Specialty retailers operate in a particular niche of the broader retail industry. Unlike big-box discount retailers or department stores, which offer a wide variety of goods, specialty retailers tend to focus on one particular product area.

Their unique focus comes at an opportune time, as it may be just what saves them from the threat of online competitors such as Amazon (AMZN). There have been a number of retail bankruptcies over the past year, as consumers clearly enjoy the ability to shop online and receive delivery at home.

Specialty Retail Dividend Stock #6: The Home Depot (HD)

• Expected Annual Returns: 9%-10%

Home Depot was founded in 1978, and today is the largest home improvement retailer in the U.S., with over $100 billion in annual revenue. Home Depot is a great example of a retailer that has not only withstood the rise of Amazon, it has thrived. This is because home renovation projects are complex. Consumers appreciate the ability to view products in person before buying. And, qualified staff members at Home Depot can help answer questions and provide guidance to shoppers.

In 2017, Home Depot’s sales grew 6.7%, to $100.9 billion. Diluted earnings per share grew 13% to $7.29. Sales and earnings both set company records. On 5/15/18, the company announced strong results for the first quarter. Net sales increased 4.4%, due to 4.2% comparable-sales growth, which measures sales growth at stores open at least one year.

A major reason for Home Depot’s continued growth, is its booming e-commerce platform.

Source: Shareholder Meeting Presentation, page 16

Online sales grew 21.5% in 2017, and 20% in the 2018 first quarter. Nearly half of online orders in the U.S. were picked up in stores last year, which is a testament to the value of physical stores as fulfillment centers.

It’s full steam ahead for Home Depot in e-commerce. The company recently announced it will spend approximately $1.2 billion over the next five years to invest in e-commerce, including building 170 distribution facilities so that it can reach 90% of the U.S. population in one day or less. Home Depot also plans to build around seven e-commerce fulfillment centers, to help speed up deliveries.

Home Depot’s future growth prospects are quite strong. The U.S. economy continues to grow, with unemployment well under 5%, and wages and home prices are rising. These trends are all positive for Home Depot, as they encourage homeowners to invest in their homes through discretionary projects, ongoing maintenance, and repairs.

For 2018, Home Depot expects sales growth of approximately 6.5%, along with comparable sales growth of 5.0%. Home Depot expects impressive earnings growth of 28% for 2018.

We forecast earnings-per-share of $9.50 for Home Depot in 2018. As a result, the stock is currently trading for a price-to-earnings ratio of 21.2. The stock is trading significantly above our fair value estimate of 18.1, which is equal to Home Depot’s 10-year average valuation. The stock is overvalued, meaning negative returns of ~3% each year from a declining price-to-earnings ratio.

Nevertheless, Home Depot could still generate strong returns, thanks to its high rate of earnings growth. We expect Home Depot to grow earnings-per-share by 10% per year going forward, which could be overly conservative given the company’s high growth rate in recent years. In addition to the 2.1% dividend yield, Home Depot’s total annual returns could reach at least 9%.

Specialty Retail Dividend Stock #5: Genuine Parts Company (GPC)

• Expected Annual Returns: 9%-10%

Genuine Parts is a legendary dividend growth stock. The company has increased its payout for an incredible 62 years in a row, which makes it a Dividend King.

Genuine Parts has been in business for 90 years. The company traces its roots back to 1928. The original Genuine Parts store had annual sales of just $75,000, and only 6 employees. Today, Genuine Parts has nearly 40,000 employees, and generates sales of more than $16 billion.

Genuine Parts operates four segments, the largest of which is its Automotive Parts Group, which includes the core NAPA brand.

Source: Investor Presentation, page 8

Its long history of dividend increases is the result of consistent growth over the past several decades. According to the company, Genuine Parts has achieved sales growth in 85 out of its 90-year operating history. It has increased profit in 74 out of 90 years. Growth has accelerated recently—the company racked up record sales results in 6 of the last 10 years, along with record earnings-per-share in 7 out of the last 10 years.

Genuine Parts made multiple acquisitions to propel its sales and earnings growth. Recently, the company announced the acquisition of Hennig Fahrzeugteile Group, one of Germany’s leading suppliers of light and commercial vehicle parts. Hennig Fahrzeugteile has 31 branches across Germany and serves more than 9,000 customers, predominantly independent workshops and retailers. Genuine Parts expects the acquired business to generate annual revenues of approximately $190 million.

Last year, Genuine Parts the company acquired Alliance Automotive Group, a European distributor of vehicle parts, tools, and workshop equipment, for $2 billion. Alliance has leading market share across multiple European countries, including #1 in France, #2 in the U.K., and #3 in Germany.

On 4/19/18, Genuine Parts reported first-quarter earnings. Revenue of $4.59 billion rose 17% from the same quarter a year ago. Adjusted earnings-per-share, excluding acquisition-related expenses, rose 18% year-over-year. First quarter sales for the Automotive Group were up 29.6%, including an approximate 1.5% comparable sales increase, combined with growth from acquisitions.

Genuine Parts’ Automotive Group continues to lead the way for the company, thanks to NAPA, which is benefiting from shifting consumer trends. Specifically, cars are being held onto much longer today. Rather than buying new cars, owners are increasingly choosing to have minor repairs done, to extend the life of the vehicle.

Source: Investor Presentation, page 12

Genuine Parts states that the prime years for aftermarket repair starts in year six of the vehicle’s life. Currently, vehicles 6+ years of age represent 70% of the U.S. vehicle fleet. This is when costs accelerate for repairs. In addition, the total U.S. vehicle fleet is growing, the average age of the vehicle fleet is increasing, and miles driven continue to rise.

Genuine Parts stock currently trades for a price-to-earnings ratio of 16.6, which we view as modestly undervalued. Our fair value estimate for the stock is a price-to-earnings ratio of 17.0, equal to its 10-year average valuation. The combination expansion, 6% annual earnings growth, and the 3% dividend yield could fuel 9%-10% annual returns.

Specialty Retail Dividend Stock #4: Williams-Sonoma (WSM)

• Expected Annual Returns: 11%-12%

Williams-Sonoma is a specialty retailer that operates home furnishing and houseware brands, such as Williams Sonoma, Pottery Barn, West Elm, Rejuvenation, Mark & Graham and others.

Williams-Sonoma is generating growth rates that place it near the top of the retail industry. The secret to its success, while so many other retailers are struggling, is that Williams-Sonoma embraced e-commerce in the early stages. It has built a significant online presence, which has allowed it to compete with Amazon much more successfully than other retailers. E-commerce revenue now makes up 53.7% of Williams-Sonoma’s total revenue.

(Click on image to enlarge)

Source: Investor Presentation, page 7

Williams-Sonoma is ow the 23rd largest Internet retailer in the U.S., which provides it with a competitive advantage over retailers that have been slow to adapt. According to the company, multi-channel customers spend five times more than single-channel customers.

On 5/23/18, Williams-Sonoma reported quarterly financial results. For the first quarter, net revenue increased 8.2%, due to comparable sales growth of 5.5%. All four operating segments reported comparable sales growth, led by West Elm (up 9.0%), Williams Sonoma (up 5.6%), and Pottery Barn Kids and Teen (up 5.3%). E-commerce revenue increased 11.3% last quarter. Revenue growth, share repurchases, and margin expansion fueled 31% adjusted earnings-per-share growth last quarter.

The focus on e-commerce has served Williams-Sonoma well. From 2010-2017, the company grew revenue and adjusted earnings-per-share by 6% and 9% per year, respectively. West Elm has been particularly successful, with 23% annual sales growth from 2009-2017.

Based on 2018 earnings expectations of $4.17, Williams-Sonoma stock trades for a price-to-earnings ratio of 14.6. In the past 10 years, the stock held an average price-to-earnings ratio of 17.5, which is a reasonable estimate of fair value. A rising valuation could generate annual returns of 3.6% over the next five years. In addition, we believe the company can grow earnings by 5%-6% per year in that time frame. Lastly, Williams-Sonoma pays a dividend yield of 2.8%. Adding it all up, and the stock could generate total returns of 11%-12% per year.

Specialty Retail Dividend Stock #3: Foot Locker (FL)

• Expected Annual Returns: 11%-12%

Foot Locker is a shoe and athletic apparel retailer, with over 3,300 stores across 24 countries. Foot Locker has been negatively impacted by the rose of Internet retail. Consumers can purchase shoes online, without taking a trip to the mall. The decline in mall traffic has hurt Foot Locker disproportionately.

In addition, to better compete with e-commerce retailers, Foot Locker has had to offer discounts and incentives, which has weighed on the company’s margins. As a result, Foot Locker’s adjusted earnings-per-share fell 17% in 2017. Last year ended a long streak of steady sales and earnings growth for Foot Locker.

Source: 2016 Annual Report, page 6

In the 2018 first quarter, Foot Locker’s comparable sales declined 2.8%, reflecting weak mall traffic, but adjusted earnings-per-share increased 6.6% excluding a non-recurring pension litigation charge. The company continued to invest in its digital platform, as SG&A expense rose 50 basis points in the first quarter.

This is a period of elevated investment for Foot Locker, but this spending is necessary to fuel a turnaround. Foot Locker has to adjust to a new, more difficult retail environment, particularly for shoe retailers. Investments are focused on building its digital business, to compete with Internet retailers. This will continue to weigh on earnings, but the investments should pay off in the long run.

Fortunately, Foot Locker has a very strong balance sheet, with more than enough financial strength to absorb the higher investment spending. The company ended last quarter with $1.02 billion of cash and cash equivalents on the balance sheet, compared with just $125 million of long-term debt.

For 2018, Foot Locker expects comparable sales to be flat, to up in the low single-digit range. Earnings-per-share could return to growth, due to comparable sales growth, as well as share repurchases. In the first quarter, Foot Locker utilized $112 million to repurchase 2.6 million shares. We expect Foot Locker’s successful turnaround will fuel 6%-7% annual earnings growth over the next five years.

We also believe the shares are currently undervalued. Foot Locker trades for a price-to-earnings ratio of 12.9, while we estimate fair value at a price-to-earnings ratio of 14.6. Expansion of the price-to-earnings ratio could generate 2.5% annual returns.

Foot Locker also pays a 2.4% dividend yield, and raises the dividend frequently. On February 21st, Foot Locker raised its quarterly dividend by 11%. The combination of valuation changes, earnings growth, and dividends could result in total returns of 11%-12% per year for Foot Locker investors.

Specialty Retail Dividend Stock #2: L Brands (LB)

• Expected Annual Returns: 17.0%

L Brands is diversified specialty retailer, with a variety of brands including the flagship Victoria’s Secret, as well as PINK, Bath & Body Works, La Senza, and Henri Bendel.The company operates 3,069 company-owned specialty stores in the U.S., Canada, the U.K. and Greater China. Its brands are sold in more than 800 additional franchised locations around the world.

The company operates four main operating segments:

• Victoria’s Secret (61% of total sales)
• Bath & Body Works (29% of total sales)
• International (5% of total sales)
• Other (5% of total sales)

On 5/23/18, L Brands reported earnings for the first quarter. Revenue of $2.63 billion increased by 7.8% year-over-year, and beat analyst estimates by $40 million. Earnings-per-share of $0.17 beat estimates by $0.01 per share. Comparable sales, which measures sales at stores open at least one year, rose 3% for the first quarter. By operating segment, comparable sales increased 1% at Victoria’s Secret, and 8% at Bath & Body Works.

The positive momentum continued in May, with 10% sales growth and 5% comparable sales growth.

L Brands is also steadily building its multi-channel approach. The company currently generates $2 billion in direct-to-consumer sales, at an operating income margin of over 20%. It expects e-commerce growth in the mid-to-high teens on an annual basis.

Source: Investor Handout, page 20

L Brands still has multiple competitive advantages, primarily its strong brands. According to a Conde Nast-Goldman Sachs survey, Victoria’s Secret is the #1 brand for millennials. It also is the #1 lingerie brand in the world, and Victoria’s Secret PINK is the #1 specialty collegiate brand. Continued brand strength is key to retaining its market share from Internet competition.

L Brands has a high dividend yield, and it appears the payout is secure. The company is highly profitable, which means the dividend is sufficiently covered. Dividends are expected to grow at 3% per year over the next five years, a slightly lower rate than earnings growth. The reason is that L Brands will likely opt to reinvest excess cash flow in growth initiatives, rather than raising its already-generous dividend payout. This would have the added benefit of lowering the dividend payout ratio over the next five years.

L Brands stock trades for a price-to-earnings ratio of 13, using the midpoint of the company’s 2018 earnings guidance. This is a fairly low valuation. In the past 10 years, L Brands stock traded for a price-to-earnings ratio of 17.0. This is our estimate of fair value, which seems reasonable for a highly profitable company with leading brands across its retail categories. As a result, we view the stock as significantly undervalued. Returning to the fair value estimate would generate annual returns of 5%-6% from expansion of the price-to-earnings ratio. In addition, the falling valuation has elevated the dividend yield of the stock to 6.5%, which is attractive for income.

L Brands still has a large presence in malls, which is a distinct disadvantage. Slowly, the company is righting the ship, closing under-performing stores in deteriorating malls, while building its e-commerce business. This will continue to take time, but the company still has long-term growth potential due to its brand strength. In the meantime, investors can collect a 6.5% dividend yield.

With a low valuation and high dividend yield, L Brands is an attractive buying opportunity for value and income. If the turnaround remains on track, L Brands stock could generate 17% annual returns.

Specialty Retail Dividend Stock #1: GameStop (GME)

• Expected Annual Returns: 25%-26%

GameStop is a video game and consumer electronics retailer. The company has over 7,000 stores and annual revenue of $9.2 billion. Its business activities include the core retailing segment, as well as its Technology Brands segment which includes nearly 1,400 Spring Mobile AT&T and Simply Mac stores. Spring Mobile sells all of AT&T’s products and services, including DIRECTV, devices and related accessories in select markets in the U.S., while Simply Mac sells the full line of Apple products, including laptops, tablets, and smartphones, and offers Apple certified warranty and repair services.

GameStop also has a large collectibles business, and a digital downloading platform for video games.

Source: BAML Finance Conference, page 3

On 5/31/18, GameStop reported first-quarter financial results, which were weak on the top and bottom lines. Total global sales declined 5.5% to $1.93 billion, or a 7.5% decline excluding foreign exchange. Comparable-store sales fell 5.3%, consisting of a 2.6% decline in the U.S. and an 11.6% drop in the international markets. New hardware sales decreased 7.9% for the quarter while new software sales decreased 10.3% for the quarter. The main culprit for the sales decline was that GameStop faced unfavorable comparisons with the launch of the Nintendo Switch in the first quarter of fiscal 2017.

GameStop shares have declined by approximately 35% in the past 12 months, due to the threat of digital downloading of video game software. Online game publishers like Microsoft (MSFT) and Sony (SNE) now sell video games online that consumers can download, which saves them a trip to their local GameStop.

GameStop’s growth prospects in 2018 and beyond rely on continued success from new consoles, which can help boost related software sales in-store. The rapid growth of digital downloads is also a risk for GameStop’s highly lucrative pre-owned business, which represented 33% of the company’s total gross profit last quarter. As a result, we do not expect high earnings growth for GameStop going forward.

Even so, GameStop generates a great deal of cash flow, more than enough to reinvest in capital expenditures, pay down debt, and maintain its hefty dividend.

Source: Q1 Presentation, page 8

Based on 2018 earnings expectations of $3.00 per share, GameStop stock trades for a price-to-earnings ratio of just 4.7. Our fair value estimate for GameStop is a price-to-earnings ratio of 10, which implies significant upside potential. An expanding price-to-earnings ratio could add 16% to annual shareholder returns over the next five years.

In addition, GameStop has a current dividend yield of 10.7% yield, and the dividend appears to be sufficiently covered by earnings. Even though we expect GameStop’s earnings to decline by 1% per year, the company should still be able to maintain its dividend payout for the foreseeable future. The combination of dividends, earnings, and valuation changes could result in total returns of 25%-26% over the next five years.