I’ve got small caps on the brain.

[This coming week], I’ll be speaking in Beaver Creek, Colorado, at an Oxford Club Private Wealth Seminar. My topic will be small cap dividend payers.

So I decided to take a look at what – on the surface – appears to be an attractive small cap stock with a robust 5.7% yield.

The Pryor, Oklahoma, maker of toilet paper, tissues and paper towels, sports a market cap of just over $250 million.

I last looked at Orchids Paper Products (NYSE: TIS) in 2013. Back then, the company generated $10.6 million in free cash flow and paid out $6.4 million in dividends, a payout ratio that I was very comfortable with.

(A payout ratio is the percentage of earnings or free cash flow that is paid out in dividends.)

But I was concerned about the company’s plan to increase capital expenditures by $10 million and the impact it would have on its ability to pay the dividend.

I gave the stock a dividend safety rating of C.

Let’s take a look and see if anything has changed.

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Over the past four quarters, Orchids Paper Products generated $20.9 million in cash flow from operations.

To calculate free cash flow, which is the most conservative measurement of cash flow, we subtract capital expenditures (capex) from cash flow from operations.

During the past 12 months, the company spent $34.9 million in capex.

That means free cash flow was negative.

In other words, the company generated $20.9 million from running its business, but when you factor in its expenses from expanding facilities and equipment, more money left the company than was taken into it.

So in order to hand shareholders the $12 million in dividends that it paid, management had to dip into cash in the bank. At the end of the first quarter, the company had only $3.2 million in cash, though it raised more than $30 million in April by offering 1.5 million shares.

In 2015 and 2016, Wall Street forecasts capex will increase to more than $50 million each year, which will keep free cash flow negative. That’s a big concern.

Orchids Paper Products has paid a $0.35 per share dividend every quarter since June 2013. With the additional 1.5 million shares, if the company maintains its $0.35 per share dividend, its quarterly payments will equal $3.6 million, or $14.4 million annually.

That’s not easy to maintain when your business doesn’t generate cash. And if Wall Street is right that it won’t generate free cash flow for the next year and a half, the company will likely have to raise capital again or cut the dividend.

The company started paying a dividend in 2011 and has never cut it, but the risk has increased now that there is more pressure from the larger number of shares and the negative free cash flow that’s expected for the next 18 months.

The current yield is attractive, but the dividend could get flushed down the toilet (sorry, I couldn’t resist, as hard as I tried) in the near future.

Dividend Safety Rating: F

Hoping your longs go up and your shorts go down,

Marc

P.S. If you’ve always wanted to read my book Get Rich With Dividends, but were waiting for the audio version, well, Christmas just came in July. Get Rich With Dividends is now available as an audiobook. In fact, you can even get it for free if you try Audible for free for 30 days.

If you prefer a good old book to the audio version, it’s about $8 cheaper at the Investment U Bookstore than it is on Amazon.

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Source: Wealthy Retirement