Livewire: Small-cap dividend champions (and how to find them)

By Marc Whittaker |  11 November 2019
Marc Whittaker

Many investors looking for equity dividend income turn to the same names, even with the possibility of a dividend cut. However, there are many stable dividend payers outside of the ASX 100. Marc Whittaker - Portfolio Manager for IML’s Future Leaders Fund – discusses these opportunities with Alex Cowie from Livewire.

Livewire: What screen would you run to produce a reasonable field of quality candidates, and can you share the results of the screen, including their yield?

Marc: Investors Mutual Limited runs a five-part screening process. This process makes up the mantra which has been at the heart of IML’s investment decision-making since we opened 21 years ago. We look for quality companies:

  • with a competitive advantage,
  • a history of consistent, recurring earnings,
  • capable management,
  • the ability to grow earnings and
  • all at a reasonable price. 

IML has always viewed yield as an important component of returns in the small-cap sector. While a company’s ability to grow is desirable, companies that can pay a sustainable, consistent and growing yield over time should be a consideration in every portfolio.

Our focus on quality and value does cull a great many stocks, leaving IML with a list of what it believes to be potentially superior investment opportunities. Dividend streams and supporting cash flows are, then, a key factor in our portfolio construction.   

Here are some of the top small-cap income stocks, in order of yield, that have passed our screening process and successfully made it into IML small-company portfolios:

Quality small-cap income stocks

Yield

GWA

5.8%

Australian Pharmaceutical Industries

5.7%

A2B

5.5%

Nine Entertainment

5.5%

CSR

5.3%

SkyCity Entertainment

5.1%

Event Hospitality & Entertainment

4.1%

Regis Healthcare

3.8%

Source: IML Research as of 18 Oct 2019

 

Livewire: What are three big risks to consider when investing in small cap income stocks?

Marc: IML is interested in holding companies that can pay a sustainable and growing yield over time. IML believes that companies such as this should outperform in the long term. We focus on the key risks to the sustainability and growth in a company’s dividend, namely:

How recurring are the earnings and cash flow which underpin the dividend? 

If a company’s earnings are highly volatile or there is a significant mismatch between earnings and cash flow, this can begin to raise questions over a company’s ability to consistently fund its dividend.  

Is the company’s payout ratio sustainable? 

The contribution of one-off profits or the normalisation of non-recurring expenses can mean that a company may find it difficult to grow its dividend over time.

Is company management choosing wisely when it comes to the decision between reinvestment and shareholder demand for growing dividends? 

If a company is consistently paying a high dividend at the expense of reinvesting into its own competitive advantage, such as R&D or new product development, the long-term outlook for the company’s products or services will diminish over time and this will have consequences for the sustainability of the dividend.  

Livewire: What are IML’s top picks for small cap income stocks?

Marc: Event Hospitality & Entertainment and A2B are two great examples of income stocks that fit well with the IML approach.

Event owns two substantial businesses – cinemas and hotels. 

Its cinema business in Australia and New Zealand is made up of Event and Greater Union cinemas, its GU Filmhouse for smaller, arthouse audiences, as well as its cinema technology supply business, Edge. Event also operates Moonlight open-air cinemas across Australia and Sydney’s iconic State Theatre. 

Its Australian hotel business consists of QT Hotels & Resorts, Rydges, Atura Hotels and Thredbo Alpine Resort. 

The company’s valuation is underpinned by a significant and strategic property portfolio. The company also maintains a conservative balance sheet that may be strengthened further through the proposed sale of its German cinema assets. The company offers a fully franked 4.1% yield at current prices. 

Event is led by a relatively new and capable management team, who is leading innovation in formats and product development. The new arthouse hotel offering QT Hotels is an example of a new and innovative format that is outperforming in terms of occupancy and room rates in what is a softer hotel market.

A2B (previously known as Cabcharge) is a payments platform provider and operator of taxi networks – that also represents a high-quality income stock. 

While the company continues to reinvest significantly into its customer and technology offerings, it continues to generate strong free cash flow, it holds a net cash balance sheet and given the relatively low payout ratio of 60%, has the capacity to continue to grow its dividend over time. The company is also attractively priced, trading on a fiscal 2020e earnings multiple of 13x and a yield of 5.5%.

Over the last few years, in the face of intense competition from other ride-sharing providers, A2b made the decision to increase its investment in technology, marketing and fleet. The business continues to face a dynamic operating environment but the strategy of Management and the Board now has the company better positioned, with a return to growth envisaged in its Service and Network businesses. Given this, we see the company growing earnings – and dividends – over time. 

 

While the information contained in this article has been prepared with all reasonable care, Investors Mutual Limited (AFSL 229988) accepts no responsibility or liability for any errors, omissions or misstatements however caused. This information is not personal advice. This advice is general in nature and has been prepared without taking account of your objectives, financial situation or needs. The fact that shares in a particular company may have been mentioned should not be interpreted as a recommendation to buy, sell or hold that stock. 
 
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