With the market hitting all-time highs, it is extraordinarily difficult to find new value ideas. At times like this, using typical screens or the 52-week low list is often unproductive. However, the search for new ideas must go on. One of the best methods of finding ideas is to search through the publicly disclosed portfolio of a well respected value mutual fund. In this article, we are going to look at the Keeley Small Cap Value Fund (KSCVX) here.
As Investing 501 begins to build its model portfolio, this will be one of the main methods we will use to find new ideas. If you want to know why we selected this particular fund, look here. If you are interested in our process for conducting these reviews, see the methodology discussion at the end of this article. First, our favorite 10 ideas from the KSCVX portfolio:
1. Kaiser Aluminum (KALU)
One of the few depressed sectors in today's market is the metals and mining group. Selecting good stocks from this sector is often difficult. Many of the companies are intent on "digging deeper holes in the ground," and too seldom seem interested in providing good returns to shareholders.
KALU is a fairly unique aluminum company because they are primarily a fabricator of finished product with little exposure to bauxite mining or ingot production. Selling at a small premium to a clean book value, KALU is not as statistically cheap as Alcoa (AA), but KALU will not suffer the problems of overcapacity that plague the rest of the industry.
We believe that Allegheny Technologies (ATI) is the best way to invest in this sector. See our report here. However, KALU is an interesting alternative for those interested in a little less volatility.
2. SunCoke Energy (SXC)
Successful value investors are well aware of the potential of spin-offs. These corporate castoffs are often misunderstood and underappreciated by Wall Street. SXC is a fairly recent spin-off of energy giant Suncor. SXC converts metallurgical coal into coke used in the production of steel.
While the stock is not cheap relative to current book value, it is quite possible that investors are not entirely unaware of SXC's earnings power if steel production returns to more normal levels.
If spin-offs are of particular interest, you might also look at Keeley's position in Deltic Timber (DEL). This spin-off of Murphy Oil (MUR), which is located in El Dorado, Arkansas, is a forest products company. The last time a Wall Street analyst paid a visit was during the Paleolithic Era.
3. Goodrich Petroleum (GDP)
KSCVX has a very interesting group of small oil & gas exploration/ production companies. Many of these stocks have done quite well, but one that has lagged is GDP. GDP's production has been primarily natural gas, but oil is now 30% and growing. The main producing basin is the Haynesville Shale; the potential upside comes from the Tuscaloosa Marine Shale in Southern Mississippi.
GDP has more debt than we would prefer too see, but the structure of the debt is adequate. Insiders own 30% of the stock. Boone Pickens owns 600,000 shares as of 3/31/2013.
Interesting to us is that the company actually has copies of old Wall Street analyst reports on its website. See here.
4. Helix Energy Solutions Group (HLX)
It is always interesting to find a high tech company buried inside a mundane industry. HLX is exactly such a company. Oil service companies often live and die with rig counts and the direction of commodity prices. HLX serves the niche markets of offshore subsea interventions and robotics. For those with long memories, this company was once called Cal Dive. Offshore is not the "cool place to be" in energy stocks, which is exactly why we are interested.
It is difficult to craft a valuation argument for HLX, other than to say earnings peaked at over $3.00/share in 2006 and today are only in the $1.50/share area. The stock is well below its 2005-8 highs and the balance sheet is much improved
5. Air Lease (AL)
It is fascinating when managers you follow own different stocks in the same industry. AL is an aircraft leasing company started by one of the industry's pioneers Steven Udvar-Hazy (the builder of International Lease Finance). Selling at just 1.2x book value, the stock is at about the same price now as when it became public in April 2011.
We have been doing some work on AL's competitor, Aircastle (AYR). AYR is owned by another manager we hold in high regard, Donald Smith & Co. AYR is statistically cheaper at only 80% of book value. However, it appears that AL might have better management. Which is the better stock to own? Stay tuned to this channel for the answer. All we can say right now is that value investors might want to start doing their homework on the aircraft leasing industry.
6. Walter Investment Management (WAC)
When a manager you respect steps forward on a controversial stock, it is a good time to pause and take a long look. WAC is a leader in the mortgage service business, with an emphasis on the "credit challenged" segment. For the last 15 years, I have had a "religious" contempt for any company that was even modestly related to the sub-prime mortgage business. It was just easier to stay away, rather than walk into the "minefield" that is residential mortgages. Maybe five years after the meltdown, it is now safe to "get back in the water?"
WAC is a complex company that looks statistically cheap and is well off its highs. Frequent SA contributor Bret Jensen just wrote a nice review here. This is a stock where everyone needs to do much more of their own work. However, it is exactly the type of name that these portfolio reviews are supposed to make you think about.
7. Titan International (TWI)
TWI is a supplier of tires to the agricultural and mining industries. Through a series of crafty acquisitions, an entrepreneurial and controversial CEO has put together an interesting company. A few bad quarters have left the stock selling for only a 40% premium to a very clean book value. The balance sheet is not pristine, but liquidity seems more than adequate for the company to execute its strategy.
If you want exposure to the growth in U.S. agriculture as developing nations clamor for a better diet, investing in TWI might be the cheapest way to do so.
8. Manning & Napier (MN)
MN is a traditional investment management company. The company has only been public since late 2011. Selling at only about 6X EBITDA, and only a modest 40% premium to book value, MN looks attractive.
If there is one business that investment managers should understand, it is (not surprisingly) the investment management business. The valuation of these businesses has some unique characteristics. When a sharp asset manager owns the stock of another asset manager, we stand up and take notice.
We also note with interest that Keeley owns our old friends at Federated Investors (FII). While FII is a well managed company with a phenomenal marketing franchise, we remain concerned about the regulatory environment in the money market industry. See our article here.
9. Denny's (DENN)
KSCVX has a heavy allocation to small restaurant stocks. We were encouraged to see they had a significant position in one of our favorites, Denny's . See our report here .
Investors still do not fully appreciate the extent of the turnaround in this much-maligned operator. A switch to a franchise model has provided interesting levels of free cash flow.
10. Starz (STRZA)
STRZA is the programming and pay TV spin-off of Liberty Media (LMCA). Although the stock has doubled since the spin-off, the cash flow multiple is still reasonable. Content providers seem to be the winners in the media business.
If you would like to own a well managed small/medium cap value fund, we strongly recommend KSCVX. If you are looking for some new value ideas to investigate further, any of the 10 ideas listed above would be a good place to start.
There are five important steps in using the portfolios of mutual fund managers to help you find new ideas:
- Select a manager that owns one of your best and most representative ideas. We selected the KSCVX because it owned Denny's. DENN not only has an attractive valuation, but the company is in the middle of making an important transition that Wall Street misunderstands. DENN is the type of name that a manager would have to do their own work on. It is not a name that was recommended to them by Wall Street. Whenever you find a stock that really fits your investment style, one of your first actions should be to investigate the other managers that own the stock.
- Do not focus on the selected manager's largest positions. It is seldom the case that a manager's largest positions are his best ideas. Large positions are often stocks that have done well in the past few months and are closer to being sold than they are to being bought. This generalization is not always true, but it is a good guideline.
- Focus your attention on stocks that have recently underperformed the market. If a manager owned a position when the stock was $30/share and now the stock is $22/share, sharpen your focus. Be sure the manager has not reduced the number of shares held. This would be a sign of a lack of confidence. Since mutual fund managers only report their fund holdings every six months, you might want to wait for the next report to see if a manager continues to hold the stock.
- Be sure to evaluate new positions and smaller holdings. Some holdings might be smaller because of the company's market capitalization or liquidity. It might also be a smaller dollar amount because the manager has not yet built his complete position. However, it also might indicate the manager has begun to liquidate this position. You might want to wait for the next semi-annual report to see which way the position is going.
- Push yourself to look at ideas in industries that you generally do not look at. The goal is to find new ideas, so look at everything. For example, we have always had an aversion to financial stocks. We find their balance sheets difficult to evaluate. KSCVX owns an interesting group of small banks and insurance/reinsurance companies. I could not force myself to put one in my top 10, but I did look at each one. Some day when I grow up, I want to one day find a financial stock that I can understand.
Additional disclosure: Business relationship disclosure: Investing 501 is a pair of analysts with over 60 years of professional investment experience. This article was written by Gregg Jahnke, one of our Founders. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.