Mining Solid Gains in Small-Caps

When Trusco Capital Management's Brett Barner digs for value, he generally finds it. That's why his portfolio is up 15.5% in 2001

By Robert Barker

Among stock funds, only precious-metals portfolios have outperformed my personal favorite corner of the market: small-cap value stocks. According to mutual-fund tracking service Morningstar, funds devoted to cheap little companies are up an average of 10.5% this year, vs. a 12.7% loss for the Standard & Poor's 500-stock index.

The group features lots of good stock-pickers. One who ranks high with me is Brett Barner, who runs $525 million for Trusco Capital Management, including the STI Classic Small Cap Value Equity Fund (SCETX ). It's up 15.5% so far this year, after an 18% gain last year.

To see what he has been buying and selling lately, I reached Barner in his Orlando (Fla.) office by phone the other day. Here are edited excerpts of our conversation:

Q: Clients have left you with more than $500 million to invest in small-cap stocks. How do you go about doing that?


It has been the same philosophy and strategy since our inception, and that is identifying small-cap, dividend-paying stocks.

Q: So to get into your fund, the stock has to be paying a dividend?


Right. And we [stick with companies that are] below $2 billion in market cap. Then we look at valuations, and we want those stocks that are in the bottom third of their historical range.

Valuation means a lot of things to a lot of people. What we want is whatever is important to that company in that industry. If it's a retailer, price-earnings ratio is the critical issue. If it's an energy company, it's price-to-cash flow, and if it's an industrial company, it might be something like enterprise value-to-EBITDA [earnings before interest, taxes, depreciation, and amortization].

Q: And how many stocks does that usually yield?


About 500 or 600 names. So then you've got a universe of cheap, small-cap value, dividend-paying companies. Most of them are cheap for a reason. Our ideal candidate would be a company that has the 18- to 24-month flu. What we want to avoid are those that have terminal illnesses.

Q: I recall one of the companies that you liked earlier was Polaroid (PRDCQ.OB) , and that one turned out to have something more serious than the flu.


Absolutely. We actually did get out a considerable time before they went completely under...[but] we exited the position at a loss.

Q: This year, things are going well for you. These things run in cycles, of course. Is this the time to be selling the kind of stocks that are in your portfolio?


There are certain names that we have sold. We had some gold-mining stocks prior to September 11. We sold them shortly thereafter because all of a sudden everybody wanted the ultimate defensive stocks, and they all moved up 30% to 40%.

Q: What's a good example?


Agnico Eagle Mines (AEM ) was one, and then we had Homestake Mining (HM ), which got bought out. Other names that have helped out in the performance were incredibly tough to stick with.

Q: Such as?


Our very best-performing stock would be Pep Boys (PBY ), the auto-parts company. It's up 250% or so this year, and we've scaled back from a 3% position to less than 1% now. Valuation is getting full again. But it had gotten down to $3.50, and now it's back to $15.

It was just crazy at the valuation of $3 because the company has a huge sales figure -- $2.2 billion -- and when it was $3, the market cap was just a couple of hundred million dollars.

Q: At Sept. 30, Harris (HRS ) was your largest holding. Is it still, and if so, what do you like about it?


It's one of our largest holdings. It's probably No. 3 or No. 4 now. We spent two days over at the company reviewing their product roster, and I went to a [baseball] spring training game with the CEO -- they've got a box for the Marlins. At the time, all the telecom equipment names -- the Ciscos (CSCO ), the Lucents (LU ) and the like -- were like death warmed over. No one in the world wanted to touch anything like that. And Harris, they've got telecommunications exposure and the stock sold off.

Q: Why did you buy?


About 50% of its business is government-related. They make all the specialty satellite phones and radio communications for the military and the NSA, the CIA, etc. They make all the handheld walkie-talkies that the SEALS and special-forces guys use. Another 20% of the company is digital broadcasting equipment. By the end of this year, all the major television stations have to be broadcasting in HDTV.... In an economic slowdown, we felt that 70% of their business was pretty much insensitive to the economy.

Q: What was your average cost?


It was $26. The stock is $32 now. It hasn't been a home run, but it has been a nice performer -- and it's one that I don't lose sleep over.

Q: What have you been buying lately?


One name that I would consider to be controversial for what we do is Embraer-Empresa Brasileir (ERJ ), the Brazilian regional jet manufacturer.

Q: They've got a big contract with Continental (CAL ), right?


Yes, and others. There are basically two players in regional jets, Bombardier (BBDb.TO ) and Embraer. And right after September 11, the stock just got creamed.... It got as cheap as $13.50, and we did a tremendous amount of work on it. At the time, they had $6 in cash per share, U.S. dollars, on the balance sheet after you exclude all the debt.

Q: What else?


We've also bought some leisure-related stocks. Fairmont Hotels & Resorts (FHR ), which was a spinout of Canadian Pacific Railway (CP ). Low debt levels, the lowest leverage of all the hotel operators out there. And right now, 70% of their profits come out of Canada. We felt Canada would probably be a good safe haven in this environment. People may decide they don't want to travel to Europe or Asia, but maybe they're going to go on a ski vacation or go to visit the Canadian Rockies or something.

More [important to future profits is the fact] they own their properties, and they are low-leveraged. They actually will be able to buy distressed properties, which is what they want to do in the major metropolitan areas.... They've got several major U.S. cities, but they don't have all of them. They have the Plaza in New York, Copley Plaza in Boston, of course, the Fairmont in San Francisco, but there are a good dozen or so major U.S. cities that they want to have an exposure in and now might be a great buying time.

Q: What did you pay for the stock?


$16.50. Stock is now around $21.

Q: I see you have owned a tech stock or two, such as Autodesk (ADSK ). Do you still?

A: Autodesk got knocked down with most of the other tech stocks. It has basically no debt, several dollars a share of cash, so they're a very conservative software company. They make almost all of the CAD-CAM software out there.

Q: That's computer-aided design and -manufacturing software?


Correct. And they do it for all kinds of fields: architecture, engineering. Or say you're designing a neighborhood and have to decide where to put the electrical poles and the lines and the plumbing. Or you're designing some piece of machinery. They're pretty much the standard in many segments of the market.

Q: With a good run under your belt, are you worried that small-cap value will move out of favor and small-growth or some other part of the market will come back in?


That thought is in the back of the head. Usually, the cycles last somewhere between two and four years. And we're really going on now about two years where small-cap value has been on top. I don't think the market is going to have a radical shift where small-cap growth is on top or large-cap growth, but I think the easy money has been made in the small-cap value sector.

Barker covers personal finance in his Barker Portfolio column for BusinessWeek. His column appears every Friday, only on BW Online

Edited by Patricia O'Connell

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