Options Hawk founder Joe Kunkle considers small-cap value stocks, highlighting 10 that are worth watching as the markets attempt to stabilise during the global coronavirus pandemic.
As markets have rebounded investors have started to see some bifurcation as phase one of the bear market sell-off sold nearly every stock regardless of fundamentals. This created opportunity for investors.
Having recently highlighted some of the higher quality mid-cap and large-cap companies for long-term investors, I am now I applying a similar method to stocks, providing 10 of interest to look out for.
These stocks cleared all of the hurdles that showed above industry-average growth, positive ROIC, healthy margins, strong free cash flow (FCF) and a pristine balance sheet.
Snap-On [SNA] is the largest name on the list with a $7bn market cap and having been a favourite short for the last few years, shares are now looking attractive. Snap-On provides tools and diagnostics to the vehicle services industry, and vehicle repair continues to be essential during the global pandemic.
Although the company could face some headwinds right now as more people are working from home, it’s more likely that it will do well thanks to an increasing number of older vehicles in circulation at the moment along with fewer new and used car purchases being made. Consumer budgets are also feeling the strain right now, which puts Snap-On in a good position coming out of the global lockdown.
“Consumer budgets are also feeling the strain right now, which puts Snap-On in a good position coming out of the global lockdown”
It is planning to expand a number of its subsidiaries by extending its services to critical industries and building out its business in emerging markets. Its shares are currently trading 7.8X FY20 EV/EBITDA, 9.85X trailing earnings and offer a 3.55% dividend yield with a strong balance sheet.
Gentex [GNTX] is a $6.1bn auto parts provider that specialises in automatic dimming rear-view mirrors and electronics. The company faces some difficulties as auto part production has ceased during the global lockdown, but it is positioned well with its digital technology proposition across the automotive industry.
With zero debt, Gentex is also expanding into other markets with a recent key contract with Airbus in Aerospace. Its shares currently trade 14.4X trailing earnings, 9.3X EV/EBITDA and 15.8X FCF with a 2% dividend yield. Gentex also has a strong cash position and should withstand the weakness in global vehicle production better than its peers. If consolidation were to continue in this industry, it would, however, be a primary target.
FLIR Systems [FLIR] is a $4.8bn company that makes thermal imaging systems and other threat-detecting devices. Of its business, 59% is thermal and 49% is non-thermal, with key technologies including thermal sensing, unmanned solutions, machine vision, integrated systems, radar, lasers, navigation, AI and more. FLIR Systems could be an intriguing play in the global pandemic as its unmanned solutions could be used to enhance decision-making in public safety. The company has contract awards it has already won worth $9bn to play with.
“FLIR Systems could be an intriguing play in the global pandemic as its unmanned solutions could be used to enhance decision-making in public safety”
FLIR Systems is shifting its portfolio after a disappointing quarter. Shares remain a bit rich on valuation at 27.5X trailing earnings, 11X FY20 EV/EBITDA and 20.8X FCF with a 1.97% dividend yield. The company has strong operating cash flows and a good cash position with a solid balance sheet.
ITT Inc [ITT] is a maker of engineered critical components and technology solutions for industrial markets. Worth $4.5bn, its revenues are divided into motion technologies, connect/control and industrial process. The company is exposed to some troubled industries however with 58% based in transportation, 32% in industrial, and 10% in energy, and 30% of the business is aftermarket.
Elsewhere ITT Inc has shown a strong margin expansion for the last few years and its shares currently trade 14X trailing earnings, 7.8X FY20 EV/EBITDA and 21X FCF with a 1.33% yield. The company trades just 7.4X cash with very little debt, and its estimates will likely be revised lower but it is a quality company that will emerge well out of the current financial uncertainty when the economy picks up again.
Deckers Outdoor [DECK] is a footwear company worth $4.3bn with key brands like UGG, Teva, Hoka, and Koolaburra under its umbrella. Deckers has been growing its (currently essential) direct-to-consumer business, which has resulted in more than 35% of its sales. It is an omnichannel leader with 37% of sales coming from international markets.
of Decker's sales come from international markets
The company has seen operating margins expand 700bps since 2017 and achieved over 20% ROIC in 2019. Shares are currently trading at 14.6X trailing earnings, 2X sales, 15X FCF and 7X cash with negligible debt obligations. Deckers has leading brands that will likely gain market share coming out of this downturn and has cheap valuation and a stellar balance sheet.
Texas Pacific Land Trust
Texas Pacific Land Trust [TPL] is a $4bn manager of land and resources such as oil and gas, grazing and other specialty leases. The company is fully exposed to the Permian Basin oil field, so it does face headwinds from oil price declines and a potential slowdown in production. However, in 2019 it generated $230m in FCF and carries zero debt with $304m in cash.
Its inventory is below $40/bbl for breakeven and also has diversified revenue streams through royalties, water and surface. It is a unique play against its peers with its lack of debt, 40% ROIC and over 80% EBITDA margins. The company’s fixed-fee revenue streams insulate it from commodity price fluctuations. Shares currently trades 12.5X trailing earnings, 10X EV/EBITDA and its yields are 1.95%.
Acuity Brands [AYI] is worth $3.7bn and a provider of lighting and building management solutions, and is an industry leader in connected systems and smart lighting. It has a comprehensive product portfolio across all indoor and outdoor applications, including IoT. Its business mix is split evenly between new construction and renovation, while its non-residential department is 85% compared to 15% residential. It is a market share leader in an estimated $20bn market in North America. Currently, it is trading at 12.3X trailing earnings, 7.2X EV/EBITDA and 8.35X FCF with a small 0.56% dividend yield. It has a very strong balance sheet with $350m in cash and its debt to EBITDA is 0.58X. The company has faced execution missteps over the last few years but shares are now looking like an attractive value.
Watts Water Tech
Watts Water Tech [WTS] is a $2.9bn provider of products and systems that manage and conserve the flow of fluids and energy in residential and commercial markets. The company receives 65% of revenues via repairs and retrofits and 35% through new construction, while 60% is based in non-residential and 40% in residential products and systems. It considers megatrends such as safety/regulation, energy efficiency, and water conservation driving business to be key.
Watts Water Tech is likely to see some negative revisions due to the closures of sports centres and events venues, but it is well-positioned thanks to being considered a necessary spend for businesses associated with sports and events. Its shares remain a bit rich on valuation at 21.85X trailing earnings, 11.1X EV/EBITDA and 21.85X FCF with a 1.1% dividend yield, but it is a company deserving of a premium valuation. Watts Water Tech is a strong cash generator and effectively deploys capital while generating a 13.4% ROIC in 2019 and has seen margin expansion.
Diodes [DIOD] is worth $2.2bn and is the leading global manufacturer and supplier of high-quality, application-specific standard products within the broader discrete, logic, analogue and mixed-signal semiconductor markets.
It serves the consumer electronics, computing, communications, industrial, and automotive markets. Diodes has diverse end-market applications and a large number of customers that will allow it to weather the storm better than many of its peers. It trades 15.35X trailing earnings, 1.8X sales, and 17.2X FCF. It has very little debt and trades 8.6X cash. The company has a strong history of operations and management has manoeuvred well on the supply side over the last few months, and although demand remains to be seen, it is a quality name at attractive levels.
“Diodes has diverse end-market applications and a large number of customers that will allow it to weather the storm better than many of its peers”
SciPlay [SCPL] is a maker of digital games for web and mobile platforms, including social casino games and family games. Worth $1.06bn, it has seven core games and has seen momentum in user-based metrics. There is room for further margin expansion with strong operational leverage as games scale and enter a growth phase.
SciPlay is now trading 17.4X trailing earnings and just 9.55X cash with no debt. It is a growth story that is trading at a cheap valuation while it is positioned well for an increase in users due to casinos being closed and consumers looking for ways to fill their time.