Five Small Cap Companies Which Had a Successful 2008

by: John Femino, CFA

While many companies and the market as a whole have struggled the last year and a half, not all companies have. Some companies were still able to succeed in the harsh climate. Today, I will take a look at five such companies. These companies are all similar in that they had EBITDA growth greater than 25% while also posting a Return on Capital (ROC) greater than 25% over the last twelve months (as of their last reporting prior to 01/21/09). In addition to achieving outstanding returns, all of these companies have minimal debt, with the highest of the five still having a debt-to-equity ratio less than 15%.

So much of the sentiment is negative right now, I set out to find some companies that have been doing things right. Having a high EBITDA growth rate means the company is growing nicely either internally or through acquisition. The low debt means that the companies are well positioned financially, which is important in this tumultuous time. And, finally, the high ROC shows that the company used its shareholders’ money well and is providing them an excellent return. Putting all of these qualities together means a company had a successful year in an awful environment.

As you can see from the following chart, none of the companies are all that expensive either, even though that was not part of the screening process. For comparison purposes, using the closing price as of Jan. 21, 2009 and the LTM GAAP EPS of the S&P 500 through Q3 of 2008, the P/E of the S&P 500 is 18.3.











Darling Int'l Inc.







Graham Corp.







Hi-Shear Tech. Corp.







Sun Hydraulics Corp.







Transcend Services Inc.







*all ratios are for LTM except Market Cap, which is as of 1/21/09

Darling International Inc.

Darling International is one of those companies that do something that no one else really wants to do (well, except maybe Homer Simpson). Darling collects used cooking oil and animal byproducts from restaurants. It also provides grease trap cleaning services to many of the same restaurants. Darling then takes the products it collects and recycles them into useable products, namely feed for livestock and fats and oils used in consumer products. Darling saw tremendous growth in revenue during 2008 thanks to increased prices and volume for its products. While prices for its products may decline in 2009, its biggest cost is natural gas, which has also dropped substantially from its highs in 2008. That being said, analysts are predicting a decline for the company in 2009, but even with their negative outlook the company is only trading at 10x 2009 estimates. This seems pretty reasonable for a company that has shown the ability in the last couple of years to generate good free cash flow and a high return on capital.

Graham Corp.

Graham Corp. designs, manufactures and sells custom-built vacuum and heat transfer equipment. These products are used in such things as refineries, power generation facilities, numerous types of industrial plants and air conditioning systems. The company has an international presence with about half of its revenue coming from outside of the United States. Graham serves a number of industries that are in the middle of an upgrade or growth cycle (even if they do take a break in capital spending in the short term). There is still a large need for increased global refining capacity as well as an increased demand for power and other services from the growing middle class in Asia. Given the fact that Graham has no debt, even if there is a decrease in capital spending, the company is well positioned to weather any short term issues and capitalize on the long-term need of its end users.

Hi-Shear Technology Corp.

Hi-Shear designs and manufactures pyrotechnic, mechanical and electronic products for the aerospace industry and national defense. Their products are in space exploration vehicles, satellites, missile systems and tactical weapons among others. The company does the majority of its business with several large clients, mainly the US Government, Lockheed Martin (NYSE:LMT) and Boeing (NYSE:BA), which are two of the largest government contractors. Given the nature of its products and the specifications needed there are huge switching costs involved so once Hi-Shear is awarded a project it is highly unlikely it will lose it at any point. Government spending, specifically for defense, impacts the company’s ability to generate revenues. While the new administration’s defense spending will not likely be as aggressive as the previous one’s, it will continue and Hi-Shear is in an excellent position to continue to receive its share of it.

Sun Hydraulics Corp.

Sun Hydraulics designs and manufactures screw-in hydraulic cartridge valves and manifolds which are integral parts in fluid power systems. The company typically generates 2/3 of its revenue from “mobile” applications such as construction, agricultural and utility equipment and 1/3 of its revenue from “industrial” applications such as machine tools and material handling equipment. Sun Hydraulics has a global footprint with 33% of sales coming from Europe and 20% from Asia. 2008 marked the 7th consecutive year Sun posted solid revenue growth in a typically cyclical industry. The company has been able to achieve this through new product releases and improving sales capabilities. While it sells to a cyclical industry that will likely have a down year in 2009, the company is well positioned with virtually no debt to minimize any negative effects and remain strong for the upswing of the cycle.

Transcend Services Inc.

Transcend Services provides medical transcription services to the healthcare industry. It takes the physician’s dictated notes and then transcribes them using either speech recognition software or medical language specialists to translate the dictation into a text report. The medical transcription industry is a highly fragmented industry which is estimated to be around $12 billion annually, with $5 billion outsourced to companies like Transcend. The continued aging of the baby boomer generation will likely keep this industry growing for the intermediate term as they will need more health care and thus transcription services. The company’s BeyondTXT proprietary workflow system will also likely be a driver of future growth as hospitals continue to update their outdated technology and continue to outsource more of its transcription service needs. The majority of Transcend’s revenue growth came from new customers in 2008 and given the highly fragmented nature of the industry there are still plenty of potential new customers out there.

While these five stocks have passed the screener and seem interesting at first glance, I have not fully analyzed these companies. If you find any of them interesting you should perform additional research before investing.

Disclosure: The author has no position in any of the stocks mentioned in this article.