Smaller High-Yield Stocks Hold Their Own

06/04/2012 11:45 am EST

Focus: GLOBAL

Rob Carrick

Columnist, The Globe and Mail

Smaller High-Yield Stocks Hold Their Own

In the Canadian market, blue chips are nice, but a select group of smaller-cap dividend payers are even more interesting, writes Rob Carrick, reporter and columnist for The Globe and Mail.

Enough with the fawning over Enbridge (ENB), Canadian National Railway (CNI), Telus (Toronto: T), and other big blue chips that made good money while the overall Canadian market plunged in the past year.

Smaller dividend-paying companies are a lot more interesting right now. Not only do they offer more generous dividend payments, but they’ve held up at least as well as big blue chips in the recent stock downturn.

Frankly, this defies logic. Smaller companies with higher dividend yields should be more risky. And yet, analyst Harry Levant of IncomeResearch.ca says the 140 high-yield corporations he follows have declined just 4.5% as a group from early 2011 through May 31, compared to a loss of 14.5% for the S&P/TSX composite index.

Levant’s top 14 picks in that group were presented in a Portfolio Strategy column in January 2011. Since then, this smaller group has risen 10% in price.

Amid continuing uncertainty in global markets, Canadian investors have shown a strong inclination for the shares of big companies with reassuringly strong franchises that can sustain dividend payments come what may in the economy. Think Enbridge, Tim Hortons (THI), Telus, and Canadian Tire (Toronto: CTC).

High-yield corporations—that’s Levant’s name for smaller-size dividend payers—may be of lesser size and reputation. But the best of them offer similar degrees of stability in the revenues they generate and the dividends they pay.

“Not that the high-yield sector doesn’t have its ups and downs, but I’ve been watching it for almost seven years and there’s a lot of stability in the cash flows,” Levant said.

Where high-yield corporations differ from big blue chips is in the amount of income they generate. Whereas Enbridge, Tim Hortons, and Telus yield between 1.5% and 4.1%, respectively, Pembina Pipeline (PBA) pays 6%, Cineplex (Toronto: CGX) pays 4.6%, and Brookfield Infrastructure Partners (BIP) yields 4.8%.

Still higher yields are available from Wajax (Toronto: WJX) and A&W Revenue Royalties Income Fund (Toronto: AW.UN), both in the mid 6% range.

The savvy investor has to be suspicious of large companies with shares yielding much more than 5%. Usually, that’s a sign the company is out of favor. But high-yield corporations offer abundant income and are very much in favor.

In fact, the Income Research Top 14 have outperformed not only the S&P/TSX composite index, but also the S&P/TSX 60 index, which is made up of the largest, most liquid stocks in the Canadian market. All stocks in the 60 index pay a dividend, with the exception of Research In Motion (RIMM).

The Top 14 also outperformed the S&P/TSX Dividend Aristocrats Index, which is made up of a mix of large and small dividend payers.

Levant believes high-yield corporations have done well in part because they’re a rich source of income at a time when interest rates are near historic lows. He also believes investors like the monthly dividends that are usually paid by these stocks, most of which used to be income trusts.

“It’s the reliability of the cash flow coming every month,” he said. “It creates a reason for owning these stocks if the market doesn’t happen to be rising a lot.”

Here’s a reason to think twice about high-yield corporations: As dividend growers, they’re mediocre. In Levant’s Top 14, only five stocks have increased their dividends in the past 18 months and two have made substantial cuts.

If you’re looking for high yields to generate income in the here and now, then high-yield corporations make sense as an investment.

“In exchange for that higher yield, you’re less likely to get less growth,” Levant acknowledged. “You’re going to have to primarily be happy with the yield you get when you buy.”

You don’t have to entirely give up on dividend growth with high-yield corporations, though. Brookfield Infrastructure Partners raised its quarterly payout to 37.5 cents a share from 26.5 cents in 2009, and Wajax increased its dividend to 27 cents a month from 15 cents in early 2011.

Concerned about the risk of dividend cuts with high-yield corporations? You may remember that plenty of half-baked income trusts came to market several years back and couldn’t sustain their payouts. Think of today’s high-yield corporations as hardy survivors from the old trust universe.

“I can’t say the chances of a dividend cut are zero, but I would say it’s extremely unlikely that you’re going to see reductions in a Cineplex, for example, or an A&W or a Brookfield,” Levant said.

As the Top 14 list shows, the most serious risk of dividend cuts comes from economically sensitive, resource-based businesses like Labrador Iron Ore Royalty (Toronto: LIF), which reduced its payout by 25% since early 2011, and Westshore Terminals Investment (Toronto: WTE-U), which reduced its payout by almost 35%.

It’s not unusual for these sorts of companies to cut payouts in hard times and raise them when things are going well. Some resource companies in the high-yield sector have held their payouts steady, mind you. Two examples from the Top 14 are Arc Resources (Toronto: ARX) and Crescent Point Energy (Toronto: CPG).

Levant is not making any deletions from the Top 14 list first presented 18 months ago, but he does have a couple of additional names for investors to consider.

One is Chemtrade Logistics Income Fund (Toronto: CHE.UN), and the other is yet another offering from the Brookfield family of companies, Brookfield Real Estate Services (Toronto: BRE). From the original 14, his top choices right now are Cineplex and Brookfield Infrastructure Partners.

What these and other high-yield corporations have in common is some appeal for investors who want income and can live with stock market ups and downs.

“I have some clients who can’t stand any volatility, even though the income is coming,” Levant said. “And then there are clients you never hear from. They just simply say, I accept this stuff’s going up and down, just send me my dividend check.”

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