Five High-Yield, Small Cap Stocks

by: John Femino, CFA

Given the uncertainty in the equity market and low current interest rates, high yielding stocks are increasing in relevance and becoming a more desired investment option as they can provide a good income stream in a weak market. Typically, utilities, financials, materials and energy companies are thought of first when one thinks of high yielding industries and for good reason - they have been known to pay a hefty dividend. Today, I am going to look at five high yielding companies outside of these industries to try and provide some diversification options for those with an income-oriented approach.

While the yield is the primary target of each of these five companies, it can’t be the only requirement. In order for a company to pay a high yield it needs to be able to generate cash flow to pay out. Each of these five stocks has a positive free cash flow over the last twelve months and is expected to be able to generate one in 2009. The other thing these five stocks have in common is that they all yield at least 6% at current prices. This is double the expected rate of the S&P 500, so these are all truly high yielding stocks. The five companies below are listed in order of yield, highest to lowest.

StoneMor Partners LP (NASDAQ:STON)

StoneMor Partners owns and operates cemeteries and funeral homes in the United States. StoneMor is the second largest owner and operator of cemeteries in the United States behind only Service Corp International in what is typically a highly segmented industry. StoneMor owns 282 properties in 29 states, primarily on the East Coast. The company sells products and services at the time of death as well as prior to the time of death.

According to the company’s latest conference call the split is about 50-50 between pre- and post- death products and services. Revenues related to cemeteries accounted for 77% of StoneMor’s revenue in the first 9 months of 2008, while revenues related to funeral homes made up the other 23%. Merchandise, which includes burial vaults, caskets, grave markers and memorials, accounted for 58% of the cemetery revenue and 50% of total revenue while services was 23% of cemetery revenue and investment and other was the final 19%.

With the sharp decline the stock saw Friday, StoneMor is now yielding over 20%. That is a huge yield. Typically, once yields start to get this high, one would be worried about whether or not the dividend was sustainable. As of now, it looks like StoneMor’s should be. The company is in a non-cyclical business that traditionally isn’t highly affected by an economic downturn. While the company does have a decent amount of planned spending for 2009, they appear to have the financing either in place or lined up in order to continue to make their acquisitions and re-finance the $80 million in debt that comes due in September without impacting current cash or cash flow.

While the company only shows $13 million in cash on its balance sheet, StoneMor generated $14 million in free cash flow over the last twelve months and should be able to continue to generate a positive cash flow in the future. Also, StoneMor generates income from the hundreds of millions in reserves it invests for yield. Given its status as a MLP, StoneMor is required to pay out most of its income so its dividend is highly unlikely to be suspended. StoneMor announced its quarterly dividend of .555 in January and already paid it earlier this month, the 18th consecutive quarter with a dividend payment of at least $.46, so the size of the dividend appears to be safe for now as well. Unless StoneMor runs into unexpected financing problems this should be a very high yielding stock for your portfolio.

B&G Foods (NYSE:BGS)

B&G Foods manufactures and distributes a number of different shelf-stable foods, i.e. boxed and canned goods. Its brand lineup includes Cream of Wheat, Ortega, Emeril’s, Polaner and B&M. It distributes its products to a variety of customers including grocery stores, warehouse clubs and mass retailers, i.e. Wal-Mart (NYSE:WMT), which turn around and sell them to the end customer. The majority of its products are stable, non-luxury brands which typically are not highly affected by a weak economy.

B&G is another stock with a huge yield, 19.2% to be exact as of the 2/20 close. While the yield might seem overly high to be considered safe, B&G management is confident that they will be able to maintain current dividend levels. At the January 15, 2009 ICR XChange Conference CEO Dave Wenner made it a point to try and paint the dividend as safe. Wenner expects B&G Foods to generate free cash flow in the mid-$30 million range in 2009 while the dividend payments at the current rate of $.17 per quarter will total around $25 million. This gives B&G a little bit of wiggle room even if the prediction does not fully hold.

Free cash flow for the last twelve months was about $28 million, so the CEO’s expectation seems achievable. Additionally, the company has $32 million in cash on its balance sheet that it is prepared to use to create benefits for shareholders including a stock repurchase program. Wenner also talked about the $535 million the company has in debt and, while he recognized that there were concerns about it, he felt that it would not be a short term issue whatsoever as there are no repayments due until October 2011 and the company can easily handle its current interest payments.

It should be noted that B&G did recently cut its dividend by 4 cents a share and, while it seems like management is very comfortable with its current dividend level, even if the dividend is cut a little more in the future, the current yield is so high at 19% that the yield after a cut of even 50% would still be very attractive.

Methode Electronics (NYSE:MEI)

Methode is a major supplier of electromechanical devices for the automobile industry. The company designs and manufactures at least 35 different products in this segment including items such as steering wheel controls, power door switches and air bag system clocksprings. Over the last twelve months, the automotive segment accounted for 64% of the company’s revenue. The Interconnect and Power Products segments account for the majority of the other 36%, at 26% and 9% respectively. The Interconnect segment provides a variety of copper and fiber-optic interconnect and interface solutions for the appliance, computer, networking, telecommunications, storage, medical, military, aerospace, commercial and consumer markets. This segment will account for a larger part of future revenues when Hectronic, a producer of industrial safety remote control products and its September 30, 2008 $53.6 million acquisition, is added. The Power Products division manufactures various items including bus devices and cabling systems.

While Methode might not appear to be in the most attractive industry given the weak auto sales environment, it appears to be good income play with a lot of upside. As of closing on 2/20/09, the stock was yielding 7.8%. While it is likely the company’s auto segment will see its sales decline in 2009, the dividend should be safe. As of its last earnings release, Methode had $52.8 million in cash and no long-term debt. Over the last twelve months, Methode had free cash flow of ~$47 million excluding acquisitions. Its strong balance sheet and impressive cash flow generation capability gives the company a lot of wiggle room even if the auto industry has a rough year or two. With the stock trading at only 37% of book value, 57% of tangible book value and 3.87x trailing normalized diluted earnings, there is also a lot of potential upside to owning Methode in addition to its impressive yield.

Ennis Inc (NYSE:EBF)

Ennis Inc. is a company that is celebrating its 100th birthday in 2009. It prints and manufactures a broad line of business forms and other business products and also manufactures a line of activewear for distribution throughout North America. They print everything from shipping labels to warranty forms to the floor mats you get after a tune-up and everything in between while also doing commercial printing and ad concepts. Ennis sells its products primarily to distributors who then sell its products to the end user.

In its apparel business, Ennis sells primarily to direct customer branded products. While it sells a variety of products, the overwhelming majority of sales comes from t-shirts, which makes up about 95% of the segment’s revenue. During FY 2008, the print business accounted for 56.5% of company revenue, while apparel accounted for the other 43.5%. Ennis earns essentially all of its revenue in the U.S. and the little that comes from outside the U.S. comes from Canada.

Ennis has kept its same $.155 quarterly dividend since October 1996 after raising it several times from its initial dividend in 1992. Having the same quarterly divided for over 12 years shows that management is very comfortable with the rate and knows how to manage it and plan for it. While at first glance this business model seems more susceptible to a spending slowdown than the others mentioned, it has already kept its dividend consistent through a number of up and down markets.

Additionally, the balance sheet, with only $3 million in cash and $71 million in long-term debt, isn’t as strong as some of the other companies in this article. But, there is good reason for this. The company appears to target a low cash balance because of its impressive cash flow generating capability. Ennis has been paying down its debt with all of its “extra” cash the last couple of years using about $20 million for this purpose in 2008. The company generated $45 million in free cash flow over the last twelve months while paying out $16 million in dividends, which is why it can afford to maintain a low cash balance. Ennis only generated about $5 million in free cash flow in its last reported quarter, which was disappointing; however, the low amount can be primarily tied to its larger than expected $14 million inventory build.

Even with the unusually high negative cash impact, Ennis still had enough positive cash flow to fully pay its dividend showing that the company should be able to maintain its payout going forward. If the company is able to properly manage its inventory this quarter, it should be able to reverse the cash effect and take in more cash than expected this quarter.

While I definitely applaud Ennis’ efforts to pay down its debt, I would like to see them give themselves a little more breathing room during this rough economic climate with their cash balance by building it up a little more if it does indeed have a high cash flow quarter. All in all, it appears like Ennis should be able to maintain their dividend going forward, which is an attractive 7.3% as of 2/23/09.

Electro Rent Corporation (NASDAQ:ELRC)

Electro Rent rents, leases and sells electronic test and measurement equipment, electrical test equipment and FTTx products. The company has over 26,000 different instruments in its inventory including oscilloscopes, spectrum analyzers, network analyzers, function generators, logic analyzers and telecommunication test equipment. While Electro Rent operates internationally the majority of its revenue (85%) comes from the US.

As of the close on 2/23/09, Electro Rent yielded a healthy 7.2%. Electro Rent has a clean balance sheet with no debt and $62 million in cash and equivalents. While its free cash flow generation capabilities are not as high as some of the other companies mentioned due to its high Cap Ex needs, it still generated over $10 million in FCF during the last twelve months.

Although the company doesn’t do a lot of direct business with the US Government, they feel that a significant amount of their equipment is used in government-generated projects. This is a more cyclical business than STON or BGS, but the government tie-ins help stabilize it somewhat. Even if Electro Rent’s free cash flow is flat, they have enough cash to pay dividends at the current rate for about the next 4-5 years. That paired with the fact that the company does not have any debt to worry about makes me feel pretty comfortable that the dividend is safe.

While these five stocks have passed the screener and seem interesting at first glance, I have not fully analyzed these companies. If you find any of them interesting you should perform additional research before investing.

Disclosure: The author does not have a position in any of the stocks mentioned in this article.