Marty Whitman’s value philosophy prevails at Third Avenue’s Small-Cap Value Fund Investor Class (MUTF:TVSVX). The three pillars of which are creditworthiness (strong balance sheet), potential to compound book value and growth and opportunity to purchase at a significant discount to net asset value.
Although it may seem contradictory for a value fund to be active at a time when it continues to trade at near all-time highs or set new highs, Third Value has been “finding plenty to do.”
The fund has been operating as the truffle-hunting pigs of small-cap value companies and adding to its portfolio accordingly. The managers admit that while there are “pockets of high expectations in the broader market” their philosophy — rooted in Whitman’s and idea origination process — has led them to discover and execute new positions.
Below are the fund’s best small-cap stocks to pick from.
Small-Cap Stocks to Buy: WesBanco Inc (WSBC)
WesBanco Inc (NASDAQ:WSBC) is a regional community bank across West Virginia, Ohio, western Pennsylvania, Kentucky and southern Indiana, managing just shy of $10 billion assets as of Q2 2017.
It leans conservative with stringent credit requirements and underwriting standards, which I like in a bank growing at its speed. Sacrificing loan quality for growth is a surefire way to run into trouble in the future. But that’s not a concern with WSBC, where non-performing assets to total assets consistently ranks below their peers. For the last full fiscal year, WesBanco clocked in at 0.49% vs. peers of 0.61%, and in Q1 2017 they did 0.56% vs. peers of 0.60%.
CEO, Todd Clossin, joined the firm in 2014. Under his supervision, WSBC made two significant acquisitions: ESB Financial (Pittsburgh) and Your Community Bankshares (Indiana and Kentucky), increasing the asset base by 60%. Also under Under Clossin, non-interest income generation is on the rise, now representing $3.8 billion in AUM, including just under $1 billion in the WesMark Funds. There is still lots of room to grow this business.
WesBanco’s loan portfolio is well-diversified with residential real estate at 22%, commercial and industrial at 17% (organic 5-year CAGR of 12%!) and commercial real estate making up the largest portion at 38%. There is minimal exposure to the oil and gas industries.
Revenue and cost synergies from acquisitions have worked well for WSBC, and it continues to look selectively at expanding the franchise via accretive transactions. Organic and inorganic growth are strong.
Small-Cap Stocks to Buy: Horizon Global Corp (HZN)
Horizon Global Corp (NYSE:HZN) designs, manufactures, and distributes custom-engineered towing, trailering, cargo management and other related accessory products across commercial and recreational segments. Its major competitors are all privately held companies and only compete on a segment by segment basis, giving it has clout in the public markets in this niche.
TriMas Corp (NASDAQ:TRS) spun off HZN in 2015 and was renamed. Horizon Global Corporation. Acquisitions have bolstered the portfolio with strong brands and diversified HZN’s business, serving the DIY market and private labels/aftermarket. E-commerce (via Amazon.com and other sites) are about a third of sales and provide insulation against a tough retail environment. The OEM business, while normally a slower growth business, is becoming more efficient, which will pump margins up.
Second-quarter results were very positive with raised guidance for full-year adjusted earnings-per-share (from $1.04 to $1.14). HZN is on-track for annual revenue growth of 30-35% and $40-50 million of operating cash. The quarter proved management’s strong execution with net sales up 51.1% and and pre-tax income up 189%. Cash management has also been improved by restructuring its debt and continuing to deleverage from 3.8x in Q1 to 3.4x in Q2.
Goals to expand margins, selective acquisitions, and product innovation are readily achievable, leaving upside for investors.
Small-Cap Stocks to Buy: PDC Energy Inc (PDCE)
PDC Energy Inc (NASDAQ:PDCE) is an independent exploration and production company with core assets in the 60,000 net acres in the Delaware Basin (Reeves County, West Texas) and 95,500 net acres in Core Wattenberg Gas Field in Colorado.
These are high-quality oil and gas deposits that will drive a 35% production CAGR from 2016 – 2019. The leverage ratio should be managed down to 1.1x from 1.7x this year. Its second quarter showed a blended 54% increase in production year-over-year. Delaware production alone was up 49% YOY. Drilling in the Permian Basin continues to drive growth and cash flow and further efficiencies could produce better-than-expected economics — often rewarded by markets.
Both projects are in good form. At Wattenberg, said drilling efficiencies have led PDCE to reduce the rig count from four to three by the end of the fiscal year. At Delaware, well costs have increased but the pilot hole program continues as does the investment in midstream.
The track record is impressive and gives confidence toward future endeavors. In 2014, PDCE did just 9.3 million boe and should reach 32-33 million for fiscal 2017. Meanwhile, operating costs during that four-year period are expected to improve 60%. The formula goes as follows: production up massively + costs down dramatically = stock outperformance.
Small-Cap Stocks to Buy: AMN Healthcare Services, Inc. (AMN)
AMN Healthcare Services, Inc. (NYSE:AMN) is a leader in healthcare workforce solutions and staffing services to healthcare facilities.
While healthcare policy may be subject to legislative changes, the long-term trends for increased care (demographics of an aging population) and more personalized care will remain, which supports a healthy operating environment for AMN.
AMN provides a valuable service of bridging the supply of workers and the demand from hospitals with qualified professionals and vetted credentials, so that top-notch healthcare can be provided in a pinch, while AMN handles the back office tasks. Thus, economies of scale will play to the company’s advantage as it grows. As it grows, it will also build stronger relationships with its clients, which will lead to additional scale.
The main profit driver for the company is its largest division, Travel Nurse Staffing. Q2 2017 showed revenues up 9% YOY with favorable trends in price and volume. With demand dynamics in AMN’s favor and high double-digit growth in the Solutions divisions too, it can continue well into coming quarters.
Small-Cap Stocks to Buy: Carrizo Oil & Gas Inc (CRZO)
Oil and gas has taken a beating, and Carrizo Oil & Gas Inc (NASDAQ:CRZO) has not been immune despite a prime, high-quality asset in the Permian basin. Carrizo also has exposure to good shale assets (103,300 net acres in the Eagle Ford Shale in South Texas) and Marcellus Shale in the Northeast.
The financial health of the company is also in good shape, again despite a challenging macro environment. Liquidity is ample, and the focus is on smart capital allocation to the highest return assets. CRZO’s intent is to invest another $540 million this year, the bulk of it going toward developing Eagle Ford. Management expects these efforts to produce 17-20% YOY growth in terms of net daily production across the total portfolio.
Carrizo has been pushing for better efficiencies at Eagle Ford. Frac prices were up double-digits in the first quarter, but operational efficiencies were able to more than offset that, which is impressive management by CRZO. In tight times for the industry, the most efficient operators will come out the strongest, and Carrizo is just that.
Well costs are down, while lateral drilled per-rig month is up sharply. These efficiency gains will translate to better economics that will translate into better earnings and better per share prices.
Small-Cap Stocks to Buy: NetScout Systems, Inc. (NTCT)
NetScout Systems, Inc. (NASDAQ:NTCT) operates in the very hot sector of cybersecurity and business intelligence. Their analytics software collects, filters and stores data, then extracts valuable insights for clients. It also protects clients.
Innovation is key here, as NTCT needs to stay ahead of increasingly advanced threats as well as innovating competitors. The company’s progress on the next product cycle is promising, as updated during Q1 earnings. The launch of vSCOUT™, vSTREAM™ and virtual nGeniusONE® (marketed for enterprise, service provider and government customers), enhances the visibility of its nGeniusONE Service Assurance Solution. Its applications can now accommodate more customers since it can run in physical or virtual data centers, private, public or hybrid cloud environments.
Additionally, NTCT’s security unit, Arbor Networks, doubled its Arbor Cloud capacity and will double again by the fiscal year end to better support new nodes in North America, Europe, Asia and South America. More traffic will require this additional capacity that Arbor is preparing for.
While product improvements steadily came online, first-quarter earnings were still disappointing. That said, management reiterated that it expects that the bulk of revenues will come through in the second half of the fiscal year, in keeping with historical trends in the business, and the market should inflect upwards if NTCT delivers.
Small-Cap Stocks to Buy: Commerce Bancshares, Inc. (CBSH)
Commerce Bancshares, Inc. (NASDAQ:CBSH) is the second-largest holding of the fund. The company is a Midwest-focused super community bank. Based on asset size ($25.3 billion in assets, $21.1 billion in total deposits), it ranks as the 38th largest U.S. bank.
Whereas larger banks may lose sight of fostering a culture of integrity and true collaboration, CBSH places this as a priority and claims to have higher employee engagement than other companies. It has always focused on talent development.
This has been a part of its success, in addition to its focus on modernizing as customer habits change. Since 2009, it has closed 28 branches, reflecting changes in preferences for different banking channels.
2016 was a strong year for Commerce, and I expect those results to continue through the current and following fiscal years. Last year, revenue and EPS were each up 7%, accompanied by loan growth of 8%. Common stock was rewarded these strides with total return for the year of 45%. 2017 is already looking to be better than last. On a YTD basis, net income is up YOY as are ROA, ROE, end period deposits and period end loans.
As of this writing, Luce Emerson did not hold a position in any of the aforementioned securities.