Amid concerns about the “Big Four” banks’ dividend outlook and as BHP Billiton and Rio Tinto slash their dividends, many investors may now be turning their attention to small and mid-cap companies in their hunt for yield.
Growth over yield
With small and mid-cap companies often growing at a much faster rate than their large-cap peers, their preference is often to reinvest profits to fund growth, rather than pay out dividends. As a result, the average dividend payout ratio of smaller companies is considerably lower than the ASX’s top 100 companies. Conversely, large-cap companies are typically more mature, lower growth businesses, with greater cash flow which they can pass on to shareholders as dividends.
Shareholders of small and mid-cap companies typically welcome the reinvestment of profits as it drives growth, providing them with a more attractive return on capital. Companies still in their growth phase with high dividend payout ratios risk constricting further growth.
Growth and yield
In the small-to-mid-cap space there are some exceptions to the high growth / low or no-yield scenario with some companies baring both growth and yield characteristics. It is worth pointing out, such companies are unlikely to have both strong growth and strong yields concurrently. As the saying goes, you can’t have your cake and eat it too. As a company successfully grows its business and experiences strong share price appreciation, its dividend yield can decline.
ARB Corporation (ASX: ARB)
Australia’s largest maker and distributor of four wheel drive accessories, ARB Corporation is a mid-size company exhibiting both growth and yield features. Unlike many mid-caps, it is a mature business and has been a strong dividend payer over time. It has grown its dividends on a per share basis over the last 10 years and recently announced a fully franked final dividend of 17.0c a share. ARB has also delivered strong capital growth. Its share price has climbed steadily since the GFC, increasing from around $3.40 a share to more than $17.00 a share.
TechnologyOne (ASX: TNE)
Similarly, enterprise software company TechnologyOne is a reliable dividend payer and also a growth story. For well over a decade, the business has delivered earnings growth of around 15.0% per year as its share price has soared from less than $1.00 a share to more than $5.50 a share. TechnologyOne is a consistent dividend payer having paid out dividends to shareholders each year over 20 years. In May this year the company announced a fully franked 2.36c per share half year dividend.
Unpaid franking balances
For most investors, particularly Australian tax payers, franking is an important consideration when it comes to dividends. Australian companies are very cognisant of their franking balances and shareholders’ preference that they be distributed by way of fully franked dividends. Franking credits are of much better use in shareholders’ hands than the company’s.
About two years ago, Harvey Norman (ASX: HVN), MACA Limited (ASX: MLD) and Tabcorp (ASX: TAH) released franking credits from their balance sheets by way of special dividends using the proceeds of capital raisings. While this was a popular move with investors, the ATO subsequently cracked-down on such initiatives. Currently, a number of small- and mid-cap companies retain considerable franking account balances on their balance sheets which shareholders are yet to benefit from.
Credit Corp (ASX: CCP)
Debt purchasing and consumer lending company Credit Corp has experienced strong profit growth over a number of years, but maintained a low payout ratio of around 50.0% which has resulted in a build-up of franking credits. With a share price of $18.98, Credit Corp currently has a franking balance of $1.85 per share. Or in other words, the company has the ability (subject to having the retained earnings to pay out) to pay a fully franked dividend of $4.25 per share based on this franking balance.
Enero Group (ASX: EGG)
Following the restructure of the marketing and communications company in 2010, Enero has been unable to pay a dividend which has led to the accumulation of franking credits on the company’s balance sheet. Enero has a franking balance of 26 cents a share ensuring the company is in a strong position if or when it resumes paying dividends. Enero shares are currently $1.125 each. Subject to having the retained earnings to pay out, Enero has the ability to pay a fully franked dividend of 59.8 cents per share based on this franking balance.
Premier Investments (ASX: PMV)
Retail group Premier Investments has a high franking credit balance as a result of its 2008 acquisition of Just Group, which unlocked $237 million in franking credits. With a share price of $15.63, the company currently has a franking balance of $1.32 per share. Based on this franking balance, Premier has the ability to pay a fully franked dividend of $3.036 cents a share provided it has retained earnings to pay out.
Payout ratios to remain static
We expect economic growth to be weak and interest rates to remain low and, in combination with SMSFs’ strong appetite for dividends, these factors will sustain the current yield-driven environment. In our view, there is an overall propensity for dividend payout ratios to remain at their current levels for the next five-to-10 years.
*All figures provided in this article are as at the market’s close on Tuesday, 27 September 2016.
Entities managed by Wilson Asset Management own shares in CCP, EGG and PMV.