere.

Target's net sales have declined slightly in back-to-back fiscal years, and this year is off to another challenging start. Comps declined 3.8% in the fiscal first quarter that it posted last month, and it's even worse at the physical store level. Digital comps are 4.7%, fueled by the growing success of Drive Up orders and Target's Circle 360 premium loyalty platform. Inside the actual stores, comps are down 5.7%.

Thankfully the chain remains more than profitable to cover the more than $500 million it's shelling out every three months in shareholder distributions. Target's guidance calls for adjusted earnings per share to clock in between $7 and $9 this year. The new dividend will set Target back $4.56 a share, translating into a forward payout ratio of 51% to 65%.

It's a reasonable ratio, sustainable if it can start growing again. Thankfully analysts see a return to growth on both ends of Target's income statement by next year. It's comforting to know, but investors have been burned by other retailers failing to turn things around after suffering popularity hiccups.

Image source: Getty Images.

Shopping for a turnaround

Target's 4.6% yield is notable. The stock shedding almost a third of its value has pushed up the dividend from roughly 3% a year ago. Short-term rates on the money market funds have gone the other way, and now Target is generating more income than many short-term fixed income options. This isn't necessarily a badge worth wearing.

There are only a couple of department store operators currently dedicating a larger cut of their market caps to quarterly disbursements. Macy's is yielding 6.1%. Kohl's is at 5.7%, and that was after slashing its dividend by 75% earlier this year. Dillard's makes the cut on a trailing basis only because of a one-time distribution of $25 a share it made late last year, but the forward rate is microscopic.

This isn't a club that Target may want to be a part of right now. Those shareholders are bracing for sharp declines in profitability this year, along with sliding sales through these next two fiscal years. Cutting fat checks while their boats are taking on water isn't a financially seaworthy approach.

Target isn't in the same boat, at least not yet. It still has time. If it coughs up the Dividend King crown next June because it has a better use for its earnings -- as in making sizable investments to turn shopper perception around -- it wouldn't be a bad thing. The income investors won't be happy, but if it's a bridge to winning back the growth investors, swapping income for capital gains is a smart trade.

Target chose complacency this time. If it can't plug the leak a year from now it could be time to chart a new course.

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Rick Munarriz has positions in Target. The Motley Fool has positions in and recommends Target. The Motley Fool has a disclosure policy.