Spotlight on Small/Mid Cap Stocks

Investing For a Better World: Spring 2013

Big companies tend to grab most of the business headlines, but smaller, more obscure firms often provide attractive investment opportunities while being the most innovative agents of social change.

Trillium’s Small/Mid Cap Core Composite was created on January 1, 2007. As of March 31, 2013, the portfolio contained 68 stocks and had produced annualized gross returns that are 81 basis point greater than the S&P 1000 returns since the inception of the composite [1].

We asked Trillium’s analyst team to name their favorite small companies (defined here as companies with a market capitalization of less than $3 billion) on the Trillium buy list. These are their picks for interesting investment opportunities in the small cap space.

Lindsay Corporation: Elizabeth Levy, CFA – Industrials Analyst

Lindsay Corporation (NYSE: LNN) provides a unique way to invest in agriculture. Lindsay’s primary product is an efficient center-pivot irrigation system that improves crop yield and decreases wasteful water use.  Center-pivot systems can reduce water use by more than 50% and achieve better than 20% greater yield when compared to a traditional gravity-fed irrigation system.   An irrigation system can therefore be thought of as both a revenue enhancer, as it increases yield, and an insurance policy, as it offers some protection in drought years.  While pivot irrigation systems can be major investments for farmers, they have an average payback period of less than two years in “normal” times and even faster during periods of drought or high commodity prices.  Climate change makes relying on past weather patterns a risky proposition, and farmers appreciate the insurance-policy aspect of Lindsay’s efficient irrigation systems.

Lindsay also sells the Road Zipper, a unique technology that lets center lanes of bridges and highways change direction, reducing congestion and tailpipe emissions while limiting the need for increasing road or bridge width.

Sales in fiscal year 2012 increased 15% versus FY 2011, and sales for the first half of 2013 have increased an additional 28%.  After taking into account non-recurring expense, earnings per share grew 29% in 2012 versus 2011 and 65% during the first half of 2013.

Having traded at greater than 28x in recent years and currently trading at nearly 19x next twelve months’ estimated earnings, a narrowing multiple echoing their earnings growth, Lindsay isn’t cheap.  Further reflecting their strong performance, Lindsay’s stock price grew from approximately $55.50 at the beginning of 2012 to $82.00 at the beginning of 2013 and $94.00 in mid-March.

Eagle Bancorp: Seth Magaziner – Energy and Financials Analyst

By now, we are used to the advocates of ”Too Big to Fail” banks telling us that their model is superior to community banking. Too Big to Fail institutions are necessary, they say, because they serve their customers better than small banks can. Furthermore, Too Big To Fail banks are better investments because they are able to spread their costs over a large number of customers, creating wider profit margins and providing shareholders with greater returns. The demise of the community bank is inevitable, the story goes, because its business model is inferior to the mighty Megabank.

It seems these “experts” forgot to tell all that to Eagle Bancorp (NASDAQ: EGBN).

Eagle Bancorp is a small community bank that operates 18 branches in the Washington DC Metro area. Against all odds, Eagle has been growing like gangbusters. Eagle’s customer deposits grew by 21% in 2012, roughly three times the national average. Even more impressively, Eagle matched this deposit growth with a 21% growth in loans. (The national loan growth average for 2012 was just 2.7%.)

Faced with a slow economy, many banks have sought growth by acquiring other banks. Not Eagle. Virtually all of its growth in recent years has been organic: based on word of mouth, personal relationships with customers, and good, old-fashioned marketing.

Eagle Bancorp stock returned 37% in 2012, making it one of the best performing stocks in Trillium’s Small/Mid Cap Core model, and beating the stock performance of a number of obscure banks with names like Morgan Stanley, Wells Fargo, and JPMorgan.

Middleby Corporation: Laura McGonagle, CFA – Consumer Staples and Discretionary Analyst

Middleby Corporation (NASDAQ: MIDD) designs, manufactures, and distributes commercial food-service and processing equipment to restaurants in the United States and internationally, with a focus on energy and water-efficient products. Clients like Subway, Domino’s, Panera, and Dunkin’ Donuts rely on Middleby to supply ovens, fryers, dough rollers, and a range of other kitchen equipment. The Company has grown its revenues to over $1 billion in 2012 (from $500 million in 2007) through strong innovation and by being an active acquirer in the food-service arena.

Middleby is a constant innovator, with 20% of each year’s revenues coming from new products. Their international footprint is also a significant growth driver, with more than 30% of revenues coming from outside the US in 2012, and a strong presence in growth markets like India and China. MIDD stock was up 49% in the past year and 16% so far in 2013.

In addition to its solid financial performance, Middleby has a strong environmental and social profile, particularly for a company of its size. Over 500 of its products carry the “Energy Star” designation, and many of their products also help to make restaurants’ food healthier. For example, their “spin fresh” technology for fried food requires 50% less cooking oil and 14% less cooking gas than traditional fryers, while also decreasing the calorie content of the food by 34% compared to traditional methods.

Teradyne: David Walker, CFA, CMT – Technology Analyst

Smartphones, tablets, and other mobile devices are forever disrupting the technology market, and Teradyne (NYSE: TER) is perfectly situated to benefit from this trend. Teradyne makes equipment to test semiconductors, circuit boards, wireless chips, and other electronic components common in mobile devices. Teradyne boasted double-digit revenue growth in 2012, has very low debt, and is well positioned to ramp earnings as technology firms shift to more advanced product designs and complex components.

Teradyne is also among the most progressive tech manufacturing companies in regards to environmental sustainability. They have clear goals for reducing greenhouse gas emissions, water use, and overall energy use in their operations, while increasing the percentage of their energy use that comes from renewable sources.

Brandywine Realty: Keith Mills, Health Care, Materials and Real Estate Analyst

Brandywine Realty Trust (NYSE: BDN) is a real estate investment trust (REIT) focusing on office property in the mid-Atlantic region.  Most of its exposure is in the Philadelphia market, where office real estate indicators are improving dramatically. BDN also has an improving financial leverage and dividend coverage profile, suggesting dividend growth in the future.

Importantly, Brandywine is also a sustainability leader.  The company develops properties to LEED certification and about half of its properties were Energy Star rated as of 2012, far more than its peers. Brandywine only uses earth-friendly cleaning materials in its building maintenance, benefiting both the environment and the employees doing the work.  The company has also been recognized by Institutional Shareholder Services (ISS) for having superior corporate governance policies.

BDN stock is up about 16% year to date, far outpacing U.S. REITs overall, which are up an average of roughly 6%.

Disclosure: The securities listed represent specific holdings as of publication date. Actual holdings will vary for each client. Discussions of such holdings are not meant to be a recommendation to purchase these securities. Trillium’s investment team and process continuously and regularly supervise holdings to determine entry and exit prices for all holdings. If you would like a list of recent recommendations to our Small/Mid Cap strategy, please contact us.