5 (More) Profitable Smallcaps Trading at a Fraction of Tangible Book Value

by: Tom Shohfi, CFA

Last November, my first Seeking Alpha contribution featured five profitable small capitalization stocks priced at significant discounts to tangible book value. Since that time, the Russell 2000 (^RUT) has fallen about 13%. However, all five of those stocks have outperformed the index and two, Chinese dietary supplement manufacturer Tiens Biotech Group (TBV) and zinc producer Horsehead Holdings (ZINC), have seen very high returns over the past five months. I once heard a director of equity research at a large buy side firm say that an analyst doesn’t necessarily have to be right on stock calls more than 50% of the time, but when he/she makes a right call, it better be very right. TBV no longer fits the criteria of trading at a fraction of tangible book value. However, since ZINC is still trading at a slight discount and is a reasonably good dollar weakness play, I’m still holding on to it for now but am examining other opportunities that may represent better present values.

There are still a number of these values out there. This time, my screener is set for public companies with market capitalization less than $250 million, a price to tangible book ratio of less than half market value, normalized trailing twelve month P/E of less than 25 (this premium multiple is, in my opinion, acceptable given the low P/TBV ceiling used) and a LTM interest coverage ratio no lower than 15 (or zero debt). The resulting list of profitable, discounted, yet balance sheet healthy, companies is much shorter than it was late last year. Five names on this list, nearly all of which have posted solid returns through the first quarter of 2009, caught my attention.

Avalon Holdings (AWX)

This nanocap sports a market cap of less than six million but also has one of the most unique combinations of business lines that one can find. They provide waste management services in addition to owning and operating several golf courses including those at the Avalon Golf and Country Club in Ohio. In 2008, 80.4% of Avalon’s revenues came from waste management services. 48% of the company’s market cap is net cash and management sees their stable cash flow and access to credit as an opportunity to acquire new golf facilities in order to expand that side of the business. Liquidity, however, is definitely an issue with AWX shares – its heaviest trading day in 2009 was a whopping 10,200 shares. That liquidity risk may be worth some price impact considering if the stock traded at just half of tangible book value, it would represent a 246% return from its current price per share of $1.53.

Benihana (BNHNA)

Since the opening of its first New York restaurant in 1964, Benihana has grown to become one of the best known teppanyaki restaurants in the United States. From Anchorage to Caracas, BNHNA’s core “entertainment cuisine” is complemented by its newer northeast-based Haru and southwest RA Sushi. Of the five stocks in this list, BNHNA has been the best performer year to date and is up nearly 150% since hitting its 52-week low in November. I wouldn’t let that nor the stock’s relatively high P/E deter me from giving it a look. Taking into account $4.2M of restructuring charges and a $9.6M non-cash asset impairment charge in fiscal Q3 (which is calendar Q4 for the company), normalized EPS implies a price-to-earnings ratio of 5.83. That charge resulted in the first loss for Benihana in any quarter over the past fifteen years - quite a track record. Shares got a nice boost last week when the company announced a 5.4% sales increase from calendar Q1 of 2008. To help provide capital for expansion and continued revenue growth, Benihana secured a relatively inexpensive (2.2%) $75M credit line in March of 2007, of which it has borrowed a little over a third, and has access to that credit for another three years.

GSI Group (GSIG)

GSI Group, a maker of lasers, laser systems and precision motion equipment is likely the most speculative of these five stocks. First and foremost, the company has some unresolved accounting issues from as far back as 2006. The company has stated that it “does not expect its cash position will be materially impacted by the correction of these accounting errors.” Since GSIG shares trade at $0.10 on the dollar of tangible equity and roughly 19% of its last reported net cash position (June 2008 balance sheet), the market, however, isn’t as confident. There are others who believe that GSI Group will get through these accounting problems and see a major recovery in share price. One such believer is Stephen Bershad, the CEO of precision motion rival Axsys Technologies (AXYS). According to this SEC filing, Mr. Bershad personally purchased 3.3 million shares of GSIG in February and did so perhaps based on interest in purchasing Axsys that he’s received from large defense contractors. AXYS, by comparison, trades at 5.16 times tangible book value. Another Seeking Alpha contributor noted these same potential catalysts in mid-March. Unless an utterly catastrophic accounting correction takes place in the next few months and annihilates management credibility, it seems as though much of the bad news is currently priced into GSIG shares.

SORL Auto Parts (SORL)

The one Chinese stock on this list is also from an industry that’s under tremendous pressure these days. SORL Auto Parts is China’s largest manufacturer of air brake systems for commercial vehicles. 2008 was a great year for the company as revenues rose 13% and net income improved 15% from 2007. There was, as expected, significant weakness in Q4 2008 as sales fell and net income dropped to $0.10/share. Even if quarterly net income dropped another 20%, SORL shares would be trading at an annualized P/E of 6.25. That’s hardly rich for a company that’s poised to benefit from growing transportation needs in China and access to markets across the globe.

TII Network Technologies (TIII)

Founded in 1964 and currently based out of Edgewood, New York, Tii Network Technologies is the second nanocap on this list. The company develops a number of connectivity products for in triple play or strictly VoIP services. Considering that TIII had $8.28M of net cash on its balance sheet at the end of 2008 and now trades at a market cap just below that level, the market is clearly pricing in weakness for telco spending in 2009 having a serious impact on the company. There are some deteriorating product lines and that has shown up in near 25% top line decrease from 2007 to 2008 and a quarterly loss to close out an otherwise profitable year. Current CEO Ken Paladino helped see the Tii through difficult times as CFO in 2003. After dropping by more than half since the beginning of the decade, company revenue troughed that year and began a steady recovery. TIII shares saw a low of $0.13/share in 2003, but bounced back sharply to see prices greater than $2 by the end of that year. On a positive note, insiders have been acquiring stock over the past six months. If the company can manage costs through an economic slowdown and kick start growth in certain product lines, profitability could be maintained and shares would then likely see a very sharp rise later this year.

While these five stocks have passed the initial screener and my brief, preliminary analysis, I have not fully analyzed these companies. If you find any of them interesting you should perform additional research before investing.

Disclosure: At the time of this writing, the author has long positions in QXM and ZINC.