In case you haven’t had a chance to read the stock updates from each of the weekly Small-Cap All Stars articles, I have aggregated them all below for your convenience.

Value Portfolio

Brocade Communications (Nasdaq: BRCD) issued an earnings and revenue warning for its upcoming second-quarter financial report on May 16^th. CEO Lloyd Carney blamed “softness” in customer demand for Storage Area Networking (SAN) products. The stock fell more than 6% on the news.

This demand weakness for technology products is not specific to Brocade, but is endemic throughout the tech sector right now (see the update on SolarWinds below). Long term, Brocade CEO Carney remains optimistic:

Brocade continues to be well-positioned for long-term success in the data center.

Gentex (Nasdaq: GNTX) reported declining revenue and flat earnings per share in its first-quarter financial report, but investors reacted positively because analysts had expected worse. The stock has actually risen 9 percent since the report’s release as investors cheer the company’s continued ability to cut costs and boost its gross profit margin. Automobile production fell in most of its markets (e.g., Europe, Japan, Korea), which detrimentally impacts the company’s original equipment manufacturer (OEM) auto parts shipments. North American car production is a bright spot (4% growth expected in Q2), but the company warned that weak economic conditions in the rest of the world are probably not going to end anytime soon:

Unstable macroeconomic factors continue to be a concern, particularly in Europe, as it remains the Company’s largest shipping destination.   

After four regulatory delays, the National Highway Traffic Safety Administration (NHTSA) has committed to issuing final rules mandating rearview camera displays (RCD) in all cars sometime during the federal government’s fiscal 2013 (ends in September). Although final RCD rules should marginally increase Gentex sales in 2014, the effect will be muted because many auto manufacturers have decided to install the rearview cameras in the car console rather than in Gentex’s rearview mirrors. The big growth drivers looking forward are auto-dimming rearview mirrors and SmartBeam technology that automates the usage of headlamp high beams.

For the second straight quarter, the company did repurchase any stock – despite the fact that the company has $518 million cash on the balance sheet and 4 million shares remain in its share repurchase plan.  The good news is that this untapped repurchase authority is a future catalyst for additional stock-price appreciation.

On May 21st, the company suddenly announced that CFO Steve Dykman was leaving and didn’t give a reason why. Such a sudden departure without explanation is a bit troubling, but the company did say that it would provide more details about Dykman’s departure at a future date. According to an analyst at Wells Fargo:

Near term, Gentex shares are likely to weaken given the suddenness of the announcement. That said, we believe Gentex’s financial strategy will remain unchanged.

Bottom line: The cost-cutting and efficiency initiatives Gentex has implemented during these weak economic times will pay off in spades in the future when economic growth improves and auto production rebounds. Peak profits in the next up-cycle could easily hit $2.25 per share or more. If you tack on a very-conservative 15 P/E multiple (Gentex has historically commanded a P/E ratio above 20), that translates into a target price of $33.75, which amounts to more than 41% upside from the current price of $23.85.

Diamond Hill (Nasdaq: DHIL) filed its Form 10-Q with the SEC, which elaborated on its first-quarter financial results that had been released a week earlier. Revenue and earnings per share were both up 10% year-over-year. Book value per share and assets under management were up 8.6% and 13.0%, respectively. A good, solid quarter.

One of the things that had worried me in the company’s previous Q4 report were net outflows from its institutional accounts. Management’s explanation in the annual report (pp. 5-7) was that its portfolios had a heavy exposure to the energy sector and energy had underperformed, resulting in some client defections. As I mentioned in the April issue of Roadrunner Stocks, however, Diamond Hill’s portfolio managers turned things around during the first quarter and outperformed their benchmarks.

The result is that net outflows from the portfolios were much less during the first quarter, which is a good thing. In the sub-advised funds, outflows fell from $149 million in the fourth quarter to only $37 million in the first quarter, and in institutional accounts outflows fell from $499 million to $33 million. As was the case in the fourth quarter, investment performance more than outweighed the cash outflows, so that assets under management increased, which is what counts from an advisory fee perspective –  up 10% year-over-year (page 18 of 10-K).

Two interesting facts from the 10-K:

• Page 9: The company is almost doubling the dollar amount of assets under management that are subject to “incentive” advisory fees rather than flat advisory fees. This means that the company will earn more fees than the base percentage if the portfolios outperform their benchmark and earn fewer fees than the base if the portfolios underperform. This is good news if you have faith in the investment talent of the portfolio managers, and I do.
  
  
• Page 17: The “Small-Mid Cap” mutual fund experienced the largest increase in assets under management (up 54%). This suggests that investor demand for the universe of equities Roadrunner Stocks  focuses on is heating up, which is good news for stock-price appreciation in the small and mid-cap space. Looking at the relative performance of Diamond Hill’s mutual funds, the Small-Mid Cap fund is the best-performing fund in each of the 1-year, 3-year, and 5-year time periods, which speaks volumes about the attractiveness of this asset class over the long term.

United Therapeutics (Nasdaq: UTHR) offered investors good news in its first-quarter financial report. Revenues – the true measure of growth – grew 20% year-over-year and beat analyst estimates. Earnings were down, but the decline was totally based on non-cash charges – primarily share-based compensation that was more expensive due to this year’s higher stock price. Ignoring non-cash charges, earnings actuallyincreased substantially by 27.4%.

In the conference call, CEO Martine Rothblatt was very optimistic about the future and noted:

Tyvaso sales will end up surpassing Remodulin sales in the very near future to become the company’s primary product.

This is important because the company’s primary treprostinil product now for treatment of pulmonary arterial hypertension (PAH) – injectable Remodulin – loses patent protection in October 2014 and is the subject of a patent infringement lawsuit with Sandoz, the generic drug division of Novartis. In contrast, Tyvaso – the inhalable form of treprostinil — doesn’t lose patent protection until 2018 in the U.S. and 2020 in the European Union (page 43). Most people would prefer to inhale a drug rather than inject it, so Tyvaso is the superior product for those patients with less-severe symptoms who benefit from it.

CEO Rothblatt also said that the company’s developmental-drug “pipeline has never been stronger.” A promising new treatment for PAH involves placental stem cells, which the company is exploring with Israeli partner Pluristem Therapeutics. A Phase I drug trial began in April.

Despite having risen 24% since I recommended it in January, the stock is still trading at a very low price-to-earnings (P/E) ratio of 10 times this year’s earnings and has an extremely low PEG ratio of 0.30. I am confident the stock will soon surpass its all-time high price of $70.74 set in April 2011 – with room to spare.

Momentum Portfolio

HMS Holdings (Nasdaq: HMSY) posted first-quarter financial results that saw revenues up 8% year-over-year and earnings flat; both figures were below analyst estimates, In addition, the company reduced its fiscal 2013 guidance on both revenues and earnings by $75 million and $0.07 per share, respectively. The stock opened down on the news, but quickly recovered to finish up on the day as investors realized that the reduced guidance was almost entirely a timing issue and not a reflection of business fundamentals.

When the federal government is your primary client, you are subject to the political whims of the procurement process and government delays in issuing contracts and making payments is an unfortunate reality. The good news is that HMS will ultimately get all of the revenue it is expecting, but it is being pushed back into 2014. As CEO Bill Lucia explained:

We face a number of near-term uncertainties, the most significant of which relate to the extended delay in the Medicare Coordination of Benefits (COB) award resolution and the re-procurement of the Medicare Recovery Audit Contractor (RAC) contract, together with potential changes to that contract’s structure.

While either of these federal procurements may resolve in our favor, we do not have clarity around the timing or outcome of the resolutions. 

In other words, the reduced forward guidance is based on timing uncertainty and was made out of an abundance of caution. In the conference call, CEO Lucia said:

Most of the uncertainty around our business this year is a function of unexpected twists and turns in the Federal government procurement process, which we could not reasonably have anticipated. 

Analysts at Wells Fargo Securities are not concerned, stating that 90% of the forward guidance reduction is timing only:

Given that about 90% of the reduction in revenue guidance relates to the timing of when the two big Medicare contracts (COB and the re-procurement of RAC) ramp, we don’t believe the reduction in revenue guidance should be viewed as a material negative.

Significant tailwinds continue to exist for HMSY heading into 2014-15 (Medicaid expansion through reform, Medicaid RAC ramp, larger Medicare RAC territory, Medicare COB ramp and the potential to increase services around the Medicaid COB lives that have transitioned to managed care).

Clearing the decks and setting up for big growth in 2014:  The picture for 2014 looks bright with multiple drivers of an estimated 32% revenue growth and 38% EPS growth.

HomeAway (Nasdaq: AWAY) announced first-quarter financials that beat analyst estimates for both revenues and earnings. CEO Brian Sharples said that he was “thrilled” with the results. The stock fell on the news, however, because forward guidance for the second quarter was weaker than expectations. In theconference call, CEO Sharples explained that the lowered guidance was due entirely to a weaker Euro currency. HomeAway gets 36% of its total revenue from Europe, so a weaker Euro has a significant effect when translated back into fewer U.S. dollars.

Interestingly, Sharples said that the forward guidance actually includes an increased growth rate on a currency-neutral basis. The company’s fundamental business is stronger than ever!  Currency effects are meaningless and simply cloud the true earnings power of a business. While investors are dumping the shares, analysts are getting more bullish. Both JP Morgan and William Blair maintained their top buy ratings on the stock, and JP Morgan actually raised its short-term price target to $35 from $30.  Big growth drivers in the future are tiered pricing (lessors pay more for listing more prominently displayed) and a pay-per-listing option (expected to launch in the third quarter) in addition to the regular annual subscription option. JP Morgan sees the pay-per-listing option having a very positive effect on 2014 financial results and William Blair loves tiered pricing:

HomeAway is successfully demonstrating the ability to increase average revenue per listing (ARPL) through its tiered pricing initiative. Further, with tiered pricing only on one-third of eligible listings and a long-term target of about 60% penetration, there continues to be a multiyear runway for ARPL lifts as tiered pricing adoption increases.

I think the stock’s 9% selloff since the earnings release reflects a misunderstanding of the company’s future growth and presents a buying opportunity for those investors who don’t yet own the stock.

Ocwen Financial (NYSE: OCN) is one of the few companies that is able to report triple-digit growth in both earnings and revenues! In its first-quarter report, earnings per share rose 121% and revenues rose 147%. Earnings hit a record high, although missed analysts’ inflated expectations, while revenues beat expectations. The big driver of performance in the first quarter was the acquisition of mortgage servicing rights (MSRs) from Residential Capital on $269 billion worth of mortgages. The April acquisition of Fannie and Freddie MSRs on $84.6 billion worth of mortgages from Ally Bank will boost growth in the second quarter. The more MSRs, the more servicing fees – it’s as simple as that.

Even better, Chairman of the Board Bill Erbey said that the company’s increased operating expenses are temporary (expenses often go up temporarily when new mortgage portfolios are acquired) and should soon fall as a percentage of revenue, resulting in “better performance versus our original expectations.” Ocwen is a great stock to own as a portfolio diversifier because its business actually benefits from a weak economy and housing market – the more distressed homeowners feel, the more likely they are to need a mortgage loan modification, and Ocwen collects fees for such modifications.

Bottom line: With a super-low PEG ratio of 0.2 and full-year 2013 earnings expected to more than triple, Ocwen looks like an undervalued growth stock set to reach new all-time highs throughout the year. Hedge fund manager Steve Eisman, who was lauded in Michael Lewis’ book The Big Short for being one of the first and only people to predict — and profit from — the subprime housing crisis before it happened, spoke on May 8th at the Ira Sohn Investment Conference and ironically said very positive things about U.S. housing. His favorite investment idea in the housing space is Ocwen, which he calls “completely and utterly mispriced” (i.e., undervalued).  

I’m raising my valuation of the stock by 15% and consequently am also raising the buy-below price on Ocwen Financial from $40 to $46.

SolarWinds (NYSE: SWI) announced first-quarter results that were a mixed bag, but investors focused on the negative and the stock fell more than 14% on Wednesday May 1^st. On the positive side, quarterly earnings per share hit a record high, operating profit margin was the second-highest in the company’s public history, 53% year-over-year growth in transaction volume set a record, and revenues and earnings grew 22% and 37%, respectively. Quarterly earnings beat analyst estimates.

On the negative side, quarterly revenue missed analyst estimates, new license revenue grew only 12% — the lowest growth rate in 3 ½ years (since Q3 2009) – and revenue and earnings guidance for Q2 and full-year 2013 was slightly below analyst estimates. CEO Kevin Thompson conceded that:

Solid interest in many of our core products did not translate into the level of new license sales we anticipated and we did not deliver the level of new license sales and total revenue growth we expected for the first quarter of 2013.

The company is taking corrective action and Thompson assured investors that license growth would soon begin re-accelerating:

Our team is focused on continuing to grow our business quickly. We believe we have taken the appropriate actions and have the right demand generation and product strategies in place in order to accelerate our pace of new business growth while delivering a continued combination of strong profitability and free cash flow to shareholders.

Perhaps even worse than the disappointing first-quarter results was the company’s May 21st announcement that it was acquiring privately held N-able Technologies for $120 million in cash. Investors and analysts hated the news, sending the stock down a sickening 14% in one day. According to the analyst at Pacific Crest, who downgraded the stock to “Sector Perform,” the acquisition sends a “mixed message” because SolarWinds expertise is in “selling direct” to IT managers of individual companies, whereas N-able sells cloud-based monitoring services to a “middle-man” known as a managed service provider (MSP):

The customer base, integration of the acquisition and deal size is incongruous with prior acquisitions. SolarWinds is spending half of its cash on an incremental opportunity that pales in comparison to its existing market.

Similarly, the analyst at BMO Capital Markets was critical of the deal because it isn’t accretive and will actually reduce earnings per share this year by 11 cents. Furthermore:

The execution risk seems high given that SolarWinds is only retaining the one-third of revenues that N-able derived from subscription deals (two-thirds were from licenses and maintenance fees).

SolarWinds CEO Thompson admits that the acquisition provides no cost synergies or cross-selling opportunities. Investors like vertical deals that enhance a company’s core business and look less favorably on horizontal deals that simply expand business into new areas. That fact that SolarWinds is spending more than half of the $221.3 million of cash on its balance sheet to buy a company that provides no synergies with its core business suggests that SolarWinds’ core business has less of a runway for future growth than originally thought.

Bottom line: SolarWinds’ disruptive sales model generates best-in-class operating margins and reduces costs for its client base of IT professionals — which is the business model that succeeds in a low-growth economy. However, the acquisition of N-able’s unrelated business is troubling and one must question whether SolarWinds’ high valuation multiples (35.7 P/E and 23.5 EV-to-EBITDA) continue to be justified by future growth potential.

I’m lowering my valuation of the stock by 15% and consequently am also lowering the buy-below price on SolarWinds from $60 to $51.

Western Refining (NYSE: WNR) delivered first-quarter financial results that CEO Jeff Stevens called:

another strong quarter as we continued to build on the momentum of our outstanding 2012 financial performance. 

Quarterly earnings were up 16% but missed analyst estimates, whereas revenues were down 6.5%, but beat analyst estimates. A mixed report, but the revenue shortfall was caused to a large extent by a “turnaround” shutdown at the El Paso refinery for scheduled maintenance. The second quarter of 2013 looks better. CEO Stevens assured investors during the conference call that “our 2013 turnaround work is behind us.” Furthermore, Stevens said:

It has been a great start to the second quarter for Western. In April, we amended and extended our revolver, resulting in lower interest expense and greater financial flexibility.

Our Board declared a second quarter dividend of $0.12 per share and we continued to repurchase shares of Western common stock as we remain committed to returning cash to our shareholders. From the inception of our share repurchase program, through April 26, 2013, we have purchased approximately 8.1 million shares at an average cost of $29.56 per share. We have also begun operating the first phase of our Delaware Basin gathering system which will give us access to additional cost-advantaged shale crude oil in the Permian Basin.”

We established ambitious goals for 2013 and we are well on our way to accomplishing them. We continue to invest in high return capital projects while maintaining our commitment to return cash to shareholders.

I am very excited about the Delaware Basin project because it will further catapult Western Refining ahead of the competition in its ability to source cheap shale crude oil as foodstock for its refineries. Reducing its foodstock costs and refinancing its debt at lower interest rates will help the company withstand narrowing crack spreads. With crude oil inventories at record highs and gasoline inventories near average, the crack spread should start widening again soon, which will benefit refiners like WNR. The company’s plans to spin off pipeline assets into a tax-advantaged MLP, as well as to expand its El Paso refinery and export diesel to Mexico, should both enhance value even further and permit additional dividends and stock buybacks.

Credit Suisse also interpreted the financial report positively, upgrading the stock to “outperform”. Barron’s Magazine ranks Western Refining as the 8^th cheapest in its “Barron’s 500” list of high-growth, high-return companies. In 2012, the 30 cheapest stocks in the Barron’s 500 outperformed the S&P 500 over the ensuing 12 months by almost triple.