Investors often find value stocks attractive when growth starts to slow, regardless of whether things are slowing down or not. Either way, value stocks can be excellent additions to your portfolio if you know where to look.
In recent interviews with me, fund managers Anand Vasagiri and Beini Zhou of Artisan Partners and James Hollier of Silver Beech Capital presented their value stock picks for the fourth quarter of 2024. The Artisan team highlighted Despegar and Zuken, while Hollier chose WillScot and Flagship Communities.
Artisan’s International Explorer Strategy invests in non-U.S. small-cap companies, targeting “high-quality, undervalued businesses that offer the potential for superior risk-reward outcomes.” Silver Beech Capital takes a fundamental, long-term view, seeking “strong, but often misunderstood North American businesses with sustainable competitive advantages.”
Despegar
Despegar (BCBA:DESP) is an online travel agency that offers a platform for people to buy airline tickets, book hotels or purchase travel packages. Although it’s similar to Expedia and Bookings.com, Despegar focuses specifically on Latin America.
The company’s two main business segments are airline and travel packages, with airlines historically being the largest contributor. However, Despegar is prioritizing selling travel packages, which provide greater opportunities to add value and charge more, thus improving margins.
The Artisan team started researching Despegar before the launch of the Artisan International Explorer Strategy in 2020. At the time, the pandemic was ravaging the travel industry, so the company was trading at an extremely attractive valuation.
“Beini and I also liked the changes the company was making,” Vasagiri said. “The moves made it clear that Despegar was run by people thinking like owner-operators.”
For example, the Artisan team said management decided they would need lots of cash on the balance sheet to eliminate the risk of bankruptcy. They also noted aggressive cost-cutting measures due to the lack of revenue at that time and uncertainty around the duration and impact of the pandemic. Once management became sure Despegar’s future was secure, they used the excess cash to acquire other struggling travel agencies.
The Artisan team’s thesis hinges on the company’s strong management, which works consistently to build value, the moat afforded by its scale in the fragmented Latin American market, a robust balance sheet, and favorable structural and macroeconomic factors. Notably, Expedia currently holds a board seat at Despegar and a 12.5% stake in the company.
As far as risks, the Artisan team believes the biggest lies in execution due to the rapid evolution of the online travel agency industry. On one hand, Despegar’s scale and technological edge makes it difficult for peers to compete, but on the other, it must be “nimble, continuously evolving and building its brand.”
The Artisan team also said Despegar must remain focused on its growth trajectory. A drawback they have discussed with management is the company’s subpar cash conversion rates. The new CFO is taking all the right steps to better the situation, so the team expects improvement in this area.
Although Despegar stock has roughly doubled from where the Artisan strategy originally bought it, Vasagiri and Zhou continue to see further significant upside. They note that Despegar is essentially unchallenged in a minimally penetrated market, while its management team continues to make thoughtful business decisions.
Zuken
Zuken Inc (TYO:6947) is a software company that targets the electronic design automation space. It has four reporting segments: printed circuit board design, wire harness design, IT solutions and maintenance/ services.
Engineers use Zuken’s software to design printed circuit boards and cable wire harnesses, both of which are used widely in machinery and devices across a wide range of markets. The company sells software subscriptions and licenses to corporate customers, charging an annual maintenance fee on licenses to generate ongoing support revenue.
The Artisan team was drawn to Zuken because it satisfied all four of their stock-picking criteria: a good business with good management, a good balance sheet, and an attractive price.
First, Zuken has sizable market share in duopolistic or oligopolistic market segments that serve large enterprises. The industry also has a global secular growth tailwind with the continued emphasis on electrification and miniaturization.
Second, the Artisan team believes management is high quality due to its operational excellence and capital allocation. They said management has steadily improved Zuken’s operating margin from mid-single digits to near 13%, and Zhou and Vasagiri believe the company can further increase its margin.
The Artisan team is also glad the company has taken a sparing approach to M&A, engendering success in its targeted ventures. They also pointed out that Zuken has “bought back around 5% of its outstanding shares last year at a price we considered depressed, which was a great capital allocation move.”
Third, they pointed out that Zuken has a net-cash balance sheet.
“We are fine with what others might consider ‘lazy’ balance sheets,” the Artisan team said. “Leverage can kill a company in a downturn, and although having a clean balance sheet might not fully optimize our upside potential, it gives us downside protection as a margin of safety.”
Lastly, they consider Zuken to be extremely undervalued at a little over 7x EBIT or 10x to 11x P/E ex-cash.
“We see no reason why a globally competitive software business with a secular growth tailwind should not trade north of 14x EBIT or 20x P/E ex-cash,” the Artisan team said.
Of course, no stock is perfect. The biggest risk they see for Zuken is competition from Australia-based Altium, which is trying to shift from selling to small and mid-size enterprises to large ones. However, the Artisan team thinks the company’s position is fairly secure.
They believe it’s very difficult to break into selling to large enterprises from a focus on small and mid-size ones. The Artisan team said it’s “a different ball game” requiring a different selling motion with a different sales cycle and a fundamentally unique product architecture with more stringent security.
Additionally, if they could improve one thing about Zuken, it would be an increase in the company’s dividend. The Artisan team believes the company could significantly boost its payout ratio above 50% without endangering its growth potential. As a result, the team is in discussions with Zuken to “nudge them in that direction.”
WillScot
Willscot Holdings Corp (NASDAQ:WSC) is North America’s leading provider of portable and turnkey modular units and portable building space. The company has 85,000 customers spanning the industrial, government, education, infrastructure and natural resources industries. WillScot operates in two segments: modular units and portable storage.
Modular units are customizable as either standalone units or stackable structures and are typically outfitted with value-added products and services. On the other hand, portable storage containers are more standardized with configurable shelving or other organization solutions.
Leases for modular units usually last three years, while leases on portable storage containers are typically signed on a one- to two-year basis. WillScot drops leased units off at the customer’s worksite and then picks it up when the contract ends.
Hollier was initially drawn to WillScot when the merger with McGrath Rental Corp was announced in January 2024. The Federal Trade Commission immediately requested more information. Since Hollier had studied the equipment leasing industry for years, the FTC’s investigation drew his interest.
“At Silver Beech, we have found that companies the FTC investigates for antitrust reasons have a higher chance than average of being the sort of high-quality companies that we are interested in learning more about,” he added.
Hollier sees WillScot as a sort of “royalty on growing North American construction and infrastructure spend.” He said the company is the “customer favorite and the clear leader in its mission-critical, specialty equipment leasing niche with over 50% market share.”
Hollier also sees minimal technological and obsolescence risk. Further, he believes WillScot is benefiting from favorable industry dynamics like growing construction and infrastructure spend, growth in the construction rental equipment industry, and outperformance in the specialty rental segment of the construction rental equipment industry.
“Over the next five years, I believe WSC will efficiently grow its top line by a 7% CAGR, operating earnings by an 8% CAGR, and normalized earnings power by a 10%+ CAGR,” Hollier added. “The company is no stranger to such growth; between 2019 and 2023, average rent per unit for WillScot’s modular fleet grew at a 16% CAGR, and this strong rent growth occurred as fleet utilization declined by a cumulative 10% over the same period.”
Although many investors dismiss WillScot as cyclical, he believes the company is less cyclical than it appears. Further, while the company has more leverage than the market would like, Hollier believes it is well managed.
He sees potential upside for WillScot to about $54 a share.
Flagship Communities
Flagship Communities (OTCMKTS:MHCUF) is a real estate investment trust that owns and operates 81 manufactured housing communities spanning over 15,000 lots. The company leases individual lots with utility access to customers for the placement of manufactured homes.
Hollier was first drawn to Flagship Communities due to his expectations for execution.
“Over the next five years, I expect the company to expand its normalized free cash flow per share at a 12%+ CAGR by executing on a capex-light, occupancy-driven growth playbook,” he said. “The company has executed well on this same playbook over the last four years.”
Hollier expects Flagship Communities to trade at a free cash flow yield in the high single digits, while its larger peers with less projected growth are trading at a 30%+ premium valuation to Flagship.
He isn’t usually drawn to REITs because REIT investors have a lower cost of capital than Silver Beech and are usually priced efficiently. Additionally, he said many REITs are just a directional bet on interest rates.
However, Hollier likes Flagship Communities because he sees years of forward cash flow growth based on the company’s strategy.
“Though real estate is not typically associated with fast-growing profits, Flagship is likely to grow unlevered profits at a 7% CAGR over the next five years, which should generate normalized free cash flow per unit growth of 12%+ per year over the same period,” he said. “I expect this growth to be capex light and occupancy driven as the company grows the occupancy of its portfolio from today’s 84% level to a stabilized level of ~95% in the next seven years.”
Further, Hollier pointed out that Flagship has been executing on this same playbook since its initial public offering in 2020, having boosted its occupancy rate from 79% then to 84% today. Same-store occupancy rates are even more attractive as multiple Flagship communities operate at over 95% stabilized occupancy levels.
As far as potential risks, Hollier noted that population growth at comparable REITs Sun Communities’ and Equity LifeStyle’s markets will be stronger than in Flagship’s markets over the next decade. However, he added that it isn’t necessary to own the highest-quality assets to earn the highest investment returns.
Hollier expects Flagship to outperform Sun and Equity LifeStyle stock over the next five years due to its growth prospects and the potential to acquire new assets that larger institutional players can’t own.
Hollier sees an intrinsic value of over $20 per unit for Flagship Communities.
Long-term outperformance of value stocks
While the growth-versus-value debate won’t be ending anytime soon, there’s no denying that value stocks outperform growth stocks over the long term. Going back to 1927, the average annual outperformance of value over growth in the U.S. has been 4.4%, according to one estimate from Dimensional Fund Advisors.
As a result, it makes sense to dedicate a portion of your portfolio to value over the long term, utilizing a buy-and-hold strategy for the best of the best names.