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3 small cap high yielders to consider

With interest rates expected to be cut even further, James Dunn explores the world of small caps for big yield ideas.

With no end to the low-interest-rate environment in sight – and the likelihood rising of the Reserve Bank of Australia (RBA) actually cutting the official cash rate even further – investors continue to look to the share market for yield.

There are several aspects of this strategy that make it one that must be constantly monitored. First, a stock market dividend yield cannot be considered as certain, because the dividend amount is at the discretion of the company, every reporting period. Two, the risk of share-price capital-loss, while holding shares for yield, is always present.

More recently, a third caveat has emerged: there are very real fears that dividend yields may fall victim, after this year’s federal election, to Labor’s proposed changes to the imputation credits policy.

The search for fully franked divided yield usually fixates on the major banks, now that Telstra’s dividend has been shown not to be immune to pruning. Investors are also attracted to some of the beaten-down retailers, on the basis that if they can maintain expected dividends, the share price falls will have turbo-charged the yields.

In fact, as long as an investor fully understands the caveats given above, there are many attractive yield scenarios potentially available on the stock market. This week, I have gone into the small-cap world to identify three high-yield possibilities, with the added attraction of scope for capital growth, as assessed by analysts.

 

1. FlexiGroup (FXL:ASX)

Market capitalisation: $509 million
FY20 forecast yield: 6% fully franked
FY20 forecast grossed-up yield: 8.62%
Analysts’ consensus target price: $1.80 (Thomson Reuters), $1.65 (FN Arena)

 

Consumer finance company FlexiGroup says it invented the ‘buy-now, pay-later’ product in Australia – it says it was the first company to have a BNPL finance product at the point of sale, about 20 years ago. So it must have been galling to watch Afterpay (APT) “Uberise” the concept to become the verb that customers use to describe buying now and paying later. While Afterpay was taking off, FlexiGroup was trying to redress a loss of focus and a growing number of unprofitable lines of business, which had their impact in a sliding share price. FlexiGroup allowed its strengths – a diversified business across point-of-sale finance, credit cards, instalment loans, leases, small business and commercial lending, and credit scoring expertise – essentially to become obscured.

The company has bitten several bullets to arrest its sliding share price, which hit a decade low last month after it surprised the market with a full-year earnings downgrade, as it took a $12 million write-down in its commercial leasing business. February’s interim report contained a 22% fall in net profit, to $31.9 million. But the report also saw a new strategy unveiled, and a major new shareholder – investment banker John Wylie’s vehicle Tanarra Capital – and these developments have reinvigorated FlexiGroup.

Its BNPL capability is to be branded Humm, and can be used for purchases up to $30,000 (Afterpay caps credit at $2,000). Retail giant Premier Investments (owner of brands including Peter Alexander, Just Jeans and Smiggle) is the fashion launch partner for Humm. But FlexiGroup sees a big market opportunity in customers’ needing to make bigger purchases, such as dental and medical expenses, furniture, sporting goods, trade services such as electronic and plumbing, and hardware.

Starting with the Australia-New Zealand launch of Humm, FXL is simplifying its range of more than 20 products and brands into four core consumer product areas: BNPL, cards, consumer leasing and commercial leasing. At last FXL has the right structure to leverage the fact that it has more than 1.2 million active customers, and is profitable.

Analysts see FXL only matching its FY18 dividend of 7.7 cents in FY19, but paying 8.2 cents a share in FY20, fully franked, which would represent a 6% yield if achieved. Grossed-up, that yield would increase to 8.6%.

 

2. Lycopodium (LYL:ASX)

Market capitalisation: $211 million
FY20 forecast yield: 6.5% fully franked
FY20 forecast grossed-up yield: 9.2%
Analysts’ consensus target price: $5.80 (Thomson Reuters)

 

Western Australia-based engineering group Lycopodium is best known for its mining services business, but it also has growing operations in infrastructure, architecture, asset and facilities management services, and process industries.

The core mining business specialises in gold, copper and diamonds work, but has recently moved into lithium and potash: Lycopodium works in Asia-Pacific, Africa and North America, through business hubs in Australia, Canada and South Africa, supported by its engineering design hub in the Philippines.

Lycopodium has built a diversified portfolio of commodities, geographies and sectors: coming off a small base, the company’s growing non-resources work is not yet ready to change the perception of Lycopodium as depending wholly on the resources cycle – resources work remains the lion’s share of revenue – but it is an area to watch, as it is steadily improving Lycopodium’s breadth of work and diversification.

Last October, Lycopodium reported a net profit of $18.2 million for FY18, comfortably above the company’s guidance of $16.5 million (Lycopodium is typically conservative when it comes to market earnings guidance). The company said that it expected results in the current year to be generally in line with FY18. That expectation did not change in February when LYL reported a 16% rise in December 2018 half-year net profit, to $8.6 million, on revenue that was down 20% to $72 million (LYL had foreshadowed this).

Lycopodium has won a series of major contracts recently, including the engineering and supply contracts for Perseus Mining’s Yaoure gold project in Cote d'Ivoire – Lycopodium has already delivered Perseus’ Sissingue gold project, also on the Ivory Coast, and completed the definitive feasibility study for Yaoure – and the EPCM (engineering, procurement and construction management) work for West African Resources' Sanbrado project in Burkina Faso.

The company’s pipeline of work continues to grow. Last year, Lycopodium and fellow WA-based engineering, construction and mining services business Monadelphous (MND) formed a joint venture company, Mondium, to work on resources projects: at its interim result, Monadelphous said that Mondium was quickly developing a strong reputation with customers, and was particularly well placed to secure further work in WA’s rapidly growing lithium market. The outlook for the resources sector is positive, and beyond the company’s guidance for static profit in FY19, analysts see scope for Lycopodium to boost its earnings and dividend in FY20. On Thomson Reuters’ consensus FY20 estimate, LYL is projected to offer a grossed-up yield of more than 9%.

 

3. Regional Express (REX:ASX)

Market capitalisation: $160 million
FY20 forecast yield: 8.3% fully franked
FY20 forecast grossed-up yield: 8.34%
Analysts’ consensus target price: $2.39 (Thomson Reuters)

 

Regional Express was very upbeat when delivering its interim result last month, with executive chairman Lim Kim Hai saying the airline had “bucked” the worldwide trend in the industry, to report a 7.7% rise in net profit, despite higher oil prices and geopolitical tensions. Revenue rose by 8.5%, to $163.8 million.

The impressive result came about through more passengers and higher fares: passenger numbers were up by 4.8% during the half – some of that due to new routes in Western Australia. Capacity, measured by available seat kilometres (ASK), increased by 1%, while the average load factor (that is, how full REX’s flights are), rose by 4.3 percentage points, to 64.2%. The average REX fare rose by $6.40, or 3%, during the December half, to $221.00. Simply put, each REX flight carries more passengers, and generates more revenue.

REX said at the interim result that it had hedged its fuel purchases for the current half-year, and that would lead to a $2.3 million cost reduction compared to the December 2018 half. While the company said there were too many uncertainties in the national and world economies for the board to provide a strong profit forecast, REX had “grounds to believe” that if trading conditions did not deteriorate further, the company could still achieve profit growth for the full financial year.

REX paid 12 cents a share, fully franked, in dividend in FY18: analysts do not expect that to change in the current year, nor in FY20 (the interim dividend for the December 2018 half-year was maintained at 4 cents. Thus, the estimated dividend yield for REX is the same as the FY18 historical yield, at 8.3%, which franking credits gross-up to 11.8% – with no indication, at present, that the dividend on which this yield is based will not come through.


About the Author
James Dunn , Switzer Group

James Dunn is an author at Switzer Report, freelance finance journalist and media consultant. James was founding editor of Shares magazine, and formerly, the personal investment editor at The Australian. His first book, Share Investing for Dummies, was published by John Wiley & Co. in September 2002: a second edition was published in March 2007, and a third edition was published in April 2011. There have also been two editions of the mini-version, Getting Started in Shares for Dummies. James is also a regular finance commentator on Australian radio and television.