from today's wsj dated 7/19. ATHM mentioned near the bottom... Hotel rooms?
Barron's Features
Paper Chase
One small-cap fund manager sees value in
two title insurance companies
By BARRY HENDERSON
Just about the time Scott Satterwhite began trundling off
to a new office in Atlanta two summers ago, he sensed
that the next few months were going to be ugly for shares
of small companies. "The Russell [2000] was at a peak,
and we just felt stocks were too high," he says. The
timing couldn't have been any worse, since Satterwhite
had just left Wachovia Bank, where he ran the
well-regarded Biltmore Special Values fund, to set up a
new small-cap fund at Artisan Partners.
Despite his misgivings, Satterwhite forged ahead and
began constructing a portfolio anyway. "We tried to buy
things that had some degree of price protection," he said.
"We were very skeptical about earnings, so we tried to
build a low-expectations portfolio." That meant that he
was looking for companies that would be propped up by
their underlying assets, not earnings growth. Even more
importantly, he wouldn't buy anything that didn't have a
stress-tested balance sheet.
The strategy paid off.
Through the end of 1997
and during the first two
quarters of 1998
Satterwhite's Artisan
Small Cap Value fund
decimated the competition.
Buoyed by names like
Capital Southwest, White
Mountains, Hilb Rogal,
Dart Group and White
River, it returned 13.8%
from September 30, 1997,
through June 30, 1998. In
that period, the average
small-cap value fund returned 2.1%, according to
Morningstar. His success points to an important lesson
that more small-cap investors should heed: Leverage
does matter, particularly in the world of small-caps, and
when you ignore its potentially disastrous impact, you do
so at your peril, particularly in the midst of a global
liquidity crunch.
Table: At A Glance
Although the fund has beaten its peers handily since
inception, don't get the idea that Satterwhite has
completely escaped the pain that most small-cap
investors endured last year. During the second half of
1998, he got stung by the Asian crisis that he had so
artfully avoided in 1997. "We rotated into energy and
capital goods a little too early in 1998," he observes. He
also acknowledges that he would have done better if he
had been holding slightly larger, more liquid stocks in
'98's second half. He finished the year down 5.76%.
Although he was in negative territory, he still outpaced
more than 60% of the funds in the small value category,
according to fund tracker Morningstar.
This year, Satterwhite's fund is back in the black.
Through July 13, it was up 15.3%, compared with
7.26% for the average small-cap value fund and 14.1%
for the S&P 500. The same energy and capital-goods
stocks that hurt him last summer have reversed course
and given his portfolio a big lift, particularly in the
second quarter. However, as those stocks have run up in
value, he's less enthusiastic about them than he was
several months ago.
These days, he's been
spending much of his time
focusing on smaller title
insurance companies. Two
of his favorites are Chicago
Title and Stewart
Information Services.
Admittedly, the near-term
earnings outlook for any
title insurer isn't great, since
a big chunk of their business
comes from home refinancings. (Sales of new and
existing homes also affect the business, but to a lesser
degree.) With interest rates on the rise-at least for
now-refinancings have fallen sharply. Nevertheless,
Satterwhite likes the fact that both of these companies
enjoy relatively low losses, and that both have healthy
balance sheets and reserves. Both also appear to be
fairly aggressive about managing their costs.
Better still, both stocks are extraordinarily cheap. At
$35 recently, Chicago Title was trading at 1.2 times
book value, the way Satterwhite figures it. Stewart,
recently around $21, is priced at about one times book.
Historically, both companies have traded somewhere
around two to three times book. "In the past, you've been
able to make good money by buying the cleanest of the
smaller title insurance companies when they started
selling for book value" and, he asserts, that probably
will be the case this time around.
One of Stewart's attractions is that it's at the forefront of
automating its industry. "These guys are really out in
front technologically," he says. Laborious,
document-based title searches would seem well-suited
to computer-based automation and that's exactly what
Stewart has been investing in during the past few years.
Last year, the company came up with "single-seat"
technology that allows one person to gather and handle
all the work for a typical subdivision file. Under the old
system, it commonly took eight days to do this work.
With the computerized single-seat system, the
document-gathering process takes about an hour. The
company also has launched RealEC, an electronic
commerce network that connects the title company with
the bank to expedite closings. Satterwhite says that Wall
Street is overlooking the fact that the companies'
technology programs will "swing into the black" in 1999
after several years of consecutive losses. That should
boost earnings in the next few quarters.
Another decidedly unsexy group of companies that
Satterwhite can't get enough of these days: cement
producers. The two he likes are Giant Cement and Lone
Star Industries. The real story here is the economy's
continued health, plus steady price increases in
cement-he estimates 3%-5% over the last couple of
years without too much competition-waiting in the
wings. "The economics of green field expansion in the
cement business are marginal, at best." And importing
such a bulky product doesn't make much economic sense,
either. At the same time, both Lone Star and Giant have
just about paid for all of their plant, property and
equipment.
"That means that these guys are cash-generation
machines," he says. Despite that, both stocks look
reasonably priced -- they're both trading at five to six
times EBITDA [earnings before interest, taxes,
depreciation and amortization]-especially when you
compare them to the valuation of the S&P 500.
Although most of Satterwhite's picks are typical value
fare-particularly the financials and basic industries in
his portfolio-a few are surprising. For example, he's
nosing around the smaller information technology
consulting companies looking for bargains. He thinks
that the Y2K fears that caused these stocks to sell off so
sharply were overdone. He won't talk specifics since
he's building a position in some of these stocks.
However, given his preference for small-caps, there are
probably only a few that he's involved in at the moment.
Intelligroup, the fallen angel among the IT consulting
operators, is likely to be one of them.
As part of his current portfolio, Satterwhite already
owns a quasi-tech stock called OnCommand. This outfit
provides in-room videos for hotel patrons and is
working on an Internet connection service that hotel
patrons can access through the televisions in their rooms.
Satterwhite started buying the stock a few months ago
when it traded between $11 and $11.50 per share. It's
since run up to $18 a share on speculation that it will get
bought out by the likes of @Home, Liberty Media,
America Online or someone else. This is about as close
as Satterwhite is willing to venture to the dot.coms of the
world. |
