This small-cap could yield more than 20%! Is time running out to buy?

I’ve had a favourable view on JackpotJoy (LSE: JPJ) and the gaming company’s outlook for some time. But until recently, I’ve also been happy to observe this growth story from the sidelines. 

However, after watching the share price fall more than 40% over the past three months, I reckon now could be the time to get involved. 

Cash cow

The first thing that you notice when you look at Jackpot’s balance sheet is the company’s debt. At the end of 2017, the firm had an adjusted net debt balance of £387m, and an adjusted leverage ratio of 3.6 times. But this balance is falling rapidly. The group’s results for the nine months ended 30 September, which were published today, show the adjusted net leverage ratio falling to around three times. Meanwhile, adjusted net income increased 36% year-on-year, partly thanks to a 36% decrease in interest expenses. 

Jackpot’s hidden weapon is its free cash flow. For the year to the end of September, the group generated operating cash flows of £33m, most of which was used to pay down debt. 

In my view, this robust cash generation indicates that Jackpot is set to become one of the market’s top income stocks when debt is reduced to an acceptable level. Management is targeting a leverage ratio of below 2.5x earnings before interest, tax, depreciation, and amortisation, at which point “the Board can consider options to return cash to shareholders.“

As group free cash flow was £31m for the year to the end of September, I think cash returns could exceed £30m per annum, which gives a yield of more than 26% on the current market value. 

That said, Jackpot’s outlook isn’t wholly speed-bump free. In today’s release, management acknowledges that headwinds, including the expiration of a non-compete arrangement and additional gambling regulations, will hurt revenue growth over the next 12 months. So, I’m not willing to bet the house just yet. Nevertheless, with a potential dividend yield of more than 20% on the horizon, it looks to me as if there’s a wide margin of safety in the figures for investors buying today. 

Slow and steady 

With so much debt on the balance sheet, some investors might not be comfortable owning Jackpot. If you fall into this bracket, I think you should check out Secure Trust Bank (LSE: STB). 

Secure Trust has grown rapidly over the past five years, expanding revenues from £57m to £131m for 2017. Analysts expect the business to report further growth in 2018, with revenues set to rise to £154m, and then £181m in 2019. Off the back of this revenue growth, analysts think the company will earn 187p per share in 2019.

Historically, Secure Trust has distributed the majority of its earnings to investors via dividends. Analysts expect this to change over the next few years, however, as earnings growth accelerates. Payout cover is predicted to rise from 1.4 times in 2017, to 2.1 by 2019. 

I think these numbers could be conservative, considering Secure Trust’s history of distributing close to 100% of earnings. And analysts’ yield projection of 6.1% for 2019 understates Secure Trust’s true potential as an income play. Even if I’m wrong, a yield of more than 6% is nothing to be sniffed at. What’s more, today the stock is trading at a forward P/E of just 9.5. What’s not to like?