Issue #4, January 2002
What...Me Worry?: RCB Small Cap Value Manager's
Long-Term View
By Richard Hefter, Editor, Small
Cap Manager Many of you
may know the name Jeff Bronchick from his 'Buy Sider' column at TheStreet.com
back in the day, but investors in his $12 million RCB Small-Cap Value Fund
know this: He can spin a profit
as well as yarn. His Beverly
Hills-based fund returned 21.4% last year, achieving double-digit returns now
in each of its three full years of operation. Bronchick has been managing small-cap investments since
joining Reed Conner Birdwell in 1989, of which he is now a partner and chief
investment officer. We caught up
with him during one of this week's strong sell-offs. |
|
|
The
markets are getting creamed as we speak. Any thoughts? We're
long-term investors, so we don't really care. The fact of the matter is, people spend way too much time
looking at the prices of things and far too little time trying to understand
the value of things. How do
you 'value' a company? We have
two different ways of looking at it ' through a discounted cash flow model as
well as looking at private market values. That is, what have other companies
in the industries been taken out at, and what would a business owner (rather
than the market) pay? What
does the discount have to be in order for you to invest? An
internal hurdle for us is to be up 50% in two years. That doesn't mean we sell it per
se. But that potential return '
realized by some sort of catalyst or industry or management change we
identify -- is the difference between the 78 stocks we think are cheap and
the 30-35 we own. Thirty
to 35 stocks is a rather concentrated portfolio. That's one of the reasons we've been able to do well. Forgetting last year when 'everyone did well in small cap value,' we've done well consistently in the last 4-5 years when a lot of small-cap value got clobbered. If you own 1700 stocks and have $3 billion in assets, like the bigger firms, you're a victim of the trend ' if small-cap value is out, you're out. But when you have the ability to own just 30-35 stocks, your results are much more dependent upon what you own and the catalysts that shake out there. Even if the overall market is lousy or small-cap value is out of favor, if we can get five or six stocks that year to 'mature' and we watch our mistakes and keep them to a minimum, we can still have very good performance. Does
the maturity come in waves by certain industries? Value does tend to cluster. Occasionally when you have one company in an industry that's cheap, a number of them are all selling for cheap. For example, we were very large investors in insurance, exclusively property and casualty, in late 1999, early 2000. We probably had 25% of the portfolio in small-cap insurers, our maximum for one industry group. They were the worst performing stocks in 1999, and they've been terrific performers since. What
industries do you like currently? In the
past year or so, particularly with September 11 and the economy rotten, we've
added some cyclical and semi-cyclical businesses that appear cheap. In a perfect world we'd rather buy a
better business and pay a reasonable price, but occasionally you get more
than compensated to take the additional risk of a very cyclical kind of
company. |
Well researched
ideas DURING A TIME OF DECLINING SMALL-CAP COVERAGE: A Message from Our
Sponsor By John Dutton, Director
of Research, JM Dutton & Associates, LLC
www.jmdutton.com Companies with market
caps of $100 million or less lost 15.6% of their Wall Street research
coverage from August to December 2001, a new study of ours has found. By comparison, the number of analysts
covering companies with market caps above $100 million dropped by just 2.4%
during the same period. The study by our Bob
Davis looked at the 9,376 public companies in the MultexNet database. Of this group, 276 companies lost
coverage during the five-month period.
Two-thirds of them, or 174, were companies with market caps below $100
million. 'Smaller companies
are losing research coverage at a far greater rate than larger companies, and
this trend has been highlighted in recent months as brokerage firms have had
increasing financial pressure,'
Bob explains. 'As
small-cap companies generate disproportionately less commissions and
investment banking fees for brokerage firms, they are most likely to be the
first to be dropped for larger companies.' Bob Davis is one of
16 analysts at Dutton & Associates who view our model as an opportunity
of for research-orphaned small caps.
We are one of the largest independent research firms, second only to
Standard & Poor's. Our firm
is operated like other top Wall Street research firms are run -- only our
revenue model is different with no commissions or investment banking. We
can be effective in today's Wall Street environment where coverage and
recommendations are driven by investment banking and commission
considerations. With our highly
experienced analysts, most CFAs, Dutton &
Associates is an objective alternative to Wall Street's
sell-side research for ideas and coverage. In the last few
weeks, Dutton & Associates has initiated coverage on the following
companies: '
HTTP
Technology (HTTP) '
Questcor
(QSC) '
The Leather Factory (TLF) '
Mexco
Energy (MEXC) '
HPSC,
Inc. (HDR) Our
reports provide in-depth institutional quality research based on
due-diligence visits, competitive analysis, and development of our own
earnings and price models. We
encourage you to read our reports at www.jmdutton.com
and see for yourself the institutional-style quality ideas of our
analysts. Also join our Dutton
& Associates mailing list to receive our other reports and alerts ' as well
as our studies and other news geared to small-cap investors ' as soon as they
are released. Please read disclaimers at www.jmdutton.com. |
|
Any
examples? Celanese
(CZ) on the New York is an example.
I actually personally own this company. This is a company for which we
paid $16 and has a tangible book of $32. The P/E is probably 910, but a lot of people make
the mistake of thinking a stock is too cheap when earnings are very high and
too expensive when earnings are very low, when the only thing that's changing
is the E. You have to look at a
lot of the more cyclical companies on an enterprise value to sales basis to
see where they've traded over the last decade and through different cycles. We think Celanese is absurdly
cheap. In
addition to Celanese, we bought Idex (IEX), which is an excellent group of
semi-cyclical businesses run by a very smart ex-GE guy who has done excellent
work; Ametek (AME), Superior Industries (SUP), Ameron (AMN), Franklin
Electric (FELE) ' all companies that we call semi-cyclical little gems. So, de facto, I would say, we're
positioned for a better economy and I think sometime in our lifetime we'll
get one. What
other stocks do you like? UCAR
International (UCR) is one. They
provide graphite electrodes to the mini-mill steel industry, which doesn't
sound like a recipe for riches and frankly hasn't been. Our cost is probably right around
where the stock is now, around 12. Admittedly, this is the worst steel industry
environment in 900 years, or since the invention of the steel industry, but
we feel they are the leader in this high-margin, very high cash flow business
that is probably near a cyclical low.
There's an old line of Warren Buffett's that when management with a
reputation for brilliance meets a business with a reputation for being lousy,
it is the reputation of the business that survives. But we think management has really done an excellent job
of ripping out cost and making this such a better company. We think
the earnings leverage is probably close to $2 in a reasonable economic
environment, so essentially you're barely paying for the core business, and
you also get two options on the future.
One is they have a subsidiary called Graftech, which has a graphite
product with strong electrical and thermal conductivity that is the primary
raw material in Ballard Power's advance fuel cell platform. The other is they've got a very large
lawsuit against Union Carbide/Dow Chemical and Mitsubishi ' and Mitsubishi has already pleaded
guilty on the exact same issue.
In the meantime, you get a company run by a very smart guy at a
cyclical bottom generating cash in a truly miserable environment, and again
if we have a decent economy sometime in our lifetime this could be a decent
stock. You're
willing to wait a lifetime? Not
quite, but for the small-cap manager, illiquidity is your friend. You are paid to take advantage of
other people's fear of illiquidity.
People say it's moving too slowly, not trading enough, but if the idea
works, there'll be plenty of people buying it when it's doubled. So if you can wait two or three
years for an idea, you get more than compensated because the stock ends up
being cheap. Any
other stocks you want to mention? SBS
Broadcasting (SBTV) is another.
We have about 12% of our portfolio in non-U.S. companies like
SBS. It's basically a television
and radio company that was formed about 10 years ago to take advantage of the
deregulation of European television stations. They floundered for a number of years, but over the past
five years have gotten their act together and they've got very attractive,
highly cash flow positive properties in television and radio in Belgium, the
Netherlands, Switzerland, Scandinavian countries. We think
several things are happening.
One is that a guy named Michael Finkelstein, who came into the company
three of four years ago actually as an investor, just took the reigns as
CEO. This guy built, ran and
sold Renaissance Communications, a very large radio and television company in
the US. He's a very hard-nosed
cost-oriented guy, and that's the key to the broadcast business. It's the old Capital Cities model of
`have the lowest costs and you'll be successful.' So he's really ratcheting up SBS operations, and even on
modest revenue growth, which frankly is to be expected over the next couple
of years given economic conditions, they have the potential for some pretty
explosive cash flow growth. Secondly,
we see him as a builder, operator, and seller, and European media in almost
all forms is a very heavily consolidating arena. Putting all these together, it makes obvious sense that
SBS is an attractive candidate sometime in the next two-ish years and we
think the value is probably in the mid-30s, whereas the stock right now is
under 17. You must
have your hands full covering the globe in search of small caps. The
beauty and fun of small caps is there are something like 8500 companies under
a billion and a half of market cap, which is how we define it, and you
probably throw in another 400-500 around the world that are conceptually
invest-able that we look at, so you have 9000 companies. You're never bored. There's always something piled up
behind your desk that in some way looks attractive or interesting or cheap
and you're just trying to find the time to get to it. ' 2002, The SmallCap Manager,
An AdviceTrade Publication, Sponsored by JM Dutton & Associates www.jmdutton.com |
|