May Model Shadow Stock Portfolio Update

We are excited to reveal a completely refreshed AAII Shadow Stocks section on AAII.com. This AAII member benefit is accessed by selecting Shadow Stocks from the drop-down Premium Services menu at the top right of the AAII.com webpage.

The AAII Shadow Stocks home page acts to consolidate access to the most recent monthly commentary, latest Model Shadow Stock Portfolio article from the AAII Journal, latest buys or sells from the Model Shadow Stock Portfolio, performance and the user’s guide.

The current stocks in the actual Model Shadow Stock Portfolio along with some basic fundamental data and portfolio notes can be accessed by clicking on Model Shadow Stock Portfolio from the horizontal navigation bar. The Model Shadow Stock Portfolio dropdown menu links to the performance tables and charts along with the history of transactions.

The Shadow Stock Ideas tab provides access to the latest list of stocks passing the initial Shadow Stock screening filter. The list of stocks is updated daily, and the data is updated throughout the trading day. Members can rank the passing companies by any of the data columns to easily see which companies have the lowest price-to-book-value ratio or are trading with the strongest relative price strength. You can also download the list of passing companies into Excel or print the list.

The Updates tab provides the latest email commentary sent to members and access to the archive of past commentaries. The archive includes commentary from monthly update emails and also alert emails that are sent out when changes are made to the Model Shadow Stock Portfolio. Clicking on Journal Commentary takes you to the most recent Model Shadow Stock Portfolio article from the AAII Journal along with links to past articles.

The How-To tab presents background information on the AAII Shadow Stocks, a User’s Guide and FAQs from a dropdown menu.

Monthly Review

The Model Shadow Stock Portfolio lagged the market during April, hurt by the 24.7% decline in PCM Inc. (PCMI) during April. As noted in Notes & News section below, PCM Inc. reported quarterly earnings that surpassed the consensus estimates and even resulted in forward estimates being increased by the two analysts following the stocks, but sales were down for the quarter compared to the same quarter last year. The Model Shadow Stock Portfolio lost 0.2% during April, while the S&P 500 index as measured by the Vanguard 500 Index fund (VFINX), gained 4.0%. Overall, small-cap stocks underperformed large-cap stocks during April, but value-oriented stocks generally outperformed growth stocks during the month.

The Model Shadow Stock Portfolio is now up 15.5% year to date, while the Vanguard 500 Index fund is up 18.2%. The Vanguard Small-Cap Index fund (NAESX) was up 3.6% during the month and has a year-to-date performance of 20.3%, while the DFA U.S. Micro Cap fund (DFSCX) was up 3.4% during April and is up 15.4% for this year through the end of April.

While value-oriented stock indexes outperformed growth-oriented indexes during April, they are still lagging on a year-to-date basis. Large-cap value stocks were up 4.1% during April, upping their year-to-date performance to 16.8%, while large-cap growth stocks gained 4.0% during the month and are now up 19.5% through the first four months of the year. The pattern is slightly different in the mid-cap segment, with mid-cap value stocks up 19.5% for the year after gaining 4.8% during April. Mid-cap growth stocks are up 18.8% for the year after gaining 3.3% during April. Small-cap value stocks are up 16.2% year to date, while small-cap growth stocks are up 20.7%. Small-cap value stocks gained 3.8% during April, while small-cap growth stocks were up 3.1%.

Stocks in the information technology (+27.6%), consumer discretionary (+22.3%) and industrial (+22.0%) sectors are leading the market this year. Sectors that are lagging this year include pharmaceuticals (+3.2%), health care (+3.8%) and utilities (+11.9%).

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 9.5% per year on average. Over the same period, the Vanguard Small-Cap Index fund (NAESX) posted an average annual gain of 10.1%.

Model Shadow Stock Portfolio Notes & News

As of the end of April, 17 stocks met the initial selection criteria for the Model Shadow Stock Portfolio, down from 21 at the end of March. Of these, three are currently held in the Model Shadow Stock tracking portfolio: Flexsteel Industries Inc. (FLXS), Hallador Energy Co. (HNRG) and Universal Stainless & Alloy Products (USAP). Beazer Homes USA Inc. (BZH) fell from the prior month’s passing list due to negative earnings per share over the last four quarters, while CPI Aerostructures Inc. (CVU) came off the passing list because of negative quarterly earnings per share. 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 notes on the website table are dynamically updated daily.)

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 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 Shadow Stock Portfolio Update email (sign up at www.aaii.com/email).

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

Amira Nature Foods Ltd. (ANFI) reported revenue of $123.7 million for the six months ended September 30, 2018, which the company said was significantly lower on a historical basis as a result of Amira’s capital constraints and the financial climate in India during the period. A loss of $1.06 per diluted share was recorded during the six-month period.

During the six months ended March 31, 2019, Amira announced a reduction in ownership in its Indian subsidiary to a minority interest, as well as a focus on international business. The company also recently announced a $28 million debt financing at a fixed interest rate of 8.5% and maturing December 17, 2023. Due to the aforementioned significant developments, the company is not providing guidance for the remaining half of the fiscal year ended March 31, 2019.

Amira also reiterated its $200 million revenue guidance for the 2020 fiscal year ending March 31, 2020. Going forward, the company’s focus will be on strengthening its international business and as such the 2020 fiscal-year $200 million revenue guidance consists solely of international revenue.

CSS Industries Inc. (CSS) reported that hedge fund Varana Capital Focused LP notified the company of its intention to nominate 10 candidates to replace CSS Industries’ eight-member board at the upcoming 2019 annual shareholders meeting. Varana Capital owns about 4% in CSS Industries’ common stock. CSS Industries said it was disappointed by Varana’s choice to pursue a “costly and distracting” proxy contest. CSS Industries will present its recommended board nominations at the annual shareholder meeting.

Ennis Inc. (EBF) reported that revenues in the fourth quarter of 2018 were $100.7 million, up 16% year over year. Gross profit margin for the quarter was 29%, as compared to 30% for the fourth quarter last year. Net earnings for the quarter were $8.2 million, or $0.32 per diluted share, flat year over year. One analyst polled by I/B/E/S was expecting earnings per share (EPS) of $0.34 for the quarter.

Net earnings in the same quarter last year were positively impacted by an increase of $3.6 million, or $0.14 per diluted share, due to the enactment of federal tax changes. Ennis also recorded a negative impact of $0.03 per diluted share in the same quarter last year from a special bonus paid to employees.

“We are pleased with our performance for the fourth quarter and the year given the challenges of the print industry,” said CEO Keith Walters. “As we have discussed previously, tight supply of raw materials has allowed for multiple price increases over the past year, which has placed considerable pressure on all print manufacturers’ margins. Although we expect pricing and costs in the marketplace to normalize over the long term, we anticipate to continue to experience pricing pressure in the short term.”

Flexsteel Industries Inc. (FLXS) reported that net sales for the third quarter of 2019 were down 12% year over year to $111.5 million, driven by a 10.9% decrease in residential net sales to $93.8 million. Flexsteel attributed the decrease to softer demand for home furnishings and ready-to-assemble e-commerce products.

Flexsteel reported a net loss of $15.6 million, or $1.97 per diluted share for the quarter, compared to net income of $3.1 million, or $0.39 per diluted share, in the prior-year quarter. The reported net loss included a pretax SAP business information system impairment charge of $18.7 million and a pretax defined-benefit plan termination charge of $2.5 million. Excluding these expenses, Flexsteel reported adjusted net income of $0.9 million, or $0.12 per diluted share, down about 84% each compared to adjusted net income of $5.5 million, or $0.70 per diluted share, in the third quarter of 2018.

CEO Jerry Dittmer said that the quarter’s results are “unacceptable” and reflect self-imposed challenges “that have contributed to [the company’s] underperformance over the past couple of years.”

“Part of our path forward will be to unwind the capital invested that has yielded very anemic returns and hold ourselves to a higher standard on investment choices and execution accountability that drives value creation and enhanced ROI for our shareholders. We have started that process by acknowledging the reality that our ERP system transition was a significant failure both in terms of customer and business disruption. Today, we took an $18.7 million impairment charge to reflect the known extent of this unsuccessful initiative.”

Hooker Furniture Corp. (HOFT) reported that consolidated net sales were $200.5 million for the fourth quarter of 2019, up 14.2% year over year. Net sales were buoyed by sales increases across all of Hooker Furniture’s segments, Hooker branded, Home Meridian and all other.

Also favorably impacting sales was fiscal 2019’s 53rd week, while fiscal 2018 and fiscal 2017 each had 52 weeks. The additional week in fiscal 2019 increased consolidated net sales by approximately $13.4 million based on average net sales per shipping day.

Fourth-quarter net income of $14.7 million, or $1.24 per diluted share, increased by 72% year over year. Hooker Furniture said that the improvement was driven by higher incremental sales and lower income tax rates. One analyst polled by I/B/E/S was expecting earnings per share of $1.05 for the quarter, leading to an 18% surprise from Hooker Furniture.

Looking forward, the company said long-term macroeconomic indicators are positive, including developments in the housing market. However, CEO Paul Toms Jr. said that the company has “seen a softening of demand and retail activity in the first two months of fiscal 2020,” with incoming orders down 13.6% on a consolidated basis and backlogs down 16.1% against the same period last year.

PCM Inc. (PCMI) reported that net sales decreased by 2% to $534 million year over year in the first quarter of 2019. There was one less selling day in first-quarter 2019 compared to first-quarter 2018. Average daily sales during the quarter were flat year over year.

Commercial net sales were $428.5 million for the first quarter, up 3% year over year. The increase was primarily due to strong demand in the commercial business sector, partially offset by several specific, non-strategic customer deals that PCM Inc. elected not to pursue based on its focus on profitable growth.

First-quarter net income was $4.7 million, or $0.35 per diluted share, up 68% and 52% year over year, respectively. Adjusted earnings per share were $0.46, up 35% year over year. Two analysts polled by I/B/E/S were expecting earnings per share of $0.395 for the quarter, leading to a 17% surprise from PCM Inc.

Commenting on PCM Inc.’s outlook for 2019, CEO Frank Khulusi said, “We believe we are well on our way toward a record 2019. Our Q1 results strongly support our full-year guidance for adjusted EPS in the range of $2.55 to $2.75, with full-year gross profit growth in the mid-single-digit range on low-single-digit net revenue growth.”

Rocky Brands Inc. (RCKY) net sales increased 7.4% to $65.9 million in the first quarter of 2019. Wholesale sales increased 4.8% to $42.4 million, retail sales increased 18.2% to $15.4 million and military segment sales for the first quarter were relatively flat at $8.1 million.

Earnings per share totaled $0.48 for the quarter, up about 9% year over year. Rocky Brands’ reported earnings per share for the quarter that beat the I/B/E/S analyst consensus earnings estimate of $0.42 by 14%.

Gross margin widened to 34.9% from 34.2% of sales, for the same period last year. The increase was driven by higher retail and military margins combined with a lower percentage of military sales, which carry lower gross margins than wholesale and retail sales.

“We are pleased to be off to a good start in 2019 with solid first-quarter results that included an 18% increase in retail sales,” said CEO Jason Brooks. “Looking ahead, we are cautiously optimistic about our prospects for growth over the remainder of the year and believe we are well positioned for sustained success over the long term.”

Strattec Security Corp. (STRT) reported that net sales for the third quarter of 2019 were $128.2 million, up 10% year over year. Net income for the quarter was $1.7 million, or $0.46 per diluted share, both down 43% year over year.

Gross profit margins were 12.2% in the current-year quarter compared to 13% in the prior-year quarter. The decrease in gross profit margin was attributed to an increase in the Mexican minimum wage for Strattec’s Mexican workforce effective January 1, 2019, and higher-than-expected production costs at the company’s door handle paint and assembly facility in Leon, Mexico.

CEO Frank Krejci said that in addition to the loss of profitability from Mexican operations, Strattec also saw lower sales in China, which the company attributes to higher development costs for new programs and breaking ground for a new plant and customers rebalancing inventories around the Lunar New Year holiday.

Universal Stainless & Alloy Products Inc. (USAP) reported that net sales for the first quarter of 2019 were $60.3 million, a decrease of 5.4%. Sales to the aerospace and power generation end markets increased year over year during the quarter, while sales to the oil and gas, heavy equipment and general industrial markets were lower over the same time period. Aerospace remained Universal Stainless & Alloy’s largest end market with sales of $42.6 million, or 70.7% of total net sales, compared to 56.9% in the first quarter of 2018.

Net income for the quarter was $1.2 million, or $0.14 per diluted share, up 100% year over year. Two analysts polled by I/B/E/S were expecting earnings per share of $0.24 for the quarter, leading to an earnings miss from Universal Stainless & Alloy.

“We continued to make progress in the first quarter of 2019, although more slowly than originally planned,” said CEO Dennis Oates. “First-quarter 2019 gross margin of 12.2% improved from the 2018 fourth quarter but was impacted by lower shipment volume as well as less favorable product mix, with demand for tool steel down substantially as our tool steel customers adjusted their inventories after strong buying in 2018.”

Looking forward, Oates said, “even with the slower-than-anticipated start, we expect 2019 to be another positive year for Universal Stainless with strong top-line growth and margin improvement forecasted as soon as the second quarter.”