October Model Shadow Stock Portfolio Update

Eight stocks met the initial selection criteria for the Model Shadow Stock Portfolio as of October 13, 2020, down from nine passing stocks one month ago. 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 discussed here since the notes on the website table are dynamically updated daily.)

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, one is currently held in the Model Shadow Stock tracking portfolio: Key Tronic Corp. (KTCC). Titan Machinery Inc. (TITN) and Big 5 Sporting Goods Corp. (BGFV) came off the list of qualifying companies over the course of the last month when their price-to-book-value ratios moved above the 0.90 cut-off level.

As of October 13, 2020, Hibbett Sports Inc. (HIBB) had the highest price-to-book-value ratio in the Model Shadow Stock Portfolio. Its ratio of 2.57 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 is helpful to think about price-to-book values below 0.90 as being very attractive, while values three times above the initial maximum as 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 valuation and size requirements are being examined for the next quarterly portfolio review.

The Model Shadow Stock Portfolio also seeks out 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 removed from the portfolio, assuming there is a suitable replacement. Hibbett Sports also has the highest market cap in the portfolio, with a value of $893.5 million as of October 13, 2020.

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

Performance Update

Stocks were generally down during the month of September, with only the materials (up 1.3%) and utilities (up 1.1%) sectors posting positive total returns for the month. The market-leading technology stocks retreated during the month, with the information technology sector down 5.4% and the communication services sector retreating 6.5% during September. The volatile energy sector, however, was the weakest-performing sector, down 14.5% during the month. The energy sector is now down 48.1% for the year, while the information technology sector is up 28.7%.

The S&P 500 index lost 3.8% during September, resulting in an 8.9% gain during the third quarter and a year-to-date gain of 5.6%. The S&P 500 equally weighted index lost 2.5% during the month and is down 4.8% year to date after gaining 6.8% during the quarter. The small-cap Russell 2000 index is down 8.7% for the year after losing 3.3% during September and 4.9% in the third quarter of 2020.

The Model Shadow Stock Portfolio bucked the trend and gained 6.3% during September. However, it remains down 18.2% for the year after gaining 28.0% in the second quarter and 24.1% in the third quarter of 2020.

The performance of growth- versus value-oriented stocks continues to be slanted toward growth stocks for most market-cap segments.

In the large-cap segment, growth stocks were down 4.7% for the month, giving them a positive 20.6% gain year to date for 2020. Large-cap value stocks were down only 2.4% during September and are now down 11.5% year to date.

In the mid-cap segment, growth stocks are hanging on to a gain of 1.4% for the year after losing 2.4% during September. Mid-cap value stocks are down 19.4% for the year, after losing 4.4% during the month.

Small-cap growth stocks are up 3.9% year to date, despite losing 2.1% during the month. Small-cap value stocks are down 21.6% for the year after giving up 4.7% during September.

Since its inception in 1993, the AAII Model Shadow Stock Portfolio has a compound annual average return of 13.0%. For comparison, the Vanguard 500 Index fund’s (VFINX) gain of 9.6% per year on average over the same period now exceeds the Vanguard Small Cap Index’s (NAESX) average annual gain of 9.5%.

Model Shadow Stock Portfolio News

Container Store Group Inc. (TCS) was the strongest stock in the Model Shadow Stock Portfolio, with its gain of 46.1% during September. As has been the case with many retailers in 2020, the Container Store saw its business trends change because of the coronavirus pandemic, and its stock has swung back and forth with changing analyst expectations. The company reported a tripling of digital sales during its first quarter, though its margins suffered in a year-over-year comparison due to store closures and increased costs in responding to pandemic-induced restrictions.

Big 5 Sporting Goods Corp. (BGFV) was the second-best-performing stock in the portfolio during the month, up 26.6%, but there was no company-specific news tied to its performance. As lockdown restrictions were put in place to deal with the pandemic, Big 5 Sporting Goods experienced “strong sales across a broad array of categories and throughout [its] geographic markets,” as consumers flocked to purchase sporting goods in search of local recreation.

Mesa Air Group Inc. (MESA) was down 19.4% during September, making it the worst-performing stock in the portfolio. The company’s business as an operator of regional air carriers has suffered from a downturn in domestic travel due to the coronavirus pandemic.

Universal Stainless & Alloy Products Inc. (USAP) was down by 18.3% during September as the second-worst-performing stock in the portfolio for the month. The company reported in July with its second-quarter results that it expected the effects of the pandemic and the related responses to continue to negatively impact its operations results, cash flows and financial position.

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

Beazer Homes USA Inc. (BZH) disclosed that, based on preliminary operating results, net new orders for the first two months of the fourth quarter rose 37% year over year, with a 26% increase in July and a 48% increase in August. This increase was primarily driven by a higher pace, as sales per community increased to 4.4, compared to 3.0 in the prior year.

CEO Allan Merrill said, “We are very pleased with our results through the first two months of our fourth quarter. Broad, resilient demand across all our markets supported by low rates and a reassessment of housing needs drove substantial sales momentum and gives us confidence as we close out 2020 and look forward to fiscal 2021.”

Covenant Logistics Group Inc. (CVLG) announced that third-quarter 2020 adjusted operating and financial results are expected to significantly exceed prior expectations.

The company said that the freight environment in the third quarter has been favorable. As a result, the company expects an adjusted operating ratio in the low 90s, compared to previous expectations of adjusted operating ratio in the mid-90s. The company expects third-quarter 2020 freight revenue in the range of $190 million and $200 million, average tractor count of about 2,525 and average freight revenue per tractor per week to be approximately $4,025.

Also, Covenant Logistics announced a resolution to its dispute with Triumph Bancorp Inc. (TBK) concerning the sale of its transport financial solutions (TFS) factoring division. In July, Covenant Logistics sold a portfolio of accounts receivable, contract rights and associated assets consisting of about $103.3 million in net funds to a subsidiary of Triumph Bancorp for approximately $122.3 million, plus an earn-out opportunity of $9.9 million. Following the close of the transaction, Covenant Logistics and Triumph Bancorp had a dispute over the nature of approximately $66 million of the assets included in the portfolio. The resolution resulted in a lower purchase price of $108.4 million and the earn out was terminated.

CPI Aerostructures Inc. (CVU) reported that first-quarter 2020 revenue declined by 23.3% to $16.9 million year over year. Net loss for the quarter was $0.24 per diluted share, compared to a net loss of $0.08 per share in the first quarter of 2019.

The revenue decline in the first quarter was largely due to the reduction in the Next Generation Jammer Mid-Band pod program revenue, which had significant revenue in the first quarter of 2019. The company recently began the system development and test phase for this program and expects to see a strong revenue program during the second half of 2020. The decline in revenue was also attributable to lower demand in the company’s commercial programs, resulting in deferred and canceled orders for certain business jet programs. Gross profit declined to $0.7 million from $2.5 million in the prior-year period, reflecting an unfavorable product mix as a result of lower revenue on the Raytheon pod program.

CPI Aerostructures said that the company is well-positioned to increase fiscal-2020 revenue and return, despite coronavirus-related expenses and significant nonrecurring professional expenses which are expected to be about $1.5 million during the year. Further, the company believes that cash savings from careful control of inventory levels, working capital improvement initiatives and continued cost management will largely offset the cash it expects to pay for nonrecurring professional expenses in 2020.

Ennis Inc. (EBF) reported second-quarter earnings in September of $0.25 per share, beating the I/B/E/S consensus estimate of $0.22 per share by 13.6%. The company reported second-quarter revenue of $86.6 million, down 20.4% year over year and down 2.7% from last quarter. Ennis’ gross profit margin decreased year over year from 29.8% to 29.0% but increased from 26.9% last quarter.

“We continue to monitor incoming order volumes so that we can proactively adjust our costs accordingly,” said CEO Keith Walters. “Although no one is sure of the exact timing of an economic recovery, we will continue to stay focused during this period of economic and social unrest. We will continue to explore acquisitions that make sense and hunt for new sales in new markets and new channels. We will focus, as always, on maintaining our dividend.”

The company declared a quarterly dividend of $0.225 per share in line with the previous declaration. The dividend is payable on November 6 to shareholders of record as of October 9.

Hooker Furniture Corp. (HOFT) reported second-quarter earnings of $0.48 per share, beating the I/B/E/S consensus estimate of $0.29 per share by 65.5%. Earnings per share are up by 37.1% year over year from $0.35. The company reported net sales of $130.5 million and net income of $5.8 million for the quarter. Net sales decreased by 14.3%, $21.7 million, since last quarter but net income increased by 38.8%, or $1.6 million.

The Home Meridian segment reported $1.1 million in operating income compared to a small operating loss in the prior-year second quarter. Hooker branded segment operating margin performance continued at a high level, and the domestic upholstery segment reported essentially breakeven operating income for the second quarter despite decreased net sales and inefficiencies from operating at significantly reduced production volumes and lower capacities early in the pandemic.

“While the coronavirus pandemic continued to impact the economy and our operations, our business began to rebound in mid-May and hasn’t let up since,” said CEO Paul Toms Jr. “Fiscal July consolidated incoming orders were up 34% compared to a year ago, and backlogs were up 35%. Based on this unusually robust order rate for the summer months, we continue to believe that furniture is an advantaged sector during the pandemic-related economic downturn and ‘safer-at-home’ practices, due to pent-up demand, a robust housing market and less competition from other discretionary spending such as travel, dining out and sporting events.”

The company also declared a quarterly dividend of $0.16 per share, in line with its previous declaration. The dividend was paid on September 30 to shareholders of record as of September 18.

Hurco Companies Inc. (HURC) reported third-quarter earnings of $0.32 per share, down 37% year over year from $0.51 per share. The company reported net income of $2.1 million. Sales in the Americas decreased by 15% year over year and European sales decreased by 36%. Total sales saw a 32% decrease year over year mostly due to the impact of the coronavirus.

“We believe our recent results demonstrated that our ability to weather both unpredictable changes and industry cycles remains a critical part of our sustained success,” said CEO Michael Doar. “Upon observing in fiscal 2019 the potential for softness in certain key markets, we developed and implemented strategies designed to maintain the strength of our balance sheet amid anticipated levels of reduced revenue and demand, including proactive cost reduction plans and delays in non-critical discretionary spending and capital expenditures. While the pandemic forced us to accelerate some of these initiatives, we believe our preparedness allowed us to navigate the last three quarters well, returning to profitability this quarter after abrupt and dramatic declines in economic and market activity.

The company also declared a quarterly dividend of $0.13 per share, in line with its previous declaration. The dividend will be paid on October 16 to shareholders of record as of October 2.

RCI Hospitality Holdings (RICK) announced a settlement by the company, CEO Eric Langan and former CFO Phillip Marshall of a civil administrative proceeding with the U.S. Securities and Exchange Commission (SEC), concluding the government’s investigation. Former independent board member Steven Jenkins has also agreed to settle a charge concerning his failure to disclose his personal bankruptcy history.

The SEC found that, from 2014 through 2019, RCI Hospitality failed to disclose a total of $615,000 in executive compensation. This undisclosed compensation included the cost of the personal use of the company’s aircraft and company-provided vehicles, reimbursement for personal airline flights, charitable corporate contributions to the school that two of Langan’s children attended and housing costs and a meals allowance for Marshall. RCI Hospitality also failed to disclose related transactions involving Langan’s father and brother and a director’s brother. The SEC further found that RCI Hospitality failed to keep books and records that allowed it to report, and lacked sufficient internal controls to flag, this executive compensation and related transactions.

Without admitting to or denying the SEC’s findings, RCI Hospitality, Langan and Marshall have agreed to a cease-and-desist order and will pay civil penalties in the amounts of $400,000, $200,000 and $35,000, respectively. Also without admitting to or denying the SEC’s findings, Jenkins has agreed to a cease-and-desist order and will pay a $30,000 civil penalty.

Preceding the announced settlement with the SEC, RCI Hospitality announced that Bradley Chhay will succeed Phillip Marshall as CFO effective immediately. Marshall, who has been CFO since 2007, will continue as part of RCI Hospitality’s financial team to assist in ensuring a smooth transition and will continue focusing on income tax matters.

RCI Hospitality reported that its business continues to improve month by month as more locations open with the rescinding of local restrictions related to the coronavirus pandemic. August revenues for clubs and restaurants totaled $9.4 million, up 23% compared to $7.6 million in July. Most locations continue to reopen to strong sales and a steadier flow of business versus before the pandemic.

RCI Hospitality declared a regular quarterly dividend of $0.04 per share, which compares to the $0.03 per share dividend it declared last quarter. The company’s alternating quarterly dividend payments are in line with its plan to pay a total annual dividend of $0.14 per share in 2020, which is up by 7.7% from its annual dividend payment in 2019. The dividend was paid on September 30 to shareholders of record as of September 15.

VSE Corp. (VSEC) announced that executive vice president and CFO Thomas Loftus will retire at the end of 2020. VSE Corp. expects to name a successor during the fourth quarter of 2020. Loftus will remain with the company through the end of the year to ensure an orderly transition of his duties.