Three Quiet Stocks That Have Managed to Outperform
About 175 U.S. stocks hit new highs in trading on the New York Stock Exchange or Nasdaq last Friday, while most of the rest of the market went poof -- evidence that even in a bear market, some stocks stay on the bull.
Most of the high notes belong to small- to mid-sized companies that are still relatively cheap and provide something their slip-sliding peers don't, such as dividend income or realistic earnings visibility. A plurality were deadly dull denizens of the least fascinating corner of the financial services sector: 32 savings and loans, 22 real-estate investment trusts , 30 regional banks and five property managers.
If you've been staying away from these names because they're boring, you might be missing some of the perkiest opportunities around. I screened the new-high list for stocks that are ranked well by our new StockScouter rating system and found three that looked as if they've still got oomph, even if they won't make good party talk.
This one's not a financial, but when you get home from shopping for pencils and notebooks for the kids' backpacks next month, consider adding shares of small-cap School Specialty (SCHS) to your portfolio. The nation's largest distributor of nontextbook educational supplies just announced a blowout quarter, with earnings up 45% in its fiscal first quarter -- and analysts boosted their estimates for growth for the rest of the year.Even a deteriorating economy can't erase the plain fact that this company is pretty cheap -- with a price-to-sales ratio of 0.7 -- as well as consistently profitable with improving margins. Got pencils? These guys sell more than 80,000 different products to 18,000 schools -- and are just getting the hang of integrating their purchase of their largest competitor, J.L. Hammett. Chief Executive Dan Spalding told me Thursday that the ABCs of success for his Wisconsin company are its "stable market that is driven by the positive demographics of education." He notes that 500,000 more kids will attend school in the fall than last year, and you can't beat selling into a market in which the government demands participation for 12 years. (Now that's what I call recession-proof.) Plus, some states are giving his business a hand by extending kindergarten to a full day by law, or by following Georgia with the requirement that all children attend pre-K classes. Although his firm has seven times the revenue of its next-largest competitor, Spalding says he still has only 13% market share. He aims to grow that to 20% to 25% -- a goal that would take the firm to something like $1.4 billion in three years from its estimated $802 million in revenue for fiscal 2002. What could go wrong? This is a highly seasonal business in which you've got to have the capacity to supply millions of items in a very short period of time, essentially from June to September. School Specialty has 2.4 million square feet of warehousing in 10 locations across the U.S., so execution risk is an annual concern. Financially speaking, Goldman Sachs analyst Matthew J. Fassler said in a report Wednesday that the keys for his "outperform" rating are the company's ability to generate gross-margin expansion through selective price increases, as well as through the elimination of duplicative overhead from its many acquisitions. StockScouter warns that the company's insider picture is clouded by some high-level sales at the end of July, and a price-to-earnings ratio that's a tad high. Still, investors looking for shares of proven companies in a stable, growing business not tied to the economy could do a lot worse than printing S-C-H-S in their primers if the price declines to the $25-$26 area.
American Mortgage AcceptanceBear with me now; this micro-cap real-estate investment trust is truly a snoozer. But there's no denying its 60% price advance in the past 12 months and 11.2% dividend yield. That's right, an 11.2% yield. For those of you who have never had a dividend-paying stock, that means that as long as the dividend isn't cut, you'll get an 11.2% return for holding American Mortgage Acceptance (AMC) shares even if the price doesn't move an inch. While most REITs own properties such as shopping centers, industrial parks or apartment houses, American Mortgage invests strictly in high-grade real-estate debt -- mostly issues of the Government National Mortgage Association, or Ginnie Mae, but also slightly riskier issues called commercial mortgage-based securities. The key reason that it and bigger peers like Anthracite Capital (AHR) and Annaly Mortgage Management (NLY) have done so well is that the Federal Reserve's campaign to cut interest rates put them in a sweet spot: They borrow money increasingly cheaply, but loan it out at relatively high fixed rates. They also use their debt assets as collateral to borrow and lend out even more money. While some REITs in this business borrow to the hilt, American Mortgage is pretty conservative, with a leverage ratio of just 1.9, compared with Anthracite at 5.9 and Annaly at 14. The way it works is illustrative of the world economic system: The world's greatest savers in Japan get about 1% or less from their money in passbook accounts at banks aligned with Nomura Securities (NRSCY). Nomura lends that money to American Mortgage at about 4.2%; American Mortgage turns around and lends it to Ginnie Mae and others at north of 8% for commercial and residential mortgages. Chief Financial Officer Michael Wirth told me Friday that he then leverages that up to the point where he's earning about 12% on his money. Most of that is returned under REIT rules to shareholders, resulting in your 11.2% yield. Don't expect another 60% price appreciation over the next 12 months, but even a 10% rise in price added to an 11% yield offers the potential for a nice 20% return. StockScouter likes all the players in this business, giving American Mortgage, Anthracite and Annaly solid 10s for the past six months straight. But beware. Wirth himself cautions that "the real-estate cycle hasn't gone away" and the recent powerful move in the mortgage business won't last forever. The last time REITs got clobbered was 1998; Anthracite lost 73% of its value from March to October that year, while Annaly lost about 30%. (They both recovered smartly after that.)
El Paso Energy PartnersEnergy investors are most familiar with the two glamorous ends of the oil and gas game: exploring and drilling, called the "upstream" business and celebrated in the old Dallas TV series; and refining and marketing, called the "downstream" business. In the middle lies the gritty infrastructure work of gathering and distributing all those carbon molecules through pipelines and other transportation systems, and that's where a short list of "midstream" firms play. El Paso Energy (EPN) is one of about 20 midstream businesses that are operated as "master limited partnerships." These unusual entities give energy conglomerates special tax benefits for spinning off subsidiaries that generate a lot of cash flow but not much income. They are typically valued by shareholders -- who are technically partnership "unit holders" -- more for their dividend stream than for their capital appreciation. But in the past year, shareholders have received barrels full of both: El Paso Energy shares are up 60% in the past 12 months, while rival Enterprise Products (EPD) is up 90% and Kinder Morgan Energy (KMP) is up 70%. They all yield 4.5% to 6%. Robert G. Phillips, chief executive of El Paso Energy, says he's in a high-growth business that's tied to the major new oil and gas fields being developed by ExxonMobil (XOM) and Chevron (CHV) in the Gulf of Mexico. His firm, which is 28% owned by $24-billion gas goliath El Paso (EPG), builds and owns the pipelines from the continental shelf to these new deep-water platforms. Phillips says the business is generally mature except when major new opportunities to build new capacity come along, and then it ramps up for a few years. Cash flows are pretty stable as they are mostly linked to long-term, dedicated platform contracts, not the price of oil and gas. About 30% of cash flow stems from the amount of energy that passes through the partnership's pipes, so if energy demand is suddenly sapped there is some "volumetric" risk, in the jargon of the industry. What drives the unit or share price is that El Paso has announced plans to transfer $3 billion worth of assets to the partnership over the next few years. Transfers so far were at transaction values of about seven times cash flow; they're almost instantly accretive to El Paso Energy's income sheet while at the same time helpful to the parent's books, as well. Phillips aims to double his firm's cash flow every two years in a balanced way that should continue to boost the unit price, as well as keep the dividend steady. StockScouter has given El Paso Energy, Enterprise and Kinder Morgan Energy solid 9s or 10s for the past 18 months, and the trend continues. Special tax treatment of the dividends from these partnerships may not make their shares appropriate for all investors, so check with your accountant or broker if you're considering buying. Readers who are experts in real estate, energy and schools: Click here to write me what you think of the prospects for these stocks, and I'll publish your remarks in coming weeks.
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