November 2018 Model Shadow Stock Portfolio Update

The market downturn accelerated for small-company stocks during October, with the AAII Model Shadow Stock Portfolio giving up 11.8% during the month and is now down 12.9% year to date. The Vanguard Small Cap Index fund (NAESX) lost 10.1% during the month, while the DFA U.S. Micro Cap fund (DFSCX) lost 10.4% during October. The S&P 500 index, as measured through the Vanguard S&P 500 Index fund (VFINX), lost 6.9% during October, but remains up 2.9% for the year.

The breadth of the portfolio, which measures the general direction of the underlying stocks in the actual Model Shadow Stock tracking portfolio, remained very negative in October, reflecting the market correction. Of the 30 stocks that were in the portfolio at the end of the month, only four stocks posted gains in October compared to 26 stocks with losses. The strongest stock in the Model Shadow Stock Portfolio in September was again Renewable Energy Group Inc. (REGI) which gained 7.9% during month. Renewable Energy Group finished the month at $31.08, just below its 52-week high of $32.52, but well above its 52-week low of $9.50. Its market cap is up to $1.167 billion and price-to-book ratio stands at 1.52.

Amira Nature Foods Ltd. (ANFI) was the weakest holding in the Model Shadow Stock Portfolio with its 56.0% loss for October. 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). The company filed its annual report in October, noting a $2.30 per share loss for the fiscal year ending March 31, 2018. (See the news section below for additional news on the Shadow Stock holdings.)

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 14.8% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.3% per year on average. Over the same period, the Vanguard Small Cap Index fund (NAESX) posted an average annual gain of 9.9%.

With the market decline, we are seeing a larger number of small-cap value stocks passing the Shadow Stock Screen. As of the end of October, 26 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, up from 22 one month ago and 17 at the end of August. Of the 26 stocks passing at the end of October, eight are currently held in the Model Shadow Stock tracking portfolio (unchanged from the month before): Beazer Homes USA Inc. (BZH), CPI Aerostructures Inc. (CVU), Delta Apparel Inc. (DLA), Flexsteel Industries Inc. (FLXS), New Home Company Inc. (NWHM), Olympic Steel Inc. (ZEUS), Strattec Security Corp. (STRT) and Universal Stainless & Alloy Products (USAP). Companies held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules are designated as “currently 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.

As of the end of October, RCM Technologies Inc. (RCMT) and Vishay Precision Group Inc. (VPG) still have the highest price-to-book values, but RCM Technologies has seen its price-to-book-value ratio decline from 2.20 to 2.18, while Vishay Precision Group’s ratio has declined from 2.44 to 2.12. Shadow Stocks with a price-to-book-value ratio above 3.0 at the time of a quarterly review are sold from the model portfolio, assuming there is a suitable replacement.

Currently, Renewable Energy Group is approaching the market-cap cutoff of $1.2 billion (three times the initial limit for consideration of $400 million) with a market cap of $1.167 billion at the end of the month. Renewable Energy Group had the strongest monthly price gain in the Model Shadow Stock portfolio with its 7.9% gain during October. PC Connection Inc. (CNXN) had a price decline of 14.8% during October, which pushed its market cap down to $857 million from $1.0 billion a month ago.

The next quarterly review of the AAII Model Shadow Stock Portfolio will take place at the end of November. 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), as well as highlighted in the mid-December AAII Model Portfolios Update email and the Model Portfolios column in the January 2019 issue of the AAII Journal.

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.

Model Shadow Stock Portfolio News

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

• Amira Nature Foods Ltd. (ANFI) announced that it regained compliance with the New York Stock Exchange’s (NYSE) continued listing standards after the company was put on probation in August following a late Form 20-F with the U.S. Securities and Exchange Commission (SEC). For foreign private issuers with listed equity shares on U.S. exchanges, the 20-F is the equivalent of the Form 10-K required of domestic companies, standardizing reporting requirements so investors can more readily compare foreign and domestic companies.
  
  As a result of meeting listing standards, Amira will be removed from the late filers’ list disseminated to data vendors and posted on the listing standards filing status page of the NYSE. Further, the late filer indicator posted on the company’s profile, data and news pages will be removed.
   
• Big 5 Sporting Goods Corp. (BGFV) reported financial results for the fiscal-2018 third quarter. Net sales for the fiscal-2018 third quarter were $266.4 million, compared to net sales of $270.5 million for the third quarter of fiscal 2017. Same-store sales decreased 2.0% for the third quarter of fiscal 2018. As anticipated, fiscal-2018 third-quarter sales comparisons to the prior year reflect a small benefit from the calendar shift related to the Fourth of July holiday.
  
  Net income for the third quarter of fiscal 2018 was $3.1 million, or $0.15 per diluted share, compared to net income for the third quarter of fiscal 2017 of $6.0 million, or $0.28 per diluted share. Earnings per share (EPS) for the quarter missed the I/B/E/S analyst consensus estimate of $0.19, a miss of 21.1%. Big 5 Sporting Goods’ president and CEO Steven Miller said the company experienced lower-than-expected sales in August and September.
  
  For the fiscal-2018 fourth quarter, the company expects same-store sales to be in the range of negative low-single digits to positive low-single digits and expects to realize a loss per share in the range of $0.15 to $0.25. 
  
  Big 5 Sporting Goods also declared a dividend of $0.05 per share, a 66.7% decrease from the previous dividend of $0.15 per share. The company said the decrease reflects its intent to use capital to maintain a healthy financial condition.
   
• CPI Aerostructures Inc. (CVU) announced that Lockheed Martin Corp.’s (LMT) Sikorsky subsidiary has ordered $8 million worth of hover infrared suppression system (HIRSS) module assemblies for use as spares on older variants of Black Hawk helicopters. CPI Aerostructures first manufactured HIRSS module assemblies for the Black Hawk as original equipment in 2006, and Sikorsky last placed a small order back in 2013.
  
  Separately, in an update to CPI Aerostructures’ litigation with Air Industries Group Inc. (AIRI) in the New York state Supreme Court, the latter has been ordered to rescind its termination of its planned sale of subsidiary Welding Metallurgy Inc. to CPI Aerostructures. Under stipulation, Air Industries will deliver Welding Metallurgy’s audited financial statements to CPI Aerostructures within 45 days, with the acquisition concluding within three weeks post-reception of the financial statements. The court will retain jurisdiction of the case for all purposes, including enforcing the terms of the stipulation and order.
  
  Additionally, CPI Aerostructures announced a proposal to offer $12 million in shares of common stock in a public offering. CPI Aerostructures also expects to grant to the underwriters a 30-day option to purchase an additional $1.8 million of shares of common stock to cover overallotments, if any. CPI Aerostructures intends to use the net proceeds from this offering for general corporate purposes
   
• Container Store Group Inc. (TCS) announced financial results for the second quarter of 2018. Consolidated net sales were $224.5 million, up 2.8% as compared to the second quarter of fiscal 2017. Net sales at the Container Store were $208.9 million, up 3.3%, with the increase driven by incremental sales from new stores, as well as a comparable-store sales increase of 1.3%.
  
  Net income was $3.2 million, or $0.07 per share, in the second quarter of fiscal 2018 compared to net loss of $0.9 million, or $0.02 per share in the second quarter of fiscal 2017. Adjusted net income was $4.7 million, or $0.10 per share, in the second quarter of fiscal 2018 compared to adjusted net income of $5.5 million, or $0.12 per share in the second quarter of fiscal 2017. Adjusted earnings per share missed the I/B/E/S analyst consensus earnings estimate of $0.14, a miss of 28.6%.
  
  The Container Store reiterated its full-year guidance for fiscal 2018: net sales in the range of $885 million to $895 million; comparable-store sales up in the range of 1.5% to 2.5%; earnings per share in the range of $0.30 to $0.40; and adjusted earnings per share in the range of $0.41 to $0.51, with an assumed tax rate of 30%.
   
• Flexsteel Industries Inc. (FLXS) reported financial results for the first quarter of fiscal 2019. Net sales were $113.5 million for the quarter, down 5.3% compared to the prior-year quarter. Residential sales decreased 5.6% within the quarter primarily driven by products sold through ecommerce. The company experienced higher returns, allowances and promotional costs related to the sales of its ecommerce products as these sales continue to stabilize after the partial implementation of the business information system in the fourth quarter.
  
  Net income for the quarter was $1.3 million, or $0.16 per share, compared to $6.2 million, or $0.78 per share, in the same period one year ago, both down 79%.
  
  Looking forward, Flexsteel said it expects sequential near-term revenue and earnings growth, subject to the impact of current and impending tariffs. The company has reduced acquisition costs and increased prices to mitigate but not eliminate the tariff impact. If new tariffs are levied, additional cost reductions and price increases would be required to mitigate negative impacts on the business. Current and future price increases may have an adverse impact on volume. Inability to reduce acquisition costs or pass through pricing to mitigate the tariffs poses significant risk to current and future earnings.
   
• New Home Company Inc. (NWHM) reported financial results for the third quarter of 2018. Total revenues for the 2018 third quarter were $159.1 million, compared to $157.9 million in the prior-year period. Home sales revenue for the 2018 third quarter increased 5% to $119.9 million, compared to $114.6 million in the prior-year period. The increase in home sales revenue was driven by a 55% increase in deliveries, which was partially offset by a 32% decline in average selling price to $922,000 as we delivered more affordably priced homes during the quarter.
  
  The net income attributable to the company was $2.5 million, or $0.12 per diluted share, compared to net income of $4.3 million, or $0.21 per diluted share in the prior-year period. The year-over-year decrease in net income was primarily attributable to a 170-basis-point increase in selling and marketing expenses as a percentage of home sales revenue and a 150-basis-point decline in home sales gross margin. Earnings per share for the quarter beat the I/B/E/S analyst consensus earnings estimate of $0.084 by 42.9%.
  
  Looking forward, New Home Company offered the following full-year guidance for 2018: home sales revenue of $530 million to $570 million; fee building revenue of $150 to $160 million; home sales gross margin of 13.8% to 14.0%; and income from unconsolidated joint ventures of $0.5 million.
   
• Olympus Steel Inc. (ZEUS) announced that the election of Richard Marabito as the company’s new CEO is effective January 1, 2019. Michael Siegal, Olympic Steel’s CEO since 1984, will transition to executive chairman of the board at the end of this year, stepping down as CEO. Under Siegal’s leadership, the company’s net sales grew from approximately $35 million in 1984 to an annualized $1.6 billion in 2018. During this time, the company grew from a single location with approximately 60 employees, to 31 locations today and more than 1,700 workers. Marabito joined Olympic Steel in 1994 as treasurer and corporate controller and has since served as CFO for 18 years.
   
• PCM Inc. (PCMI) reported third-quarter results for 2018. Consolidated net sales were $510.6 million for the quarter, compared to $543.3 million in the same period one year ago, a decrease of $32.7 million or 6%. Gross profit increased 5%, to $85.1 million.
  
  Net income for the third quarter of 2018 was $6.0 million, compared to a net loss of $0.8 million for third-quarter 2017. Diluted earnings per share were $0.47, compared to a loss per share of $0.06 in the same period of the prior year. Non-GAAP earnings per share (adjusted earnings per share) were $0.61 for the quarter, compared to $0.27 in the same period one year ago. PCM’s adjusted earnings per share beat the I/B/E/S analyst consensus earnings estimate of $0.50 by 22%.
  
  Commenting on PCM’s outlook, CEO Frank Khulusi said, “Given our continued strong performance and solid outlook for the fourth quarter, we are increasing our 2018 guidance for non-GAAP earnings per share to a range of $2.22 to $2.32 and increasing our gross margin guidance for the year to a range of 16.15% to 16.35%, assuming fourth-quarter net revenue roughly in line with the third quarter.
   
• RCI Hospitality Holdings (RICK) announced total and same-store sales for its nightclubs and Bombshells restaurant segments for the fourth quarter of fiscal 2018. The company expects to report complete fourth-quarter 2018 results on or before December 14, 2018.
  
  Fourth-quarter nightclub sales were up 3.8% year over year on a total basis and 6.1% on a same-store basis. Results reflect effective marketing, management and appeal combined with the strong economy, including a continued rebound in the Texas oil patch.
  
  Fourth-quarter Bombshells sales were nearly level year over year on a total basis, but declined 21.3% on a same-store basis. This was due to one-time issues, such as the heat wave in July and August in Texas, which reduced late night patio business; the follow-on effect of one top store closed for 19 days in June; the closing of a freeway next to another top store almost every weekend in the fourth quarter of 2018; and difficult comparisons to a year ago when the Houston locations were among the first restaurants open after Hurricane Harvey.
  
  Looking forward, president and CEO Eric Langan commented, “We are making steady progress with our previously announced plans for full-year 2019. We have signed definitive agreements to acquire leading nightclubs in Chicago and Pittsburgh which should generate $5.0 million in combined annual EBITDA [earnings before interest, taxes, depreciation and amortization]. Closings on these acquisitions are expected in first-quarter 2019, assuming the timely transfer of all necessary permits, licenses and other authorizations, and subject to usual conditions for transactions of this kind, including due diligence.”
• Rocky Brands Inc. (RCKY) announced financial results for its 2018 third quarter. Third-quarter net sales increased 1.9% to $65.9 million compared to $64.7 million in the third quarter of 2017. Wholesale sales for the third quarter increased 2.1% to $47.0 million compared to $46.0 million for the same period in 2017. Retail sales for the third quarter increased 7.6% to $11.9 million compared to $11.1 million for the same period last year.
  
  Rocky Brands reported third-quarter net income of $5.0 million, or $0.67 per diluted share compared to a net income of $2.2 million, or $0.30 per diluted share in the third quarter of 2017. Adjusted net income for the third quarter of 2018 was $4.5 million, or $0.60 per diluted share compared to adjusted net income of $2.9 million, or $0.39 per diluted share in the prior-year period. Third-quarter adjusted diluted earnings per share beat the I/B/E/S analyst consensus earnings estimate of $0.49, a surprise of 22.4%.
   
• Strattec Security Corp. (STRT) reported operating results for the fiscal first quarter of 2019. Net sales for the company’s fiscal-2019 first quarter were $117.2 million, compared to net sales of $102.5 million for the prior-year quarter. Sales to Fiat Chrysler Automobiles (FCAU), General Motors Co. (GM), tier-one customers and commercial and other original equipment manufacturer (OEM) customers increased year over year; sales to Ford Motor Co. (F) remained flat year over year; and sales to Hyundai Motor Co. (HYMTF) and subsidiary Kia Motors decreased year over year.
  
  Net income for the current-year quarter was $3.5 million, compared to net income of $2.5 million in the prior-year quarter. Diluted earnings per share for the current-year quarter were $0.93 compared to diluted earnings per share of $0.67 in the prior-year quarter.
   
• Universal Stainless & Alloy Products Inc. (USAP) reported earnings for the third quarter of 2018. Net sales were $69.1 million for the quarter, an increase of 35.7% from $50.9 million in the same period one year ago. The company said that all end markets contributed to the year-over-year growth, with the exception of power generation. Aerospace remained the Universal Stainless & Alloy’s largest end market, at 54% of total company sales. Aerospace sales totaled $37.3 million for the quarter, up 34.6%.
  
  Net income for the third quarter of 2018 totaled $3.9 million, or $0.44 per diluted share, (which includes an additional 1.4 million weighted average shares outstanding due to the second quarter 2018 equity issuance), compared with a loss of $0.3 million, or $0.04 per diluted share, in the third quarter of 2017. Net earnings for the quarter missed the I/B/E/S consensus estimate of $0.48 per share, a miss of 8.3%.
  
  The net loss in the third quarter of 2017 included unusual charges of $0.06 per diluted share related to facility fires as well as discrete tax items. Net income in the 2018 second quarter included other income of $0.06 per diluted share as a result of a favorable legal settlement.