Your IndustryJul 14 2016

Spotting bright sparks in US small cap universe

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Spotting bright sparks in US small cap universe

Smaller companies in the US have less analyst coverage and therefore the potential for many good, overlooked stocks and sectors to be found by active stock-pickers.

This is the view of Francis Gannon, co-chief investment officer for The Royce Funds.

In the team’s portfolios - which includes the £408m Legg Mason (LM) Royce US Small Cap Opportunities fund - they are investing in “pockets of opportunity”.

Mr Gannon says: “We are actively and investing in several sectors and industries right now, including financials, industrials and information technology.

“Even with the recent rally in US small caps, many companies in the more economically sensitive, cyclical sectors still sport valuations that we find attractive.

“As always, our primary focus is on well-managed, conservatively capitalised, profitable businesses. It may sound surprising, but other investors were mostly ignoring these kinds of companies for several years, so we see considerable long-term potential in these areas.”

Opportunities

According to Cormac Weldon, manager of the £64m Artemis US Smaller Companies fund, says: “I work as part of a US team of seven - four analysts and three fund managers.

“This gives us the strength in numbers to do the fundamental analysis that may be lacking on the sell side and so uncover undervalued investment opportunities.”

Some of these ‘undervalued’ opportunities for Artemis include the airline industry. Mr Weldon explains: “In a break with its past, it has been run on a commercial basis since the financial crisis.

“Renegotiated contracts with unions, mergers between some of the big carriers, increased capital discipline have improved the competitive environment.

I look for companies where management has ‘skin in the game Robert Siddles

“The large carriers are behaving in an oligopolistic fashion: rather than competing for market share they are protecting their margins.

“This creates opportunities for smaller carriers to gain market share, particularly where they have a differentiated business model, like Spirit Airlines, an ultra low-cost operator.”

Other bright spots include infrastructure, which Mr Weldon says would still need investment regardless of whether the US inaugurates a president Trump or a president Clinton. Within the infrastructure sector, he likes Summit Materials, a cement and aggregates company headquartered in Denver.

Another hot pick is Red Rock Resorts, which operates a casino in Las Vegas. Perhaps not known well by UK investors, Mr Weldon claims its attraction is “this is not a destination casino on the Strip, marketing itself to long-haul tourists.

“Instead, it operates off-strip in the locals market, where people who live and work in Las Vegas go to relax away from the tourists.”

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Housebuilding

For Matt Axline, a US-based portfolio manager on Allianz Global Investors’ global small caps team, Allianz is finding strength in the “homebuilding and related building products” market.

He says: “This continues to be a major crutch for the US economy.

“We are also seeing strength in the optical market, given the prospect of new fibre build-outs across America. Cloud-based software providers are also benefiting from the secular shift from on-premise software licensing and the significant return on investment they provide.”

Jenny Jones, head of US small and mid-cap equities for Schroders, also likes the housing industry although within this broad church, “the one group we have not invested in is home builders”.

She comments: “We continue to find some interesting developments relating to the housing industry, which has an important multiplier effect on the US economy. This is due to ancillary purchases relating to the purchase of a home.”

Over the past four years, her team has been investing in companies providing building materials, multi-family apartment real estate investment trusts, pest control companies, providers of heating and air conditioning units, waste haulers and financial companies providing mortgages or information to housing insurers and mortgage lenders.

Transport and the consumer

According to Robert Siddles, manager of the £159m Jupiter US Smaller Companies Trust, the best way to find good long-term opportunities is where “the market has panicked in the face of short-term worries”.

Two of these situations are transportation and consumer goods. He says: “The US transportation industry is huge - over half a trillion dollars.

“De-regulation has created a multitude of growth niches and recent concerns about US manufacturing created opportunities to buy companies capable of growing through the cycle at knock-down prices.”

Stocks now in the trust include Dominion Freight Line ($4.8bn market cap - equivalent to £3.71bn). Another stock which has been added to the portfolio is consumer goods company Ollie’s Bargain Outlet Holdings ($1.4bn market cap - equivalent to £1.08bn).

Mr Siddles adds: “I look for companies where management has ‘skin in the game’ - insiders own 12 per cent of Old Dominion and 22 per cent of Ollie’s.”