It’s a Small Cap World (for Now) – Russell 2000 Index Up nearly 18 Percent for Year

Graphic courtesy of Russell Investments

 

The stock market finally “took a breather” on Monday of this week, as the Wall Street Journal characterized it. The resilient bull market of 2013 has seen only four sessions in May that had a decline in the Standard & Poor’s 500-stock index and Monday was one of them. This year’s bull market rally has recently been across the board–Asian markets have been up, European markets turned up, and market watchers are anxiously waiting for tomorrow, Wednesday, May 22, when Federal Reserve Chairman Ben Bernanke is scheduled to testify to Congress and the Fed releases the minutes from its last public policy-setting meeting. Will Bernanke offer up any clues about his next steps?

Most importantly for Smallcap World, the Russell 2000 index, which tracks the performance of smallcap U.S. equities, climbed above the 1,000 level for the first time Monday, a metric that MarketWatch considers “psychologically important” for smallcap stocks. As of Monday morning, May 20, the Russell 2000 was up 17.9 percent for the year-to-date, according to FactSet (The Associated Press reported the Russell 2000 up 17.5 percent for the year).

The conventional wisdom is that small caps stock are doing well because they are more U.S. focused than the large caps, which tend to be multi-national. And the U.S. economy is recovering as opposed to other economies around the world. But many large caps are doing well, too,

You don’t have to look far to find small cap stocks at 52-week highs, even “all time highs.” Of course the question always is, how much higher can these stocks go? Buy now or wait for the correction that so many experts have been predicting is right around the corner for months now?

We’ve selected a few stocks we know are at all-time or 52-week highs, and others we’ve covered lately that seem to be on the upswing.

Calabasas, CA-based National Technical Systems * (Nasdaq: NTSC, http://www.nts.com/) is a relatively unknown smallcap stock but also the world’s largest independent engineering services and testing company. It’s biggest markets include aerospace and defense, but also works in the automotive and telecommunications markets, among others. NTSC closed at an all-time high of $13.09, up 94 cents on May 21, with a market cap now of about $150 million. NTSC is lightly traded, only about 7,500 shares a day, although that is trending up. 

Northville, MI-based Gentherm * Incorporated (Nasdaq: THRM, http://www.gentherm.com/) is a global developer and marketer of thermal management technologies for a broad range of heating and cooling and temperature control technologies. Best known for its Climate Control Seat systems that actively heat and cool seats in more than 50 vehicles made by the world’s leading automobile manufacturers, Gentherm (formerly called Amerigon) has branched out into heated and cooled bedding systems, cupholders, storage bins and office chairs. THRM also reached a 52-week high of more than $18 this week, then closed May 20 at $17.78, down 33 cents for the day. Its market cap is now $594 million. As recently as last July THRM was trading at just above $10.

We recently featured Cincinnati-based LSI Industries (Nasdaq: LYTS, http://www.lsi-industries.com/) , a company that offers a different take on an LED lighting company. LYTS creates LED video screens and LED specialty lighting for sports stadiums and arenas, digital billboards and entertainment companies. It closed April 29 at $7.09 with a market cap of $170 million. LYTS closed May 21 at $8, up 1 cent for the day, with a market cap now of $192 million.

Analysts at CRT Capital recently upgraded Atlanta-based Beazer Homes USA (NYSE: BZH, http://www.beazer.com/), a company that builds and sells single-family and multiple-family homes in 16 states in the U.S., to a “Buy” with a $29 price target. BZH also acquires, improves and rents homes. The company operates through commissioned home sales counselors and independent brokers. As recently as last Sept. 14 BZH was trading for $3.77. It closed March 20 at $16.86 with a market cap of $410 million. BZH closed May 21 at $21.75, down 98 cents for the day. Its market cap is now $538 million.

San Jose, CA-based SunPower Corp. (Nasdaq: SPWR, http://www.sunpowercorp.com/), like many solar stocks, have been on the upswing lately. SPWR closed May 8 at $15.36, down 6 cents for the day, with a market cap of $1.8 billion. It closed May 21 at $21, down $1.70 for the day but got up to $23.76 just last week. Its 52-week trading range is now $3.71-$23.76.

Fremont, CA-based Procera Networks (Nasdaq: PKT, http://www.proceranetworks.com/) works with mobile and broadband network operators providing intelligent policy enforcement solutions for managing private networks. PKT’s products are sold under the PacketLogic brand name to more than 600 customers in North America, Europe and Asia. PKT’s 52-week trading range is $10.12-$25.99. At mid-day May 2 it was trading at $11.22, with a market cap of $229 million. At market close May 21 PKT was trading at $13.89, down 3 cents for the day, with a market cap of $282 million.

* Denotes client of Allen & Caron Inc., publisher of this blog.

Mary Lisanti: Continued Corporate Earnings Growth in 2013 (When the Federal Government Resolves the Budget)

Mary Lisanti is president and portfolio manager of AH Lisanti, an investment management company currently focused on small cap growth companies. She is a 33-year veteran of small cap growth research and investing. For the first 12 years she was a small cap analyst and strategist on Wall Street. During the past 18 years, she has managed small cap portfolios at premier asset management companies. As CIO of ING Investments LLC, (1998-2003) she was responsible for building the active equity management team, and assets under management in her area grew from several hundred million to several billion dollars. Prior to ING, Mary was at Strong Capital Management as Senior Portfolio Manager for both the Small Cap Growth and Mid Cap Growth Strategies and was Managing Director and Head of the Small/Mid Cap team at Bankers Trust Company. Mary was named Fund Manager of the Year in 1996 by Barron’s. She was named #1 small cap analyst in 1989 by Institutional Investor’s All-Star Research Team. In addition, she was ranked #2 and #3 in 1987 and 1986 respectively.

Mary-headshot

I had the pleasure of talking to Mary just before the New Year’s holiday at her office near Rockefeller Center.  We had first met in the late 1980s when she was interested in a technology company that proposed the radical idea of a keyless car ignition or computer security system using a fingerprint.  Interesting how what seemed futuristic now seems almost as old hat as, well, men on the moon.

JA:  How are you feeling about the year ahead?

ML:  Undecided.  I’ll give you some positives and some negatives.  One big positive is that corporate profit growth will still be decent.  Corporations are at very high profit margins, but when you break down what’s going on, there’s no reason they shouldn’t go higher.  Virtualization – the use of cloud computing, and other aspects of today’s high tech should help them cut costs.  For that trend to stop, two things would have to happen: a long period of negative revenue growth, accompanied by fast-rising wages.  Neither of those things is happening.

That will be a positive for the market.  Corporate profits are growing 8-10% and we believe that can continue, and that is widely dispersed across the board.  Small caps can grow even more,we believe, although again there will be wide dispersion in individual results.  This will be a classic stockpicker’s market.

The biggest negative for the market is that we cannot seem to govern ourselves.  That weighs on multiples.  That’s why, four years into this recovery, multiples are still low, particularly when you take into account where interest rates are and how  GDP growth, although below trend, continues to chug along at 2% or so.  In that scenario, logic would have it that multiples would be in the range of 18-19, but they are not.  Why not? I believe it is because of our inability to govern. Politicans are behind the curve;as they usually are, in addressing our structural issues to bring the long term deficit issues under control. Will they address the longterm issues or not?  If they do so now, it will require only modest changes to entitlements and spending. The extent to which we address those issues will affect the performance of the market going forward.

It is psychologically important to multiples: if you can slow the growth in spending at least a bit, you give people more confidence.  In the Clinton years they managed to slow the rate of growth in spending, and Clinton left office with a surplus.  I believe we will spend most of 2013 arguing about entitlements and other budget issues.  Next year it will be the Democrats saying no to entitlement reform, just like this year it was Republicans saying no to taxes.  I don’t know how much it is possible to get done, because it is being done in a fishbowl and from ideological positions that don’t accommodate compromise.

If they do not get something done, I fear that US debt will get downgraded again.

JA:  And would any of the DC politicians feel responsible if that happened?

ML:  I do not believe so, no.  Politicians, in my opinion, are in the business of passing the blame.  If there were another downgrade, it would affect President Obama’s legacy, and I don’t think he wants to be the president who oversaw two debt downgrades in his time in office.  Both sides will have an incentive to compromise and hopefully they will.  The biggest risk to all of us, and to the market, is that the dollar loses a bit of its luster as the currency of last resort.

When you look at Japan and China and Europe, they are getting their act together with regard to being attractive places to invest and could even potentially be attractive as reserve currencies in a few years.  My biggest concern is that we permanently change corporate behavior: if you have a climate of uncertainty for long enough you make people afraid.  Business overall has been clear with Washington that the uncertainty is damaging.  R&D tax credits, farm and agriculture bills, accelerated depreciation – Congress has been handling these as though they were annual issues, and they’re not.  They affect multi-year planning.  When the R&D tax credit was put in place in the early 1980’s, it was in place for 4.5 years.   That would be better—it would give businesses the ability to plan longer term..

These and other things are casualties of this ideological warfare in Washington.

JA:  What do you see as strengths in 2013?

ML:  It is an enormous positive that housing is recovering, and the recovery should continue, assuming Washington does not cut the mortgage deduction..  Unemployment is declining, although it is declining too slowly.  And we have cheap sources of energy.  . A number of industry sources believe that we will be energy independent in the next decade or so, which is a huge positive for our manufacturing competitiveness.

When you look at these things, once we make it through this budget and debt-ceiling problem, things look a lot better.

Governments all over the world have been spending money to fix the problems that caused the recession, and odds are that things will not fall apart again soon.  Over the past several years, we have had a major issue every year that has “terrified” us: last year it was the potential breakup of the Euro and Greek debt default, and this year it was the budget crisis in the U.S. Beyond the budget crisis, I do not see an issue that has the potential to scare investors as much as these two issues have. We should enter a period of more “normalcy,” where macro issues take a backseat to fundamental issues, and that change should allow multiples to increase. But belief in a more stable future will come slowly.

JA:  What should we look for in 2013 when we look at investments?

ML:  As small cap growth investors, we look for earnings growth.  But one of the great positives in this market is that there are many ways to make money in the market.  When I came into the business in the late 1970s, you could make get 7-8% returns several ways.  You could make money with yields –- those companies with no earnings growth offered very high dividend yields, say about 7%; those companies with earnings growth offered more modest dividends, say 2-4% dividends and 4-5% annual growth in earnings.  Growth stocks offered  very little in the way of dividends, but you could get capital appreciation as earnings would increase 10% to 15%.annually. Then, as we moved through the great bull market of the 1980’s and 1990’s, we got to the point where dividends were out of favor and capital appreciation was the only way to make money.. Now dividends are back and once again there are multiple ways to make decent returns in the stock market, depending upon one’s tolerance for risk..That is very, very positive for the equity markets.

JA: How about sectors?  Any of special interest, or any you would avoid?

ML:  There are good companies in every sector.  I would not recommend the utilities, but there are very good opportunities in materials, energy, consumer products and services, industrials and financial services,  In most of these the small caps usually have something unique about the way they do it, or the technology they apply to it.

Tech spending is not forecast to be up much in 2013.  There will be winners and losers.  We need to keep in mind that the corporate world is moving toward Software as a Service, which allows them to stop buying perpetual licenses, and to pay as they use software.  They are going from buying licenses and maintenance contracts, and now are basically paying just for what they use.  Same with cloud computing.  So they are going from spending $20,000 on software and a server to paying $1,000 month.  So even though tech spending is forecast to be close to flat, the companies that will be winners will have SaaS and cloud computing.  These trends will hold down spending.  It’s hard to see how the semiconductor companies are going to prosper in that environment, unless it is the specialty chipmakers who are specialized in populating ever-smaller chips with ever-larger amounts of circuitry for tablets and smart phones – or those companies that are specialized in the ability to manage the signals for those tablets and phones.  But other than those two, I don’t see a lot of growth there.  And I would be careful about traditional license-oriented software companies.  .

JA: What about healthcare companies?

ML:  Interesting.  It’s hard to guess how ObamaCare will play out.  There are some longterm secular trends in healthcare that are worth keeping in mind.  Keep your eye on the value proposition: better, faster, cheaper, more automated.  One of the most interesting areas is the second generation biotechs.  Think about AIDS, for instance.  Over the last 25 years it has become a livable disease – that is, we haven’t cured it, but we can make it possible to live with it, and to do well, not just to survive for a few more months.  Now the industry is working to make cancer livable in the same way; there are whole new classes of drugs that enable people to live with cancer, and not to just be blown away by it in a short time.  Possibly we are spending the same amount of money making cancer livable as we used to, but now we’re spending it over a longer period, and not all at the end of life.  Diabetes monitoring, for instance – the closer we get to continuous glucose monitoring, the better for diagnosis and treatment; One of our investments is Dexcom (DXCM), which has a promising technology for that.  All those big diseases are interesting, and medicine is getting its arms around them too.

JA: How about healthcare IT?

ML:  It has historically been mostly about billing and insurance, but now the future is to move on to quality of care.  Since we have had health insurance as a society, the focus has been on what you might call “industrial metrics,” such as how many patients you can process.  Now the quality of the outcome is more important, and best practices are more important.  There will have to be penalties for readmissions of the same patient.  Mobile apps for monitoring things like blood pressure, glucose, heart problems and blood gases – these things are going to become standard practice over the next 5 to 10 years.

JA:  You mentioned the impact of technology on industry.

ML:  There are lots of new beginnings now, along with outmoding of old things.  Software as a service and the use of the cloud – this is the biggest piece of cost to cut.  If you can cut your IT costs you have overall better margins, and better processes too.  And industrial automation is interesting too.  The first generation of automation concentrated on, for instance, lasers to cut steel.  Now automobiles are being made with lighter materials, so new lasers are needed, lasers to cut nonsteel materials.  Aerospace is an interesting area for this.  Two things that are driving aerospace are new materials that lower weight and cost, and a continuing cutback on oil-based materials.  There is a bit of a renaissance going on in aerospace.

One of our investments is IPG Photonics (IPGP) for the new lasers needed to deal with new lighterweight materials.  Another is Polypore International (PPO), which is making the membranes needed for new electric vehicles like the Chevy Volt and the Nissan Leaf. By the end of 2013, they are expected to be supplying membranes for 24 models of cars.  That goes back to the fact that fuel efficiency standards by 2025 will be at 54.5 mpg.

Another of our investments is Aspen Technology (AZPN), which basically supplies SaaS for factories and plants.  If you are a refinery, for instance, you are required by law to take your systems down every so often for maintenance and test for a number of things such as safety and pollution.  Doing that manually is difficult; it can be done, but it is hard, and if you are global it is harder.  Aspen automates all of that, and they are in a field by themselves basically.

JA:  And energy?

ML:  The shale revolution will be a big job creator, and the move toward natural gas for vehicles is important.  Fleets will be moving to Compressed Natural Gas (CNG), and we believe the infrastructure will be built out for CNG refueling.  Federal Express, UPS and the other big fleets will be the drivers.  We are interested in Westport Innovations (WPRT) for the CNG engines.  And we are watching Clean Energy Fuels Corp (CLNE) for the CNG supply chain, but big oil will be the installer.  We also believe solar will become economical to use, with panels on the roofs, for instance, of warehouses, and power being sold back to the grid when it is not needed.  Between the increased supply of natural gas, shale energy, coal, oil and renewable, we can get to be energy independent.

JA:  How about housing?

ML:  Housing is fascinating.  What happened with housing is what happened with autos.  Now after a period of low sales, we probably need as a nation to do some catching up.  We could need 1.7 million new housing starts for a couple of years.  That would double the current rate.  The Echo-boomers (who used to be called Generation Y) are starting to buy houses; their demand for houses is growing at 5% per year, and will grow at 10% per year soon.  My personal opinion is that this housing cycle will be a long one, similar to what we saw after the housing collapse in the mid 1970’s. In the first few years, we will see a catchup in pricing, but after that we believe housing prices will probably go up a couple of percentage points per year. If they implement the rules on mortgages that are being talked about, the housing market will become a lot steadier and more stable, more like the Texas market, where they tightened the downpayment requirement and favor 30-year-fixed mortgages.  That will be positive for the housing market and for consumer confidence.

There is nothing better for consumers than to have their biggest asset become more valuable every year.  Three years ago if you hadn’t already lost your job, you were still afraid you might lose it.  Your 401(k) and your house were devaluing.  This recovery is more like the late 1970s than the 1990s.  People got burned in the mid-70s and it took a long time to feel better.  When we are operating at full potential, we should have 3-1/2% to 4% GDP growth, and that will come eventually.

JA:  And in 2013?

ML:  I think GDP this year will be 2-1/2% overall because of federal and state problems, but corporate GDP growth will be a good bit better than that, assuming there is a budget deal at some point.  The first half of the year if we watch the government argue about spending, it could be a bit of a damper on growth.  If we regain faith that the politicians will be able to compromise and come up with some answers, the market will go higher.  Having our debt downgraded shook everyone’s confidence.    So the market is at 12-13 times earnings as a result.

If we get a budget deal we could get much stronger investor confidence, but in the short term, our ability to govern ourselves is the big issue.  Once that is resolved, the market will lift.

JA:  Thanks, Mary.

For AH Lisanti:  For financial intermediary use only.  Not for use with investing public.

The information provided should not be considered a recommendation to purchase or sell any particular security.  It should not be assumed that any security transactions, holdings, or sectors discussed were or will be profitable, or that the investment recommendations or decisions we make in the future will be profitable or will equal the investment performance discussed herein.  The views expressed reflect those of the portfolio manager as of 12/31/2012.  The portfolio manager’s views are subject to change at any time based on market and other various conditions. The performance reflected herein is not representative of performance of AH Lisanti individually managed accounts or comingled vehicles that AH Lisanti advises.

 

Nick Galluccio on Economic Recovery Outlook for 2013, Equity Valuations, Sectors to Watch

Nicholas F. Galluccio is President and CEO of Teton Advisors, Inc. (www.tetonadv.com), based in Rye NY, which runs a family of listed mutual funds under the family name of TETON Westwood, and representing a range of investment strategies. Teton Advisors is itself listed under the ticker “TETAA.” It is affiliated with GAMCO Investors, Inc. (NYSE: “GBL”), a large and well-known diversified asset manager and financial services firm (www.gabelli.com).

Nick was a journalist early in his career, starting as a staff writer at FORBES, and moving into the financial services business as a semiconductor analyst at Lehman Brothers Kuhn Loeb. He and I first met during the 25 years he spent at Trust Company of the West, where he was Group Managing Director and headed smallcap value and midcap value funds. Seven years after TCW was acquired by Societe Generale, he joined Teton Advisors, and has built the platform to $1.2 billion in assets under management (AUM). Today he is at the helm of Teton, and runs the TETON Westwood SmallCap Equity Fund.

I asked Nick before the national election if we could talk after the election in broad strokes about the state of the economy, the vigor of the recovery, his outlook for 2013, and generally about which sectors he finds most promising going forward. He agreed, and we met shortly after Thanksgiving at his offices in Rye.

JA: To start off, I wonder if you have some thoughts you could share about the overall economy, the fiscal cliff or other issues, and what your crystal ball says about 2013.

NFG: We think the US economy will get stronger as we go through 2013. Capital spending was constrained during the extended campaign as business managers and investors put off spending until the outcome of the elections was known. And of course there was a long-running debate over the fiscal cliff. Now we believe that the pent-up need for capital expenditure, which had been delayed during the campaign, will begin to be implemented, which will have a positive effect on the economy.

We are seeing a recovery in housing, underscored not only by the builders themselves, but by good results from companies like Home Depot (NYSE: HD), which had strong comps up 4.3%, and Lowes (NYSE: LOW); both of those are riding at 52-week highs.

The tech sector has been impacted by slow spending by consumers and a slight inventory build throughout the supply chain, but we think that spending will be stronger in 2013. And we think that the Christmas season will show good retail sales comps this year, better than it has been in many years.

It’s important to recognize that the European economic situation has been a drag on the US economy, as consumption of US products by Euro-zone consumers dropped. We believe the biggest declines from the downturn in the European Community are now behind us, which may not be much of a plus, but it will be less of a minus or a drag on the economy.

Finally we are seeing a very accommodating Federal Reserve, with all signs pointing to QE3, which will actually expand the capacity of the Fed’s balance sheet. We’re speculating that Chairman Bernanke may be replaced by someone like Janet Yellen, current Vice Chair of the Fed and head of the San Francisco Fed. If she were to succeed Chairman Bernanke, we believe her leadership would continue to foster the accommodative monetary policy established over the past several years under Bernanke.

JA: Does that mean you see a strong recovery in 2013?

NFG: We believe we will see a somewhat stronger economy, with growth improving from sub-2% to better than 2%. That still represents a rather anemic economic outlook, which will change for the better when we get some major tax and entitlement reform, which would instill the confidence among business leaders necessary for them to jumpstart capital spending. And let’s not forget that the consumer needs to believe the country is on the right path. We need exemplary leadership from both our President and his Republican counterparts.

JA: Do you think Washington will come up with a solution for the fiscal cliff? Will they just kick the can down the road?

NFG: My gut says that they will do something this time. The Tea Party was partially discredited in the election, and that means that the extreme right wing of the Republican party may lose some clout, with the likelihood being that the Republicans will regroup right of center. It behooves the Republicans to work out a compromise with the Democrats. On the other hand, Obama only won by a margin of 2.4% of the popular vote, not what you’d call a mandate. He wants to leave behind a legacy, and will move from far left to just left of center, in order to get things done. He has to make some changes, and I believe he will. He hasn’t shown the kind of leadership that Clinton and even Bush did. If he wants to leave a legacy in four years, he is going to have to cross the aisle toward compromise.

JA: And Grover Norquist and the tax pledge?

NFG: Outdated.

JA: What is it going to do to the market?

NFG: We have been in a bull market since the bottom in about March of 2009, Since then the market is up over 100%. We have had a correction since the election, and that correction has discounted a lot of the negatives. If we make any progress toward resolution of the fiscal cliff, we will enter the next phase of the  bull market in 2013. I believe we are in a secular bull market. It is ironic that as the market moves up on relatively low volume, retail investors have continually sold equities. Retail investors have had net redemptions every month of 2012, even with the market moving higher. Over the past five years, domestic equity mutual funds have had $500 billion of net redemptions. At some point the retail investor will come back to the market and money will start to move back into equities. That would be a driver of the next phase of the bull market.

For several years, money has been flowing out of the equities and into the bond market. Money keeps coming into fixed income, and at some point that will turn. As rates move up, investors at the lower rates will get burned, and many will move back to equities. Many fixed-income investors are actually losing money, adjusted for inflation. If rates were to move back above 2-1/2%, there would be many reasons to be bullish on equities. Overall sentiment among retail investors is still bearish, but valuations are very cheap, at decades-low levels. The S&P is selling at 14 times earnings and smallcaps are at 8 to 12 times earnings. Even though retail investors don’t yet have an interest in small caps, it is a great opportunity for contrarian-minded investors.

JA: Would this be a second leg of a bull market then?

NFG: Coming out of a recession, small caps usually lead the market higher. Small caps get sold down hardest in a downturn, and then they gain faster coming back out of a downturn. We believe that in 2013 we could have a credible strong fundamental underpinning to surge in small caps, because their valuations have fallen further than large caps. And when liquidity comes back into the market, it acts as a slingshot with small cap equities.

JA: What sectors would be the most interesting if that happened?

NFG: The hardest-hit sectors have been industrials and technology, because they are the most sensitive to economic changes. Likewise,  as car companies and auto parts companies had a good 2010 and 2011, inventories built up. After we exited 2011 we had a destocking of inventory, but now those inventories have come back into balance. With housing picking up, the economy will begin to restock in earnest, which will create the next leg up in the cycle. Stocks have already discounted a weakened economy, so valuations are very good for buyers.

In the industrial sector we like suppliers to the commercial aircraft industry. The global aircraft industry has designed more fuel-efficient planes, which the airlines badly need. The buyers, however, are both the aircraft leasing companies and the airlines, which have restructured over the last several years with some big bankruptcies. The backlogs of Boeing and Airbus show a growth in demand for many years. Remember that the international carriers are healthier. The order book is full, and no one wants to drop out of the queue because it is hard to get back in line. We own Woodward Inc (NYSE: WWD), Hexcel Corp (NYSE: HXL), Moog Inc (NYSE: MOG.A and MOG.B), Carpenter Technology (NYSE: CRS), and the smallest market cap of the group, AAR Corp (NYSE: AIR).

JA: Any other sectors?

NFG: Energy is very interesting, particularly oil and natural gas. We believe there is great promise in horizontal drilling, as well as in hydraulic fracturing, both of which will be essential to move the US to be the largest fossil fuel energy producer in the world by 2035. Fraccing may have problems state by state, but overall there is too much national need for it to get stopped. We believe it will go ahead in Ohio, Pennsylvania, upstate New York, Wyoming, Montana. In the energy space we own Patterson-UTI Energy (Nasdaq: PTEN), which is a major high-tech horizontal driller that is hired by energy majors and independents. On the E&P side, we own Energy XXI Ltd (Nasdaq: EXXI), which is a beneficiary of Exxon divesting energy assets in the Gulf of Mexico. We also own Approach Resources (Nasdaq: AREX), a natural gas exploration company with properties in the Permian Basin in West Texas. And we own Comstock Resources (NYSE: CRK), which has most of its assets in the Gulf of Mexico, Texas and Louisiana. We believe that natural gas will be the energy of the future.

JA: How about one more?

NFG: Financial services. We have about 14% of our portfolio in regional community banks that are primarily home and small-business lenders. Most of  the charge-offs in that industry have already been taken, so going forward the provisions will decline and the bottom lines will improve. We see a pickup in demand, both from small businesses and from homeowners. These banks will see profits from mortgage origination, mortgage servicing, and mortgage refinance, even if the mortgages themselves are securitized and sold to others. In addition, these smaller banks will be making car loans, home equity loans, and small business loans.

I read the FDIC reports, and a few quarters ago we saw the first pickup in several years in loan demand, although that pickup was rather small, in single digits.

In that area we like ViewPoint Financial (Nasdaq: VPFG), an over-capitalized Texas bank that has a balance sheet that needs to be converted to loan volume. We also own Washington Trust Bancorp (Nasdaq: WASH), a clean Rhode Island-based bank that has a significant trust department and an attractive lending franchise in the corridor including Connecticut and Massachusetts. We also own Oriental Financial Group (NYSE: OFG) which, in spite of its name, is the best-capitalized bank in Puerto Rico.

JA: So I take it you believe there will be a meaningful step taken on the fiscal cliff before Santa Claus gets here?

NFG: We think there will be a first step toward a solution before the end of the year, yes. Even so, investors are braced for the worst, which is reflected in their redemptions from equity funds, and the bears that caused the correction after the President was re-elected. Since then all indications are that both sides are willing to compromise.

JA: Many thanks for your time and for sharing these thoughts with us, Nick.

Editor: None of the companies mentioned in this interview is a client of Allen & Caron, the publisher of this blog.  We do not make recommendations with regard to investments; please do your own research. 

Business-Jet Market Expected to Show ‘Solid’ Growth in Short, Long Term

One business sector that is expected to be experiencing solid growth in both the short and long term is the business-jet market, according to The Economist (http://www.economist.com/blogs/gulliver/2012/10/business-aviation). Honeywell Aerospace recently put out its annual Business Aviation Outlook, a forecast based on surveys of 1,500 business-jet operators worldwide.

According to the survey (and The Economist), “between 680 and 720 new business jets will be sold this year, a ‘single

Photo courtesy of priog.org

digit’ increase over last year.” The survey then predicts will get much bigger over the next 10 years with about 10,000 jets expected to be sold at a total price of $250 billion.

The article notes that the good news for the business-jet industry is not so much a reflection of positive global economic conditions as buyers wanting the various new features offered in newer jets. Honeywell’s report indicates that today’s buyers want jets with more range, more comfort and larger cabins.

Other statistics in the article include regional numbers. A total of 46 percent of the buyers in BRIC countries expect to buy a new jet in the next five  years; the Russian business-jet fleet is expected to expand by 15 percent by 2017; the Indian and Chinese fleets by 18 and 30 percent, respectively. North America continues to lead the business-jet industry by a long shot “because of its massive installed base of jets…the region is expected to account for 53 percent of all sales in the next five years.”

On a related note, Lockheed Martin (LMT) hit a 52-week high Nov. 6, closing at $94.88.

There are a host of small cap stocks that work in the business-jet/aircraft industries. Here are a few randomly chosen companies to look at:

Wood Dale, IL-based AAR Corp. (NYSE: AIR, http://www.aarcorp.com) has a variety of aircraft-related businesses and does a lot of business with the US government. AIR sells and leases used commercial aircraft; repairs, leases and sells airplane parts, components and instruments;  provides logistics services, designs and installs in-plane cargo loading systems, just to name a few of its business sectors. AIR was founded in 1951. Its 52-week trading range is $10-$23.67. AIR closed Nov. 6 at $15.06, up 11 cents.

South St. Paul, MN-based Ballistic Recovery Systems (PINK: BRSI, http://www.brsparachutes.com) is tiny, only slightly over $1 million in market cap. It makes rocket-deployed parachute systems for general aviation and recreational aviation aircraft that are designed to parachute the entire plane to safety in the event of an in-air emergency. BRSI stock barely trades at all, averaging only about 3,900 shares a day. Its 52-week range is $0.05-$0.30. It traded 10,000 shares Nov. 6 and closed at $0.14, up 4 cents.

Portland, OR-based Erickson Air-Crane Inc. (Nasdaq: EAC, http://www.ericksonaircrane.com) manufactures and operates Erickson S-64 Aircrane heavy-lift helicopters. One side of its business maintains, overhauls, repairs and provides aircraft services, the other side uses its fleet to aide in firefighting, timber hauling and infrastructure construction. AIR has a 52-week trading range of $5.35-$8.50. It closed Nov. 6 at $7.49, up 3 cents.

Calabasas, CA-based National Technical Systems * (NASDAQ:NTSC; http://www.nts.com/) is a leading provider of testing and engineering services with the largest network of test laboratories and engineering service centers in North America and more than 50 years of experience.  The majority of its revenues come from the aerospace and defense industries. It also offers end-to-end unmanned aerial vehicle services. NTSC’s 52-week trading range is $4.22-$8.80.  Its market cap is currently almost $91 million. It closed Nov. 6 at $7.92, up 8 cents for the day.

Monrovia, CA-based AeroVironment, Inc. (NASDAQ: AVAV; http://www.avinc.com/) engages in the design, development, production, support, and operation of unmanned aircraft systems, and efficient energy systems for various industries and governmental agencies.  In late July, its market cap was $503 million and AVAV stock was trading for about $23. By early November it had not changed much. It closed Nov. 6 at $22.60, down 3 cents.

* Denotes client of Allen & Caron Inc., publisher of this blog.

‘Renaissance’ in U.S. Manufacturing Could Lift Small Cap Manufacturing Stocks

Assembly line photo courtesy of Oregonlive.com

Concerns over the so-called “fiscal cliff” and a slowdown in global economic growth have hit manufacturing stocks hard in recent months. Based on this, many manufacturing companies have reduced their guidance.

But TheStreet.com’s Real Money site has noted that manufacturing in the U.S. “has gone through a renaissance over the past decade,” reducing cost structure and increasing productivity, compared to their global competitors (http://online.wsj.com/article/SB10000872396390443545504577563400285418034.html).

With that in mind, Real Money picked two large caps that it believes are now selling cheaply and offer a dividend as well: Dover Corporation (NYSE: DOV), a manufacturer of specialized products and components; and The Timken Company (NYSE: TKR), a manufacturer of bearings, assemblies, alloy steels and mechanical transmission systems.  Some of the details to watch for, according to Real Money, are a strong balance sheet, insider buying and valuations, along with the dividends they pay.

With manufacturing as a focus, here are four randomly chosen small caps that might also deserve a look:

Burlington, MA-based CIRCOR International (NYSE: CIR, http://www.circor.com/) manufactures valves and sub-systems used in the energy, aerospace and industrial markets. CIR has more of a global manufacturing presence than the U.S. stocks Real Money offered. It has more than 7,500 customers in 100 countries. On Aug. 3 Stifel Nicolaus upgraded CIR from hold to buy and set a $41 price target. CIR’s market cap is $615 million and its 52-week trading range is $26.15-$42.79. It closed Aug. 7 at $35.33, up 45 cents.

Atlanta-based Mueller Water Products (NYSE: MWA, http://www.muellerwaterproducts.com/) manufactures products that are used in the transmission, distribution and measurement of drinking water and water treatment facilities. Products include iron pipe, water and gas valves, fire hydrants, water meter products and systems, among other things. In December 2010 it acquired Echologics Engineering Inc, a water leak detection and pipe condition assessment company. On Aug. 7 TheStreet Ratings upgraded MWA from sell to hold. Its market cap is $623 million and 52-week trading range is $1.94-$4.06. At the close of market Aug. 7 MWA was trading at $3.97, up 5 cents for the day.

Braintree, MA-based Altra Holdings Inc. (Nasdaq: AIMC, http://www.altramotion.com/) manufactures a range of mechanical power transmission and motion control products for customers in the energy. general industrial, mining, transportation and turf and garden industries. Forbes noted Aug. 3 that AIMC had crossed above its 200-day moving average of $17.57. Its market cap is $468 million and 52-week trading range is $10.12-$22.18. AIMC closed Aug. 7 at $17.58, down 7 cents for the day.

Bloomfield, CT-based Kaman Corporation (NYSE: KAMN, http://www.kaman.com/) operates in the aerospace and industrial distribution markets as a manufacturer and subcontractor. Since November 2011 KAMN has acquired five companies. Most recently, in July 2012, a subsidiary, Kaman Industrial Technologies Corp., acquired Miami-based Florida Bearings Inc. On Aug. 7, KAMN’s Board of Directors declared a regular quarterly dividend of 16 cents a share to shareholders of record on Oct. 9. KAMN’s market cap is $867 million and 52-week trading range is $25.73-$36.07. It closed Aug. 7 at $32.82, up 47 cents on the day.

Unmanned Aerial Vehicle (UAV) Market: It’s Taking Off

Unmanned Aerial Vehicles, or UAVs, or drones are making headlines daily, as part of military exercises or in a variety of other ways. The market for these vehicles has begun to grow and is expected to keep growing in the near future.

Shadow UAV photo courtesy of Wikipedia.org

 Market research estimates the global UAV market is now about $15 billion this year, with growth to up to $20 billion annually by 2020. Part of the reason for the growth is the FAA is opening up air space to commercial activities.

There are several high-profile, large cap companies such as Lockheed Martin and Boeing, active in this space. But so are many smallcaps, including:

Monrovia, CA-based AeroVironment, Inc. (NASDAQ:AVAV; http://www.avinc.com/) engages in the design, development, production, support, and operation of unmanned aircraft systems, and efficient energy systems for various industries and governmental agencies.  Revenue in 2012 reached $325 million with fully diluted earnings per share of $1.36, representing compound annual growth of more than 20 percent since 2010.  Its market cap is now $503 million and the 52-week trading range is $21.14-$34.28.  The stock has taken a beating lately and at the close of market July 24 was trading at $22.96, down 88 cents for the day.

Calabasas, CA-based National Technical Systems * (NASDAQ:NTSC; http://www.nts.com/) is a leading provider of testing and engineering services with the largest network of test laboratories and engineering service centers in North America and more than 50 years of experience.  It offers an end-to-end UAV service including the design and integration of a payload, help with building a POD, testing of UAVs, even flying missions.  The Company’s 52-week trading range shows it was trading for as low as $4.02 in November, but has been reaching new highs in the low $7s this month.  Its market cap is currently around $81 million. It closed July 24 at $7.12, down 1 cent on the day.

Carson, CA-based Ducommun Incorporated (NYSE:DCO; http://www.ducommun.com/) provides engineering and manufacturing services to the aerospace, defense, and other industries through a wide spectrum of electronic and structural applications.  Its capabilities include aviation and UAV sensors.  The stock is trading near the bottom of its 52-week range ($7.71-$23.54), and the market cap is around $105 million. It closed July 24 at $9.94, up 1 cent for the day.

Austin, TX-based Astrotech Corp. (NASDAQ:ASTC; http://www.astrotechcorp.com/), through its subsidiaries, has provided support for manned and unmanned launch vehicles for the last 30 years.  It is a leading provider of commercial aerospace services, and one of the first space commerce companies.  Its market cap is about $21 million and its 52-week trading range is $0.50-$1.34. It closed July 24 at $1,11, down 3 cents for the day.

Edgewood, NY-based CPI Aerostructures Inc. (NYSE:CVU; http://www.cpiaero.com/) is engaged in the contract production of structural aircraft parts principally for leading the U.S. Air Force and other branches of the U.S. armed forces.  As a subcontractor to leading defense prime contractors, the company delivers various pods, and modular and structural assemblies for military aircraft.  The Company’s 52-week trading range is $8.78-$16.42, and the market cap is currently about $75 million. It closed July 24 at $10.69, down 11 cents on the day.

Dulles, VA-based Orbital Sciences Corp. (NYSE:ORB; http://www.orbital.com/) develops and manufactures small- and medium-class rockets and space systems for commercial, military and civil government customers.  The company`s primary products are satellites and launch vehicles, including low-Earth orbit, geosynchronous-Earth orbit and planetary spacecraft for communications, remote sensing, scientific and defense missions; human-rated space systems for Earth-orbit, lunar and other missions; ground- and air-launched rockets that deliver satellites into orbit; and missile defense systems that are used as interceptor and target vehicles.  The market cap is currently about $739 million and its 52-week trading range is $10.59 to $18.48. It closed July 24 at $12.53, down 17 cents for the day.

* Denotes client of Allen & Caron, Inc., publisher of this blog

Looking for Silver Linings in Small Cap Energy Storage/Electric Power Market

All of us at Smallcapworld are optimists at heart, so when it’s time to write about battery companies, we look for the good story lines. It’s a “glass half full” philosophy.

PbC batteries courtesy Axion Power International

For that reason we are temporarily ignoring lithium ion battery maker A123 Systems (Nasdaq: AONE), which on May 11 posted a first quarter net loss of $125 million, more than twice the loss it reported in  the fourth quarter of 2011 and the first quarter a year ago. Quality problems and a slack demand for electrical cars are mostly the blame, according to press statements.

Perhaps we can put another lithium ion technology company, Valence Technology (Nasdaq: VLNC), in the same category, being that it is trading at the very bottom of its 52-week range (67 cents as of May 14 with upper end of range $1.34) for many of the same reasons as A123. As optimists, however, we might argue that these low valuations (A123 closed May 14 at 91 cents and was as high as $6.20 last June) may be good bargains. We shall see. If you want to know more about VLNC, listen to the company results conference call May 23 at www.valence.com).

So where are some silver linings in the small cap energy storage/battery market? Here are a few randomly chosen companies where you might find some hope:

San Diego-based Maxwell Technologies (Nasdaq: MXWL, http://www.maxwell.com) makes ultracapacitors and high voltage capacitors that provide energy storage and power delivery solutions for applications in many industries including transportation, automotive, information technology, renewable energy and industrial electronics. It also makes microelectronic products for satellites and spacecraft. While management reduced sales growth guidance durings its earnings call May 9, four insiders bought 48,000 shares at prices between $9 and $10.20, suggesting perhaps that they thought it was a good buy, according to Renewableenergyworld.com.  (http://www.renewableenergyworld.com/rea/news/article/2012/05/maxwell-technologies-mxwl-buy-or-steal). Market cap is about $233 million, 52-week range is $8.62-$21.49. MXWL closed May 15 at $8.26, up 21 cents for the day.

Reading, PA-based EnerSys (NYSE: ENS, http://www.enersysinc.com) is a little big for our blog (market cap is $1.52 billion) but we’re looking everywhere for some good news. We found it at Motley Fool (http://www.fool.com/investing/general/2012/04/10/1-reason-to-expect-big-things-from-enersys.aspx) which apparently believes that ENS inventory levels indicate the company may see increased demand on the horizon. ENS makes industrial batteries, battery accessories, chargers and power equipment. Its 52-week trading range is $17.35-$36.51. Daily trading volume is about 390,000 shares a day. It closed May 15 at $31.44, down 32 cents on the day.

Newark, NY-based Ultralife Corp. (Nasadaq: ULBI, http://www.ultralifecorp.com) operates in three segments: Battery and Energy Products, Communications Systems, and Energy Services. It makes a lithium 9-volt battery as well as various other rechargeable and non-rechargeable batteries. Management confirmed its previous guidance of year-over-year revenue growth “approaching double digits,” according to Reuters. ULBI has a market cap of about $74 million and its 52-week trading range is $3.88-$5.50. It closed trading May 15 at $4.16, down 30 cents for the day.

New Castle, PA-based Axion Power International * (OTCBB: AXPW.OB, http://www.axionpower.com/) manufactures high-performance, low-cost lead-carbon (PbC(R)) batteries for a variety of markets, including for “mild” and “micro” hybrid vehicles, which are anticipated to be the commonest form of hybrid in the US within a couple of years (and already the most common in Europe). Its PbC batteries are as easy to manufacture as the older lead-acid batteries, but they use activated carbon instead of half the lead.  They are lighter and 100% recyclable (unlike lithium ion batteries), and have a higher charge acceptance and faster recharging rates, making them ideal for the growing  micro-hybrid and mild hybrid markets.  AXPW announced in April that Norfolk Southern had placed an initial order for the company’s PbC batteries for a battery-powered locomotive. AXPW has a market cap of $46 million and a 52-week trading range of $0.25-$0.84. It closed May 15 at $0.38, down 4 cents for the day.

Danbury, CT-based FuelCell Energy Inc. (Nasdaq: FCEL, http://www.fuelcellenergy.com) makes high temperature fuel cells for clean electric power generation. FCEL sells its products to electric utilities, independent power producers, universities, waste treatment facilities and other customers. The company has posted three consecutive quarters with “positive gross margins, revenue that beat expectation and a strong backlog, according to Seeking Alpha (http://seekingalpha.com/article/546321-fuelcell-energy-strong-quarter-and-a-shot-at-fuel-cell-profitability?source=yahoo). FCEL has a market cap of $151 million and a 52-week trading range of $0.80-$1.97. It closed May 15 at $1.09, up 5 cents for the day.

* Denotes client of Allen & Caron Inc., publisher of this blog