By Christopher Palmeri COVER STORY PODCAST
Wilmerding, Pa., seems an unlikely place to find a Hot Growth company. The historic hamlet 13 miles east of Pittsburgh was a company town built in the 1880s by inventor George Westinghouse. He made it the headquarters for his first business, the Westinghouse Air Brake Co. Today, Wilmerding is still home to that business, now called Wabtec Corp. (WAB) And the fast-growing maker of locomotives and train parts has steamed its way onto BusinessWeek's annual tally of the 100 hottest small companies in the U.S.
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You'd expect to see a list like this populated by high-flying tech companies and trendy consumer-product manufacturers. There are plenty of those. No. 1-ranked Heelys Inc. (HLYS) makes the wheeled sneakers kids everywhere are skating around on. Smith Micro Software Inc. (SMSI) (No. 29) was founded in 1982 by CEO William W. Smith Jr., who started out selling personal-finance software from the trunk of his car. These days, Smith Micro provides big wireless carriers with code that helps consumers download music and data to their phones. This year's list, however, is dominated by Old Economy businesses: metal benders, defense contractors, and others that measure their history not in decades but in centuries.
Smith & Wesson (SWHC) (No. 77), founded in 1852, still manufactures in its original plant. Today, under CEO Michael Golden, handguns are made of lightweight polymers with ergonomic grips. Steel distributor A.M. Castle (CAS) & Co. (No. 51), founded in 1890, looks spry for its age. Last year the company passed $1 billion in sales, completed its largest acquisition, and launched a new foray into higher-end specialty products.
Don't forget the oldest company on the list, auction house Sotheby's Inc. (BID) (No. 54), founded in 1744. It has made a killing recently, thanks to soaring sales. At its semiannual contemporary auction in New York, on May 16, Sotheby's put the hammer down on a record $344 million worth of art. The big winner: David Rockefeller, who sold a 1950 painting by Mark Rothko for $72.8 million. (He paid $8,500 for it in 1960.) In all, companies representing nearly one-third of the list were founded in the 1960s or earlier. Seven were founded before 1900, the same number as those started in the present decade.
A lot has changed since George Westinghouse dreamed up the idea of pneumatic locomotive brakes. Wabtec—still on Air Brake Avenue—mirrors the history of American business. It was bought by conglomerate American Standard Cos. (ASD) in 1968, taken private in a management-led leveraged buyout 12 years later, and went public in 1995. Since then the company (No. 97) has grown by acquiring other railroad equipment makers, focusing on international markets, and reinvesting some $30 million a year in research and development. One result of that R&D: a cleaner-burning diesel locomotive that helps municipal transit authorities meet federal air-quality standards.
Wabtec Chief Executive Albert J. Neupaver can look out the window of the company offices and see the ornate stone castle that once served as Westinghouse's headquarters. It's now a museum devoted to George Westinghouse. The days of vertically integrated manufacturing are over. The foundry, which once cast steel parts, is a parking lot. Assembly lines where each employee added one bolt have been replaced by a single worker assembling an entire compressor or brake directly from a customer's order. Employee empowerment is in. Several times a year, management and line workers hold brainstorming sessions in keeping with Japan's kaizen philosophy of continuous improvement. "We suspend all titles, roll up our sleeves, and get dirty," Neupaver says. "If you listen to the operators, they'll give you the solutions."
To identify Hot Growth companies, BusinessWeek sifts through the Standard & Poor's Compustat database of 10,000 public companies for those with revenues of $50 million to $1.5 billion a year. We rank businesses by three-year sales and earnings growth as well as return on capital. Companies must have a market cap of $25 million or more and a stock price of at least 5. Profit or stock price shortfalls, or news that puts prospects in doubt, may knock a company off the list.
In the best small-cap fashion, the profit growth of list companies trounced that of the S&P Industrials. The average annual profit growth: 90.1%. For the industrials: 21.9%. Sales growth soared an average 34.5%, more than three times that of the Industrials. Return on capital, a measure of how well management invests its assets, clocked in at 19.8% for companies on the list, vs. 11.3% for the industrials.
The global boom in commodity prices has lifted the fortunes of many companies on the list. There are oil and gas producers such as Gulfport Energy Corp. (GPOR) (No. 44) and coal mine owners such as Penn Virginia Resource Partners (PVR) (No. 52). Titanium Metals (TIE) (No. 5) is benefiting from increased orders for its namesake product from customers such as Boeing (BA) and Rolls-Royce. (RYCEY) The latter uses titanium in its jet engines.
NUTS AND BOLTS
The list proves the adage that you can make just as much money selling picks and shovels to miners as you can by doing the mining yourself. Grey Wolf Inc. (GW) (No. 31) supplies rigs for drilling on land. Metretek Technologies Inc. (MEK) (No. 37) provides equipment that measures natural gas pipeline flows. Tidewater Inc. (TDW) (No. 75) rents out supply boats to oil companies operating in the Gulf of Mexico.
The tally reflects national trends. Defense spending is hot. That's evident at companies such as Ceradyne Inc. (CRDN) (No. 17), which makes ceramic plates for body armor, and Emergent Biosolutions Inc. (EBS) (No. 27), whose products include a vaccine for anthrax. Kids want the latest look: Witness surfwear retailer Zumiez Inc. (ZUMZ) (No. 21) and Tween Brands (TWB) (No. 87). Boomers have their own needs: Hence the entry of mattress makers Select Comfort Corp. (SCSS) (No. 39) and Tempur-Pedic International Inc. (TPX) (No. 46) to the list.
All these businesses have learned to adapt. The consultants who formed Huron Consulting Group found themselves out of work when their previous employer, Arthur Andersen, went under. Today they help other businesses comply with legal and regulatory issues, including requirements put in place as a result of the corporate scandals. Genesco Inc. (GCO), founded in 1924, once was one of the largest shoe manufacturers in the U.S. As low-cost imports flooded the market, the company became a retailer. Today its Journeys and Underground Station stores provide young adults with trendy footwear. "It was a consumer-driven shift," says CEO Hal N. Pennington, "evolutionary more than revolutionary."
There is no magic strategy for getting on the list. When Steve Sanghi took over as CEO of Microchip Technology Inc. (MCHP) in 1991, the Chandler (Ariz.) company was losing $2.5 million a quarter. He eliminated unprofitable commodity products, reinvested in technology, and gave employees a say in the manufacturing process. Today, Microchip is one of the world's leading providers of programmable chips that control the functions in everything from alarm clocks to iPods. Last year, Sanghi co-wrote Driving Excellence, a book about the experience and about a management technique he calls the Aggregate System. "It cannot be distilled down to one thing," he says. "All areas of the company—the products, the culture, the manufacturing, the stock options—everything has to work in unison, so that everything looks slightly better."
Palmeri is a senior correspondent in BusinessWeek's Los Angeles bureau