August Model Shadow Stock Portfolio Update

Eight stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of August 13, 2020, down from 11 passing stocks one month ago. 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 eight qualifying companies, two are currently held in the Model Shadow Stock tracking portfolio: Big 5 Sporting Goods Corp. (BGFV) and Penn Virginia Corp. (PVAC). 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, 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 August 13, 2020, had Ennis Inc. (EBF) had the highest price-to-book-value ratio in the Model Shadow Stock Portfolio. Its ratio of 1.61 is above the 0.90 maximum value used for initially qualifying a stock for inclusion in 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), assuming there is a suitable replacement. Ennis is engaged in the production and sale of printed business products, business forms and other business products.

Ducommun Incorporated (DCO) has the highest market capitalization in the portfolio, with a value of $490.7 million as of August 13, 2020. Ducommun is a global provider of engineering and manufacturing services used in the aerospace, defense, industrial, natural resources, medical and other industries. The Model Shadow Stock Portfolio looks for stocks with a market cap (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 removed from the portfolio, assuming there is a suitable replacement.

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.

Performance Update

The markets posted gains during July amid a backdrop of reported large losses incurred by many companies during the second quarter of 2020. Investors continue to price stocks with the expectation of an economic upturn, even as the crystal ball of most companies is too cloudy to even provide any meaningful future guidance.

The Model Shadow Stock Portfolio gained 6.9% during July but remains down 29.5% for the year. The S&P 500 index gained 5.6% during July and is now up 2.4% during 2020. The S&P 500 equally weighted index gained 4.8% during the month and is down 6.5% year to date.

The S&P 500 is market-cap weighted so that larger companies (price times share outstanding) have a greater impact on its performance. The 10 largest companies in the S&P 500 constitute 27.8% of the index. Apple Inc. (AAPL, 6.4%), Microsoft Corp. (MSFT, 5.7%), Amazon.com Inc. (AMZN, 4.9%), Alphabet Inc. (GOOGL, 3.3%) and Facebook Inc. (FB, 2.3%) alone account for 22.6% of the S&P 500. In the equally weighted S&P 500 index, the top 10 holdings account for 2.6% of the index and each holding is around 0.2% of the index.

The S&P MidCap 400 was up 4.6% during July and is down 8.7% for the year, while the Russell 2000 small-cap index gained 2.8% during the month and is down 10.6% for the first seven months of the year.

The consumer discretionary sector had the greatest gain during July, up 9.0% for the month and is now up 16.9% for the year. The energy sector was the only sector down during the month with a loss of 5.1% leading to loss of 38.7% during 2020. The information technology sector continues to lead the market for the year with its year-to-date gain of 21.4% after gaining 5.6% during July.

Growth stocks continued their dominance over value-oriented stocks during July.

In the large-cap segment, growth stocks were up 7.0% for the month, giving them a positive 15.5% gain year to date for 2020. Large-cap value stocks were up 3.7% during July and are now down 12.4% year to date.

In the mid-cap segment, growth stocks gained 6.1% during the month and are now in positive territory for the year with a 0.6% gain. Mid-cap value stocks are down 18.8% for the year, after gaining 2.7% during the month.

Small-cap growth stocks are also up slightly for the year with a 0.27% gain after returning 3.4% during July. Small-cap value stocks are down 21.9% for the year after gaining 2.1% during July.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 12.5% versus the Vanguard 500 Index fund’s (VFINX) gain of 9.6% per year on average over the same period. The Vanguard Small Cap Index (NAESX) now trails the Vanguard 500 index with an average annual gain of 9.5%.

We will conduct the next quarterly review of the portfolio toward the end of August. 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).

Model Shadow Stock Portfolio News

Big 5 Sporting Goods was the strongest stock in the Model Shadow Stock Portfolio, with its gain of 188.7% during July. The company is a sporting goods retailer based in the western U.S., offering a range of products through its stores and its e-commerce platform. With its latest quarterly earnings, covered in the news section below, Big 5 Sporting Goods noted that its operating leverage has improved over the course of the coronavirus pandemic, which allowed it to reinstate its suspended quarterly dividend.

Strattec Security Corp. (STRT) was the second-best-performing stock in the portfolio during the month, up by 35.6%, but there was no company-specific news item tied to its performance. As a maker of automotive access control products—including mechanical and electronically enhanced locks and keys, power lift gate systems and door handles—the company benefited from automotive demand as manufacturers sought to work through backlogs and take on new orders. The company’s second-quarter results will be covered in next month’s update.

Universal Stainless & Alloy Products (USAP) was down by 16.4% during July, making it the worst-performing stock in the portfolio. The company reported that sales are lagging due to the economic pressure on the aerospace industry—which accounts for the vast majority of the company’s sales—from the coronavirus pandemic. A note from the CEO is in the news section below. The stock has been placed on earnings probation and will be sold if it reports another quarter of negative earnings, before its trailing earnings turn positive.

RCI Hospitality Holdings (RICK) followed as the second-worst-performing stock in the portfolio for the month, down by 12.8%. The company reported preliminary results from their third fiscal quarter of 2020, which captured the impact of location closures due to the pandemic. Total sales for the company’s nightclubs and restaurants were $14.3 million, compared to $46.2 million in the same period one year ago. More information is available below in the news section.

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

Bassett Furniture Industries Inc. (BSET) reported a second-quarter 2020 net loss of $20.4 million, or $2.04 per diluted share, compared to net income of $0.4 million, or $0.04 per diluted share, in the prior-year quarter. Second-quarter earnings per diluted share of a loss of $2.04 missed the I/B/E/S consensus estimate for a loss per share of $0.581. Consolidated sales for the quarter fell by 41%, to $63.8 million year over year.

The company’s wholesale segment posted sales of $33.1 million, down 47.3% year over year. Second-quarter sales for the retail segment declined by 47.0% year over year to $33.2 million. The company’s logistical services unit reported that revenues declined by 24.1% year over year to $15.2 million. Consolidated retail operating loss for the quarter was $9.2 million compared to a loss of $3.0 million in the second quarter of 2019.

Bassett Furniture instituted a ‘virtual appointment’ program in late March, allowing consumers to digitally engage with the company’s designers and transact without physically visiting a store. Ninety-six percent of the company’s design appointments were conducted virtually in April and 21% of appointments were conducted virtually after stores began to reopen. The company’s e-commerce business expanded by 97% during the quarter, representing 9% of total retail volume. At the second-quarter end, the company was operating with 1,300 associates or 54% of its total workforce before the coronavirus pandemic.

Bassett Furniture also declared a regular quarterly dividend of $0.08 per share, down 36% from the prior dividend of $0.125. The company’s board of directors also reinstated the dividend of $0.125 per share that was previously deferred on March 31, 2020, due to economic uncertainties amid the coronavirus pandemic. Both dividends are payable on August 28 to shareholders of record as of August 14.

Beazer Homes USA Inc. (BZH) reported that fiscal third-quarter 2020 net income of $15.3 million, or $0.51 per share, was up year over year compared to adjusted net income of $11.6 million a year ago. Earnings per share for the quarter beat the I/B/E/S consensus estimate of a loss per share of $0.09. Homebuilding revenue increased by 10.4% to $532.5 million compared to the prior-year quarter.

Home closings during the third quarter increased by 7.6% to 1,366 homes, combined with a 2.6% increase in average selling price to $389,800. Net new orders decreased by 11.1% year over year to 1,372 units. The decline in net new orders was primarily driven by a 7.4% decrease in the absorption rate to 2.7 sales per community per month and a 4.0% decrease in average community count to 167. The cancellation rate for the quarter increased by 590 basis points to 21.1% year over year. At the end of the quarter, Beazer Homes’ backlog remained relatively flat at a total dollar value of $884.9 million, or 2,237 homes, compared to $881.6 million, or 2,264 homes, at the same time last year.

Looking forward, Beazer Homes expects fiscal-2020 earnings before interest, taxes, depreciation and amortization (EBITDA) to increase in the range of 3% to 5% compared to last year. For the fourth quarter, the coronavirus pandemic has impacted a variety of the company’s operational metrics, especially timing. As a result, the company expects the backlog conversion ratio to be in the low 70% range rather than in last year’s high 80% range. The company expects gross margins to increase by at least 100 basis points to 21%, and selling, general and administrative (SG&A) costs to decline by more than 5% on an absolute-dollar basis. Finally, the company said that with its re-underwriting complete, its cash component of land spend will accelerate, likely exceeding $100 million.

Big 5 Sporting Goods Corp. (BGFV) reported a net loss of $0.52 per share for the second quarter of 2020, compared to break-even net income of $0.00 per diluted share for second-quarter 2019. Net sales increased by 5.4% to $227.9 million compared to net sales of $241.0 million a year ago.

Same-store sales increased by 4.2% during the quarter, compared to a 0.7% increase in the same period one year ago. During the first half of the quarter, same-store sales declined due to a highly reduced store count caused by the coronavirus pandemic. However, over the second half of the quarter, same-store sales began to rebound as stores reopened.

“Strong sales across a broad array of categories and throughout our geographic markets, combined with the continuation of certain cost reductions that we implemented in response to the pandemic, have positioned us to drive significant operating leverage and earnings per share for the third quarter,” said CEO Steven Miller. “While the circumstances created by COVID-19 are unprecedented, we are confident in our ability to respond to future challenges by applying lessons learned from our recent experience and success.”

The company reported revolving credit borrowings of zero and a cash position of approximately $38 million at the end of the quarter, reflecting a strong capital structure. The improved financial performance has positioned the company to reinstate its previously suspended quarterly dividend of $0.05 per share.

Big 5 Sporting Goods declared a cash dividend of $0.10 per share, which will be payable on September 15 to shareholders of record as of September 1. This $0.10 cash dividend reflects the company’s reinstated dividend of $0.05 per share as well as an additional $0.05 per share to recognize that the company did not pay a dividend in the second quarter, as it engaged in various actions to conserve cash in response to the uncertainties of coronavirus pandemic.

Container Store Group Inc. (TCS) reported preliminary consolidated net sales of $151.7 million for the first quarter of 2020, down 27.6% compared to the prior-year quarter. Net loss per share of $0.32 for the quarter increased year over year but missed the I/B/E/S consensus estimate of a net loss per share of $0.25.

Container Store Group reported a strong increase in e-commerce business, with online customer orders nearly tripling when compared year over year. Other expenses for the quarter increased to $0.8 million, primarily due to severance costs associated with the reduction in workforce and temporary store closures as a result of the coronavirus pandemic.

The company said it does not believe that first-quarter 2020 same-store sales is a meaningful metric to present, given the extended closure of its stores caused by the coronavirus pandemic and the company’s policy of excluding extended store closures from the same-store sales calculation.

Chairwoman and CEO Melissa Reiff said, “As of today all of our stores are now reopened and operating at close to normalized schedules, with limited capacity. Retail sales trends have improved, and we preserved approximately 90% of prior-year sales for the fiscal month of July when looking at our sales orders taken. While we expect sales and margin performance to improve as fiscal 2020 progresses, we remain disciplined and agile as we manage the business in this still uncertain environment.”

In other news, the company announced that Jeff Miller, vice president and chief accounting officer, will succeed Jodi Taylor as CFO effective August 31, 2020. Taylor will continue to serve as chief administrative officer and secretary.

Covenant Transportation Group (CVTI) announced the sale of the transportation factoring assets of its transport financial solutions (TFS) segment to Triumph Business Capital, an indirect wholly owned subsidiary of Triumph Bancorp Inc. In exchange for the sale of TFS’ factoring assets, Covenant Transportation received cash proceeds of approximately $107.5 million, Triumph common stock valued at approximately $13.9 million and the opportunity to earn contingent cash consideration up to $9.0 million after the 12-month period ending July 31, 2021. In addition, the companies entered into an ongoing referral arrangement.

On July 22, 2020, Covenant Transportation announced that it will delay the release of second-quarter 2020 earnings.

Delta Apparel Inc. (DLA) reported fiscal third-quarter 2020 net loss per share of $2.58, compared to earnings per share of $0.70 in the prior-year quarter. Net loss per share for the quarter beat the I/B/E/S consensus estimate of a net loss of $3.45 per share by 25.2%. Net sales decreased by 39.8% year over year to $71.8 million.

Third-quarter gross profit was $3.0 million, compared to $24.8 million in the prior-year third quarter. Operating loss declined to $21.6 million, compared to operating profit of $8.3 million in the prior-year quarter.

During the June quarter, Delta Apparel reported $23.1 million of nonrecurring expenses associated with impacts from the coronavirus pandemic. These costs are primarily associated with the curtailment of manufacturing operations, incremental costs to right-size production to new forecasted demand, and increased accounts receivable and inventory reserves related to the heightened risks in the market. These costs primarily impacted operating income in the Delta Group segment, of which approximately $11 million are noncash charges.

According to the company, net sales in June were tracking at nearly 90% of the prior-year levels, with further acceleration in July. The company’s DTG2Go business delivered over 30% net sales growth for the quarter, onboarded several new customers and received additional digital print volume from existing customers. The company generated over $32 million of operating cash flows during the quarter and improved its liquidity to $46 million, which represents a 50% increase from March levels.

Ducommun Incorporated (DCO) reported net income of $0.43 per diluted share for the second quarter of 2020, compared to earnings per diluted share of $0.66 in the prior-year second quarter. Earnings per diluted share for the quarter beat the I/B/E/S consensus estimate of $0.268 per share by 60.4%. Revenues declined by 18.4% to $147.3 million year over year.

Lower revenues from the company’s commercial aerospace markets due to lower build rates on large aircraft platforms were partially offset by higher revenues from the military and space markets due to additional content and higher build rates. Gross margins increased to 22.2%, primarily driven by an improved product mix in defense, effective cost controls, value-added pricing and the acquisition of Nobles Worldwide last year.

Commercial aerospace demand was negatively impacted by the coronavirus pandemic; however, defense-related revenue increased by 23% year over year, leveraging a variety of integral military programs and missile systems. Also, the company’s military and space backlog increased to $505 million, bolstering the company’s outlook for this business.

Ducommun said the expansion with Airbus since 2017 will benefit the company going forward and provide important balance and diversification to its portfolio. The backlog within the commercial aerospace sector was about $307 million at the end of the second quarter, with the decline primarily attributed to the 737 MAX program. Further, Ducommun expects revenue to decline in the range of 16% to 20% for the third quarter and 14% to 18% for the fourth quarter. The company expects operating income margins between 7% and 8% for the third quarter, up 100 basis points more than the company’s previous guidance in April.

Hibbett Sports Inc. (HIBB) provided an update on second-quarter same-store sales, forecasting them to increase year over year by over 70%. The brick-and-mortar comparable-store sales are expected to increase by about 60%, while digital comparable sales are expected to increase by about 200%. The statement also said that the $50 million that the company’s credit facilities borrowed in the first quarter has been repaid in full. The company has yet to put out fiscal-2021 outlook, due to worldwide uncertainty caused by the coronavirus pandemic.

Hooker Furniture Corp. (HOFT) finalized its first-quarter financial results. They recorded their final net loss as $34.8 million or a loss of $2.95 per share. However, as of the finalization of these results, Hooker Furniture generated $18.9 million in cash from operations and finished out the first quarter with $51.2 million in cash and cash equivalents, an increase of $15.2 million compared to fiscal-2020 year end.

Mesa Air Group (MESA) signed a five-year cargo contract with DHL Express. As part of this agreement, they will add two Boeing 737-400Fs to their fleet and open a new crew and maintenance base in Cincinnati. “We are proud to offer new opportunities to our employees as we enter the cargo industry,” said chief operating officer Brad Rich. “In particular, Mesa pilots will now have the ability to earn a 737-type rating and receive the highest pay in the regional industry, all without leaving the company.”

Mesa Air also reported that July’s block operating hours declined 75.8% to 9,247 as a result of flight cancellations and reduced schedules caused by the coronavirus pandemic

New Home Company Inc. (NWHM) reported second-quarter adjusted net loss of $0.04 per diluted share, missing the I/B/E/S estimate of $0.04 by 200%. Net orders for the quarter, however, increased 6% year over year and June net orders increased 68% year over year. New Home Company recorded total revenue of $99 million, 48.7% less than last year’s second-quarter revenue.

During the second quarter, the company repurchased and retired 817,300 shares of common stock for $1.80 per share, about $1.5 million in total. They also extended the maturity date of their bank credit facility to September 30, 2021. Although the company recorded a loss, executive chairman Larry Webb said, “We were pleased with the progress we made, including our continued shift to more affordable price points, right-sizing our cost structure and strengthening our balance sheet.”

For the third quarter, the company estimates a home sales revenue range of $100 million to $115 million, a fee building revenue range of $10 million to $15 million and a home sales gross margin range of 12.0% to 12.5%.

Perion Network Ltd. (PERI) acquired the assets of Pub Ocean—a technology company focused on digital publishers—for about $22 million. Pub Ocean is a digital publisher-focused technology company that offers scalable content distribution and real-time revenue analytics. The acquisition offers significant immediate synergies to Content IQ, which Perion Network acquired in January, driving incremental revenue opportunities and enhanced profitability.

RCI Hospitality Holdings (RICK) provided a quarterly business update ahead of the official release of its third-quarter earnings. Total sales for the company’s nightclubs and restaurants were $14.3 million, compared to $46.2 million in the same period one year ago. Restaurant sales were about flat year over year, while nightclub sales were down from $37.5 million to $5.8 million.

None of RCI Hospitality’s locations were open long enough during the quarter to qualify a same-store sales comparison year over year. All 48 locations were closed in April due to the coronavirus pandemic. Following changing regional conditions and government regulations, 11 locations reopened by May 15, a total of 34 by May 31, a total of 40 by June 15, but the number went back down to a total of 29 by the end of the quarter.

RCI Hospitality said that it continues to believe based on a combination of revenues generated, locations currently operating and those anticipated to reopen, plus cash on hand, that it is still well-positioned to weather temporary regional economic conditions.

Rocky Brands Inc. (RCKY) reported earnings per share of $0.33 for the second quarter of 2020, which decreased year over year by 21.4%. Earnings per share beat the I/B/E/S consensus estimate for a loss per share of $0.16. Second-quarter net sales were $56.2 million compared to $62.0 million in the second quarter of 2019.

Wholesale sales for the second quarter declined 15.6% to $34.3 million, retail sales increased 15.8% to $16.3 million and military segment sales for the second quarter were $5.6 million compared to $7.2 million in the second quarter of 2019. Beginning in May, many of the locations that were closed began to reopen, and by mid-June close to 95% of all wholesale doors were open.

The positive result of the retail segment was driven by explosive growth in e-commerce sales, both through Rocky Brands’ own branded websites and online marketplaces. Total web sales were up 144%, with Georgia, Rocky and Durango.com all strongly increasing by triple-digits.

Rocky Brands said it is proceeding cautiously and does not expect its business in the second half of the year to improve compared to the second quarter. Overall sales are expected to be flat year over year. Based on its order book, Rocky Brands said retailers are more bullish in the immediate term but a bit more cautious concerning later in the year.

Universal Stainless & Alloy Products (USAP) reported a loss of $0.38 per share for the second quarter of 2020, which compared year over year to earnings per share of $0.24. The loss per share missed the I/B/E/S consensus estimate for a loss of $0.28 per share. Net sales were $52.5 million, a decrease of 26.1% from the second quarter of 2019.

Universal Stainless & Alloy’s sales to the aerospace market have declined, primarily due to the cancellation or delay in orders for new airplanes caused by the coronavirus-related fall-off in air travel , as well as a sharp decline in aftermarket sales due to the significant reduction in air travel. The company also has experienced extreme pressure in demand from the oil and gas market.

“Our premium alloy sales increased 62.3% from the first quarter to $12.4 million, nearing the record level achieved in the second quarter of 2019,” said CEO Dennis Oates. “Premium alloys remain our highest priority for targeted growth and we continue to gain traction with new products and approvals, with underlying demand coming from defense and specialty applications.”

While the company expects the effects of the pandemic and the related responses to continue to negatively impact its operational results, cash flows and financial position, the uncertainty over the duration and severity of the economic and operational impacts of the situation means the company cannot reasonably estimate the related future impacts at this time.

VSE Corp. (VSEC) reported adjusted earnings per share of $0.60 for the second quarter of 2020, which decreased year over year by 35%. Adjusted earnings per share beat the I/B/E/S consensus estimate of $0.34 per share. Total revenues over the same period decreased by 10.8% to $168.7 million.

Fleet segment revenue increased by 32.4% year over year to $71.2 million in the second quarter of 2020. Revenues from sales to other government customers increased by approximately $15.3 million or 36.3%. Federal & defense segment revenue declined 18.7% year over year to $65.3 million in the second quarter of 2020. Aviation segment revenue decreased 31% year over year to $32.2 million in the second quarter of 2020, versus $47.0 million in the same period in 2019. The year-over-year revenue decline was attributable to the adverse impact of the pandemic on commercial air traffic, resulting in lower customer activity.

During the second quarter, VSE Corp. generated positive free cash flow that was used to continue to pay its quarterly cash dividend and reduce total debt outstanding. VSE Corp. also acted to reduce working capital requirements during the period, including an initiative to reduce inventory levels across the business.

VSE Corp. also declared a regular quarterly dividend of $0.09 per share, in line with the previous declaration. The dividend is payable on November 18 to shareholders of record as of November 4. The stock will trade ex-dividend on Tuesday, November 3.

Separately, VSE Corp. announced new contract commitments worth a total of $59 million. The contracts include $42 million for a 26-month delivery order with the U.S. Naval Sea System International Fleet Support Program Office and $17 million for maintenance services over a three-year period.