article 03-08-2016

What's Working in the Current Market?

Portfolio Manager Jay Kaplan looks at three holdings in the trucking and transport industry, which is bucking the market's downward trend in 2016. 

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Many small-cap stocks have been declining since last summer, battered by headlines expressing heightened concerns about the condition of the global economy. During this challenging period, we have been hunting for bargains, looking for what we think are strong long-term opportunities in several areas as valuations were growing increasingly attractive.

Year-to-date through the end of February, one of the Industrial sector’s industry groups—the road & rail category—was showing signs of life after struggling through much of 2015. We asked Portfolio Manager Jay Kaplan to discuss how he came to see a combination of high quality and attractive valuation in this group:

“Beginning in the spring of 2015, a handful of companies in the trucking industry began to look inexpensive to me. I generally like to focus on industries where expectations are low and where I see compelling bargains, which was the case for a few stocks in this group.

“Stock prices throughout the trucking industry were hit hard in 2015, first in spring and again later in the year. The market was concerned that the industrial economy was slowing down, and by the end of 2015-beginning of 2016, a lot of people were afraid it was heading toward recession.

“By mid-January 2016, many trucking stocks seemed to have priced in a recession that we weren’t in. In addition to these fears, there are regulatory changes taking effect in the trucking industry that should probably decrease supply a bit, making it more expensive for some of the smaller marginal players to keep up, especially with labor costs also rising.

“To me, this amounted to a potentially rewarding contrarian opportunity. So between, roughly, April of 2015 and January of 2016, I was able to invest in what I think are terrific businesses at prices I don't see very often, with the potential for some of these companies to gain additional market share in the new regulatory environment.

“In Royce Small-Cap Value Fund I initiated a position in Saia during April of 2015 and Werner Enterprises during May. Later in the year, I also began to add to my position in Knight Transportation. As is sometimes the case, I bought early—each company’s stock declined further in 2015. But that’s part of the price you pay being a contrarian investor.

“Saia provides less-than-truckload (LTL—companies that transport relatively small freight) services throughout the U.S., has many underpriced routes, and is moving to eliminate routes that do not make economic sense. The company recently reported earnings and a full-year outlook that were both a bit better than many were expecting. I really like its potential going forward.

“Werner Enterprises is a truckload (TL—companies that carry large amounts of generally homogeneous cargo) carrier that does a lot of business with large retailers such as Wal-Mart and operates with many long-term contracts. With capacity likely to tighten, the company should benefit from this as its customers seek to lock in capacity now. I see Werner as a high-quality player in the TL space.

“Knight Transportation is also a TL carrier that operates primarily in the U.S. The company has more exposure to the non-contractual spot market, as opposed to longer-term, contractual business. I think those new regulations may cause spot-market prices to increase throughout 2016, which would benefit Knight’s business.

“The last several months have offered a good example of what I like to do when industries fall out of favor—I try to take the opportunity to buy high-quality companies when prices are falling because quality doesn’t go on sale very often. And if the economy picks up, I think we’re poised to do well in trucking.”

Important Disclosure Information

Jay Kaplan is a Portfolio Manager and Principal of Royce & Associates, LP, investment adviser to The Royce Funds. He serves as Portfolio Manager for Royce Total Return Fund, Royce Small-Cap Value Fund, and Royce Capital Fund–Small-Cap Portfolio. He also serves as Assistant Portfolio Manager for Royce Pennsylvania Mutual Fund. The thoughts and opinions expressed in this piece are solely those of the person speaking and may differ from those of other Royce investment professionals, or the firm as a whole. There can be no assurance with regard to future market movements. There can be no assurance that companies that currently pay a dividend will continue to do so in the future.

This material is not authorized for distribution unless preceded or accompanied by a current prospectus. Please read the prospectus carefully before investing or sending money. Royce Small-Cap Value Fund invests primarily in small- cap and mid-cap stocks, which may involve considerably more risk than investing in larger-cap stocks. In addition, as of 6/30/14 the Fund held a limited number of stocks, which may involve considerably more risk than a less concentrated portfolio because a decline in the value of any one of these stocks would cause the Fund's overall value to decline to a greater degree. (Please see "Primary Risks for Fund Investors" in the prospectus.) The Fund may invest up to 25% of its net assets in foreign securities (measured at the time of investment), which may involve political, economic, currency, and other risks not encountered in U.S. investments. (Please see "Investing in Foreign Securities" in the prospectus.)

Percentage of Fund Holdings as of 12/31/15 (%)

Saia Werner Enterprises Knight Transportation
Small-Cap Value 2.9 2.4 0.6
Capital Fund - Small-Cap 2.2 1.7 0.5
Total Return 0.0 0.6 0.1
Dividend Value 0.0 0.6 0.1
Pennsylvania Mutual 0.6 0.3 0.02

There can be no assurance that any of the securities mentioned in the interview will be included in these portfolios in the future. References to specific securities in this interview are not intended as recommendations and should not be relied upon as the basis for anyone to buy, sell, or hold any security.

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