Shelter From the Storm

L.A. Companies’ Shares Outperform Broad Indexes

By ANTHONY PALAZZO

Staff Reporter

Stocks are falling all over the place, but L.A., it seems, has an umbrella.

All the major indexes are in negative territory for the year, as improvements in the national and local economies haven’t been enough to offset the effect of international instability and a growing list of accounting scandals.

Yet the LABJ 200 Index, made up of the largest public companies in Los Angeles County, has held up better than the others, remaining only slightly lower than where it was on Dec. 31.

As of June 6, the LABJ 200 was down 2.5 percent since year-end 2001. Meanwhile, the Dow Jones Industrial Average was down 4 percent, the S & P; 500 down 10.4 percent, and the Nasdaq composite index down 20.3 percent year-to-date.

Why is L.A. doing better?

In part, it’s thanks to the local economy, which avoided the deepest impact of last year’s recession. That has helped local lenders, homebuilders and real estate companies some of the region’s strongest year-to-date performers show continued profit gains through the slump. It also has helped theme parks like Walt Disney Co.’s Disneyland fill up with locals despite low tourism arrivals from outside the region.

Also, there’s the make-up of many of the companies on the roster of L.A.-based stocks a smaller, steady-growing group in a diverse lineup of industries including apparel, aerospace and manufacturing. Those sectors have done well, and the region has avoided reliance on telecommunications and technology that has hurt Boston and the Bay Area.

Sunny days

Finally there are the intangibles, even including the weather, that have kept Los Angeles an attractive destination for talented people from points East despite well-publicized drawbacks to the region’s business climate.

“There are no snow days,” said Steven Nichols, chairman and chief executive of K-Swiss Inc., the Westlake Village-based athletic shoe maker. He recruited his top vice presidents for marketing and product development from the East Coast. “I grew up in New York, and we closed down plenty of times because of snow. You don’t get that (here), and it’s a big advantage.”

K-Swiss’s stock is up 28.8 percent this year, but Nichols points out that it has logged a 47 percent compound growth rate over the past five years. “Things have been going OK for a while,” he said.

Indeed, the broader stock category that most closely resembles L.A.’s roster of public companies is “small-cap value” generally defined as companies with stock market values below $1 billion or $1.5 billion, producing generous cash flows.

It is also a category that happens to be in vogue, now that many of the high-growth investments of the 1990s have backfired. The Russell 2000 Value Index, a commonly used gauge of the category, was up 5.1 percent for the year through June 5.

“People are getting tired of the Enrons or the Global Crossings. They’re too complicated,” said Tom Kerr, portfolio manager for Reed Conner & Birdwell LLC in Los Angeles.

L.A. produces these companies for a number of reasons. The oft-noted entrepreneurial character of the region and a regulatory and tax climate that discourages large companies from relocating here keeps ambitious growers from remaining. Throw in the occasional power crisis, and L.A. ends up with lots of small, steady-growing companies with stable management teams and shareholder bases.

“A lot of these small-cap companies are still run like family-owned businesses,” Kerr said. “They take a lot of pains and a lot of care not to destroy what their families have built up over the years.”

Reed Conner has a value-oriented investment style that isn’t geographically limited. But since the firm likes to get to know management of companies it invests in, it finds a fair portion of its investments within California, Kerr said.

He mentioned restaurant franchiser IHOP Corp. (up 14.8 percent year-to-date), veterinary chain VCA Antech Inc. (up 13.4 percent) and aluminum wheel maker Superior Industries International (up 13.8 percent) as examples of conservatively run local companies that are still trading at reasonable prices, despite the small-cap value sector’s run-up.

Recession sidestep

L.A.’s stocks also get an assist from a local economy that, unlike the recession of a decade ago, avoided the worst effects of the latest downturn.

Rising home prices allowed local homeowners to take cash out of their homes through refinances, cushioning the impact of the slow economy last year, said Steven Cochrane, senior economist at Economy.com in West Chester, Pa.

Spending by these borrowers helped prop up consumer-dependent local industries, such as apparel, automobile parts and manufacturing of such products as toys.

In fact, local banks can be seen as a proxy for the local economy, said Lloyd Greif, president and chief executive of Greif & Co., a downtown investment bank.

Unencumbered by far-flung operations that characterize the nation’s largest banks, the 20 financial services firms in the LABJ 200 contain only two whose stock prices were negative year-to-date as of June 5. Compare that result with some of the largest East Coast financial services firms: Citigroup Inc., down 15.4 percent; Merrill Lynch & Co., down 21 percent; JP Morgan Chase & Co., down 3 percent. (Two national banks with large West Coast operations, Bank of America Corp. and Wells Fargo & Co., are both in positive territory.)

The strength of the local economy, the strength of real estate lending, and a ongoing interest in acquiring local banks by outsiders will continue to support local bank stocks, Greif said.

National support

A broader economic upturn is helping some companies. Recruiting firm Korn/Ferry International, which fell outside of its bank-lending covenants last year when large corporations stopped hiring, was able to extend its current loan facility through November.

The firm has seen a turnaround in hiring trends during the first quarter, said Daniel Margolis, director of marketing communications, and is close to finalizing a new lending agreement to replace its old line. Its stock is up 4.9 percent for the year.

Notable for their absence in the L.A. landscape are some of the worst hit industries, such as energy traders, major technology companies and makers of basic commodities such as chemicals and textiles, Cochrane said. “Those industries are suffering either because of international competition, low prices or abundant supply.”

While aerospace is still a mixed bag, with defense doing well and commercial aerospace such as satellites doing poorly, international trade is beginning to pick up, Cochrane said.

His view was seconded by Benjamin Hong, chief executive of Nara Bancorp Inc. (up 51 percent year-to-date). An improving economy in Korea has helped Nara’s customers on many levels, he said. Trade with Korea, which has been off for about a year, is reviving, and tourist and business travel is increasing.

“I don’t know about Japan yet, but China is OK, Korea is OK,” he said.

Of course, Los Angeles has had its share of disaster stories. Global Crossing Ltd., based in Bermuda but run from L.A., is the biggest example, but there have been others caught up in accounting controversies, such as Homestore.com Inc. and Gemstar-TV Guide International.

There is no guarantee there won’t be more. In fact, there likely will be.

Oversight increasing

After a slow start, regulators of all stripes are beginning to focus on earnest on all sorts of financial misdeeds. “We have more financial fraud investigations pending in the office than we ever had,” said Randall Lee, head of the SEC’s L.A.-based Pacific regional office, covering nine states. “It remains our highest priority.”

The SEC is focusing on not only people inside of companies, but outside advisers, such as auditors. “I think you will see this office in the coming months bringing a number of important and high-profile cases,” he said.

It’s fair to expect most of those cases to be conducted in Silicon Valley, where the SEC recently initiated cases against three technology companies, Lee said.

While regulators tend to focus on the largest companies due to resource allocation issues, Kent Graham, a corporate governance specialist and partner at O’Melveny & Myers, said he doesn’t think the accounting problems are as widespread as they appear. There will be a wash-out period, he said, but “I think the worst will be over relatively soon.”

Hot Stocks. Here are some of L.A.’s best-performing industry sectors, year-to-date:

– Aerospace & Defense, up 21.2 percent: Once L.A.’s dominant industry, now it has 80,000 fewer jobs than motion pictures, according to a recent report by the Center for Continuing Study of the California Economy. The companies that remain, led by Northrop Grumman Corp. (up 18 percent), are more profitable.

– Apparel, up 20.2 percent: Led by clothing company Cherokee Inc. (up 89 percent), sector participants including Skechers U.S.A. Inc. (up 44 percent) and Hot Topic Inc. (up 29 percent) have ridden the popularity of cost-conscious, trend-aware shoppers.

– Construction & Engineering, up 14.4 percent: Low interest rates and pent-up capital fleeing stocks has helped homebuilders KB Home (up 24 percent) and Ryland Group Inc. (up 44 percent) post sizeable earnings gains.

– Financial Services, up 15.4 percent: Local banks, benefiting from L.A.’s better-than-average economy, have found believers on Wall Street. Earnings have been strong all along, but price-earnings multiples the price investors will pay for those earnings have improved.

– Health Care, up 28.4 percent: The two big HMOs that dominate the local index, Health Net Inc. (up 29 percent) and Wellpoint Health Networks (up 29 percent), have found ways to raise rates.

– Miscellaneous Manufacturing, up 29.2 percent: Toy makers Mattel Inc. (up 21 percent) and Jakks Pacific Inc. (down 9 percent) make up a fair share of this hodgepodge category. Big gainers also include Dole Food Co. (up 17 percent), Avery Dennison (up 10 percent) and Farmer Bros. Co. (up 31 percent.)