The New Criterion: small cap dividend stocks you probably have never heard of

Tim Boreham

Independent Investment Research

Bored with the Big Four? Tired of Telstra? Have Coles and Woolworths exceeded their shelf life?

For yield chasing investors, the small cap sector can offer attractive dividends based on sound and sustainable earnings. Many of these dividends delights are virtually unheard of, which means they haven’t been bid up as aggressively as the handful of blue chip stocks that investors flock to.

We proffer the mandatory health warnings as well: most of the stocks are cyclical and with low liquidity. They are also poorly covered, so they are not well understood. But that can also be an advantage in terms of creating hidden opportunities.

So that readers don’t have to, Criterion has scoured the small-caps industrial sector for stocks with a reliable earnings and dividend paying record. In some cases, the yields are attractive because the company has suffered a hiccough (not that glitches are confined to the small cap sector – just ask Westpac).

The companies mentioned have given recent AGM updates, so investors can be reasonably confident that things won’t change too much ahead of the February results season.

While debt is not necessarily the work of the Devil – especially in this low-rates climate – we like to see gearing well under control. The companies must also have genuine growth prospects, rather than being a short term dividend milch cow.

The $57 million market cap Acrow Formwork & Construction Services (ACF, 34c) is suitably obscure, but its handiwork is evident on building sites across the country.

Acrow hires formwork and scaffolding to civil infrastructure and residential projects. In the case of formwork – the wooden framing to cast concrete and such – the equipment is offered on a ‘dry hire’ basis (with no attached labour). In the case of scaffolding, Acrow provides the muscle to erect the structures.

Having reverse listed in April last year, Acrow has just completed its first meaningful acquisition: the $21m cash-scrip acquisition of the Queensland-based Uni-span Australia.

In the 2018-19 year Acrow turned over $71m with underlying earnings (ebitda) of $11.5m. In the same year Uni-span chalked up $34m on ebitda of $4.8m, so the acquisition is a true company maker.

At Acrow’s AGM in late November, CEO Steven Boland pointed to a first (December) half performance previously to the similar year’s, followed by a “considerable stronger” second half.

Bell Potter forecasts current-year sales of $93m, a net profit of $9m and a 2.2c dividend, implying a yield of 6.8 per cent.

RXP Services (RXP) 51c

The I.T. outfit has disappointed in recent years but looks to be retaining its mojo after moving from commoditised work to digital services (that is, helping enterprises with their online strategies and systems).

Never one to shy of acquisitions, RXP in mid 2017 bought the creative agency The Works for $33m (upfront cash plus earn outs), thus winning the work of big-ticket clients including the Australian Football League, Woolworths and Optus.

RXP recorded flat revenue of $141m in the 2018-19 year, on ebitda of $16.3m (up 26 per cent). The $3.4m net profit, down 69 per cent, was tarnished by a $10.8 million non-cash goodwill impairment.

Management dispatched a 4.25c dividend, fully franked, as well as a special div of half a cent.

Given management’s confidence of double-digit earnings growth in the current year – albeit weighted to the second half - we will assume the ordinary div is at least maintainable, which puts the stock on a plump yield of 8.5 per cent.

Paragon Care (PGC) 45c

The provider of medical equipment, devices and consumables is also no acquisitive wallflower, having bought 16 businesses over the last 15 years.

Management also knows how to bid adieu to the lesser bits, having just sold a legacy operation called Axis Health to Cabrini Health for $4.5m cash.

As with RXP, Paragon is focusing on selling higher margin technology rather than the bog-standard stuff: think intraocular lenses rather than lab aprons.

Paragon’s revenue doubled to $236m in the 2018-19 year, with ebitda increasing 28 per cent to $28m. However some research and development costs and accounting flummery meant the company posted a $14m loss, which constrained the dividend to the first half payout of 1.1c.

There’s no reason why Paragon can’t resume its policy of paying out 40-60 per cent of net earnings in the current year. Bell Potter forecasts earnings per share of 4.2c, which equates to a 5 per cent yield assuming a 50 per cent payout.

Meanwhile, CEO Andrew Just has resigned just shy of two years’ service, to be replaced by Phil Nicholl (the head of the company’s biggest division, Surgical Specialties).

Intriguingly, co-founder Mark Simari has returned to the board after a two-year hiatus. The reshuffle comes amid reports that private equity interests are sizing up the company, so this one might not stay a simple yield play for too long.

Capral (CAA) 11c

Admittedly, the maker of aluminium products such as windows and doors has been more of a dividend trap in recent times, with the housing downturn and unfair import competition playing havoc with the bottom line.

But there are better times ahead if Capral’s rightsizing exercise – as well as a round of anti-dumping tariffs –proves to be the tonic.

Capral makes a range of extruded and rolled products – mainly the former – and is equally exposed to the residential and industrial sectors. The latter includes transport and marine.

Capral posted a June (first) half loss of $8.4 million no steady revenue of $201m, with the restructuring costs of $6.4m accounting for most of the deficit.

Trading ebitda – management’s preferred measure that allows for extraneous revenue and expense items – fell to $2.4m from $6.9m previously.

But management expects a much better current half, with calendar 2019 trading ebitda guided at $10-12m.

The company dispensed a half a cent interim div and a 1c final payout last year, but refrained from a half-year distribution this year.

But if management’s projection is on the money, February’s full-year numbers should deliver some dividend joy.

A one cent a share payout implies a yield of 8.7 per cent. The stock is also trading under net tangible asset backing of 23.8c.

Gale Pacific (GAP) 27c

The Melbourne-based maker of shade sails and crop protection fabrics shows that an export-oriented manufacturer in this country can be viable with an innovative attitude, a sharp eye on costs and a favorably low Aussie dollar.

Gale also makes some of its product in China, which is posing a problem in its important US market as Tariff Man hoists the protective barriers and makes these products more expensive for US consumers.

Difficult markets locally and in the Middle East mean Gale’s first (December) half earnings will be off the pace -- a loss in fact – but full year profits before tax should be 20 per cent lower than the previous year’s $11.2m.

At the post tax level this implies a full year div of 2c a share, given the company’s policy of paying out at least 60 per cent of “underlying” net earnings.

We’ll be conservative and assume only a one cent a share final div, in line with the previous year’s payout. This puts the stock on a yield of 3.8 per cent (unfranked).

Tim Boreham edits The New Criterion


Disclaimer: The companies covered in this article (unless disclosed) are not current clients of Independent Investment Research (IIR). Under no circumstances have there been any inducements or like made by the company mentioned to either IIR or the author. The views here are independent and have no nexus to IIR’s core research offering. The views here are not recommendations and should not be considered as general advice in terms of stock recommendations in the ordinary sense.

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5 stocks mentioned

Tim Boreham
Tim Boreham
Editor of New Criterion
Independent Investment Research

Many readers will remember Boreham as author of the Criterion column in The Australian newspaper, for well over a decade. He also has more than three decades’ experience of business reporting across three major publications.

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