“We seek companies that look capable of surviving adversity and flourishing when their fortunes change. Those that generate free cash via high returns on capital can give investors a return in the form of dividends, take advantage of their low valuation by buying back stock, or make acquisitions to grow their business when organic growth is harder to come by. Strong fundamentals mean these companies have the necessary tools to make it through difficult periods and emerge stronger.”
Royce also wrote in the same letter that he believes the macro events – Europe, fragile U.S. recovery and Chinese economic deceleration – that have dominated investor behavior should subside and result in a “less extreme, more historically normal phase,” with less volatility. In the future, they estimate that stocks will deliver returns in the mid- to upper-single digits.
In the second quarter, Royce’s largest new purchases were: Alex & Baldwin (ALEX), Entegris Inc. (ENTG), Tahoe Resources (TAHO), Deckers Outdoor Corp. (DECK) and Parametric Technology (PMTC).
Royce bought 494,700 shares of Alexander & Baldwin (ALEX) in the second quarter. ALEX is the Hawaii-based land, agriculture and transportation company that separated its transportation and land businesses into two publicly traded companies in June, naming the ocean transportation company Matson Inc. (MATX). It is thought that Bill Ackman, noted activist investor who owns 8.6% of the company, influenced the decision.
ALEX’s agribusiness consists of three sugar plantations of 130,000 acres and is the state’s largest farmer. Its real estate business is the state’s most active real estate investor, with 88,000 acres primarily on Maui and Kauai and other assets.
ALEX has a market cap of $1.25 billion; its shares were traded at around $30.
In the second quarter, ALEX’s real estate leasing operating profit was $10.5 million, compared to $10.4 million the previous year. Its agribusiness reported operating profit was $7 million, a $1.5 million decline from the previous year. The company sold roughly the same amount of sugar in the second quarter, but the price it received for sugar was higher in the second quarter of 2011. The company’s revenue in the second quarter was $72.4 million, compared to $73.2 million the previous year.
ALEX can be considered a play on Hawaii’s economic recovery. In 2011, the number of building permits declined 26%, but has increased 23.1% as of April 30, 2012. The unemployment rate also declined for the last three years, while GDP grew at a rate of 1.2% for 2010 and 2011.
Royce bought 2,972,000 shares of Entegris (ENTG) at an average price of $8. Royce has traded this stock many times in the past, most recently selling out of a position in the first quarter of 2011.
Entegris is a provider of materials management solutions to the microelectronics industry including, in particular, the semiconductor manufacturing and disk manufacturing markets. Entegris has a market cap of $1.21 billion; its shares were traded at around $9.12 with a P/E ratio of 14 and P/S ratio of 1.6. The stock is currently trading near a one-year high P/E of 12.7 times earnings.
In 2011, the company achieved record sales, earnings and cash flow, with new emerging markets performing well and strong contribution from new products, and grew faster than its markets and peers. It also achieved record cash flow from operations, record operating profit, has a cash balance exceeding $265 million and no debt.
In the second quarter, Entegris’ sales declined 10% from the prior year, and earnings per share were $0.16 compared to $0.24 the prior year. It expects sales to be flat to do 5% for the fiscal third quarter.
Royce purchased 1,628,400 shares of Tahoe Resources (TAHO). The stock trades for $19 on Friday.
Tahoe Resources Inc. is engaged in the exploration and development of mineral properties in the U.S. for the mining of precious metals. It is focusing on developing its Guatemalan Escobal project into a profitable mining operation and becoming a leading silver producer. The company trades on the Toronto Stock Exchange (TSX), and joined the New York Stock Exchange (NYSE) in May 2012.
The Escobal project is still in the exploration, development and construction phase and is awaiting an exploitation permit. It has posted net losses for the last five quarters.
Royce bought 279,000 shares of Deckers Outdoor Corp. (DECK) at an average price of $55.50. The stock has declined almost 40% year to date after several years of growth.
Deckers Outdoor Corp. designs, manufactures and markets innovative, function-oriented footwear and apparel that have been developed for high-performance outdoor, sports and other lifestyle-related activities, as well as for casual use.
Deckers Outdoor Corp. has a market cap of $1.91 billion; its shares were traded at around $46.12 with a P/E ratio of 11.2 and P/S ratio of 1.4. Deckers Outdoor Corp. had an annual average earnings growth of 40.7% over the past 10 years. GuruFocus rated Deckers Outdoor Corp. the business predictability rank of 4.5-star.
Decker is also the maker of UGG sheepskin boots, which comprises about 62% of its total sales. Baron Funds commented in May that they believed the company faced headwinds from increased costs of sheepskin and one of the warmest winters on record, causing it to issue earnings guidance lower than analysts’ expected. “We believe sheepskin prices are peaking and will decline in 2013, giving a cost to 2013 earnings. We also believe weather patterns will eventually return to the mean,” Baron Funds wrote.
Royce bought 527,000 shares of Parametric Technology (PMTC) at an average price of $21. He has traded this stock numerous times in the past.
Parametric Technology Corporation develops, markets and supports collaborative product commerce software solutions that help companies manage the product development process in order to better shape innovation and achieve sustained competitive advantage. Parametric Technology has a market cap of $2.54 billion; its shares were traded at around $22.37 with a P/E ratio of 20.1 and P/S ratio of 2.2.
In April, Parametric’s stock dropped more than 20% in April when it announced its preliminary second-quarter results that were below its guidance. Results were lower primarily because a large European transaction failed to close and performance in North America was beneath expectations, contributing to reduced license sales.
In the third quarter, revenue was toward the higher end of its guidance range and EPS was higher than its guidance range, which sent the stock price up.
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