I don't normally waste my time on situations that are "too good to be true." If I see a double-digit payout next to a stock symbol that is not a REIT or LP, I assume it is the result of something bad. Usually it is because the stock price has dropped dramatically on its way to bankruptcy, and the old dividend policy is no longer in effect. Then again, maybe the payout was a one-time distribution due to the sale of its most profitable division, and we will never see that again. Management may be getting rid of a cash hoard to avoid losing their jobs to a takeover. At any rate, I assume the big dividend is a red flag more than an enticement to buy the stock.
That is why it is unusual to find legitimate double-digit dividend payers that may actually be able to increase the payout. This article is about two little-known special situations that have been paying big dividends, and we have reason to believe they may pay even more.
Both of these small cap stocks have these seven things in common:
A. Management that is inclined to pay dividends.
B. Prospects for growth in income and cash balances.
C. Need to get market recognition.
D. Possible removal of a restraint to increasing dividends.
E. Irregular and flexible dividend policy.
F. Revenue stream from existing customers.
G. Success of similar companies in their area with distribution increases.
The combination of the above factors may be forming the "perfect storm" to start raining dividend income to their stockholders. Of course, everyone is familiar with the management disclaimer that the "dividend will be evaluated quarterly on the basis of the cash needs of the company's operation." Of course, if we wait for the dividend announcement, we may find ourselves chasing the stock. It is not that difficult for us to be aggressive about taking a small position in a growing $4 stock with a juicy dividend history.
The situation of Cimatron, Ltd. (CIMT) is very intriguing. In my studies, I have been skipping past this one simply because of its alleged 18% payout. However, it popped up while screening for micro-cap growth stocks, so I decided to put it under the microscope. CIMT sells for $3.88, and it paid a total of $.71 in two distributions in 2011. It is based in Israel, and I have noticed that many companies outside of North America only pay one or two dividends annually, so that is not unusual.
Cimatron develops, sells and supports CAD/CAM software to facilitate the manufacturing process for clients globally. In 2011, its net earnings increased 50% to $.48 per share, a PE of 8. Obviously, earnings are less than the payout, but it is only 70% of free cash flow. CIMT currently still has $1.27 per share in cash per Yahoo statistics, so the current yield percentage is sustainable if the company just breaks even this year. CIMT essentially sells licenses and maintenance, and so their gross margin is about 87% of revenue. Value-wise, the company has sales exceeding market cap, and the stock is priced at about 2X book value.
Growth drivers for Cimatron are product innovations, acquisitions and further global penetration. The current revenues are divided as follows: Europe 49%, US 32%, Asia 15% and rest of world 4%. Given that its largest market has been and remains in economic crisis, the long-term prospects for European growth could be very good. However, the short-term could get worse, which may be priced into the stock already. It does have competition, but the cost may be prohibitive for existing customers to modify their manufacturing process to change software. The repeating stream of software and maintenance fees supports dividend stability.
CIMT is currently being restrained from paying as much as they would like. In the February conference call, the management mentioned that they began a court process to get approval from the Israeli government to pay out up to $10MM in distributions. For perspective, last years' $.71 represented a $3.2MM payout. The company expects the resolution by mid-year, and the bulk of license renewals are received in the first six months of the year, so we suspect the next big payout will be mid-year. We do not think that CIMT will actually pay out $10MM in distributions, but if it maintains a 70% payout rate we could see more than the 2011 distribution.
I must admit that I was still skeptical about an Israeli company with a somewhat mature technology raising its already generous distribution. Then we saw Ituran Location and Control, Ltd. (ITRN) announce a fair earnings report and a dividend increase a few weeks ago, and the stock popped more than 10%. It did get a shove from Zacks, but the similarities between ITRN and CIMT are notable. Besides being Israeli with maturing technologies and a global customer base, it also has repeat revenue streams. ITRN clients subscribe to a vehicle location and recovery service. From a value point of view, ITRN's stock price is 2X sales and 3X book value. If CIMT's stock price increased 50% - 100%, it would have similar comparisons, giving us some room for capital appreciation. Of course, if the price doubled, the current distribution would not exceed 10% of stock price. Crazy as it may seem, if that occurred, investors might be bigger believers in CIMT at the higher price.
Finally, in the conference call there was discussion about doing something to attract more investor interest, and I know nothing better than a nice distribution increase to catch investor attention. Right now investors may be looking at 2011 as a one-time anomaly, so another nice payout in 2012 would establish credibility in the income generation prospects for CIMT.
While we are on the subject of a company looking for respect, enter Universal Insurance Holdings (UVE), one of the three leading writers of homeowners' insurance in Florida. It is also beginning to operate in the Carolinas and Georgia. Premium revenue has been flat lately, and the company's third quarter income compared poorly with the year earlier, mostly due to losses on its equity investments. Nonetheless, for the nine months they have earned $.55 per share, so if they make no income in the fourth quarter they have a sub-8 PE ratio. We have reason to believe that the fourth quarter report, scheduled for March 26, should yield some improvements.
UVE last declared a $.10 quarterly dividend, which equates to about 10% annually. The company does not pay a consistent dividend, and that is reason for concern for current and future stockholders. This policy is somewhat understandable given that their income is dependent on such things as the weather and the stock market, both of which can surprise the best prognosticators.
In the third quarter the company lost $10MM on stock investments, which surely was considered in the reduction of the quarterly dividend from $.14 to $.10. At the end of the third quarter, they held about $100MM in stock, and the S&P 500 added 14% in the fourth quarter. If we assume they underperformed the market and only earned back the $10MM, after adding nominal insurance profits and deducting taxes, the company could earn $.20 in Q4, and $.75 for the year. A 60% distribution rate would raise the annual dividend to $.45, or a 12% increase. Maybe it could reinstate the $.56 dividend ($.14 quarterly), especially if income beats these conservative projections.
We also know that Q1, ending this month, could show another exceptional return for equity investments. Additionally, the State of Florida allowed a 14.9% premium increase for homeowners' renewals, effective February 28, 2012, so Q2 2012 may also show some growth. The point is that we have reasons to believe that the company can show nice income improvements in the next three reports.
I am skeptical that a small local insurance company will get enough investor interest to actually move the stock. We should look at the recent performance of Homeowners Choice (HCII), which also sells property insurance in Florida. This company was the subject of our first "Shadow Stock" article. It spent three months trading sideways until it raised its dividend and reported a blowout Q4. The stock has risen 50% since those events in less than two months. It is possible that UVE can do the same.
Both have dependable revenue streams from policy renewals, but HCII has a defined dividend policy which makes investors more comfortable. As a result, the HCII dividend is substantially less than that of UVE.
While it is nice to know that a company will pay a defined amount quarterly or monthly, that requires a conservative stance on payout percentage of cash flow or income. The case can be made that companies such as Cimatron and United Insurance Holdings are more flexible to maximize distributions to shareholder advantage. There is always the risk that the management may divert resources to acquisitions or other corporate uses and forego the dividend. However, for small cap stocks with growth prospects, excellent valuations and defensible double-digit distribution histories, we are willing to take the chance.