One of the ways in which private investors can gain an edge over big institutional investors is by focusing on poorly-researched small cap stocks. This doesn’t necessarily mean going without a decent dividend yield.
Small caps such as Norcros (LSE: NXR) and TT Electronics (LSE: TTG) both offer well-funded yields of 4% or more. Both companies have also issued trading updates today. While market reaction has been limited, my impression is that both sets of figures look quite promising.
Is this too good to be true?
Pre-tax profit rose by 10% to £7.7m during the first quarter at bathroom fittings firm Norcros. Net debt fell from £29.2m to £27.5m, while underlying operating cash flow rose by 20% to £16m.
The interim dividend has been lifted by 9.1%, and now stands at 2.4p per share. This suggests that full-year forecasts for 7.1p per share are entirely reasonable. That’s equivalent to a dividend yield of 4.9%.
A mixture of organic growth and acquisitions has lifted Norcros’s after-tax profits from £13.5m in 2011, to £25m last year. But investors refuse to buy into this growth story. Norcros shares trade on a forecast P/E of just 5.7.
What’s the problem?
Norcros has a massive pension deficit. According to today’s results, the gross deficit on its UK final salary scheme rose from £55.7m to £97.8m during the six months ending 30 September. This is the result of falling bond yields following the EU referendum.
Norcros currently makes a deficit reduction payment of £2.5m each year. This payment may rise in the future, hence the market’s caution. But it may be worth remembering that bond yields have risen sharply since the US presidential election. If this continues, we could see a sharp reduction in pension deficits, as fewer bonds will be required to produce the income needed to fund pension obligations.
In my view, pension risks are already fully priced into Norcros’s share price. At current levels, I rate the shares as a strong buy for patient investors.
Ahead of market expectations
Electronic component manufacturer TT Electronics has had a tough few years. The firm’s shares have lagged the market and are still worth less than they were at the end of 2011. But today’s trading statement suggests that the tide could be turning.
Organic revenues rose during the four months to the end of October. TT said that its order book is “marginally ahead” of where it was one year ago, while the integration of recent acquisition Aero Stanrew has added further orders.
I was disappointed that TT didn’t include any details of sales growth in today’s update. But the firm did provide some numbers to show how the weaker pound has boosted profits.
Exchange rate movements during the first 10 months of 2016 have added £2.5m to underlying operating profit. To put this in context, the group’s operating profit was £21.7m last year.
TT Electronics now expects full-year results to be ahead of expectations. This suggests that earnings per share will be above current consensus forecasts of 10.6p per share. My estimates suggest that the shares now trade on a forecast P/E of no more than 12, and offer a prospective dividend yield of 4.3%. I’d rate TT as a buy at these levels.