April 2019 Model Shadow Stock Portfolio Update

The S&P 500 index gained 13.6% during the first quarter, its strongest start to a year since 1998. The S&P 500 as measured through the Vanguard 500 Index fund (VFINX), was up 1.9% during March. In contrast, small- and mid-cap stocks were generally down during March as investors digested the implication of a more dovish Federal Reserve and its interest rate policy, a temporary inversion of the yield curve, signs of a slowing global economy and progress in negotiating a U.S.-China trade deal with the backdrop of the uncertainty regarding the U.K. Brexit.

The Model Shadow Stock Portfolio was down 3.8% during March, lowering its 2019 year-to-date performance from 20.3% last month to 15.8%. The S&P MidCap 400 index was down 0.6% during March and is now up 14.5% for the year, while the S&P SmallCap 600 index lost 3.3% during the month and is up 11.6% year to date. The Vanguard Small-Cap Index fund (NAESX) was down 0.9% during the month and has a year-to-date performance of 16.1%, while the DFA U.S. Micro Cap fund (DFSCX) was down 3.6% during March and is up 11.6% for this year through the end of March.

The performance of growth versus value-oriented stocks was again mixed during the month. Large-cap growth stocks were up 15.0% versus the 12.2% gain for large-cap value stocks for the first three months of the year as large-cap growth stocks were up 2.7% during March while large-cap value stocks gained 1.1% during the month. The pattern is reversed in the mid-cap segment, with mid-cap growth stocks up 14.0% after giving up 1.8% during March. Mid-cap value stocks are up 15.0% for the year after losing 0.6% during March. Small-cap value stocks are up 12.5% year to date, while small-cap growth stocks are up 10.8%. Notably, small-cap value stocks lost 3.9% during March, while small-cap growth stocks were down 2.8%.

Stocks in the information technology (+19.9%), industrial (+17.2%) and energy (+16.4%) sectors are continuing to lead the pack year to date. Sectors that are lagging this year include pharmaceuticals (+6.1%), health care (+6.6%) and financials (+8.6%).

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 14.5% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.4% per year on average over the same period. Over the same period, the Vanguard Small-Cap Index fund (NAESX) posted an average annual gain of 10.0%.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place around the end of May 2019, after most of the Shadow Stock holdings have announced their quarterly earnings. Any changes to the portfolio will be announced at the time they are made in a special Model Portfolios Update email (sign up at www.aaii.com/email).

Model Shadow Stock Portfolio Notes & News

As of the end of March, 21 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, up from 20 at the end of February. Of these, five are currently held in the Model Shadow Stock tracking portfolio: Beazer Homes USA Inc. (BZH), CPI Aerostructures Inc. (CVU), Flexsteel Industries Inc. (FLXS), Hallador Energy Co. (HNRG) and Universal Stainless & Alloy Products (USAP). Qualifying companies are those held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules. (They are designated as “qualifies” in the notes column of the Model Shadow Stock Portfolio table on AAII.com. However, the notes may not match the list here since the passing list on the website is revised daily and the notes are dynamically updated based on the revised list.)

Currently, PCM Inc. (PCMI), with a price-to-book-value ratio of 2.91, is approaching the price-to-book-value ratio limit of 3.00. Shadow Stocks with a price-to-book-value ratio above 3.00 at the time of a quarterly review are sold from the model portfolio, assuming there is a suitable replacement.

PC Connection Inc. (CNXN) and Renewable Energy Group Inc. (REGI) are approaching the market capitalization cut-off of $1.2 billion. PC Connection had a month-end market cap of $948 million, while Renewable Energy Group had a month-end market cap of $841 million. Shadow Stocks with a market cap above $1.2 billion at the time of a quarterly review are sold from the model portfolio, assuming there is a suitable replacement.

Amira Nature Foods Ltd. (ANFI) was the strongest stock in the Model Shadow Stock Portfolio with its 64.1% gain for March. Amira Nature Foods is an Indian food company best known for processing and distributing basmati rice and related food products. As we noted previously, the stock was late in filing its financial statements with the U.S. Securities and Exchange Commission (SEC) but filed its semiannual statements last October. The company remains on earnings probation.

Big 5 Sporting Goods Corp. (BGFV) was the weakest stock in the Model Shadow Stock Portfolio, dropping 19.8% during March. Big 5 Sporting Goods is a sporting goods retailer in the western U.S., operating 436 stores in 11 states as of the fiscal quarter ended December 30, 2018. Big 5 Sporting Goods provides a full-line product offering at compelling values including athletic shoes, apparel and accessories, as well as a broad selection of athletic equipment for team sports, fitness, camping, hunting, fishing, tennis, golf, winter and summer recreation and roller sports.

Click here to see the current purchase and sell rules for the portfolio. The size and value rules are subject to revision depending on prevailing market conditions.

The next quarterly review of the Model Shadow Stock Portfolio will take place at the end of May 2019. Any changes to the portfolio will be announced at the time they are made in a special Model Portfolios Update email (sign up at www.aaii.com/email).

Here are some news highlights from March for the holdings in the AAII Model Shadow Stock Portfolio:

CPI Aerostructures Inc. (CVU) reported that fourth-quarter revenue in 2018 was $26.5 million, up about 11% year over year from $23.8 million. Product sales were $26.6 million, up from $17 million in the same period of 2017, a 56% increase driven largely by the Next Generation Jammer pod program under contract with Raytheon Co. (RTN).

Net loss for the quarter was $807,000 or $0.07 per share. This compares to net income of $2.1 million, or $0.23 per diluted share, in the same period one year ago. On an adjusted basis, net income was $2.8 million, or $0.21 per share. Adjusted earnings per share (EPS) beat the I/B/E/S analyst consensus earnings estimate of $0.17 by 23.5%.

In February 2019, the U.S. Internal Revenue Service (IRS) informed CPI Aerostructures that the net operating loss carryback that was used in 2014 was under examination and could possibly be disallowed. Although the company has yet to receive further written notice from the IRS, CPI Aerostructures recorded a $3.1 million liability during the fourth quarter, as required by law, leading to the net loss.

Looking forward, CFO Vincent Palazzolo said, “For fiscal 2019, we expect revenue in the range of $98 million to $102 million. Pretax income is anticipated to be in the range of $11 million to $11.3 million. Our expected effective tax rate is in the range of 20% to 22%, as a consequence of the Tax Cuts and Jobs Act.”

Ennis Inc. (EBF) announced that one of its wholly owned subsidiaries acquired Integrated Print & Graphics (IPG). Ennis’ subsidiary will assume the IPG name, while the former IPG business—including its current facility lease and employees—will continue to produce the same products as before. Ennis believes that the acquisition will be accretive to earnings in the current year.

Hallador Energy Co. (HNRG) reported that revenue of $89.7 million in the fourth quarter of 2018 was up by 29% year over year from revenue of $69.3 million. Net income for the quarter was $2.6 million, or $0.09 per share, down about 88% year over year from net income of $21.4 million, or $0.69 per share, as a result of fourth-quarter 2017 receiving a one-time benefit from federal tax changes. Hallador’s earnings per share for the quarter of $0.09 missed the I/B/E/S analyst consensus earnings estimate of $0.10 by 10%.

Looking forward, Hallador said it was revising its 2019 sales guidance up to 8.2 million tons annually from 7.3 million tons previously. In addition, the company is forecasting sales of eight million tons annually for 2020 through 2022. Chairman, CEO and president Brent Bilsland said, “Currently we have 78% of our production sold for the next four years at an eight million tons pace. I do not know of another producer in the industry that is hedged that well for the next four years.”

RCM Technologies Inc. (RCMT) reported revenues of $55.3 million for the fourth quarter of 2018, an 8.3% increase year over year compared to $51.1 million in revenues for the fourth quarter of 2017. Unadjusted net income for the quarter was $0.6 million, or $0.05 per diluted share, compared to net income of $0.3 million, or $0.02 per diluted share in the same quarter in 2017. Adjusted net income of $2.6 million compared to adjusted net income of $2.5 million for the same period of time in 2017. RCM Technologies’ adjusted diluted earnings per share for the quarter of $0.08, as reported by I/B/E/S, missed the I/B/E/S analyst consensus earnings estimate of $0.11 by 27.3%.

Renewable Energy Group Inc. (REGI) reported total revenues of $519.8 million for the fourth quarter of 2018, down about 10% year over year from total revenues of $576 million in the same period one year ago. The decline was driven by lower biomass-based diesel prices and lower prices for biofuel credits, called renewable identification numbers (RINs), partially offset by the 6.8% increase in gallons sold.

Net income for the quarter was $33.4 million, or $0.66 per diluted share, which compares to fourth-quarter 2017’s net loss of $13.9 million, or $0.36 per diluted share. Adjusted earnings per share for the quarter, as reported by I/B/E/S, of $0.33 beat the I/B/E/S analyst consensus estimate of $0.205 by 61%.

REX American Resources Corp. (REX) reported that net sales and revenue for the fourth quarter of 2018 increased by 3.5% to $113.3 million, compared with $109.5 million in fourth-quarter 2017. The year-over-year net sales and revenue increase was primarily due to higher average selling prices for dried and modified distillers grains as well as increased production in the company’s ethanol and byproducts segment, which was partially offset by a 7.9% reduction in the average selling price per gallon of ethanol.

Net income for the quarter was $1.1 million, or $0.17 per share, compared to $19.1 million, or $2.89 per share in fourth-quarter 2017, the results of which reflect a $14.4 million tax benefit from federal tax changes.

Rocky Brands Inc. (RCKY) announced the approval by its board of directors of a new share repurchase program of up to $7.5 million of the company’s outstanding common shares. This repurchase program replaces the previous repurchase that expired on March 1, 2019.

Townsquare Media Inc. (TSQ) reported that net revenue for the fourth quarter of 2018 increased by 12%, to $109 million, as compared to $97.3 million in the same period last year. Net loss for the quarter decreased by 39.9% to $16.3 million, compared to $27.1 million in the same period last year. Loss per diluted share from continuing operations for the quarter was $1.26, which compares to diluted earnings per share of $0.34 in fourth-quarter 2017.

Adjusted net income was $7.02 million, or $0.26 per diluted share, up by about 33% and 37%, respectively, from adjusted net income of $5.27 million, or $0.19 per diluted share, in the fourth quarter of 2017. Adjusted earnings per share for the quarter as reported by I/B/E/S of $0.270 missed the I/B/E/S analyst consensus estimate of $0.272.

Looking forward, CFO Stuart Rosenstein said that for the first quarter of 2019, Townsquare Media is expecting net revenues between $92 million and $94 million, about a 3% to 5% increase year over year. Earnings before interest, taxes, depreciation and amortization (EBITDA) are expected to increase by about 1% to 7% year over year to between $17.5 million and $18.5 million.

VSE Corp. (VSEC) announced that CEO and president Maurice Gauthier will step down from his executive roles after 11 years with his position. VSE Corp.’s board of directors has elected John Cuomo—formerly vice president and general manager of Boeing Co.’s (BA) Distribution Services Inc.—to replace Gauthier effective April 2019.