Investors in traditional ASX 200 dividend stocks are expected to receive chump change over the next 12 months as companies "deny, defer or diminish" payments, as Nikko AM alludes in this recent wire. The fall in income expectations, combined with a spike in share prices, has seen yields compress across the broader market towards 3%.

But this situation provides investors an opportunity to fish for income in the world of small caps, where select companies offer a perfect mix of good income, durable business models and attractive valuations.

Here, Simon Conn of Investors Mutual and Dean Fremder of Perpetual Investments discuss 6 stocks with yields from 3.5%-6.5% (fully franked in most cases), with Dean pointing to one business growing earnings at over 10% annually, trading on a forward P/E of only 9x and the scope to boost its yield to ~11% given its surplus franking credits balance.

Notes: Watch, read or listen to the discussion below. This episode was filmed on 17 June 2020.


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Edited Transcript

Vishal Teckchandani: Welcome to Buy, Hold, Sell, brought to you by Livewire Markets. My name is Vishal Teckchandani and today, we're going to unearth some small-cap dividend darlings to help you offset some of those potential income losses from other parts of your portfolio. Joining me on the show today is Dean Fremder from Perpetual and Simon Conn from Investors Mutual. Simon, let's start with you. AUB Group on a circa 3.5% fully franked yield. Buy, hold, sell?

AUB Group (ASX:AUB)

Simon Conn (Sell): It's a sell for me. It's a good business and a really good management team, but I think it's run pretty hard and it looks pretty full. You got to remember that all those brokers part of their business is in the risk management business, which is not true insurance broking. I think that deserves a lower multiple, but you could set a good run and it just looks pretty full for me.

Vishal Teckchandani: Dean, AUB's share price has seen a bit of a V-shaped recovery. It provides risk management advice. Is your advice to sell it or buy it or hold it?

Dean Fremder (Buy): It's to buy it. I'm going to disagree with Simon on this one. Ultimately, insurance broking is an awesome industry because it's an essential service. If you're a business, you buy insurance. It's that simple. No matter what the economy does, businesses are going to be out there buying insurance. And absolutely, there is a small component of the business that does more risk management services, but the bulk is the core insurance broking, which we're quite favourable on. So the cost of insurance has been going up, which is a good thing because off brokers take a small percentage of that. That's a good thing. And most importantly, it's just a broker, which means they're not on the hook for any of the claims that come through on the insurance policies. So ultimately, a very long track record of delivering really profitable growth, good cashflow, management we think are talented, strong balance sheet. It's a buy for us.

McPherson's (ASX:MCP)

Vishal Teckchandani: Number two, staying with you, Dean. McPherson's on a 3.7% fully franked yield. Buy, hold, sell?

Dean Fremder (Buy): McPherson's a buy for us. It's a really exciting business. They're making the transition from being an owner of kind of more mature consumer brands, like the Multix suite of brands, towards more high-growth skincare and other forms of high-growth consumer goods that are going gangbusters into China right now. Both parts of their business actually did really well for the last few months. And I think what's really exciting is the balance sheet's in fantastic shape, which means they can go out there and buy some other, some additional high-growth consumer brands, bolt them onto their existing broad distribution network, and realise some really super incremental margins. So it's a buy for us.

Vishal Teckchandani: The balance sheet is in such good shape, Simon, that management actually gave staff a stipend to learn an instrument during lockdowns, music to your ears? Buy, hold, sell?

Simon Conn (Buy): Music to my ears Vishal. It's been a good performer for us for many years. I really like the pharmaceutical sector and it's a buy because it's got a good management team, a good balance sheet and a good resilient portfolio. Dr LeWinn's has performed well for them and they've executed very well into China, one of the few companies to give an upgrade through the coronavirus period. The balance sheet positions them well to make a bolt-on acquisition, which they've been looking at for some time. And one of the ways I think companies can grow over the next 12 months is making opportunistic acquisitions. They've got the platform to distribute product into pharmacies. So if they do buy something, there'll be quite a lot of synergies. So, I think it's a buy.

Vishal Teckchandani: Next stop, Simon. Metcash on a 5% fully franked yield, something to add to your grocery list?

Metcash (ASX:MTS)

Simon Conn (Buy): I think Metcash is a buy. It's a good solid business. Not the most exciting thing again in the world, but it's a solid business. We've been eating more at home and I think that really speaks to the resilience of the business. I think actually what we've been seeing, people are buying more local, which I think speaks to your local IGA business, it's going okay. And the liquor business is a really strong one. Again, drinking more at home, so it helps them.

Vishal Teckchandani: We have been drinking more at home. So, is it Metcash or Metcrash, Dean? Buy, hold, sell?

Dean Fremder (Sell): It's a sell for me. Again, disagreeing with Simon. The wholesale business model is a structurally pressured business model. It's difficult. Metcash has lost a few of their big customers in recent times, which is going to present a further headwind for earnings in coming periods. They raised money recently which obviously puts the balance sheet in a bit better shape, but they have quite significant liabilities that you can't see on the balance sheet that they may need to fund in coming times, and so putting it all together, risk-reward doesn't really stack up for us, so we'll say sell.

Vishal Teckchandani: Okay. Now, we did ask our guests to bring two small caps that they're finding really attractive dividend opportunities in. Dean, what's your small-cap darling today?

Pacific Current Group (ASX:PAC)

Dean Fremder (Buy): It's Pacific Current. So, stock code is PAC. They're a boutique funds management group that owns stakes in about 15 different fund managers. Each in really exciting, kind of niche growing parts of the investing world. The stock's really cheap. It's on nine times earnings. It's growing earnings at double digits, so more than 10% a year. It's paying a 6.5% fully franked yield. And most excitingly, we think they can pay out a much larger portion of their earnings as dividends. We see no reason, given the surplus franking credits they have on the balance sheet, they can't be paying a 10 or 11% fully franked yield in the next 12 months. So, really excited about that one.

Vishal Teckchandani: Nice. Simon, what's your small-cap dividend darling?

Tassal Group (ASX:TGR)

Simon Conn (Buy): We like Tassal in the salmon sector. The cost of meat's going up and salmon's an attractive alternative. We're all eating more at home and we'd like to eat better quality foods. So, in this sector, it's a duopoly between Huon and Tassal. Well managed, they manage price quite well, generates good reasonable levels of cash. They're growing into the prawn sector. They raised money last year, so the balance sheet's in good nick. Pays a 5% yield. We like that. 

Spark New Zealand (ASX:SPK)

Simon Conn (Buy): And then Spark New Zealand in New Zealand. They are Telecom New Zealand. It's a good duopoly with Vodafone now. They're a disciplined owner, it generates about a 5.5% per cent yield. Unfortunately, no franking because of New Zealand, but a good cash generative business with the opportunity to take costs out. So we like Spark New Zealand as well.

Vishal Teckchandani: The banks may not be paying you income, but in the world of small-caps, there's plenty of dividends to fish from.

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  • Earlier this week Dean and Simon discussed whether the ferocious rally in the Small Ords Index has made this asset class too richly valued, and sectors they're favouring/avoiding
  • The duo also discussed 5 quality small caps at a reasonable price covering Nanosonics, Service Stream, InvoCare, QANTIM IP and SkyCity
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