Emails have been flying in requesting the list of companies that passed my leveraged small-cap screen, which I discussed Tuesday. This list is based on a strategy outlined by Dan Rasmussen of Verdan Capital.
In his study Leveraged Small Value Equities, Rasmussen, along Brian Kundai Chingono from the University of Chicago Booth School of Business, created a private-equity replication strategy that bought highly levered small-caps that were starting to pay down their debt at low multiples of enterprise value-to-EBITDA. They found that stocks with these characteristics outperformed the market -- by a wide margin.
My backtests confirmed Rasmussen's idea that these companies outperform the market. It is a very volatile approach, but the rewards seem to more than justify the risks. While Rasmussen looks for debt paydowns, my tests used Piotroski F-scores and Z-scores as a measure of the financial condition of these levered companies. The results are very similar.
I limited my search to those companies with a F-score of 6 and a Z-score of 1.5 or higher. The Z-score bond equivalent rating is B.
Dean Foods (DF) is the largest company on the list, with a market cap of $1.8 billion. The company is in the dairy business and markets milk, butter and ice cream as well as a line of juices and teas. Dean has a debt-to-equity ratio of 1.52 and trades at an EV/EBITDA ratio of 6.6. The company's F-score is a strong 8, and the Z-score of 4.6 tells me Dean is in solid financial condition.
Cooper-Standard Holdings (CPS) designs, makes and sells sealing, fuel and brake delivery, fluid transfer,and anti-vibration systems for automotive manufacturers. The company currently has an EV/EBITDA ratio of 6.7 and a debt-to-equity ratio of 1.1. Its F-score is 7, and the Z-score is 2.72.
Also selling to the auto industry, American Axle & Manufacturing (AXL) makes driveline and drivetrain systems for original equipment manufacturers. AXL's debt-to-equity ratio is 2.7 and the stock trades at an EV/EBITDA ratio of 4.21. That's the lowest multiple in the current portfolio.
Regional airline SkyWest (SKYW) operates flights under the brands Delta Connection, United Express, American Eagle, or Alaska under code-share arrangements. The company is expected to grow rapidly over the next several years, and I hope it uses its cash flow to pay down debt. The air carrier's debt-to-equity ratio is currently 1.4, and its EV/EBITDA ratio is 6 at the current price. SkyWest just made the cut with a Z-score of 1.55 and an F-score of 6.
TTM Technologies (TTMI) makes printed circuit boards for the networking and communications, cellular phone, computing, aerospace and defense, and medical/industrial instrumentation markets. Its debt-to-equity ratio is 1.3, and the stock's EV/EBITDA ratio is 6.8 at the current price. The company earns a Z-score of 8 and a Z-score of 1.84.
Rasmussen has talked several times about Quad/Graphics (QUAD) , a print and market services company. It prints magazines, marketing inserts and does direct-mail marketing. While these are competitive businesses pressured by the online world, the stock is cheap with an EV/EBITDA ratio of just 5.03. QUAD's debt-to-equity ratio is 2.7, so it is leveraged, but the Z-score of 2.17 and F-score of 6 indicate it can survive. The company also pays a generous dividend, and the shares currently yield 4.58%.
American Railcar (ARII) makes hopper and tank railcars for the North American railroad industry. Carl Icahn owns more than 60% of the company and it is one of his oldest holdings. ARII is trading with an EV/EBITDA ratio of 6 and the company's debt-to-equity ratio is 1.1 right now. ARII's F-score is 6, and its Z-score is 2.04.
Michigan-based Universal Logistics Holdings (ULH) is in the trucking business and also offers what it calls value-added services such as material handling, repacking warehousing and returnable container management. This company earns the second highest Z-score in the portfolio with a 3.46. Its F-score is 6, and the EV/EBITDA ratio is currently 6.8.
IEC Electronics (IEC) provides electronic contract manufacturing services to the aerospace, medical, industrial and defense sectors. The company's debt-to-equity ratio is 1.43, but it has a healthy Z-score of 3.11, indicating there is little risk of financial distress. IEC's F-score is currently 8, and its EV/EBITDA ratio is 6. Looking at its year-end earnings release, the company was able to pay down debt levels by $11.8 million last year. That is a 40% decrease in long-term debt from the end of 2015.
So, there you go. That's your shopping list for this private-equity replication strategy. (There is a tenth stock on the list but it has very low value, and it would not be appropriate to discuss on Real Money.)
The list is very short as we approach the eighth anniversary of the current bull market so some caution is in order. As we mentioned, the strategy is volatile, but by exercising some restraint and patience, you may be able to make the volatility work for you.
