At the end of the fourth quarter what he sees as a dim economic environment and hazy business prospects compelled him to have cautious positioning with net exposure to risk assets at 70.5%, which includes 5% of mainly lower-risk corporate bonds. Romick is conflicted about the economic landscape of 2012. He believes the market won’t likely crash as it did in 2008-09 mainly because people are more fearful. Yet despite deep analysis, he could not decide whether inflation or deflation is more likely to occur. Therefore, he did not tilt his portfolio one way or the other. Nevertheless, he said in his investor letter, “In the inflation outcome, our stocks should do well (at least nominally), but not as well as a portfolio committed to commodities. Should deflation come to pass, stocks will likely perform badly, but in that event, our substantial cash stake will allow for deployment at lower asset prices.”
No matter how the year unfolds, he plans to let price be his guide, and will welcome volatility as an opportunity to add shares.
He bought three new stocks in the fourth quarter, which are Arris Group Inc. (ARRS), Citigroup Inc. (C) and Hollyfrontier (HFC).
Arris Group Inc. (ARRS)
Steven Romick bought 3,447,200 shares of Arris Group Inc. at an average of $11 per share. Arris is a global communications technology company that specializes in the design, engineering and supply of broadband services for residential and business customers around the world. Their service enables broadband operators to deliver telephony, demand-driven video, next generation advertising and high speed data services.
Arris Group’s stock has been essentially flat for the last 10 years, but the stock once traded near $60 during the dot-com bubble of 2000. By 2001 it had plummeted to under $4.
Over the same time period that the company’s stock price was coasting, the company experienced slow but steady revenue growth at an annual rate of 4.9 percent, and free cash flow growth at an annual rate of 24.3 percent. In 2011, revenue increased to $1.089 billion from $1.088 billion in 2010, EBITDA declined to $108 million from $146 million in 2010, and earnings declined to a net loss of $12.8 million from a net gain of $64 million in 2010.
The stock price declined slightly during the year due to a weak first quarter under analysts’ expectations and a second quarter with revenue, earnings and gross margin declines. Net sales also declined in the second quarter 2011, largely due to lower pricing in its broadband communication systems segment the company had to implement to remain competitive.
Another negative factor for the company is that two companies account for almost 40 percent of its sales. In the three months ended June 30, Time Warner Cable dropped to 10.4 percent of its sales from 18.9% the same period of 2010. Comcast and its affiliates grew to 25.3% of sales, from 23.4% the same quarter the previous year. By the third quarter, Time Warner made up 12.4%, and Comcast makes up 29.2% of sales.
In the fourth quarter, the company returned to improvements in revenue, net income and gross margins, sending the stock price back up. Demand is being driven by a rise in the number and usage of connective devices in homes that require more bandwidth. The company also closed its acquisition of BigBand Networks, which will help the company expand its video product suite and what the company called “the evolution towards network convergence onto an all IP platform.” On the company’s earnings call, it said it would not provide specific guidance but does anticipate 10 percent or more of top line growth and EBITDA to increase in the high teens.
Citigroup Inc. (C)
Steven Romick bought 1,172,320 shares of Citigroup Inc. (C) at an average price of $28. Citibank is the New York-based financial services corporation that has the largest financial services network in the world and had to be rescued in 2008 by a bailout from the U.S. government after realizing massive losses. Partial government ownership of the bank ended in December 2010.
Romick said in his investor letter that he took out some small bank positions as part of a housing recovery play. “We are mindful that when a big asset bubble finally bursts, the ramifications are large, and the time to resolution is usually long,” he said. “Take housing for example. The drinking binge of easy money has created a five year hangover, and counting. The housing market remains weak, but does seem to be bumping along a bottom. We have made a number of investments exposed to the housing sector, e.g., Lowes, mortgage whole loans, and some small bank positions.”
Citigroup has focused on building its balance sheet and loan portfolio since the crisis. Its Tier 1 Capital ratio was 13.5% at ten end of the third quarter, and its Tier 1 common ratio was 11.7%. Total allowance for loan losses also dropped to 5.1% of total loans, down from 6.7% year over year, due to asset sales, lower non-accrual loans and overall improvement in credit quality of its loan portfolios.
Romick also said in his letter that he is seeking U.S.-based companies with strong growth in emerging markets, a bill that Citigroup fits. Revenue from Latin American Regional Banking grew 11% year over year in the nine months ended Sept. 30, 2011, revenue from Asia grew 9% in the same span of time, and revenue from EMEA countries increased 2% in the same span of time. Revenue from its North American regional consumer banking segment, on the other hand, declined 10% in the same span of time.
Steven Romick bought 226,116 shares of HollyFrontier at an average price of $27 per share, which is a relatively small holding representing just 0.11% of his portfolio.
HollyFrontier formed July 2011 when Holly Corporation merged with Frontier Oil Corporation to give it a more diversified company with greater global presence, stronger financial position, more efficient corporate overhead structure, and greater earnings per share resulting from synergies. IT is a petroleum refiner that produces gasoline, diesel, jet fuel, specialty lubricant products and specialty and modified asphalt.
HollyFrontier’s stock price appreciated from just over $20 per share to as high as just over $44 per share by mid-year when the merger occurred. In the fourth quarter, when Romick bought it, it had dropped to just over its initial price on declined earnings that fell short of forecast.
The companies have only been reporting as one for two quarters. In the most recent fourth quarter, net income declined to $223 million from $523 million the previous year, and sales declined slightly to $5 billion from $5.2 billion the previous year. Revenue, however, increased significantly and was helped by a 19% year-over-year increase in refined products sales prices. Currently HollyFrontier has $1.7 billion in cash on its balance sheet and $1.9 billion in long-term liabilities and debt.
Since it completed its merger to the end of the fourth quarter, shareholder-friendly management had issued $1.50 per share of specialty distributions to shareholders, approximately equivalent to $315 million. It also has a $350 million share repurchase program and a regularly quarterly dividend of $0.10 per share.
See more of Steven Romick’s portfolio here or check out the Undervalued Stocks, Top Growth Companies, and High Yield stocks of Steven Romick.