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Undiscovered Gems: 5 Small-Cap Buys
06/05/2015 10:00 am EST
Money manager Peter Mantas of Logo LP avoids the well-known names held by most investment firms; instead, he looks for unloved companies trading below what he considers their intrinsic value. Here, he discusses five small-cap stocks that are currently off the radar of most investors.
Steven Halpern: Our guest today is value-oriented money manager, Peter Mantas of Logos LP. How are you doing today, Peter?
Peter Mantas: I’ve very well, thank you. Thanks for having me on the show.
Steven Halpern: Now, you know that the world’s leading financial institutions tend to own many of the same names, and have the same large stocks, but at Logos LP you pride yourself on avoiding these names. Could you expand on that?
Peter Mantas: Sure. If you were to look at the multitude of 13F filings from the large investment managers, endowment funds, and institutions, you’re going to find a significant correlation between some of the most common names; Apple (AAPL), Microsoft (MSFT), Amazon (AMZN), IBM (IBM), Google (GOOG), Alibaba (BABA).
And whether it’s Einhorn, Soros, Ackman, Icahn—whoever it is—they’re all going to own the same names.
Now presumably, the large reason for this is because of the amount of capital that needs to be deployed and there’s nothing more efficient than finding a somewhat undervalued name and deploying billions of dollars into that position, but our approach is slightly different.
Our ideal investment is anywhere from $500 million to $10 billion, sometimes 15 if the name is significantly undervalued as we feel—and we like to focus on—names that are outside of Wall Street’s scope.
They’re not covered as much, under the radar or unloved. A large reason for this is we try to find names that have the largest deviation between intrinsic value and market value, and for a number of reasons as stated, this range has a lot of those names.
Steven Halpern: Now, in a recent report, you focused on your favorite small-cap stocks, which could form the core of a small-cap portfolio. Could you first walk us through some of the criteria you look at when selecting small-cap stocks.
Peter Mantas: Sure. Regardless if it’s small- or large-, the number one thing we look for is consistency in its earnings and there are a number of small-cap stocks that have consistent earnings.
Many investors think that by getting into small-cap, these companies are too nascent or too young and they don’t have the consistent level of earnings that a Proctor & Gamble (PG) or Coca-Cola (KO) can provide.
Coca-Cola and Proctor & Gamble, those types of names are definitely consistent earners and great compounders, but there is a plethora of names in the small-cap world that are just as consistent and are trading at significant discounts to true value.
We look for high economic value, so is their return on invested capital’s significantly above their weight average cost of capital and many equities provide that. We also look at the growth in both value, growth in free cash flow, as well as return on equity and future prospects; so, understanding the business model as a whole. That’s our process.
Steven Halpern: Let’s walk through some of these undiscovered gems in the small-cap arena and then point out that—as you suggest—many of these names will be unfamiliar to our listeners. First off, you recommend Ansys (ANSS), which makes engineering simulation software. What’s the attraction here?
Peter Mantas: Right. Well Ansys is getting quite near fair value range, but this is one of the best companies—I would say—over the last ten years. Doesn’t pay dividends, which is using all of its capital to fuel organic growth, but net sales have grown nearly nine times since 2005 and it even grew sales during the great recession, even margins are at near 40% ROC, or double digits. The cash flow per share has quintupled over the last decade.
I mean, this thing is extremely consistent. It’s a quality name. It’s about a $9 billion market cap and we believe that the level of growth that’s behind this name will continue over the next decade, especially since weighted average cost of capital for a lot of these names—especially a name like Ansys—is quite low.
We’re looking at 10% per year growth and revenue, double digits in earnings per share as well over the next decade. This name has been incredibly consistent; this thing would blow Apple out of the door in terms of consistency.
Their technology is extremely complex. They employ an army of PhDs. The switching costs are quite high. It’s definitely a name that we like and that we’ll continue to watch.
Steven Halpern: Now, another idea that you have is a decidedly low-tech firm in the restaurant equipment field. What do you like about Middleby Corp. (MIDD)?
Peter Mantas: Middleby is again another very, very consistent earner. It’s grown book value per share 17 times over the last ten years. ROE is at 21%. Margins are very high. We expect, again, double-digit revenue growth every year, double-digit earnings per share growth every year.
It doesn’t pay dividends. We assume over the next decade that it will, especially as the market becomes more mature. The main strategic motive behind this company is its acquisition strategy.
This company has done dozens of acquisitions in the last year and a half, and there’s no reason why it won’t continue to, especially because this is the market in the restaurant equipment. Restaurant oven manufacturing is quite segmented. As consolidation occurs, Middleby will be at the forefront of that.
Currently, the company is trading around $6 billion. There’s no reason for this company not to be trading at $10 billion to $15 billion over the next decade. Just like Ansys though, maybe a bit more so, it is quite expensive and the market has been noticing its acquisition strategy, which has made it a bit frothy. I would certainly be interested if the name gets below 100 or 95.
Steven Halpern: Now another small-cap idea where you highlight the very strong financials is Nordson (NDSN). What attracts you to this outfit?
Peter Mantas: Nordson is similar to Thermo Fisher Scientific or a Danaher. They make testing equipment and adhesive systems, great industrial name, compounded annual return. Over the last few years, has been in the 40%, which is incredible. Has a $5 billion market cap, but we believe it has continued growth.
The one thing with names like a Nordson is they will be more volatile given its industrial nature. In the great recession, you could see declines of 30% in the stock price. It’s one of those names where in good times—it’s important that you’re picky—but we do believe that, again, double-digit revenue growth and earnings per share over the next ten years easily.
Steven Halpern: Now, you also highlight an interesting company in the broadcasting field, and here many of the investors are focused on social media and global distribution, but you’re highlighting a company called Gray Television (GTN), which remains focused on its local markets. Could you share your thoughts?
Peter Mantas: This is very much a Buffet-esque type of name. Even if you go on the Web site, it’s very—it’s as if it existed in 1994—HTML. A very low maintenance Web site.
This is an incredible company. It’s just run up drastically. Margins are near 30%; return on equity 18%. Sales last quarter grew 46%. Earnings per share are expected to grow 200% next year.
It has what I think is a unique strategy in that it focuses solely on smaller towns, local television markets and it’s consolidated all those networks. Local TV is still very, very hot because people still want their sports, news, and weather.
We believe that this will continue—the fundamentals—for local television, especially in the southern United States, I believe are still intact for the next ten to 20 years. We don’t see a major disrupter in this space at all and I expect it’s because we are still in the midst of early-to-mid bull market. This name will continue to run over that period of time.
Steven Halpern: Now, finally, let’s turn to Lassonde Industries (LAS-A), which you point out is a relatively unknown company, despite being one of the best performers on the Toronto exchange. Could you tell our listeners about Lassonde?
Peter Mantas: Sure. I think over the last 15 years the company has generated 60% a year compounded annual return and this is one of the most boring businesses you have ever seen in your life. It makes juices.
I like to compare it to the Dr. Pepper/Snapple group of Canada. They only have roughly a $400 million to $500 million market cap, but they’ve been also on an acquisition spree. They recently acquired a juicer in the United States.
It’s still run and headed by Mr. Lassonde himself, who writes his letters personally every year and I recommend readers to read the annual report, he does a good job.
Over the past ten years, revenue has quadrupled. Free cash flow has grown by seven times, book value, four times. It supports a payout ratio of 24%. There’s a lot of room for organic growth.
We see stabilization in the consumer noncyclical industry in Canada as well; I believe that over the next ten years the company will easily have 3% to 5% organic growth in addition to high single digit EPS free cash flow growth. I expect this name to compound in the double digits over the next ten to 20 years.
Steven Halpern: Again, our guest is Peter Mantas of Logos LP. Thank you so much for taking the time to join us today.
Peter Mantas: Thank you again.
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