May Model Shadow Stock Portfolio Update

Twenty-seven stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of May 14, 2020, down from 39 passing stocks one month ago. Even with the market bouncing back from its March 23, 2020, low point, a wide array of stocks continues to pass the Model Shadow Stock valuation rules. AAII members can see and research which companies are currently passing the initial selection criteria in the Shadow Stock Ideas table on AAII.com. The list of Shadow Stock Ideas is updated daily—Tuesday through Saturday.

Of the 27 qualifying companies, four are currently held in the Model Shadow Stock tracking portfolio: Hibbett Sports Inc. (HIBB), Hooker Furniture Corp. (HOFT), Perion Network Ltd. (PERI) and VSE Corp. (VSEC). Delta Apparel Inc. (DLA), RCI Hospitality Holdings Inc. (RICK), Universal Stainless & Alloy Products (USAP) came off the list of qualifying companies over the course of the last month, while VSE Corp. was added. Qualifying companies are those held in the Model Shadow Stock Portfolio that currently meet the initial purchase rules. (They are designated as “currently qualifies” in the notes column of the Model Shadow Stock Portfolio table on AAII.com. However, if you go online, the notes may not match the list here since the notes on the website table are dynamically updated daily.)

As of May 14, 2020, Ennis Inc. (EBF) had the highest price-to-book-value ratio in the Model Shadow Stock Portfolio. Its ratio of 1.43 is above the 0.90 maximum value used for initially qualifying a stock for inclusion to the portfolio. However, stocks are not removed from the portfolio until their price-to-book-value ratio rises to three times the initial maximum value (2.70). It may help you to think about values below 0.90 as being attractive, while values three times above the initial maximum are expensive. Allowing the price-to-book ratio to expand for stocks that you own allows your winners to run up a little, since the price-to-book ratio typically gets larger as the stock price goes up. The initial price-to-book level is adjusted over time to reflect the changing market conditions, and we are examining valuation and size now for the next quarterly portfolio review.

The Model Shadow Stock Portfolio looks for stocks with a market capitalization (share price times shares outstanding) greater than $30 million but less than $300 million when adding stocks to the portfolio. Shadow Stocks with a market cap three times the initial market cap maximum ($300 million × 3 = $900 million) at the time of a quarterly review are sold from the portfolio, assuming there is a suitable replacement. Ennis also has the highest market cap in the portfolio with a value of $419.7 million as of May 14, 2020. With the market decline, no stocks in the Model Shadow Stock portfolio are in risk of hitting this ceiling.

Click here to see the current purchase and sell rules for the portfolio.

Performance Update

The stock market bounced back strongly in April, with the S&P 500 index finishing the month at 2,912.43 for a monthly gain of 12.8%. The share prices of energy stocks were particularly strong performers during the month—gaining 29.8% during the month—but continue to lag other sectors for the year. The Model Shadow Stock Portfolio gained 12.8% during April but remains down 41.9% year to date. The S&P 500 as measured through the Vanguard 500 Index fund (VFINX), was also up 12.8% during April and is now down 9.3% for the year. The S&P 500 equally weighted index gained 14.4% during the month and is down 16.1% year to date. The S&P MidCap 400 index was up 14.2% during April and is now down 19.7% for the year, while the Russell 2000 index gained 13.7% during the month and is down 21.1% year to date. The Vanguard Small-Cap Index fund (NAESX) was up 14.7% during the month and has a year-to-date performance of –19.8%, while the DFA U.S. Micro Cap fund (DFSCX) was up 13.3% during April and is down 26.1% for this year through the end of April.

The performance of growth- versus value-oriented stocks continues to be slanted toward growth stocks.

In the large-cap segment, growth stocks were up 14.5% for the month, bringing their year-to-date loss to just 2.2% for 2020. Large-cap value stocks were up 10.7% during April and are now down 17.4% year to date.

In the mid-cap segment, growth stocks are up 14.2% for the year, after gaining 14.0% during April. Mid-cap value stocks are down 25.8% for the year, after gaining 14.3% during the month.

Small-cap growth stocks are down 14.7% year to date, while small-cap value stocks are down 27.7%. Small-cap growth stocks gained 14.9% during April, while small-cap value stocks gained 12.3% during the month.

Stocks in the information technology (+0.2%), health care (–1.6%) and consumer discretionary (–2.7%) sectors are leading the market this year. Sectors that are lagging this year include energy (–35.7%), financials (–25.4%) and industrials (–20.7%). Information technology is the only sector in the black this year after gaining 13.8% during April. The weakest-performing sectors during April were the defensive groups such as utilities, which gained 3.2% during April, and consumer staples, which gained 6.9% for the month.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 11.8% versus the Vanguard 500 Index fund’s gain of 9.2% per year on average over the same period. Over the same period, the Vanguard Small-Cap Index fund posted an average annual gain of 9.0%.

We will conduct the next quarterly review of the portfolio toward the end of May. 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:

Model Shadow Stock Portfolio News

Bassett Furniture Industries Inc. (BSET) reported that earnings per share of $0.12 increased by 100% year over year for the first quarter of 2020, which ended February 29, and beat the I/B/E/S consensus estimate of $0.016 per share. Consolidated sales over the same period fell by 7% to $112.1 million but were flat on a weekly basis. First-quarter 2019 consisted of 14 weeks compared to first-quarter 2020’s 13 weeks.

In the company’s wholesale segment, the year-over-year decrease in sales by 3.8% was primarily driven by the company’s exit of its juvenile furniture line and a decrease in shipments to traditional open market customers. Comparable-store sales decreased 10.4% year over year as Bassett Furniture continues to close underperforming stores. Consolidated retail operating loss for the quarter was $1.2 million compared to a loss of $3 million in the first quarter of 2019. Normalizing results for the extra week in first-quarter 2019, Bassett Furniture’s logistical services unit reported that revenues increased by 5.5% year over year to $21.3 million.

At the time of the company’s first-quarter earnings release, Bassett Furniture’s stores and factories were closed due to the coronavirus pandemic. The company is focused on preserving its balance sheet. All employee salaries have been cut substantially through May, ranging from 20% to 25%—depending on salary level and the individual’s position—to 50% for top management. All non-essential spending has been eliminated, and the company has decided to postpone the payment of the regular quarterly dividend it declared on March 12, due to be paid on May 29. The company also doubled its revolving credit facility with its lender to $50 million.

Separately and later in April, Bassett Furniture announced that it will resume production at its manufacturing facilities in a limited capacity. The company will begin to work through its existing backlog as it prepares for the reopening of the U.S. economy. Twenty of its 66 retail stores will also re-open, in addition to its distribution centers, which are making home deliveries again. More operations will resume based on local and state guidelines.

Beazer Homes USA Inc. (BZH) reported that second-quarter 2020 net income of $10.6 million, or $0.35 per share, was up year over year compared to adjusted net income of $4.4 million. Earnings per share for the quarter beat the I/B/E/S consensus estimate of $0.26 by 35%. Homebuilding revenue of $488 million was up 16% over the same period.

Revenue for the quarter was driven by a 13% increase in home closings to 1,227 on an increase in the average selling price by 2.9% to $382,100. Net new orders for the second quarter increased by 4% year over year to 1,661. The increase in net new orders was primarily driven by a 2.2% increase in average community count to 167. The cancellation rate for the quarter was 15.8%, up from 14.5%. At the end of the quarter, Beazer Homes’ backlog increased by 14% to a total dollar value of $895 million, or 2,231 homes, compared to $783 million, or 1,989 homes, at the same time last year.

Despite strong quarterly results, Beazer Homes announced that it has withdrawn its financial guidance for the current quarter and the year due to the coronavirus pandemic. The company has shifted its operations to deal with the impacts of the outbreak, including an increase in the use of digital sales tools and requiring its builders and vendors to meet new safety and social distancing guidelines.

At the end of the quarter, Beazer Homes’ total liquidity was $294.3 million, including a fully drawn $250.0 million revolving credit facility. This compares to total liquidity of $221.4 million on March 31, 2019, including cash of $86.4 million and an undrawn revolving credit facility capacity of $135.0 million.

Big 5 Sporting Goods Corp. (BGFV) announced that disruptions to its business due the coronavirus pandemic have required the company to delay the filing of its report for the first quarter of 2020 from May 13 to the end of the month. The company has until June 27 to file its quarterly report.

Same-store sales for the quarter decreased year over year by 10.8%, which includes the impact of temporary store closures beginning in late March as local and state shelter orders took effect. About 25% of Big 5 Sporting Goods stores remain closed at the time of the company’s announcement in late April. Reduced store hours and limited customer occupancies also reduced sales.

In response to the decline in sales, Big 5 Sporting Goods exercised the accordion feature of its credit agreement to expand the total facility it can borrow by $25 million to $165 million. The company has drawn on $143 million of its line in total and has a cash position of about $72 million.

Big 5 Sporting Goods is also reducing expenses to preserve cash, including negotiating with landlords to reduce or defer lease-related payments, reducing merchandise inventory orders and extending payment terms with merchandise vendors, reducing a significant amount of its workforce, suspending normal annual salary increases and reducing advertising and the amount of planned capital spending in fiscal 2020. Until further notice, the company has also suspended its dividend payments.

Container Store Group Inc. (TCS) announced that it was closing all remaining stores that were not already closed due to local and state orders, as the company shifts to curbside delivery and pick up in response to the coronavirus pandemic. Additional employees are also being furloughed due to store closures.

Covenant Transportation Group (CVTI) announced that it will delay the filing of its first-quarter financial report due to the coronavirus pandemic to June 15. This was in addition to several other announcements the company made during the month.

At the end of March, Covenant Transportation had about $75.3 million in liquidity. CEO David Parker said the company has other potential sources of liquidity should the need arise.

Covenant Transportation announced a shakeup of its executive management structure, shifting the roles and promoting four executives while retaining David Parker as CEO. The new appointments are expected to better align with the strategic goals of the company. Covenant Transportation’s executive management and board of directors have also accepted salary reductions and cash retainer reductions, respectively, effective April 6.

Covenant Transportation will close operations at its trucking terminal in Texarkana, Arkansas, which will include a permanent reduction in 150 support staff tending to the facility. The terminal primarily served as an operating center for the company’s solo-driven refrigeration service. All professional truck drivers and non-driving functions will be transferred to Covenant Transportation’s other terminals in Chattanooga, Nashville or Greeneville, Tennessee.

CPI Aerostructures Inc. (CVU) announced that it closed on a $4.8 million loan under the federal government’s Payroll Protection Program. The loan has a term of two years and bears a fixed interest rate of 1% per year with the first six months of interest deferred and will be forgiven if at least 75% of the proceeds are used by CPI Aerostructures to cover payroll costs and the company maintains its employment and compensation within certain parameters during the eight-week period following the loan origination date.

Delta Apparel Inc. (DLA) reported that second-quarter earnings per share of $0.19 increased year over year by 46.2%. When adjusted for plant curtailment expenses of $0.20 per share, earnings per share for the quarter was $0.39. Results compared to the I/B/E/S consensus estimate of $0.38 per share. Net sales decreased by 6% over the same period, to $96.7 million.

According to the company, sales were on track to grow year over year by 9% before the onset of the coronavirus pandemic. During March, the closure of retail stores throughout the U.S. dramatically halted revenue during the final month of the quarter. Second-quarter gross profit was reduced by $1.9 million from plant curtailments caused by government-mandated country closures in El Salvador and Honduras in March.

Looking forward, the company said it is uncertain as to what will ultimately transpire under the coronavirus pandemic’s impact on retail stores, though it does expect a “dramatically” negative impact for the third quarter. Delta Apparel’s factories in Honduras and El Salvador also remain closed on government orders, further clouding the future.

During the quarter, Delta Apparel repurchased about $2 million of its stock. Total debt, including capital lease financing, as of March 28, 2020, was $167.9 million. The company has access to over $30 million in liquidity, including cash and borrowing availability under its credit facility.

Ducommun Incorporated (DCO) reported that earnings per share of $0.67 for the first quarter of 2020 increased by 4.7% year over year and beat the I/B/E/S consensus estimate of $0.33 per share. Revenue increased by 0.5% over the same period to $173.5 million.

Higher revenue from the company’s military and space markets due to higher build rates were offset by lower revenue in the company’s commercial aerospace market due to lower build rates. Ducommun said it expects the diversification of its portfolio into more defense contracts for military and space customers as the commercial aerospace industry suffers under the impact of the Boeing 737 MAX delays and the coronavirus pandemic.

Looking forward, Ducommun cited its strong backlog of $876 million in orders primarily from growing defense programs. However, company revenue is expected to be lower in the second quarter in a range of 16% to 20% due to the impact of the commercial aerospace market’s downturn. For the year, that downturn is expected to bring revenues down 8% to 12%.

Ennis Inc. (EBF) reported that fourth-quarter 2020 earnings per share of $0.33 were up by 3% year over year but missed the I/B/E/S consensus estimate of $0.35 by 5.7%. Revenues increased by 6% over the same period to $106.7 million.

Gross profit margin was $29.9 million for the quarter, or 28.1%, compared to $29.1 million, or 28.9%, for the fourth quarter last year. “Our gross profit margin percentage for the quarter and the year continues to be impacted by the consolidation and integration of our past four acquisitions completed in 2019, which all had gross profit and operating margins considerably lower than our historical margins,” said CEO Keith Walters. “With that being said, these acquisitions increased our sales by $55.3 million and added $0.15 to our diluted earnings per share for the year.”

Looking forward, Ennis expects fiscal 2021 to be a challenging year due to the coronavirus pandemic, though the company’s manufacturing services have been deemed essential. The company has extended the maturity date of its $100 million credit agreement to November 2021, allowing it to borrow more if necessary. Ennis plans to continue its dividend program and will continue to concentrate on advantageous uses of its capital, including acquisitions and buying back shares.

Flexsteel Industries Inc. (FLXS) reported a net loss per share for the third quarter of 2020 of $0.66, compared to a net loss per share of $1.97 in the same period one year ago. Net sales decreased by 11.4% year over year to $98.8 million.

Residential net sales declined by 5.7% compared to the prior-year quarter. The decline was mainly due to the 25% tariff impact on volume and to a lesser degree widespread customer store closures that started mid-March in response to coronavirus pandemic restrictions. The company continued to serve customers through its e-commerce channel, which delivered 37.1% growth in the third quarter.

Flexsteel said that it expects a negative impact from the pandemic. In response, the company is reducing some base salaries and compensation to the board of directors, suspending its 401(k) match through the end of the calendar year, negotiating with vendors to extend payment terms and eliminating all non-essential expenses and capital expenditures. Some employees have been temporarily laid-off based on business needs. Flexsteel’s distribution center in Lancaster, Pennsylvania, has been permanently closed, with demand being supported by other distribution centers.

Flexsteel is accelerating portions of its restructuring plan due to the pandemic. Based on rapidly declining demand and changing market conditions driven by the coronavirus pandemic, it was determined that some businesses are no longer a strategic fit. The specific timing of these exits and the associated financial impact will be determined in the fourth quarter and subsequently communicated once known.

Hallador Energy Co. (HNRG) announced that it will delay the filing of its first-quarter financial report from April 29 to the second week of May due to the impact of the coronavirus pandemic on operations. Hallador Energy also said that it expects to deliver slightly less coal in 2020 than it initially said it would and expects deliveries to be weighted to the second half of the year.

Additionally, Hallador Energy has suspended its quarterly dividend indefinitely and has increased its liquidity by expanding its credit agreement by $50 million and by receiving a $10 million loan at a 1% interest rate under the federal government’s Paycheck Protection Program. Eighty percent of the loan is expected to be forgiven in June.

Hooker Furniture Corp. (HOFT) reported that fourth-quarter 2020 earnings per share of $0.59 decreased by 52% year over year. However, earnings per share beat the I/B/E/S consensus estimate of $0.55 by 7%. Over the same period, net sales decreased by 18% to $165 million.

Net sales decreased due to lower sales across all reportable segments—Hooker branded, Home Meridian and domestic upholstery—and due to the shorter fiscal fourth quarter compared to the prior year’s fiscal fourth quarter. The shorter quarter accounted for about 40% of the 18% year-over-year decline in revenue. Tariffs continued to hurt the company’s largest business, Home Meridian, as the majority of products come directly from Asian manufacturers.

Hooker Furniture said it has almost $26 million in its revolving credit facility to draw on if necessary. The company had a cash position of $36 million at the end of the fiscal year. To further preserve cash, the company has reduced the base salaries of executives and some managers and has reduced compensation to its board of directors. About 500 employees have been furloughed in addition to some layoffs. All non-essential capital expenditures have been cut.

Mesa Air Group (MESA) reported a 14.8% drop year over year in block operating hours for March 2020 as a result of reduced schedules during the coronavirus pandemic. The company also reported controllable completion factors of 99.85% and 99.99% for American Airlines Group (AAL) and United Airlines Holdings (UAL), respectively.

Separately, Mesa Air Group announced that it expects to receive $92.5 million in assistance from the Treasury Department under the Payroll Support Program as part of the Coronavirus Aid, Relief and Economic Security (CARES) Act. The company is also considering applying for federal loans through a separate program under the CARES Act.

The company has agreed to certain conditions under the payroll program, including prohibitions against involuntary furloughs and reductions in employee pay rates and benefits through September 30, 2020; the elimination of share repurchases and dividends until September 30, 2021; and limits on executive compensation until March 24, 2022. Because the amount of payroll support is less than $100 million, the company will not be required to enter into a loan or equity agreement with the Treasury Department.

RCI Hospitality Holdings Inc. (RICK) reported that total and same-store sales were up 11.8% and 5.3%, respectively, through the first 10 weeks of the second quarter of 2020 until mid-March, when concern about the coronavirus pandemic caused declines in the company’s clubs and restaurants. With the inclusion of the impact of the pandemic, total sales for the quarter decreased by 9.8% year over year.

RCI Hospitality has furloughed 1,900 employees; reduced pay of the roughly 100 remaining employees to 75% of previous levels, with plans to drop to 50% should closings last through the end of May; obtained three-month payment deferrals from both of their major lenders and deferral agreements with others and some of their landlords in the small number of locations where subsidiaries pay rent; reduced or eliminated nearly all areas of discretionary spending; and filed for business interruption insurance claims.

Separately and later in April, RCI Hospitality announced that all 10 of its Bombshells restaurant locations would reopen in May following the Texas state government’s guidelines. Depending on how the state proceeds with its guidelines, RCI Hospitality said it may open its other 33 business locations in the state.

REX American Resources Corp. (REX) announced that it has idled its One Earth Energy ethanol plant. This action reflects current market conditions primarily brought on by lower ethanol pricing and the slowdown in ethanol demand due to the nationwide impact of the coronavirus pandemic. REX American Resources has now idled both of its consolidated ethanol plants. The company plans to reopen the plants when management deems market conditions have improved to satisfactory conditions.

Rocky Brands Inc. (RCKY) reported earnings per share of $0.16 for the first quarter of 2020, down compared to $0.48 in the same period one year ago. Adjusted earnings per share of $0.27 missed the I/B/E/S consensus estimate of $0.47 by 43%. Total sales for the quarter were down by 16%, to $55.7 million. 

Wholesale sales for the first quarter were $35.0 million, compared to $42.4 million for the same period in 2019. Retail sales for the first quarter increased 9.4% to $16.9 million compared to the same period last year. Military segment sales for the first quarter were $3.8 million, compared to $8.1 million in the first quarter of 2019.

Rocky Brands estimates that about two-thirds of its wholesale partners have been designated as essential services and remain open. For both its retail and wholesale segments, digital sales are increasing to offset the loss of in-store sales. Sales on Rocky Boots, Georgia Boot and Durangoboots.com are all up strong double digits, driven by robust gains in new users and conversion.

Looking forward, Rocky Brands said it is adjusting future orders from its suppliers and it plans to work down its current inventory position over the next couple of quarters to better align production with demand. About 70% of the company’s inventory is in the core product line for the year. The company is not providing further guidance for the year beyond what it outlined in February.

Strattec Security Corp. (STRT) reported earnings per share for the third quarter of 2020 of $0.79, which were up 72% year over year and beat the I/B/E/S consensus estimate of $0.32 per share. Net sales over the same period were down by 9%.

During the latter part of March 2020, customers started reducing production schedules and closed their assembly plants due to the coronavirus pandemic. Sales to Fiat Chrysler Automobiles, Ford Motor Co. and Hyundai/Kia in the current-year quarter decreased in comparison to the prior-year quarter due to lower production volumes of the vehicles Strattec supplies. However, sales increased to General Motors due to higher sales content on models using Strattec components, in particular power access products and latches.

Sales to Tier 1 customers decreased due to lower sales of driver control steering column lock products. Sales to commercial and original equipment manufacturer (OEM) customers decreased in comparison to the prior-year quarter mainly due to decreases in sales related to key fobs sold to Harley Davidson and related to reductions in sales of door handle and power access products to Honda of America Manufacturing Inc.

Strattec said that net sales for the fourth quarter of 2020 could be down by as much as 50%, as manufacturing facilities remain reduced due to the coronavirus pandemic, dramatically impacting the company’s cash flow and profitability. The company is reducing its cost structure through layoffs, reduced hours, officer salary cuts and escalating decisions regarding capital spending.

Universal Stainless & Alloy Products Inc. (USAP) reported a net loss of $0.16 per share for the first quarter of 2020, compared with earnings per share of $0.14 in the first quarter of 2019. Results for the quarter missed the I/B/E/S consensus estimate, for a loss per share of $0.06. Net sales over the same period decreased by 3%, to $58.5 million.

Sales of premium alloys totaled $7.7 million, or 13.1% of sales, in the first quarter of 2020, compared with $7.4 million, or 13.4% of sales, in the fourth quarter of 2019, and $9.4 million, or 15.6% of sales, in the first quarter of 2019. Premium alloy sales are substantially driven by the aerospace market, which has been challenged by the Boeing 737 MAX production situation—the effects of which are expected to be severely exacerbated by the drop off in global air travel in response to the coronavirus pandemic. Universal Stainless & Alloy expects customers to take a conservative approach to order entry. Backlog at the end of the quarter was $110.7 million, compared with $119.1 million at December 31, 2019, and $130.1 million at the end of the 2019 first quarter.

The company’s total debt at the end of March was $76.3 million. In response to the pandemic, Universal Stainless & Alloy is monitoring the effects on the markets the company serves, including the aerospace and oil and gas markets, and has entered into a term loan for $10 million under the Paycheck Protection Program. Otherwise, each of the company’s facilities is considered to be an essential operation and remains operational in accordance with the laws of the states in which the facilities are located.

VSE Corp. (VSEC) announced about $90 million in contract and delivery order awards with the U.S. Department of Defense. The awards include a five-year contract, commencing in the second quarter of 2020, to provide procurement and technical support services for the Marine Corps Advanced Amphibious Assault (AAA) family of vehicles, and delivery orders to provide services under VSE Corp.’s foreign military sales contract with the Naval Sea Systems Command International Fleet Support Program Office.

Separately, VSE Corp. announced a one-time order valued at $26.6 million for coronavirus-related supplies for a U.S. government customer in conjunction with ongoing efforts to respond to the pandemic. VSE Corp. anticipates weekly shipments to commence soon, with the delivery of all supplies completed during the second or third quarter of 2020.