Many Canadian investors, especially those folks who just follow the largest companies on the TSX, are missing out on a plethora of interesting opportunities by not checking out small-cap stocks.
The small-cap sector offers everything from dirt-cheap value stocks to intriguing growth names to recession-proof companies poised to protect investor cash during the next downturn.
Some of Canada’s most interesting high-yield dividend stocks are small caps too, which means they get ignored by many institutional investors. This can possibly create an interesting buying opportunity for retail investors to lock in succulent yields.
Let’s take a closer look at one such situation today, a little-followed small-cap REIT that pays a ridiculous 12.9% dividend yield. No, that’s not a typo. It really does return more than 1% of investor capital each and every month.
American Hotel Properties
American Hotel Properties REIT (TSX:HOT.UN) owns 112 hotels across 89 cities spanning 32 different states, focusing on secondary cities like Tampa, Baltimore, and Oklahoma City. The portfolio is currently split between more upscale hotels in these cities and economy hotels in smaller centres, but the economy portfolio has been sold. We’re just waiting for the deal to close.
The company has been an aggressive acquirer of property over the last few years, as it transforms its portfolio into something that owns high-quality assets in cities. Selling the legacy economy hotel business was a logical step, freeing up company resources — and capital — to focus on making more acquisitions in the higher end space.
One of the beautiful things about the hotel business is there are thousands of acquisition opportunities out there under all sorts of different brands. It’s up to management to stay focused and only make deals that make sense for the company, but thus far American Hotel Properties has done a good job on this.
There have been a couple of issues that have pushed the stock price down, which is creating the buying opportunity we see in front of us today. When it acquired some of its more recent properties, American Hotel Properties agreed to take part in a series of expensive renovations to some of these locations. This temporarily decreased cash flow but should be better for the stock over the long term. Renovated hotels command a higher rate.
The problem is, investors are focused on the drop in adjusted funds from operations over the short term rather than thinking about the long term. They looked at the sudden drop in payout ratio to the 100% range and proclaimed the dividend unsustainable. Management argued the real payout ratio was more like 70-80%, saying that the renovation program would only be a short-term blip on earnings.
Now that the company has agreed to sell its budget hotel division, investors are also a little nervous the cash generated from the sale will be put to work in an sub-optimal way. The good news is, if management can make shrewd acquisitions, then shares will get a nice boost from the transaction.
The final reason for loading up on American Hotel Properties shares today is the stock’s rock-bottom valuation. The company earned US$0.72 per share in funds from operations over the last 12 months — a number that was depressed because of the renovation program. The company’s U.S. dollar-denominated shares trade hands at US$5.21 each. That gives us a dirt-cheap price-to-funds from operations ratio of just over seven times. You won’t find many stocks cheaper.
The bottom line
With a payout ratio of approximately 100% of trailing adjusted funds from operations, American Hotel Properties REIT does have a bit of a risky payout. The good news is, that ratio should go down as the renovation program is completed. And the proceeds from the economy hotel sale will end up reinvested in assets that should grow the bottom line.
Investors are getting the opportunity to earn both a fantastic 12.9% yield and the potential for sweet capital gains once the market figures out the opportunity here. That’s the kind of double-whammy that should get any investor excited.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.
Fool contributor Nelson Smith owns shares of American Hotel Properties REIT.