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This cheap small cap stock boasts a big dividend yield

Investors looking for that magical combination of value, growth prospects and high dividend yields might be well advised to look beyond the usual suspects from Commonwealth Bank (ASX: CBA) to Wesfarmers (ASX: WES).

Before you condemn me for heresy, take a look at one of the most intriguing opportunities in the ASX today, Salmat Limited (ASX: SLM), a Sydney-based direct marketing and communications company with a $316 million market cap. Not only does this company trade at what appears to be a cheap valuation, it also offers a 7% dividend yield, fully franked — and even the potential for future profit growth.

Restructuring could equal opportunity

It’s true that, over the past five years, Salmat shares have significantly underperformed the S&P/ASX 200 index (Index: ^AXJO) (ASX: XJO), as shown in the chart below.

SLM vs AXJO

But this unadjusted return does not reflect any dividends paid during this time. And, more importantly, it’s the restructured company’s position, potential and balance sheet today that investors would be wise to focus on now.

To wit: In October 2012, Salmat divested its business process outsourcing division, raking in $375 million from Fuji Xerox Asia Pacific. The company used some of the cash to pay off debt (and also paid shareholders a fat special dividend). It now has around $100 million in net cash.

Going forward, Salmat is looking to further expand its catalogue business to clients in the small-to-medium enterprise space, cut its corporate costs, and move to an omni-channel, data-gathering model for its contact centre business, as well as grow its digital marketing businesses. These initiatives should lead to margin expansion and increased profitability over time, though there is of course no guarantee the going will be smooth.

Valuation and the bottom line for investors

Trading at 14 times earnings, and on an EV to EBITDA basis of just 2.2, the shares sure look cheap. Between this cheap valuation and the hefty fully franked dividend yield, investors may be well compensated for assuming some risk in a changing business.

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Motley Fool contributor Catherine Baab-Muguira has no financial interest in any of the companies mentioned in this article. Take Stock is The Motley Fool’s free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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