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Cargojet Inc.

Larry MacDougal/The Globe and Mail

Investing in Canadian small-cap stocks can reap dividends – literally.

While the big blue-chips with payouts garner the attention, there are dividend opportunities among smaller companies, too. Some are former income trusts used to doling out healthy distributions. Others have more modest payouts because they need to fund growth. Because smaller caps can take a bigger hit than their larger peers during market downturns or fly under the radar with little analyst coverage, investors may be able to snap up these shares at attractive prices.

We asked three portfolio managers for their small-cap dividend picks.

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Alex Sasso, portfolio manager with Norrep Capital Management Ltd., Toronto

  • Hardwoods Distribution Inc. (HWD-TSX): This hardwoods distributor is a way for investors to play the U.S. housing recovery because 75 per cent of its sales come from south of the border, says Mr. Sasso, who runs Norrep Income Growth fund. The British Columbia firm, which has a solid balance sheet, has been growing by acquisition. Its 2014 purchase of U.S.-based Hardwoods of Michigan Inc. provides exposure to the growing commercial market, while it is also increasing sales of imported lumber, he said. A strong U.S. dollar has been a tailwind as earnings from its American operations are converted back into Canadian dollars, but a weaker greenback could be a risk in the second half of this year, he noted. The stock, which trades at about 11 times next year’s earnings, could hit $20 a share in a year, he suggested.
  • Badger Daylighting Ltd. (BAD-TSX): Rising infrastructure spending is a potential tailwind for the Calgary-based excavation contractor whose shares have struggled amid falling oil prices, says Mr. Sasso. Half of Badger’s revenues used to come from the energy sector, but that percentage has fallen recently to 38 per cent, he said. The rest of the revenues now stem from the utility and construction sectors. Revenue has been flat in the past couple of years, but it’s been “a wonderful growth story” over the long term, he said. Badger, whose hydrovac trucks can dig earth without damaging buried pipes and cables, is also expanding into the larger U.S. market. Shares of Badger, which has a payout ratio of less than 20 per cent, trades at about 17 times next year’s earnings, he said. “We think this stock could be in the $30 range in a year.”

Aubrey Hearn, portfolio manager with Sentry Investments, Toronto

  • Information Services Corp. (ISV-TSX): Shares of the Saskatchewan provider of registry and information services has struggled recently amid a weaker economy, but it still benefits from having a monopoly, says Mr. Hearn, who manages Sentry Small/Mid Cap Income fund. The company, which is 30 per cent owned by the province, administers land, personal property and corporate registry services. “Saskatchewan is not Alberta but it does have some oil and gas exposure … and we are seeing a weakening housing market,” he said. However, Information Services has about $34-million in cash on its balance sheet, and part of its business is tied to recurring revenues, such as mortgage refinancing. The payout ratio is close to 80 per cent so the dividend is still safe, he added. His target is about $18.50 a share within two years.
  • Cargojet Inc. (CJT-TSX): Shares of the Canadian cargo carrier are poised to gain more altitude with the help of a seven-year contract from Canada Post that began last year, says Mr. Hearn. The contract – a massive win on top of business from major customers such as United Parcel Service Inc. and TransForce Inc. – has about doubled the size of the company, he said. Cargojet now has a near monopoly on the domestic market, while “the tailwind of e-commerce is also going to benefit the company for many years,” he added. More than 70 per cent of revenue stems from long-term contracts, while the rest is ad hoc business, he said. Continued weakening of the western economy or potential problems integrating the Canada Post business are possible risks to the stock, he said. His target is $34 within two years.

Michael Waring, portfolio manager with Galileo Global Equity Advisors Inc., Toronto

  • Chorus Aviation Inc. (CHR.B-TSX): The stock of the regional airline is appealing for income-oriented investors because of its robust yield and sustainable dividend, says Mr. Waring, manager of Galileo High Income Plus fund. Most of its revenues come from an agreement with Air Canada, which will buy seat capacity at pre-determined rates until 2025. Nova Scotia-based Chorus, which operates aircraft under the Air Canada Express brand, pays about 60 per cent of its free cash flow for dividends so there is room to raise the payout. Chorus, which has little competition on its routes, is adding new capacity, and recently inked a deal to buy five CRJ900 aircraft from Bombardier Inc. Chorus’ stock, which trades at seven times Galileo’s free cash-flow estimate, could hit $7.50-to-$8 a share within a year, he suggested.
  • Pure Multi-Family Real Estate Investment Trust (RUF.UN-X): This Canadian REIT, which operates resort-style apartments in Texas, will benefit from the state’s strong job and population growth, Mr. Waring says. Cheap rents, a young work force and lack of corporate income taxes have spurred more firms to move head offices to the state. The REIT, which has properties in Dallas, Austin, San Antonio and Houston, has had consistent rental growth in a state with no rent controls. The REIT, which has a payout ratio of about 86 per cent, trades at a discount to its net asset value and at lower price-to-earnings multiples versus comparable U.S. REITS, he said. Potential headwinds include rising interest rates and a weaker U.S. dollar versus the loonie because of the impact of currency conversion. The REIT’s units could reach $8.50 to $9 a unit within a year, he said.
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