Morgans says buy this small-cap stock on a 10% dividend yield

The market may be more focused on growth than income stocks as interest rates have bottomed and are likely to rise next year. But there’s a small cap stock on a fat dividend that is hard to ignore, according to Morgans.

The stock is residential property developer Villa World Ltd (ASX: VLW), which has recently announced two project transactions that will give the company a nice return.

The first is the sale of the Donnybrook joint venture project for circa $100 million. Villa World owns 51% of the JV and will book a gross profit of around $52 million.

Villa World will start receiving the proceeds in stages between FY20 and FY23, which underpins Morgans’ 18% earnings growth forecast for the company from that year.

What’s significant is that the proceeds will help offset any weakness in the housing market as there are signs that the domestic residential market has peaked and could be in for a period of softness, if not decline.

The second transaction is the part sale of its Wollert project to Ho Bee Land, which will add around $5.2 million to Villa World’s net profit in the first half of 2018.

Villa World will retain a 51% control of the Wollert project, which includes 285 land lots, and will receive fees for development management, sales and marketing and the potential for performance fees, added the broker.

“In our view, the sale of Donnybrook helps de-risk any impact from a weaker residential market (from FY20 onwards) and adds to the sustainability of the dividend in the medium term,” said Morgans, which has an “add” recommendation on the stock with a price target of $2.96.

“In the short term, Villa World has upgraded 1H18 NPAT guidance to A$17-18m (from A$10-12m), predominantly due to the Wollert JV contribution.”

Villa World is expected to pay a 19 cents a share dividend in FY18, which goes up to 20 cents in the following year. This puts the stock on a yield of around 10.4% for FY19 if franking credits are included.

That contrasts well with the more traditional high dividend paying stocks that includes the likes of Telstra Corporation Ltd (ASX: TLS), Commonwealth Bank of Australia (ASX: CBA), Transurban Group (ASX: TCL) and APA Group (ASX: APA).

I am not suggesting that you should sell the large cap high yielders for Villa World, but you should have a good mix of large and smaller cap stocks in different sectors with sustainable dividend streams in your income portfolio. This will help mitigate the risk of picking a “yield trap”.

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Motley Fool contributor Brendon Lau has no position in any of the stocks mentioned. The Motley Fool Australia owns shares of and has recommended Telstra Limited. The Motley Fool Australia has recommended Transurban Group. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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