Chuck Royce founded Royce & Associates in 1972. The fund employs a value-based approach to invest in companies with small market capitalizations. According to Royce, the core business of his company is small-cap value investment. Royce looks for small-cap companies that are underpriced relative to its enterprise value. Most stocks in Royce’s portfolio have market caps of lower than $5 billion.
Recently, Royce released his latest holdings through a 13F filing. We will discuss his most bullish bets and decide whether it makes sense for investors to purchase these stocks.
Nu Skin Enterprises Inc (NUS): NUS is the largest position in Royce’s portfolio. The fund reported owning $346 million worth of NUS shares at the end of last year. There were 11 hedge funds with NU positions at the end of the third quarter. Jim Simons’ Renaissance Technologies had $19 million invested in NUS. NUS announced in December last year that it had closed the transaction to acquire LifeGen Technologies LLC for $11.7 million. LifeGen is a genomics company that has been researching the genetic basis of the aging process. The acquisition will enhance NUS’s position in the anti-aging industry. NUS has solid financial statements with reasonable debt levels and growing earnings and revenue. It does not look very attractive compared with Avon Products Inc (AVP) though. NUS has a forward P/E ratio of 16.38 and its EPS is estimated to grow at 12.47% per year in the next five years. So its P/E ratio for 2014 is about 13, versus 9.4 for AVP.
Unit Corp (UNT): Royce boosted his UNT stakes by 3% over the fourth quarter. As of December 31, the fund had $335 million invested in UNT. Cliff Asness, Jim Simons, and Paul Tudor Jones are also among UNT investors. We see great potential in UNT too. The company has robust revenue growth and net income growth, as well as strong cash flow from operations. UNT also has attractive valuation levels. It has a forward P/E ratio of 10.58 and it is expected to grow at 17% on the average per year over the next five years. This indicates that the stock’s P/E ratio for 2014 is only 7.7. UNT is not the only energy stock with attractive valuations. Its main competitors, Nabors Industries Ltd (NBR) and Precision Drilling Corporation (PDS), are also trading at low multiples. Their forward P/E ratios are 8.92 and 7.11 respectively, with expected growth rates of more than 20%.
Lincoln Electric Holdings Inc (LECO): Royce also increased his position in LECO by 2% over the fourth quarter. At the end of last year, Royce had $324 million invested in LECO. Ken Fisher also likes LECO. Fisher Asset Management had $66 million invested in LECO at the end of 2011. The company recently announced that it is planning to spend $40 million in renovating its facility in Euclid, Ohio. LECO has a strong balance sheet and reasonable debt levels. Its total debt-to-equity ratio is only 0.08 and its long-term debt-to-equity ratio is zero. LECO also has solid revenue and earnings growth as well as healthy cash flows. On the other hand, the welding business is cyclical and there exists so many uncertainties in the global economy. LECO also looks less attractive compared with its peers when it comes to valuation. It has a forward P/E ratio of 16.24 and its EPS is expected to grow at 18.47% on the average over the next five years. So its P/E ratio for 2014 is 11.6. LECO’s competitor, Illinois Tool Works Inc (ITW), has a 2014 P/E ratio of 9.75. We prefer ITW over LECO.
A few other large positions in Royce’s portfolio include Reliance Steel & Aluminum Co (RS) and Teradyne Inc (TER). Both companies are trading at low multiples. RS has a forward P/E ratio of 10.70 and TER’s forward P/E ratio is 10.81. They are also expected to grow at around 10% per year in the next five years. Royce’s 13F portfolio is a good place to look for undervalued small-cap companies. Both of these stocks will have single digit 2014 PE ratios with double digit expected growth rates.