A Hedge Fund's Picks for a Stronger Economy

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Richard S. Meisenberg is the manager and founder of ACK Asset Management, a hedge fund created in 2005 that specializes in small cap and mid cap equities. Before founding ACK Asset Management, Meisenberg was an analyst for small- and mid-cap stocks at Oppenheimer & Co. and Smith Barney. It’s no wonder, then, that Meisenberg’s fund focuses on these two market caps. A broad economic outlook, a long/short strategy, and an eye for catalysts are the mainstays of Meisenberg's strategy.

The following article reviews the fund's equity holdings as revealed in its 13F regulatory filing (you can view the entire portfolio here). Each of these companies occupies at least 5 percent of ACK Asset Management's 13F portfolio, and they all have market caps below $2 billion.

Emcor Group (NYSE: EME) is a construction and facilities services firm. The company specializes in energy infrastructure that operates about 70 subsidiaries and joint venture entities in the United States and the United Kingdom. In 2011, as the company notes in its annual report, 90 percent of revenues were generated from contracts initiated during the recession period. This likely explains why its 10.4% return-on-equity is below the BMI industrials average of 14%, in addition to the company's slim 2.3% net profit margin. After what ACK likely viewed as price depression induced by these sub-par figures, Emcor’s shares are up 12% year-to-date and are trading at 12.5 times forward consensus earnings.

Management correctly observes that it needs to grow top-line revenue in order for its “value engineering” and “labor management” measures, which only improve bottom line earnings, to have a lasting impact. We thus look for an improvement from the first half of 2012, where the company managed to expand revenues 6 percent while gross margins continued to contract. With its present valuation, we think Emcor has a potential for greater upside if it continues to broaden margins and revenue, the latter of which is closely tied to the broader economic picture.

After a strong start to the year, Dycom Industries (NYSE: DY) missed on both its earnings and revenues estimates for the second quarter and is seeing steadily shrinking margins. This telecommunications construction and maintenance firm reported $0.39 in earnings per share for the second quarter, which was $0.02 below S&P estimates. This comes several months after the company reported its highest historical quarterly earnings for the fourth quarter 2011. The market priced in this strong performance as shares rose to over $23.50 in the first quarter 2012, but they have since fallen to around $14 after the earnings slip.

Since the company has maintained negative free cash flow for both 2011 and 2012, we are cautious about the company's capacity to continue its share repurchasing program at the levels it has recently. That said, capital expenditures, particularly focused on improvements in the telecommunications infrastructure, have been the major free cash flow sink for the company. With its capex aligned in this way, we look for the company to take advantage of the long-term demand for telecommunications infrastructure upkeep.

Up 71% year-to-date, Capital Senior Living (NYSE: CSU) operates 84 senior living facilities with approximate 11,800 residents. The company has a growth-centered valuation, with shares trading at 38 times forward earnings. Additionally, the price/earnings to growth (PEG) of the company is 4 (closer to one is better), indicating that the company's P/E is about 4 times the company's estimated 5-year earnings growth. Generally, earnings growth should match P/E, so even as a growth stock, its shares looks expensive.

However, though Capital Senior Living might not be a bargain, it is still faring better than its peers in the senior living sector, many of which reported negative earnings thus far in 2012. JMP Securities has a price target of $18 for the stock, with shares presently trading around $14. This price target could be supported over the long-term by the aging of the Baby Boomer generation, which will increasingly populate senior living properties in the near future.

Rogers (NYSE: ROG) provides a number of materials for communications, transit, and defense infrastructure and maintains a clean technologies division. The company recently displayed its special circuit material, which increases overall performance of high-speed digital circuits, known as Theta. With materials and products like Theta, Rogers has managed to be a trendsetter in the 3G and 4G infrastructure construction. To quote the company's 2011 annual report, “Rogers’ advanced Printed Circuit Materials are essential to the ongoing global communications revolution, helping to ensure the high frequencies vital for 3G and 4G wireless networks, power amplifiers and high speed digital systems.” Given the obvious growth potential for 4G LTE adoption in the United States, and the significant room for growth in 3G adoption in the developing world, this is an excellent way to play 4G and 3G mobile proliferation without directly investing in either cell phone carriers or original equipment managers (OEMs).

Meisenberg's portfolio contains a number of industrial businesses that operate on thin margins and are relatively sensitive to market fluctuations (these top four holdings, about 24% of the portfolio, have a beta of 1.5 or higher). They all have, however, very specific ways of playing various secular growth patterns. In general, this is an interesting portfolio for those looking to bet on a strengthening economy.

This article is written by Brian Tracz and edited by Meena Krishnamsetty. They don't own shares in any of the stocks mentioned in this article.

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