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3 fund managers reveal their favourite small-cap dividend stocks

A Badger Daylighting crew drills holes in the ground for the replacement hydro poles after a storm caused damage to hydro lines in Cambridge, Ont., in 2007. Badger is one of a number of smaller companies now offering dividends to investors.

Peter Lee/CP

The menu of dividend-paying stocks is expanding thanks to the insatiable appetite of yield-hungry investors.

Once largely the domain of the big banks and utilities, regular payouts are now being offered by more small to mid-sized players as interest rates remain at paltry levels. In Canada, many of them were former income trusts that converted to corporations, but dividends are now coming from less-conventional sources such as energy firms and miners. There are now 281 dividend payers with a market value of between $50-million and $3-billion versus 242 (including trusts) in late 2009 after the worst of the global financial crisis, according to S&P Capital IQ data.

"A lot of small companies have found that if they put on a dividend, they get a lot better share price," says Michael Decter, president of LDIC Inc.

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"Investors are comforted by the dividend … It's [often] better than they can get on a bond, and have the possibility of capital gains."

Many smaller-dividend stocks are more attractively priced now compared with some larger peers that have been bid up to "fairly lofty levels," and have a greater risk of falling should interest rates rise, said Terry Thib, a portfolio manager at Hesperian Capital Management Ltd.

A few smaller players with stable businesses have enjoyed a bump in their share price because of dividend chasers. AutoCanada Inc., an operator of car dealerships, has seen its yield fall to 4 per cent from 7 per cent a year ago as its stock has climbed.

Still, the party for the smaller-cap companies is not over because they tend of outperform early in an economic recovery, Mr. Thib noted.

"You are getting paid to wait with the yield … Smaller companies can show faster growth, and are typically cheaper because they are underfollowed."

Still, there's a double-edged sword with the smaller fry.

Unlike their larger, better-financed cousins, they could be forced to cut payouts if they can't weather rough patches of slower revenue and cash flow. Any hint of dividend cut could send their share price tumbling, Mr. Thib said.

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For players new to the dividend game, the focus on offering payouts could come at the expense of future growth.

"It places a discipline on boards that did not previously exist," said Michael Waring, chief investment officer of Galileo Global Equity Advisors Inc.

"This could alter capital spending patterns going forward."

Because the smaller names tend to be under the radar, we asked the three fund managers for their top picks.

Terry Thib, co-manager of Norrep Income Growth Class

Badger Daylighting Inc.

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Annual dividend: $1.08 a share for yield of 2.7 per cent; last close: $39.48

The operator of hydrovac trucks used to dig and remove soil increased its fleet by 25 per cent last year to about 630 units, and continues to expand in the U.S. market.

Badger has a strong management team, a clean balance sheet and a history of increasing dividends, Mr. Thib said. With a low payout ratio in 2012 of 25 per cent (including capital expenditures for maintenance), "the dividend is safe," he added. Mr. Thib could see its shares hit $40 in a year.


Michael Waring, manager of Galileo High Income Plus

Canadian Energy Services & Technology Corp.

Annual dividend: 66 cents a share for a yield of 5.3 per cent; last close $12.35

The drilling fluids company has just bought a U.S.-based supplier of specialty chemicals used to make oil and gas wells productive.

It will benefit from the greater demand for these chemicals as they have become more critical in "today's more complex world of tight [shale] oil and gas exploration," Mr. Waring said. The firm, which has raised its dividend six times in three years, has a payout ratio of 71 per cent. Mr. Waring's target price is $16 a share.


Michael Decter, manager of Redwood Diversified Income

Twin Butte Energy Ltd.

Annual dividend: 19.2 cents a share for a yield of 7.9 per cent; last close: $2.41

The oil producer has successfully been drilling inexpensive wells so "it's more like a manufacturing business," Mr. Decter said.

It had a bad fourth-quarter due to weather, but "everything is fine now," he said. The company, which hedges its production and uses railways to deal with pipeline jams, could be a takeover target, he added. Twin Butte, which had a payout ratio of 91 per cent last year, could hit $3 a share within18 months, he suggested.

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