Often ignored by income seekers, UK small caps offer a surprising number of payout opportunities.
Laura Foll, UK equities manager at Janus Henderson Investors, believes people always assume smaller companies are all fast-growing names, such as Asos and Fever-Tree, but they are not. ‘This gives us opportunities to find income in small caps: in companies with scope to grow and pay an attractive dividend,’ she said.
Foll is finding such opportunities across several sectors, including retail and industrials. ‘We’ve been adding to Redde, a service provider to the motor insurance industry,’ she said. ‘It pays a 6% yield and the management team is excellent.’
She also highlighted convenience store business McColl’s. Foll pointed out it had bought 300 stores from the Co-op and signed Morrisons up to a supply agreement.
‘It has a canny management team and is on an attractive 3.5% yield,’ she said. ‘It’s what we’re looking for: a traditional business with strong management that’s growing.’
Pros and cons
Foll is aware of potential downside risks associated with smaller companies. ‘They tend to be more domestically focused. So a sharp slowdown in the UK economy would have more of an effect on small cap income than FTSE 100 income,’ she said.
However, there are also upside opportunities, with dividend growth often higher than expected because of strong earnings growth. ‘When we’re doing our dividend forecast for the year we are often far too conservative. Both the growth and dividend growth of these businesses tend to be quite strong,’ she said.
Plenty of opportunities
David Taylor, Citywire A-rated manager of the MI Chelverton UK Equity Income fund with David Horner, agreed there are plenty of income opportunities. ‘There’s lots of income in the small- and mid-cap area, concentrated within UK housebuilders, UK builders, retailers, and small financials,’ he said.
Taylor argued stocks are being sold off despite the top-down news. This makes the background appear worse than the conditions that companies are actually experiencing.
He cited Crest Nicholson, the housebuilder, as an attractive holding. ‘It’s run well, there’s a lot of demand for houses, people can still get mortgages, and there’s a 5% yield,’ he said.
Retailer Halfords is another favoured name. ‘The management team has done a good job. The business is very cash generative, and it has a niche in the market,’ he pointed out.
Range of returns
There are many innovative businesses among small caps. But there is also a huge dispersion of returns, according to Mike Prentis, manager of the BlackRock Smaller Companies trust.
‘We focus on high-quality, cash-generative businesses with predictable revenues that can deliver both growth and dividends over the long term,’ he said. The portfolio is also very international: ‘Around half of the portfolio’s revenues are generated from overseas. This gives us exposure to the improving global economic backdrop,’ said Prentis.