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.

LED: Looking alot Like Lighting’s Future

Our interest in small cap lighting companies was piqued this week with the announcement April

Photo courtesy of trinamao.en.busytrade.com

Photo courtesy of trinamao.en.busytrade.com

25 that New York-based ForceField Energy (OTCQQB: FNRG) had signed a letter of intent to acquire a 60 percent interest in 1-800 NY Bulbs.

The combination seems to make sense. During its 25 years of existence, Bulbs has more than 8,000 commercial clients, is an authorized dealer and distributor of GE Lighting Products and has projected about $5 million in revenue in 2013, according to the press release announcing the letter of intent. ForceField is focused on renewable energy, energy efficiency and LED (Light Emitting Diode) products.

LED lights are the latest in modern technology and energy efficiency, but have been slow to become the standard in households because of their price, according to Time magazine (http://business.time.com/2013/04/25/light-switch-why-youll-start-using-led-bulbs-this-year/). But the Time report suggests LED prices are coming down. Also, the Energy Independence and Security Act, passed in 2007, requires lightbulbs to become more energy efficient  and has led to the phasing out of standard 100-watt and 75-watt incandescent bulbs, with the 60-watt and 40-watt bulbs to follow.

So the day of the LED light could be near, as could be an intriguing jolt of energy to small cap lighting companies.

FNRG (http://www.forcefieldenergy.com) is a lightly-traded, $87 million market cap, pink sheet company with a 52-week trading range of $2.20-$5.64. It is also involved in transforming waste heat from manufacturing and other sources into electricity. It owns 51 percent of TransPacific Energy Inc. FNRG closed April 26 at $5.35, no change for the day.

Charlotte, NC-based Revolution Lighting Technologies (Nasdaq: RVLT, (http://www.nexxuslighting.com/) designs, manufactures and sells commercial grade LED replacement light bulbs and LED-based signage under the Array Lighting and Lumificient brands (Lumificient Corporation is a subsidiary). It was formerly called Nexxus Lighting and operates mainly in the global commercial, hospitality, institutional, retail and sign markets. RVLT closed April 29 at a 52-week high of $4.01, up 45 cents for the day with a market cap of $140 million. Its 52-week trading range is $0.11-$4.01.

Cincinnati-based LSI Industries (Nasdaq: LYTS, http://www.lsi-industries.com/) is 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. Its 52-week trading range is $5.81-$7.77. It closed April 29 at $7.09, up 18 cents for the day, with a market cap of $170 million.

Solon, OH-based Energy Focus Inc (OTC Pink: EFOI, http://www.energyfocusinc.com/) makes LED lighting products as well as products based fiber optic and other energy-efficient technologies. EFOI focuses on the government and public sector markets, as well as the general commercial and pool markets. Its 52-week trading range is $0.16-$0.40. It closed April 29 at $0.22, up 3 cents for the day, with a market cap of $8.4 million.

Stocks Rally to Record Highs in Early January with Small Caps Leading the Way

Stocks soared to a great start in 2013, posting the best weekly gain in two years, with small caps leading the way. But the rally was really just an extension of a small cap surge that  started back in mid-November, according to the Wall Street Journal (http://online.wsj.com/article/SB10001424127887323374504578217923720381476.html?KEYWORDS=matt+jarzemsky). The story headline notes that the Russell 2000 index of small cap stocks was up 14 percent since mid-November, when small caps hit bottom, compared to an 8.1 percent increase for the S&P 500.

Photo courtesy of joshkilen.com

Photo courtesy of joshkilen.com

The rally was connected to improvements in home construction and related industries and analysts’ forecasts that small caps will report stronger earnings growth in the fourth quarter than mid-size and larger companies, according to the WSJ. There are also expectations that merger activity will be beneficial to small caps in the coming months.

Finally, the bullish mood in this market tends to benefit small caps, according to analysts quoted in the story. Small caps are more volatile, so when investors are feeling bullish they are willing to make bets on the stocks that have more “juice,” the report noted.

The first week of 2013 also featured a lot of small cap stock picking. The WSJ small cap story mentioned two to watch, Big 5 Sporting Goods and OfficeMax.

Naperville, IL-based OfficeMax Inc. (NYSE: OMX, http://www.officemax.com/) operates 978 retail stores selling office supplies in the U.S. and Mexico, three large distribution centers in the U.S. and one in Mexico. OMX also operates what it calls its Contract segment that sells directly to corporate and government offices. Formerly called the Boise Cascade Corporation, OfficeMax was founded in 1913. The WSJ noted that OMX stock has climbed 27 percent in the past three months. It’s 52-week trading range is $4.10-$10.62 and its current market cap is $869 million. OMX closed Jan. 4 at $10.02, up 42 cents for the day.

El Segundo, CA-based Big 5 Sporting Goods (Nasdaq: BGFV, http://www.big5sportinggoods.com/), which was also featured in a recent Barron’s article, has seen its stock price soar by 31 percent in the same three-month period.  Big 5 operates 409 retail sporting goods stores in the western U.S. and was founded in 1955. According to Barron’s, Big 5 is enjoying a successful turnaround since hitting bottom during the recession. The turnaround strategy included moving to higher-priced, “name brand goods” which resulted in the third quarter of 2012 enjoying the best same-store sales growth since 2006, according to the Barron’s story. A Piper Jaffray analyst says if Big 5 can regain the margins it lost during the recession years, bigger things are ahead. BGFV’s 52-week range is $6.12-$14.30 and its market cap is $283 million. It closed January 4 at $13.28, up 15 cents for the day.

The Barron’s story, which focused on small cap winners for 2012 that the publication had featured during the year, suggested two other small caps to watch: Farmer Brothers and Reading International.

Torrance, CA-based Farmer Brothers (Nasdaq: FARM, http://www.farmerbroscousa.com/) is a producer and distributor of coffee and related products as well as teas, soup bases, sauces, pancake mixes and preserves. Barron’s calls it the small cap column’s “biggest winner to date” based on the fact its stock has nearly doubled since July. The company has turned around this year, expanded its margins and signed up McDonald’s as a client, according to Barron’s. Its 52-week trading range is $6.73-$15.37 and its market cap is $217 million. It closed Jan. 4 at $13.98, down 66 cents on the day.

Los Angeles-based Reading International (Nasdaq: RDI, http://www.readingrdi.com/) develops and operates real estate and entertainment (cinemas, theaters including Union Square theater in New York) assets in the U.S., Australia and New Zealand. Barron’s called the stock a good pick for “patient investors.” RDI’s 52-week trading range is $4.11-$6.62 and its market cap is $140 million. It closed Jan. 4 at $6.07, down 1 cent for the day.

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.

 

Scouring for Small Caps Highlighted in Current Barron’s: CENT, VPFG, SCVL

BarronsLogoWe are well aware of the power a mention in Barron’s can mean for a stock, either for the good or bad. So we make a regular habit of scouring The Dow Jones Business and Financial Weekly, as it calls itself, for any mentions of small cap stocks. This week (the December 24 edition) there were at least three.

Barron’s staffer David Englander is a regular small cap contributor via his weekly Sizing Up Small-Caps column. This week he covered Walnut Creek, CA-based Central Garden & Pet under a headline “A Paws that Refreshes.” Central is a supplier of garden and pet products that boasts Wal-Mart, Lowe’s, Home Depot, PetSmart and Petco as customers.

Central stock had been rising throughout most of 2012 as it cut costs dramatically (original goal was $120 million by September, according to Englander) by streamling its manufacturing and distribution efforts.  That rise came to a screeching halt Dec. 11 with a selloff triggered by the announcement of its fourth quarter earnings. Apparently the cost cutting “led to supply-chain disruptions” and delays in filling orders, which were not well received by Wall Street.

Central (Nasdaq: CENT or CENTA for class A shares, http://www.central.com/) has a 52-week trading range of $7.99-$12.61 with a market cap of $479 million. CENT was trading at $11.42 as recently as Dec. 7. It closed Dec. 27 at $9.99, up 17 cents for the day.

The two other small caps (by our definition under $1 billion market cap, give or take…) in the current Barron’s were part of an interview of Eric Marshall, portfolio manager, Hodges Capital Management. In the list of top 10 holdings in the Hodges Small Cap Fund are:

Plano, TX-based ViewPoint Financial Group (Nasdaq: VPFG, http://www.viewpointfinancialgroup.com/) is a regional bank that was “converted from a sleepy credit union that Marshall calls ‘a value play with a growth component.'” Marshall likes the new life new management is providing. Its 52-week trading range is $12.96-$21.99 and its current market cap is $774 million. It closed Dec. 27 at $20.76, up 17 cents for the day.

Evansville, IN-based Shoe Carnival (Nasdaq: SCVL, http://www.shoecarnival.com/), a shoe retailer with 352 stores in 32 states and Puerto Rico, is called a “big growth prospect” in Barron’s. SCVL has a goal of doubling the number of stores. Its 52-week trading range is $15.23-$24.66 and its current market cap is $386 million. It closed Dec. 27 at $19.26, up 20 cents on the day.

Buzz Zaino: Royce Fund Manager Sees Strong Growth Upside for 2013, Boosted by Housing, Transportation, IT Spending

ZainoB_gBoniface A. (“Buzz”) Zaino is a portfolio manager advising several of the high-profile Royce Funds, to wit, the Royce Opportunity Fund and associated funds. By any measure a veteran of the industry, Buzz has more than 40 years of experience in the financial services industry, the last 14 with Royce. I first met him when he was managing the Value Added Funds for Trust Company of the West more than 20 years ago, but prior to that he was president of the Lehman Capital Fund and a principal of the “original” Lehman Brothers. He went to school at Fordham, and took his MBA from Columbia. In 44 years, Buzz has seen enough economic cycles to offer an MBA from the University of Zaino.

Buzz agreed to talk about his 2013 outlook from his home in Aspen which, like much of the US snow belt, has seen little of the white stuff so far this year.

JA: It seems generally agreed that the US economy is growing at a slower pace than it has coming out of previous recessionary periods. What is your outlook for 2013? Will the economy continue to grow, and if so, will it grow at the same rate, faster or slower?

BZ: The reason that the US economy has had a slow lift-off has been that coming out of recessions in the past, the Fed has lowered interest rates, and people took that opportunity to buy houses and cars. This recession was different, because the banks were not giving out money, because money was scarcer and because bank lending standards were significantly more stringent. So there was a hiatus and it took a lot longer for the economy to recover. The recovery finally started this year, 2012, and it is finally beginning to give a boost to the economy, especially as construction gets going again. That boost is going to continue, and it will help us accelerate in 2013. But the recovery was complicated by the fact that Europe went into recession. American companies tend to be worldwide in scope, and caution at the top levels helped bring inventory levels down due to the European recession. That meant that capital spending was also muted. I think that capital spending is also constrained in anticipation of the budget settlement that is still out in the future. A “normal” recovery was delayed until 2012, and then delayed again by the European recession. But those delays now give us the opportunity to accelerate as 2013 progresses.

JA: Will we get a budget?

BZ: Sooner or later, yes. We will get a budget deal out of Congress. Once we have that deal defined, we can go forward from there. That will be a positive, and will be on top of the acceleration we can expect from normal factors like housing and auto sales. We could get a nice surprise in 2013. But we’re cautious about January.

JA: Why is that?

BZ: Most managers will make their January decisions based on their December orderbooks, and we don’t think the December orderbooks will be strong enough to give them confidence, but as we go into February and March, a lot of the inventory build-up will have started to occur, so the orderbooks will look better. And the trade between China and the US is expanding again, after a period of slower growth. We think that could have an increasing effect, especially after the Lunar New Year. By the end of the first quarter, growth could be looking quite good.

JA: The harsh talk by Washington DC and Beijing won’t slow down that growth?

BZ: The China-US trade is too big a market for both sides, and politics will not interfere with it. Certainly the Chinese government’s expansion plans are not going to be held back. There are Chinese hotel companies looking for hotel properties in the US – to build or to buy. Very smart people, and I don’t think either side is going to let politics inhibit our trade relationships. Nothing is going to come of the yelling.

JA: Will the growth rate be higher going into the second quarter then?

BZ: I think we could have a weak-ish economy and market in January, like I said. Everyone will be paying higher taxes, at least with FICA deductions back in everybody’s paychecks. With orderbooks in December that may not be strong, managers and consumers could still have their hands in their pockets. If we have a warm winter like we had last year, we could have more construction starts. If we have a cold, snowy winter, those starts could be delayed, and the weak period could extend through January. We are looking very favorably at housing. Housing is still somewhat depressed, but the housing stock is aging — and mortgage money is more available than it was a year ago. And the automobile fleet is aging and will need to be updated, as will the commercial truck fleet.

JA: Do you think the growth rate will exceed 2%?

BZ: Yes, better than 2%, but maybe not in January. But after that it could be substantially more than 2%. Four to five percent would not be out of the ballpark, although 5% would be at the high end of probability. And the market would react to that. If the market is down – and cheap – they don’t want to buy, but if it goes up 15%, everybody wants to buy. If UPS starts to replace its fleet and buys trucks, all the others will update their fleets at the same time. It’s much cheaper to run your truck or your fleet on CNG (compressed natural gas) too. A town near Aspen has converted their entire bus fleet to CNG, and although they can fuel up at the bus barn, there are additional CNG stations being built. Boone Pickens and his group are encouraging these new CNG fueling stations. We’re surprised that trucking companies are not moving faster than they are toward natural gas. We have an investment in a building materials company and I asked them if they are considering CNG, and they said they had not looked into it, but they would. Conversions to CNG are not expensive. Ford and GM are now offering pickup trucks with CNG engines.

JA: Is there going to be a fiscal cliff solution?

BZ: Eventually. Whether or not it happens before December 31, there’s no way to tell. But the congress can pass a continuing resolution to postpone the cuts and tax increases while they work on it. Eventually this Mexican standoff will be resolved. And by the way, the fiscal cliff does not seem to be a big motivator for the American consumer. They need to replace things, and they are not overly concerned with the big picture as long as the economy seems to be getting healthier.

JA: What sectors are going to do better as the economy improves?

BZ: IT spending will pick up. There is a big pent-up need factor here, and it has been a relatively easy way to postpone expenditures for the last couple of years. Windows 8 is very much under-rated. It takes a while for people and corporations to decide to make a big change like the change to Windows 8, but it will be very good for PC companies. Corporations need to have the latest and fastest. Technology in corporate environments needs to be the newest and most capable. Areas like IT are why you can think of higher growth rates. After this hiatus, there is enough pent-up need to start a new momentum.

JA: How about healthcare IT?

BZ: I went to see my physician in New York, and he is one of the best, highest-rated doctors in his specialty. He was really annoyed that he was going to have to convert my file, which is a manila folder with all kinds of paper and bits of paper in it – to computer files. I thought, hey, this is 2012, get with the plan.

JA: How about housing? Any areas there where investors ought to be looking?

BZ: We have had a good run with housing companies, and we think that will continue. One area that may have real potential is mortgage insurance companies. It is a fairly narrow field, and some people infer from the papers that these companies may not be able to cover their losses. The reality is that housing prices could be moving up at a rate of nearly 1% per month in the near future, and as a result those liabilities would be decreasing. Mortgage applications for refinancing were up last week 47% year over year. That’s a meaningful number. Apparently not everyone is under water. Those areas that have dropped the most are improving the fastest in some cases. California is one of those.

JA: Any areas where you would be wary going forward?

BZ: Defense companies. We think there will be lots of cutbacks, lots of programs cancelled. Defense personnel contractors may do better as the armed services cut back their personnel. Company by company there may be some good bets in defense, but we believe the sector will be down.

JA: And in summary?

BZ: Other than defense, it is going to be a broad-based recovery. If we have a growing, recovering economy, interest rates would rise, and inflation would rise. Commercial banks will do better. They will use their asset bases to increase lending. The moderating factor will be that regulations will add some cost, but that will not be an inhibitor for the larger banks looking to expand regionally. If I were a larger bank and wanted to expand regionally, it would be attractive to me to buy a regional bank and expand my profitability without appreciably expanding my regulatory exposure.

JA: Thanks, Buzz.

Note: Buzz prefers not to name specific companies in his portfolios. The interviewer has no investments in the sectors discussed, and does not intend to initiate such investments in the next few days or weeks.

Real Estate Experts Seem to Agree: Home Prices ‘Inching Up’ and Housing Is Back

The housing market is back. That news has been popping up throughout August based in part on the word that storied investor Warren Buffett is “betting big” on housing, according to a Wall Street Journal video featuring housing reporter Joe Light (http://live.wsj.com/video/why-buffett-is-betting-big-on-housing/432BAEE2-88DB-4382-9496-2DA9F86E3047.html?KEYWORDS=joe+light+housing#!432BAEE2-88DB-4382-9496-2DA9F86E3047).

Photo courtesy of 123RF.com

Light brings up some excellent points aimed at the retail investor. They include:

  1. New home inventories are the lowest they have been in almost five decades. As of Aug. 2 there were only 144,000 new homes for sale.
  2. Home prices have started to “inch up,” based on the Case-Shiller Home Price Index and other similar reports.

Light suggests that the most important thing for home prices is momentum, which he says is now in home prices favor. Along with the momentum effect, the other important indicator is price-to-rent ratios, comparing home prices to rents, which are back to the very low level they were at in either 1999 or 2001, depending on what index you are looking at. 

For retail investors, Light says there are two ways to play this improving housing market: either by buying commercial real estate investment trusts which are focused on properties with short leases such as self-storage units where owners can raise the rents quickly as the economy gets better; or by buying home builders. As examples, he listed Lennar and KB Home.

Light’s views on the low supply of newly constructed homes was seconded by J. Allen Smith, chief executive of Prudential Real Estate Investors, owners of about $50 billion in real estate assets. In part of a wide-ranging interview in the Aug. 29 the New York Times, Smith said “new construction starts are so low that even with an anemic economy–one bouncing along at 2 percent growth–the supply-demand fundamentals will continue to improve.” (http://www.nytimes.com/2012/08/29/realestate/commercial/the-30-minute-interview-j-allen-smith.html)

Housing prices, even in the hardest hit areas like Miami, Atlanta and Detroit, seem are “inching up” nationally “for the first time since 2010, when sales were helped by a temporary tax credit for home buyers,” according to another story in the Aug. 29 New York Times (http://www.nytimes.com/2012/08/29/business/economy/home-prices-rise-survey-shows.html).

There are several  small cap home builders to choose from, including four we have covered in the recent past.

Red Bank, NJ-based Hovnanian Enterprises (NYSE: HOV, http://www.khov.com/) specializes in single-family detached homes, condominiums and town homes and operates in two segments: homebuilding and financial services.  The company’s 52-week trading range shows it was trading for as low as $0.89 last October and then went on a tear, going as high as $3.31 in early February. When we last checked on July 11 it was trading for $2.65 and its market cap was about $350 million. It closed Aug. 31 at  $2.92, up 20 cents for the day, increasing its market cap to more than $370 million.

Los Angeles-based KB Home (NYSE: KBH, http://www.kbhome.com/) is also a home building and financial services company catering in large part to first time buyers. KB is an old Southern California home builder, founded in 1957 and formerly called Kaufman and Broad. Back on July 11 its market cap was $754 million and it was trading for $9.74. It closed Aug. 31 at $11.04, up 17 cents for the day, increasing its market cap to $851 million.

Columbus, OH-based M/I Homes Inc. (NYSE: MHO, http://www.mihomes.com/) builds single family homes primarily in the Midwest, Mid-Atlantic and southern parts of the U.S. The  company was founded in 1973 and, like most of the other builders, has homebuilding and financial services divisions. Back on July 11 its market cap was $331 million and it was trading for $17.50. It closed Aug. 31 at $19.30, up 32 cents for the day, increasing its market cap to $352 million.

Atlanta-based Beazer Homes USA (NYSE: BZH, http://www.beazer.com/) builds and sells single-family and multiple-family homes in 16 states in the U.S. It also acquires, improves and rents homes. The company operates through commissioned home sales counselors and independent brokers. Back on July 11 its market cap was about $283 million and it was trading for $2.86. It closed Aug. 31 at $2.94, up 6 cents on the day, increasing its market cap to $297 million.

Two home builders we didn’t cover previously, that are both trading near their 52-week highs include:

Irvine, CA-based Standard Pacific (NYSE: SPF, http://www.standardpacifichomes.com/) builds single family and detached homes targeting a range of homebuyers. It also provides mortage financing services through its mortage finance subsidiary, Standard Pacific Mortgage. It’s market cap is currently $1.34 billion and 52-week trading range is $2.17-$6.71. It closed Aug. 31 at $6.70 up 14 cents for the day.

Westlake Village, CA-based The Ryland Group (NYSE: RYL, http://www.ryland.com/) a homebuilder and mortage finance company. RYL covers many aspects of the home buying process including design, construction, title insurance and escrow. Its 52-week range is $9.15-$27.15 and its market cap is $1.21 billion. It closed Aug. 31 at $26.81, up 81 cents for the day.