4 Small-Cap Dividend Stocks for Retirement

Meena is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Small-cap stocks are generally perceived riskier than large-cap stocks, but they still have their fair share of strategies with market-beating potential. In the small-cap universe, there are some committed dividend payers who have paid dividends consistently over the years and have raised them over extensive periods of time. Some of these dividend-paying equities may represent good candidates for income-centric retirement portfolios; let’s take a look.

The top two

Essex Property Trust (NYSE: ESS), a West-Coast-based multi-family residential REIT has been named one of the REIT Elite members, blue chips among REITs, with consistent earnings quality through different business cycles. With 166 properties consisting of more than 34,000 residential apartments, the case for Essex in the longer run rests on its presence in markets which have the highest projected rent growth through 2016.

In fact, nearly two-thirds of the company’s revenue comes from these markets. One example is the San Jose market, which accounts for about 17.2% of total revenue and has a projected cumulative rent growth of 18.9% between 2013 and 2016. Its same-property NOI grew 9.2% last year -- the highest growth rate among its peers -- which may slow down to about 7%, but still the fastest pace in its group.

The company’s plan to boost occupancy in order to drive rent growth, to add value through redevelopment, to focus on acquisitions and property development in high-expected rent growth areas, and to maintain solid balance sheet looks like a sound strategy. The REIT pays a dividend yield of 3.1% on a payout ratio of 64% of the 2013 FFO guidance midpoint.

Likewise, Northwest Natural Gas (NYSE: NWN) is an archetype of a strong income play for retirement portfolios. This natural gas storage and distribution company boasts 57 consecutive years of dividend increases, yet it still pays a high dividend yield of 4.2%, which is a whole 120 basis points above its peer group average yield. Testifying to the strength of its earnings is the fact that after so many years of consecutive dividend growth, the stock has a payout ratio of 81%. With a forecast of 3.8% EPS CAGR for the next five years, inflation-beating dividend growth looks most likely.

What bodes well for this utility company is its constructive regulatory environment, which includes margin stabilization that increases stability of earnings and cash flows. To aid that process, the company introduced three key regulatory mechanisms, including decoupling, weather normalization, and system integrity tracking. This comes on the heels of an EPS downtrend amid the falling price of natural gas since 2008, which, in turn, has produced substantial savings for clients to the tune of $400 million over the past four years or so. At the same time, the customer count has been increasing.

The best of the rest

United Bankshares (NASDAQ: UBSI) is a strong example of a financial stock sustaining dividend payments through both good and bad times. This bank holding company reached its 39th year of consecutive annual dividend increases last year, the track record that only one major U.S. banking corporation can match. The bank’s yield of 4.8% on a payout ratio of 71% of the current-year EPS estimate and the historical dividend growth of 9% over nearly four decades are reflections of the bank’s robust financial performance over those past few decades. In fact, the bank’s low credit costs and its operational efficiency have enabled it to sustain profitability even during the credit crisis.

The bank has strong asset quality that outperforms the asset quality metrics of its bank peers. The bank is also well capitalized, with risk-based capital ratio of 13.8% (versus a 10% requirement), Tier I capital ratio of 12.6% (more than double the required 6.0%), and leverage ratio of 10.8% (versus the required 5%). The bank has completed some 28 mergers and acquisitions since 1982, and is in the process of acquiring Virginia Commerce Bancorp.

This deal will position United Bankshares in a leading position as the largest independent banking franchise in Northern Virginia and Washington, D.C., markets, and will result in accretion to first full-year earnings and will result in double-digit internal rate of return in excess of United Bankshares’ cost of capital.

Northwestern (NYSE: NWE), a diversified natural gas and electric power utility company has paid dividends since 2008 and has raised them each year since the first quarter of 2009. As is the case with other regulated utilities, this fully regulated utility has cash flow stability that supports dividend stability and sustainability. The company is predominantly an electricity provider (78% of gross margin) and is 83% residential customer-oriented. Currently, it is paying a dividend yield of 3.7% on a payout ratio of 60% of the current-year EPS estimate, which leaves ample room for continued dividend growth.

The company’s investments are expected to yield average EPS and dividend growth of between 4% and 6% annually over the long run. Analysts are generally optimistic about the company, as they forecast a 5% EPS CAGR for the long-term. Northwestern has already enjoyed earnings and dividend growth momentum over the past five years, along with stronger cash flows due to net operating loss carry forwards that will aid free cash in the long run. In fact, this utility company is one of the few utility sector players with positive free cash flow balances, which bodes well for the utility’s future capital spending on growth.

Still, capital spending, excluding any supply capacity additions and distribution system infrastructure expansion, is expected to decline 23% by 2017. This will lend additional support to free cash flow, and, thus, to dividends.

A contribution to the company’s growth will also come from its recently announced agreement to purchase natural gas production interests in northern Montana’s Bear Paw Basin from Devon Energy, including Devon’s 82% interest in the Havre Pipeline Company. The deal will boost Northwestern’s owned supply for Montana retail sales of natural gas from the current 11% to 37%, helping reduce supply cost volatility and aiding the company’s long-term growth.

Final thoughts

In principle, stock investing for retirement requires conservative allocation of funds into equities that assure stable or consistently rising income streams, and Northwestern, United Bankshares, Northwest Natural Gas, and Essex Property Trust are worth watching. 

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This article is written by Serkan Unal and edited by Jake Mann. Insider Monkey's Editor-in-Chief is Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. 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. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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