Manager CommentaryThe month of January was a disappointing one for the micro cap market with the Russell Micro Cap Index down 10.4%, in-line with the decline in the broader small cap market. Over the past twelve months, the Russell Micro-cap index has fallen 42.2%, and valuations have likewise compressed.
Punch Micro Cap Partners, LLC (PMCP) fared much better than the broader market inJanuary, declining only 1.4%. Although the fund had no short positions in the month, our cash balance at month-end was 24.2%. Going into year-end 2008, we had been becoming more concentrated in the number of our holdings in anticipation of a difficult fourth quarter for many micro-cap companies.Through January 31st, we have heard from a dozen portfolio companies as to how their sales and earnings shaped up in 2008. On average, revenues increased 10% from the year earlier, andearnings increased 16%. We are deploying capital into those companies in whose earnings wehave the most confidence for the coming year(s).
Looking ahead to the rest of the year, we are anticipating that this recession will take many by surprise as being longer and deeper than current consensus expectations. That being said, there are a number of micro-cap companies that we anticipate will end the year with higher sales and earnings, among them:Neogen Corporation ($350 million market cap) develops and markets diagnostic tests used to ensure food and animal safety. With leading market share in most of its niche product markets, Neogen has increased its sales in 63 of the past 68 quarters and has been profitable for 59 consecutive quarters. We met senior management of the company several years ago and were impressed by a number of things: first, they had been with the company since its founding twentysix years ago and had an enviable track record of developing and acquiring product lines consistently and profitably.
Second, a significant portion of the company’s sales is predictable; recurring consumable test kits must be purchased every time a test is run. Finally, a more complex and global food supply chain coupled with recent high-profile salmonella food scares increase both the need for and the focus on Neogen and its products.
American Caresource Inc. ($100 million market cap) provides ancillary healthcare services to large healthcare payors and plan sponsors. The company negotiates pricing between payors and its own network of labs, dialysis centers, surgery centers and other out-of-hospital healthcare providers, allowing payors to both reduce their cost-of-care and offload some of their administrative burden onto American Caresource. We came across the company early last year, and after several conversations with the company’s CEO, we learned that cost containment is the fastest-growing trend in the healthcare industry today. We also learned that the company’s large contracts are made up mostly of predictable, recurring fees, and that the backlog of potential customers would likely double the company’s revenues this year and next. The stock turned out to be the best-performing NASDAQ stock in 2008.
H&Q Sustainable Maritime Industries Inc. ($85 million market cap) is the largest producer of tilapia in the world with operations in Hainan, China. After significantly building out its farming and processing capacity the past couple of years, the company today sells its products into Costco and Wal-mart under the “TiLoveYa” brand and is pursuing a relationship with McDonalds to replace pollock with tilapia in the restaurant’s fish filets. After posting disappointing sales and earnings in the second quarter of 2008 because of unusual weather in mainland China, we met with senior management and learned that the quarter was an aberration and that growth and profitability will accelerate over the coming year. The company has a solid balance sheet with $50 million in cash, and the business will likely generate $20 million in cash flow this year.
Many of the managers of portfolio companies we speak with are upbeat on the prospects for their businesses over the next several years. We share their enthusiasm and look forward to the prospects for micro-cap stocks from these depressed levels.
Thank you for your interest in Punch Micro Cap Partners, LLC.
CONTACT ANDREW MATYSIK 952-224-4350
