Value Portfolio

MSC Industrial Direct (NYSE: MSM) is turning lemons into lemonade.  The nationwide distributor of metalworking and industrial supplies continues to be well positioned to gain market share in a weak demand environment.  On the company’s third quarter earnings call, CEO Erik Gershwind spelled out how a cyclical slowdown in the industry could manifest into greater success for MSC:

As I look ahead, longer term dynamics remain favorable for an exciting growth story. First, the MRO marketplace is very large and highly fragmented, with clear signs that we’ve entered the early stages of a consolidation story.

This is starting to play itself out in the large accounts arena, and I expect the trend to build momentum over time. If the recent softness continues, local and regional distributors will be hit disproportionately hard, and that will mean even more opportunity for MSC to execute our growth plan.

The company reported third-quarter adjusted EPS of $1.03, soundly beating analysts’ estimates of $0.96 per share. Jeff Kaczka, Executive Vice President and Chief Financial Officer, commented:

Despite the challenging demand environment, we achieved earnings per share well above our guidance range. A key driver was the prompt actions that we took to manage our operating expenses. We achieved operating expenses as a percent of sales at the same level as the year ago quarter, even though sales growth was only low single-digits and we increased our investment spending. The second driver was another quarter of gross margin stabilization, which reflected our successful countermeasure efforts, offset by the gross margin headwinds from large account growth and the soft pricing environment.

For the quarter, net revenues rose 3.5% of $745.5 million, compared to $720.5 million in the same quarter last year. Although MSC revenue growth is slowing, investors who have been listening to CEO Gershwind’s honest and direct communication in previous calls were not the least bit upset by this temporary weakness. Revenue is expected to grow 2% in the fourth quarter.  Management noted that the significant and swift deceleration in demand witnessed earlier in the year has dissipated and orders are leveling off.  The cross selling opportunities envisioned when MSC purchased Barnes Distribution North America are coming to fruition.  Salespeople who previously were primarily selling metal working parts now are able to offer customers a wider range of products.

MSM released its guidance for fourth-quarter with 2015 net sales between $735 million and $747 million, representing sales growth of about 1% to 3%. MSC is set to make $3.79 per share this year and pays a handsome 2.25% dividend yield to investors as they comfortably wait out a cyclical upturn in industrial manufacturing.  

One look at the Sanderson Farms’ (Nasdaq: SAFM) chart would leave investors guessing the company’s earnings had laid an egg.  Nothing could be further from the truth.  Second quarter earnings reported at the end of May showcased a 41% increase in earnings per share.  The stock, which is down 27% since our July 2014 inclusion in Roadrunner’s Value Portfolio is down 15% year to date despite delivering robust earnings.

The problem lies in the cyclicality of Sanderson’s business.  Although stronger domestic demand has supported mid-single digit revenue growth, the real propulsion to earnings has been the shriveling cost of corn feed.  Investors are nervous that earnings will plummet when feed costs return to normal levels.

According to data from the Chicago Board of Trade, corn prices have fallen 50% in the past two years.  In that same time period, Sanderson’s earnings have catapulted from $2.35 in 2012 to $10.80 in 2014! Although estimates for 2015 call for an increase to $11.58, 2016 pencils in a 30% drop to $8.00 per share.

Add to that fears that McDonald’s may follow suit of Chick-Fil-A and Chipotle who promise customers antibiotic-free chicken.  In early May competitor Tyson Foods announced that they will phase out the use of all antibiotics for chicken raised for meat by 2017.  CEO Joe Sanderson responded in May that the company is not changing their company policy on antibiotics, which may increase the risk of lower sales in the future.

Yet Sanderson trades at the low end of its historical P/E range.  The company has traditionally traded at 8 times historical earnings and is currently trading at 6.5 times 2014 earnings.  It has almost no debt and a book value of $44, versus its current stock price in the low 70s.  Investors can likely start wading into the chicken coop knowing that this low valuation should insulate them from large future losses.

W.R. Berkley (NYSE: WRB) has been a resounding winner in the Roadrunner Value Portfolio since its May 2014 initiation.  The stock is up 42% since inclusion and up a remarkable 9.5% year to date.

The specialty insurer’s combined ratio in the second quarter of 94.2% (below 100% means insurance underwriting is profitable) marks the 34th consecutive quarter under 100% and underwriting profitability continues to benefit from strong pricing trends in the domestic U.S. market.  In the company’s second-quarter financial report, CEO William R. Berkley noted that international insurance and global reinsurance remain “painfully competitive” but thanks to strength in the domestic U.S. insurance segment the overall business picture is bright:

We were pleased with our second quarter results. While the environment is becoming more competitive, we continue to emphasize those parts of our business that offer the best profit potential while simultaneously pursuing new business opportunities. The domestic insurance market remains the bright spot, workers’ comp, General Liability, as well as select parts of the professional market remain particularly attractive.

Mergers and acquisitions (M&A) activity in the insurance sector is picking up steam, which has helped boost W.R. Berkley’s valuation as speculation rises that WRB may be the next target. In early June, Japanese insurer Tokio Marine acquired HCC Insurance Holdings for $7.5 billion in cash. On July 1st, Swiss insurer ACE Limited announced it was acquiring Chubb for $28.3 billion in cash and stock. Both deals are illustrations of foreign broadline insurance companies’ hunger to diversify into specialty lines of insurance in the United States.  Both foreign insurers specifically mentioned the benefit of enjoying the higher insurance growth in the U.S. marketplace, where demographics support higher demand for insurance.

W.R. Berkley’s fundamentals continue to roll in the right direction. The company raised its quarterly dividend by 9%  and initiated a 10 million share repurchase program on June 2nd, which represents 8% of its outstanding shares. The dividend hike marks its 10^th consecutive annual increase. Last year, the company raised its dividend by 10% and the company has a 5-year dividend growth rate of 12.4% compared to the industry’s 8%..

Analysts at both Credit Suisse and Goldman Sachs raised their price targets for WRB. Despite the market’s recent downturn, WRB rose 11.6% in the past 30 days hitting an all-time high on July 10.

Momentum Portfolio

Apogee Enterprises (NASDAQ: APOG) reported a solid first-quarter with EPS almost doubling to $0.41, topping analysts’ estimate of $0.37. First-quarter revenues rose 14% to $240 million, also beating consensus estimates of $241.76 million.

The strong performance was driven by its Architectural Services and Architectural Framing systems segments which rose 8% to $55.7 million and 12% to $71.9 million, respectively. Its third and smallest segment saw modest growth of 1% to $20.2 million. Apogee’s order backlog currently stands at $470.8 million, a 22% increase compared to the prior year’s quarter.

Management said it plans to invest $45 million to $50 million to increase its capabilities, capacity and productivity. For fiscal 2016, Apogee Enterprises expects EPS in the range of $2.10 to $2.25, up five cents from a prior range of $2.05 to $2.20. Analysts expect the company to post a full-year EPS of $2.13. Management anticipates surpassing $1 billion in revenues in fiscal 2016 with trailing 12-month operating margin of 10% midway through fiscal 2017. It offers a longer term outlook of $1.3 billion at 12% operating margin by 2018.

CEO Joe F. Puishys said:

This outlook is based on the continued strength of our backlog, commitments, and bidding and award activity, combined with industry forecasts for low double-digit growth for the commercial construction market sectors we serve.

Zacks upgraded shares of APOG from a “hold” to a “buy” rating with a price target of $59. 

GIII Apparel (Nasdaq: GIII). “Simply put, regardless of the direction the wind is blowing, at G-III, we get the job done”.  Morris Goldfarb, President and CEO of G-III Apparel, pretty much nails it in the first-quarter conference call when describing the company’s performance as of late.

While many retailers are blaming poor weather or tight purse strings on their lackluster results, G-III is delivery incredible results.  The designer, manufacturer and marketer of licensed apparel has diversified its business so well, that it does, in fact, get the job done regardless of the cross-winds blowing against the retail industry.

In the first quarter, reported on June 3rd, the company grew revenue 20% and increased its forecast for annual earnings to $2.71 up from a previous estimate of $2.58 representing 20% growth. Despite being its largest brand, the company’s Calvin Klein business continues to grow.

Part of G-III’s recent success has been its keen focus on dresses, the one bright spot in women’s apparel. Geometric print maxi dresses by its Eliza J. brand have been jumping off the racks at Nordstrom.  Floral Vince Caputo swing dresses were all the rage at Macy’s. Management noted that Eliza J. has become the number one dress brand at Nordstrom, quite an accomplishment when considering the portfolio of brands Nordstrom’s has at its disposal. The Eliza J. business doubled in the most recent quarter.

Luckily for G-III it is not dependent on any one brand or traffic to any one department store. Although almost 60% of its sales are to department stores, only Macy’s accounts for more than 10%.

In addition to expanding the licenses for which it develops product, G-III grows its revenue by gaining space on the floor of retailers.  In January, premier brand Jones NY announced that it would shutter its wholesale business.  This leaves G-III the opportunity to grab that retail space and fill it with racks of Calvin Klein sweaters and Tommy Hilfiger jackets.

Like your favorite jeans, it’s hard to let go of G-III which has been a fabulous pick for Roadrunner Stocks. The stock is up 230% since our May 2013 inclusion.  Yet with ever increasing estimates, the stock still fits quite well.

Hill-Rom Holdings announced it will acquire industry rival Welch Allyn for $2.05 billion in cash and stock. Under the terms of the deal, Welch Allyn shareholders will receive $1.625 billion in cash and 8.1 million shares of Hill-Rom common stock. The acquisition is transformational in that it changes the company’s focus from hospital beds to high-tech diagnostic services.

Hill-Rom expects the deal to be immediately accretive to its adjusted gross and EBITDA margins and is expected to add 10% to EPS in fiscal 2016. The combination of both companies is expected to generate over $2.6 billion in revenues and over $500 million in adjusted EBITDA. The combined companies expect run-rate cost synergies of at least $40 million by 2018.

Third-quarter financials were very strong, with both revenues and earnings beating analyst estimates. Third-quarter revenue increased 19 percent from the prior year to $475 million, on the strength of 11 percent organic, constant currency growth. Forward guidance for full-year revenue growth was raised to between 12 and 13 percent, compared to between 10 and 11 percent previously.

CEO John Greisch is one of my favorite CEOs because he is an honest, straight shooter who is not afraid to point out problem areas in the business. I must say that Greisch sounds more upbeat in this quarter’s conference call than in any other one I have ever listened to:

Our North America business continues to have a great year. Orders for the third quarter increased sequentially 24% to the highest quarterly level we have seen in about four years, while backlog was up 15% sequentially. Unlike our fiscal fourth quarter in 2014 were we benefited from a couple of sizable individual orders most notably from HCA we saw strength in all product categories across the board without the benefit of any unusually large orders. Our team is very excited with the progress we are making this year and by the prospects we have as we look ahead.

Simply put, business must be very good for Greisch to be so uniformly upbeat!

Marcus & Millichap (NYSE: MMI) has certainly earned its place in the Roadrunner Momentum portfolio. The stock is up 106% since its August 2014 inclusion and shows no sign of slowing down.  

The commercial real estate broker more than doubled earnings per share in its most-recent first quarter to 35 cents. Earnings for the year are expected to equal $1.65 for the year ending December.

The company, who championed exclusive listings for commercial properties way back in 1971, continues to reap the benefits of its well-trained team of brokers. The company notes that the commercial real estate recovery, which had originally been concentrated in the East and West coasts in 2012, has spread to all major metros in the country.

Just as George Marcus explained to his inaugural team of inexperienced brokers in 1971, the real estate business is about providing honest value to customers. Once you have a handful of happy customers, referrals will grow the business for you.  Certainly that’s a simplification of the work done by Marcus and Millichap’s to extend its real estate portfolio from hotels to apartment buildings blanketing the country.

The company has close to 3,000 properties listed on its website ranging from a $50 million hotel at the foot of the Lincoln Tunnel to a $30 million self-storage facility in Seattle Washington.

Management is ebullient about the business going forward.  The dearth of new retail properties built over the past 5 years will continue to feed the secondary market. Demand for commercial restaurant properties continues to track the rise in demand from millennials who are eating out more than ever. As Senior Executive Vice President Hessam Nadji so accurately describes, there has been very little supply of new commercial properties since the recession.  As the commercial broker scoring an abundance of these properties, Marcus and Millichap looks right at home as a momentum stock.

Paycom Software (Nasdaq: PAYC). With only three months under its belt in the Roadrunner Momentum portfolio, Paycom Software is already a big winner. The stock is up 15% since our April 29th inclusion. Although the stock is expensive utilizing traditional valuation tools, its tie to a secular change in human resource regulations should keep that valuation afloat.

For years, human resource departments have employed software to manage and organize the oodles of data fed to them.  There is no shortage of products for a recruiting team to help find and screen applicants. The same can be said for payroll packages that track hours, salaries and taxes. There is also sufficient supply of software to coordinate and execute the knotty regulations of employee benefits.  

However, after buying these various and often discordant products, companies found themselves spending huge amounts of time tying the information from various software packages together. Paycom is one of the few companies that unifies talent acquisition, time and labor management, payroll, benefits and talent management in a single subscription product.

Human resources is one industry where a subscription model makes much more sense than purchasing a software bundle.  In a sector where tax rules and regulations are continually changing, updates to tax rates, healthcare savings account rules and mandated coverage guidelines are updated continuously.  

Obamacare has been and will continue to be a driving force for Paycom’s growth.  Any company with more than 50 employees finds itself up against a January 2016 deadline to meet various Affordable Care Act (ACA) requirements or paying a fine. Paycom just released an updated ACA compliance product.  According to the company, two thirds of companies are not ready to comply with the January 31, 2016 Obamacare deadline. Paycom’s software allows companies to free up resources to manage other aspects of their business and to remove human error from manual input of critical data.

On August 5th, the stock skyrocketed more than 18% after it released stellar second-quarter financials. Adjusted second-quarter earnings skyrocketed 150% to 10 cents per share, beating analyst estimates by 4 cents, and revenue grew 47% to $49 million, well above analyst estimates for $46 million. Profits are beginning to reap the benefits of ten new sales offices that have opened in the past two years. Management notes a drag in productivity in new offices until they mature 24 months later, which is starting now.

A secondary offering in May reduced private equity firm Welsh, Carson and Stowe’s position by almost one third. This is a common exit strategy for a private equity firm to reduce their position once an investment becomes public and not necessarily a red flag to investors. Additional secondary offerings may be announced in the future.  The CEO, who also sold on the deal, continues to hold 19% of the company shares.

The Ensign Group (NSDQ: ENSG) continues its spending spree. The company recently announced that its subsidiary Cornerstone acquired Buena Vista Hospice, a Medicare and Medical certified hospice agency in California. The acquisition is expected to be accretive to its 2015 earnings.

With this new deal, Cornerstone now owns 14 hospice operations, 14 home health operations and three home care operations in nine western states.

The acquisition follows its June purchase of The Orchard Post-Acute Care Center, a 162-bedroom skilled nurse facility also located in California. The takeovers will also add approximately 1514 beds to the company’s collective capacity of around 15,500 operational skilled nursing, assisted living and independent living beds. 

Acquisitions have been the key to Ensign’s growth. In the past two years, the company has taken over 29 facilities across eight states with revenues generated by these facilities growing by about $57.5 million to almost $90 million last year. The company now operates 161 health care facilities, 26 of which are owned, 13 hospice agencies, 14 home health agencies, three home care businesses and 17 urgent care clinics across 12 states. 

Shares of ENSG are currently trading near its lifetime high of $53.88 and have returned almost 16% since it was added to Roadrunner in mid-February 2015.