ASX share Adairs Ltd (ASX: ADH) paid its shareholders big dividends before inflation hit the Australian economy, and the Commsec forecast implies sizeable dividends could be on their way again.
A leading retailer of homewares in Australia, Adairs also sells furniture through its Mocka and Focus on Furniture businesses.
The ASX share may not seem like an obvious candidate for sizeable passive income, but there are a couple of important factors to focus on. The first mention goes to the company's now very low price.
Extremely low valuation
Two inputs decide what a company's dividend yield will be. There's the dividend payout ratio – how much of its annual profit it pays to shareholders. There's also the price/earnings (P/E) ratio – the multiple of earnings the business trades at.
ASX retail shares typically trade on a lower earnings multiple than some other sectors, such as technology. However, Adairs is on a particularly low P/E ratio.
According to Commsec's estimates, Adairs shares are valued at just 9x FY24's estimated earnings and around 6x FY26's estimated earnings. As a comparison, the JB Hi-Fi Ltd (ASX: JBH) share price is valued at 15x FY24's estimated earnings and just under 15x FY26's estimated earnings, according to Commsec.
It's understandable that investors are somewhat nervous about discretionary retailers at the moment because of the cost-of-living difficulties for households. Based on the RBA's latest comments, interest rates appear likely to stay higher for longer, which may prolong the pain for some consumers.
Big dividend yield tipped
Adairs' board has shown a willingness over the years to reward shareholders with a pleasing level of investment income.
As the chart below shows, the Adairs share price has fallen by around a third since 27 March 2024 and by around 60% since June 2021. A lower share price can raise the potential dividend yield.
The estimate on Commsec suggests that Adairs could pay a dividend per share of 10.8 cents in FY24 and 19.8 cents in FY26. That could translate into a grossed-up dividend yield of around 9% in FY24 and more than 16% in FY26.
Foolish takeaway
Despite the uncertainty of the current economic environment, Adairs could be a compelling investment because it is working on several profit improvement initiatives.
For example, the company's transition to operating a new national distribution centre is improving its service and cost per unit dispatched. Adairs is also focused on managing its overall costs to return to an earnings before interest and tax (EBIT) margin of more than 10%.
In addition, the ASX share is looking to open additional upsized Adairs stores, close some smaller ones, open more Focus on Furniture Stores and keep improving Mocka's inventory, margins and costs.
