Companies listed on the Alternative Investment Market (AIM) are set to pay £1 billion in dividends in 2018, the first time the small-cap index has reached that milestone, according to research from Link Asset Services.
AIM dividends have tripled between 2012 and 2018, with more the index as a whole yielding 1.2%. Excluding non-dividend payers, AIM companies yield 2.1%, which is around half the 3.9% investors can get from their large-cap counterparts.
Still, with higher growth and returns expected from fledgling companies, it’s not a bad starting point.
Housebuilders have proved a fertile opportunity set for investors looking for income from the stock market. The likes of Barratt Developments (BDEV), Persimmon (PSN) and Bovis (BVS) each yield in the region of 4 to 6%.
In fact, the consumer goods and housebuilding sector accounted for 13% of the main market’s dividend payouts in 2017. But AIM also has numerous housebuilders that could help investors with their income requirements. The consumer goods and housebuilding sector made up 11% of AIM dividends in 2017.
But some fund managers have started to take profits from their holdings in large-cap housebuilders. This is due to a combination of a stunning post-referendum rebound and the imminent end of Government incentives, such as help-to-buy that have contributed significantly to their outperformance.
Below, we highlight a few small-cap areas of the home construction market investors might like to delve into.
Telford Homes (TEF)
Telford Homes is a London-based housebuilder that was founded in 2000 and listed on AIM in 2001.
It builds across London, but its current developments are focused in North and East London, selling on to housing associations, owner-occupiers, individual investors and institutional investors.
Telford is far more defensive than larger rivals due to its exposure to build-to-rent, says James Lynch, manager of the MI Downing Monthly Income fund. This removes a large portion of the development and house price risk as sales are contracted and paid throughout the construction process.
Further, he adds: “The attractive forward sales approach means that Telford has already sold sufficient stock to meet next year’s sales forecasts, removing an element of forecast risk. This approach is also more capital light, increasing return on invested capital.”
Lynch bought into the firm early last year at 348p and topped up later that year at what would have been around 400p, attracted to its exposure to segments of the London market that have significant supply/demand imbalances.
Revenue growth of 19% and 8% and pre-tax profit growth of 6% and 35% in 2017 and 2018 respectively is impressive. Pre-tax profit for the year ended 31 March 2019 is expected to exceed £50 million, meaning the firm would have doubled this metric over four years.
Meanwhile, last year’s dividend grew by 8% to 17p, giving it a yield of around 4%. Telford pledges to pay one third of earnings to shareholders each year.
The share price, at 408p, is slightly down on the year, and pretty much flat over three years. It is up 34% over the five years, though. Currently trading at around 8 times last year’s earnings, Lynch believes the business has been mis-valued by the market.
A return to its long-run average forward price/earnings multiple would value the firm at 530p, while if analyst forecasts are met, the stock could rise to around 570p, giving plenty of upside.
Watkin Jones (WJG)
Student accommodation provider Watkin Jones floated on AIM in March 2016 at an offer price of £1. It’s since doubled to trade at 202p today.
Previously, in addition to its student accommodation business, Watkin also had residential development and general construction divisions. However, in 2015 it dropped the latter to focus on student accommodation and multi-occupancy private rented sector developments.
It also established Fresh Student Living in 2010, through which it offers management services for student accommodation sites. This means it now offers end-to-end solutions for clients.
Like Telford, it runs a forward sale model in association with its institutional partners. This gives it “good predictability of numbers” going forward, says Ken Wotton, manager of the Livingbridge UK Multi Cap Income fund.
This also means it is able to sell developments onto institutional investors as soon as it has gained planning permission, passing development risk in the projects onto the end investor.
“Because they’ve got a good reputation, their investment partners are prepared to take that development risk on from them, where they probably wouldn’t be prepared to do that with more generalist construction firms,” adds Wotton.
There is long-term demand of student accommodation plots in University towns and cities. The company is highly cash generative and has good a management team, explains Wotton.
Watkin Jones is held in Livingbridge’s Multi Cap Income and Micro Cap funds, having got in early – around mid 2017. From Wotton’s point of view, there are no catalysts for a short-term re-rating: “It’s a long-term growth story,” he says.
“Unless they start doing something completely different, it shouldn’t be re-rated or de-rated.”
In the year to 30 September 2017 the dividend grew 10% to 6.6p, giving a yield of 2.4%. Meanwhile, revenue and adjusted operating profit – the latter metric strips away 2016’s IPO costs – each grew by around 13% year-on-year. It trades on a 2017 price/earnings multiple of just under 15 times.
Sigma Capital (SGM)
Private rental sector specialist Sigma runs the PRS REIT (PRSR), which it launched in May 2017. At IPO the real estate investment trust raised £250 million. It raised a further £250 million in February and is expected to do another £200 million in the first quarter of 2019.
For James de Bunsen, co-manager of the Henderson Alternative Strategies Trust (HAST), it’s a simple story. The firm charges a 1% performance fee on the REIT, meaning they went from pretty much zero earnings to around £2.5 million at the first raise, £5 million at the second, and then £7.5 million once they do the third.
“Fund management business are very scalable, so all this goes straight through to the bottom line,” de Bunsen explains. “For a company like that to go from zero earnings from running a REIT to potentially £7.5 million is transformative.”
And it certainly was transformative. Before announcing its intention to float PRS REIT, Sigma’s share price was at 72p. By the time it had raised its second tranche, it was up to 117p and now trades at 146p – doubling in the space of 18 months.
But there’s still plenty to go for, according to Vishal Bhatia, co-manager of the Morningstar Silver Rated JOHCM UK Growth fund. The company aims to create 10,000 new rental homes for middle-income families. By the time it does its second raise next year, it should have done more than half of that target.
“If we want to eliminate the housing deficit in the UK, we need 340,000 units per annum,” says Bhatia. “They only expect to do 10,000 units in three years – that could easily double. Profits this year are expected to be £14 million – we easily see a runway for that to double.”
The board last week confirmed it would pay a final dividend at its AGM in 2019, with a progressive dividend policy to commence from next year.
The outlook is positive, with James Goldstone, manager of the Invesco Perpetual Select Trust UK Equity Share Portfolio (IVPU), noting the support the family housing sector has from both local and central Government.
