Value Portfolio

Shares of the well-known discount footwear retailer DSW Inc. (NYSE: DSW) have taken a beating, sinking 35% in 2015. Like so many retailers, DSW hit a couple potholes this year, the latest being a rough third quarter in which profits fell 20% against a backdrop of tepid consumer spending and unusually warm weather that hurt seasonal item sales.

But we view this as a prime opportunity to get a deal on one of retail’s most consistent long-term performers. DSW’s stock is up over 130% in the past decade, roughly double the S&P 500’s gain during that time. As always, the company boasts a sturdy balance sheet with plenty of cash on hand—currently $99 million versus the three-year average of $91 million—and no debt.

At $113 million, annual free cash flow is, as usual, more than sufficient to cover DSW’s dividend, which has more than quintupled to $0.80 a share since a payout was initiated in 2012. The stock currently yields 3.5%.

Importantly, DSW continues to evolve into an omni-channel retailer, coordinating an expanding online presence with 469 traditional brick-and-mortar outlets to spur sales. CEO Michael McDonald provided an update on this strategy during the November 24th conference call.

Omni-channel sales, which I define as sales that are demanded in one place and fulfilled in another, represent 5% of total sales on a year-to-date basis and they jumped to 6.5% in the month of October. This acceleration provides clear evidence that our omni-channel strategy is resonating with our customers.

Because current headwinds are apt to persist, DSW could have a couple more tough quarters ahead. But analysts see profits rallying 10% next year and maintaining solid gains through 2020, indicating the company still offers plenty of long-term growth and income potential. Its stock only sells for 14.7 times next year’s estimates, which is incredibly cheap for a retailer of DSW’s caliber.

Lattice Semiconductor (Nasdaq: LSCC) jumped 8% Nov. 18th on higher than average volume, thanks to news of yet another takeover in the semiconductor space, this time involving Fairchild Semiconductor. Back in June, CEO Darin Billerbeck said that the Lattice board of directors was open to the idea of selling the company if the price offered was high enough, but no bid for the company has materialized yet. Third-quarter financials were uninspiring, with the company reporting a loss thanks to restructuring charges and issuing fourth-quarter guidance of flat revenue growth. The stock has risen regardless on takeover speculation and investor realization that the company’s cost-reducing restructuring will set the stage of more profitable performance in the future.

Another stock bargain hunters would be wise to grab while it’s down: one of the world’s leading industrial product distributors, MSC Industrial Direct (NYSE: MSM), which we added to the RoadRunner Value Portfolio in June.

More than a 20% drop in the company’s stock this year reflects the pain many industrials are experiencing because of a sharp slowdown in the manufacturing sector, MSC’s main stomping ground. There, the firm sells fasteners, plumbing supplies, metalworking tools and many other types of industrial products, currently offering a million SKUs from several thousand suppliers.

Though its stock has plunged, MSC’s business is holding up impressively. When management reported full-year fiscal 2015 results on October 27, sales had actually jumped more than 4% to $2.9 billion, while earnings only fell slightly to $3.74 a share from $3.76 in fiscal 2014. The company managed flat sales and only a 5% earnings decline in the fourth quarter, even though market conditions worsened throughout the quarter.

MSC’s strength during downturns typically provides a chance to pull further ahead of competitors, as CEO Erik Gershwind explained during the November 27th conference call.

Historically, economic slowdowns are the times when MSC makes its greatest strides and we expect to do the same this time. While the 70% of the market that’s made up of local and regional distributors is on its heels, we are on our toes. While others are cutting inventories and receivables to preserve cash, our strong free cash flow generation allows us to invest and to provide customers with industry leading service.

While others are retrenching and only focusing on a handful of accounts, we’re attracting new accounts and increasing our share of wallet with existing ones. While others are hanging on to what they have, we’re aggressively pursuing improved purchase cost and supplier deals and pursuing new supplier relationships that will add to the strength of our product portfolio.

The healthy cash flow Gershwind mentioned enabled MSC to raise its dividend every year for the past decade. The stock currently pays $1.72 a share and yields more than 2.8%, giving shareholders plenty of incentive to hang in as MSC rides out the tough times.

Rackspace Hosting (NYSE: RAX) reported that third-quarter revenues increased 10.7% over a year ago to $508.9 million, and earnings beat estimates by almost 24%. This bumped up the company’s share price by 11% for a few days until it dropped back down $27. Rackspace’s financials were up across the board. However, CEO Taylor Rhodes highlighted new partnerships with Amazon, Intel and Microsoft.

Investors should focus on gross margin and how well Rackspace is able to capitalize on its new partnerships to become the supplier of choice for Amazon, Intel and Microsoft’s cloud platform needs.

Utah Medical Products (Nasdaq: UTMD) is already up about 17% since joining the Roadrunner small-cap value portfolio on August 17. But we don’t see that as a chance just to book a quick profit. We plan to keep this prolific medical device maker around.

Its main draw: a savvy, shareholder-friendly management team that thoroughly understands one of healthcare’s choicest segments—state-of-the-art medical devices for the care of women and infants. Among those in Utah Medical’s extensive lineup of such devices are electronic monitors needed to safely manage difficult infant deliveries, tube-feeding systems for critically ill infants and surgical tools for gynecological procedures.

Consistent growth attests to Utah Medical’s expertise. Since 2010, annual sales have expanded by more than two-thirds to $42 million while earnings nearly doubled to $3.08 a share. The past year’s 27% net profit margin is nearly three times the industry average of 10%.

Roughly a third of sales are invoiced in foreign currencies, so Utah Medical is feeling the negative effects of the strong dollar—namely poor exchange rates when foreign money is converted to greenbacks. Yet the company still managed a robust third quarter, increasing earnings 8% to $0.81 a share. The gross, operating and net margins were all substantially higher, both for the quarter and the first nine months (9M) of the year.

CEO Kevin Cornwell touted third-quarter performance in a October 22nd press release:

Opposite to the previous year, an improvement in our 2015 domestic business is compensating for weaker international performance. Given the leveraged negative effect of the stronger [U.S. dollar] on profits, I believe that achieving 9M profit margins at or better than in the previous year, which is certainly better than we expected, represents excellent operating performance.

Despite the recent pop in price, shares of Utah Medical only sell for 14.7 times next year’s profit estimates. So in our book, the stock is still an attractive value.

Weis Markets (NYSE: WMK) share price was highly volatile in the third quarter in reaction to former Chairman of the Board Robert Weis passed away in October at the age of 96. Weis had relinquished the chairman of the board role to his 47-year-old son Johnathan Weis in April. Perhaps investors are nervous over the change in leadership, and whether the company will make itself open to being bought. Weis Markets’ share price dropped 10% on the announcement of Robert Weis’ resignation back in April.

Whether or not a takeover occurs anytime soon, Weis Markets is still a profitable enterprise. Third-quarter financials have been delayed due to a minor accounting irregularity, but same-store sales for the quarter were reported up 4.0%.

Momentum Portfolio

Ambarella (Nasdaq: AMBA) dropped about 14% in October in tandem with the drop in share price of camera manufacturer GoPro, Ambarella’s biggest customer of its video-chips representing 25% of total sales. GoPro missed third-quarter earnings estimates back in October but Ambarella just released its third-quarter numbers and both its earnings and revenues beat estimates. Guidance for fourth-quarter revenues, however, was weak based on what CEO Fermi Wang calls “near term headwinds.” After this temporary hiccup next quarter, Wang sees “strong annual growth” continuing:

Our strong third quarter results reflect our success in expanding revenues in new markets such as flying cameras and home security monitoring, as well as existing markets for professional IP security cameras and automotive after-market dash cameras. We are very pleased by the wide range of new cameras introduced by customers during the third quarter, and by our introduction of three new SoC families that will drive the next generation of innovative camera products.

Further, Ambarella has already recovered some of October’s share loss in November after getting a boost from analysts at FBN Securities who issued an outperform rating for Ambarella, and set a $70 target for the stock. While it may take some time for the company to hit its 52-week-high from earlier this year, Ambarella represents an exceptional opportunity for patient investors.

China Biologic Products (Nasdaq: CBPO) is one of our best picks of 2015, returning about 70% since we added it to the small-cap momentum portfolio in January. In fact, the Beijing-based biotech has been on a tear for some time, soaring 56% in 2012, 77% in 2013 and 133% in 2014.

But we believe this high-growth story is far from over.

That’s because it’s at the forefront of a nascent, fast-growing segment of the Chinese healthcare market: pharmaceuticals made from plasma, the main component of human blood.

Like drug companies in the U.S. and other developed markets, China Biologic uses the clear, straw-colored liquid to make the fluid solutions hospitals administer to patients in shock resulting from blood loss or burns. The company’s plasma-based lineup also includes intravenous immunoglobulins (IVIGs), which are medicines for a variety of serious conditions like rabies, tetanus, hepatitis B and clotting problems.

Owing to its leadership in these areas, China Biologic increased annual revenue and profits roughly nine-fold apiece since 2007 to $286 million and $3.16 a share, respectively. The company just reported strong third-quarter results, which included year-over-year gains of 14% and 24%, respectively, in the top and bottom lines.

During the third-quarter conference call, CEO David Gao acknowledged that plasma inventory was low heading into the quarter because of exceptionally strong product demand in the first half of the year. However, Gao stressed inventory had been replenished and China Biologic was set for sustainable long-term expansion.

He also announced another key growth catalyst—a green light from the China Food and Drug Administration to begin clinical trials on the next generation of IVIGs:

We expect to be able to complete these clinical trials over the next 24 months, such that we will begin commercial production of our next-generation IVIG in our new fractionation facility in Shandong in 2018.

Even after four straight years of huge gains, China Biologic’s stock only trades for 26 times 2016 estimates. In the high-priced biotech sector, that’s a veritable bargain.

“Best Buy” Gentherm (Nasdaq: THRM) does a big chunk of its business (nearly 60%) in foreign markets, so it’s facing some pretty lousy currency exchange rates, too. But that didn’t stop the auto components maker from smashing profit estimates when it reported third-quarter results on October 29th.

For the quarter, Gentherm earned $0.76 a share, beating consensus forecasts by 31% and the prior year’s third quarter by 58%. The bulk of profits came from sales of the company’s unique thermal management technologies for the automotive sector, which include a range of products such as heated and cooled seats, heated cup holders, thermal storage bins and battery temperature regulation systems.

Gentherm also made large strides with new endeavors, especially Global Power Technologies (GPT), a small but fast-growing thermoelectric technology company acquired last year. Now operating as a Gentherm subsidiary, GPT more than doubled third-quarter sales to $21.1 million, bringing its contribution to 9% of Gentherm’s top line from 4% in last year’s third quarter.

GPT’s rapid advance stems from market leadership in thermoelectric generators that produce power remotely using technology pioneered in the 1970’s for NASA’s Apollo program. Such generators are increasingly popular with offshore drillers, telecommunications providers and other companies that often operate in areas where power isn’t readily accessible.

CEO Daniel Coker’s thoughts on Gentherm’s third quarter, which also included an 8.6% year-over-year improvement in total revenue to nearly $224 million:

We had another solid and productive quarter, particularly in terms of our bottom-line performance. Our top-line revenue growth during the quarter was not quite what we expected, but that was largely due to currency headwinds. Adjusting for the currency impacts, we believe our revenue growth would have been close to 15% over the 2014 third quarter.

Coker and his management team warned that uncertain economic conditions in parts of Western Europe, Eastern Europe and Asia could hold the top line to a 6% increase for all of 2015. However, they believe growth will then rally to 10% in 2016.

Paycom Software (NYSE: PAYC) had a superb third quarter. On November 3, the Oklahoma City-based provider of online human resources technology reported a 51% year-over-year increase in third-quarter revenue to $55.3 million, marking its 19th straight quarter of double-digit top-line growth. Quarterly earnings of $0.08 per share, which represented a 60% gain, surpassed estimates by $0.01.

During the Q3 conference call, CEO Chad Richison said Paycom keeps performing robustly because its salesforce is maturing and the company offers a powerful yet user-friendly cloud-based HR system that’s gaining traction in target markets, small and medium-sized businesses with up to 2,000 employees. The system attracts such businesses with services like employment application tracking, background checks, payroll and employee training.

Plus, Paycom regularly adds new services, like the Affordable Care Act (ACA) Toolkit it launched in June to help clients comply with the 2010 healthcare reform legislation the Obama administration championed. Also in June, the company announced the release of GL Concierge, an accounting application designed to further streamline the payroll process.

Looking forward, Richison sees plenty more need for Paycom’s services because so many smaller businesses have inefficient HR functions. As he related during the conference call:

As we speak with prospective customers, we routinely encounter companies that have substandard solutions in place, and as a result are not fully leveraging their valuable talent asset. Many are deploying multiple systems that have been pieced together over years. In these situations, we typically find multiple log-on requirements for employees, as well as a difficult user interface.

A negative article by short-seller research firm The StreetSweeper caused the stock to drop 6.5% on December 2nd, but the warnings about an 18-million share lockup expiration on December 28th and Obamacare compliance mandates ending in Q1 2016 are old news that have already been fully incorporated into the stock price. Paycom, recently trading around $40 a share, is up more than 23% since we added it to the small-cap momentum portfolio in April 2015. Continued strong growth suggests these shares still have ample upside.

VCA Inc. (Nasdaq: WOOF), the animal healthcare specialist, looks to be experiencing a record-breaking year in 2015. The company, which is up more than 60% since joining the Roadrunner Momentum Portfolio in April 2014, is on track to pass $2 billion in sales for the first time ever, with analysts forecasting 11% top-line growth to $2.1 billion.

Profits should thoroughly demolish the prior company record, diluted earnings per share (EPS) of $1.55 in 2008. VCA’s current guidance is for full-year diluted EPS of $2.08 to $2.18, a 35% improvement at minimum.

VCA is exploding at a time when many companies are hitting a wall because it owns and operates the nation’s largest network of freestanding veterinary hospitals, as well as a formidable collection of laboratories that perform animal diagnostic tests. This places VCA at the forefront of the steadily expanding $29.5-billion pet healthcare market, which is projected to top $44 billion by 2020.

The firm’s market leadership was apparent in third-quarter performance, which CEO Robert Antin discussed in an October 28 press release:

Animal Hospital revenue in the third quarter increased 11.6% to $441.9 million, driven by acquisitions made during the past 12 months and same-store revenue growth of 5.4%. Laboratory revenue increased 9.1% to $100.3 million. Our Laboratory internal revenue growth increased 6.0% to $97.4 million.

Laboratory gross and operating margins were especially impressive, jumping to 51.2% and 41.7%, respectively, from 49.0% and 39.6% in the third quarter of 2014. Animal hospital margins were robust, as well.

Looking forward, we expect VCA to retain its powerful one-two punch of healthy organic growth turbocharged by aggressive dealmaking, like the recent acquisition of 19 animal hospitals with combined annual revenue of nearly $44 million. These catalysts should keep profits climbing at a mid-double-digit pace for at least the next few years, perhaps even a lot longer since consumers are increasingly willing to pay top dollar for specialized pet healthcare services.

Vipshop Holdings (Nasdaq: VIPS) dropped 33% in the two days following its issuance of a revenue warning for its third quarter. I almost can’t write “warning” with a straight face because the “warning” involves revenue growth of “only” between 61% and 63%, compared to previous guidance of 71% to 74% growth. To be clear, 61% revenue growth is awesome, the type of ultra-strong growth virtually any company would be ecstatic to achieve. The company blames “warmer-than-expected fall weather in China, which caused customers to delay purchases of relatively higher-priced autumn and winter apparel.” 

The Jefferies brokerage thinks the revenue miss might also be caused by increased competition from other Chinese online retailers such as Alibaba and JD.com, but even so the Jefferies analyst maintained a “buy” rating on the stock and has a $23 price target, which is 84% above its current price of $12.50. Hard to believe that this Chinese former high-flyer has fallen so far that it now can be considered a value stock, with a PEG ratio under 1.0.

I love growth stocks at reasonable valuations and Vipshop definitely qualifies, but the fact remains that its severe price drop is the antithesis of positive momentum, so the stock’s continued inclusion in the Momentum Portfolio is questionable.