While the L.A. economy was perhaps best known last year for its spectacular e-commerce flops, another group of L.A. companies was quietly pumping out big profits. As the e-world crashed around them, these mundane money-makers served up solid returns for shareholders. And that is making them attractive to today’s chastened investors.
“Institutional investors are looking for companies that can still grow, even when the marketplace has slowed down,” said Byron Roth, CEO of Roth Capital Partners. “It’s back to the old rule of looking for companies with at least three quarters of profitability.”
No single sector dominates this year’s list of most profitable companies, but the best-represented sectors are known for staid, steady performance real estate, retail/apparel, financial services and health care.
Topping the list with an 84.7 percent return on equity in fiscal 2000 is Intergroup Corp., a little known housing developer. Its sky-high ROE for the fiscal year ended June 30, 2000 was due primarily to its robust net income of $17.2 million ($8.75 per share), a dramatic reversal from a net loss of $1.4 million (83 cents per share) in fiscal 1999.
Investors, however, aren’t exactly flocking to Intergroup, possibly because of its tiny market cap ($32 million) and its uneven financial performance. Intergroup stock hit a new 52-week low of $16 a share this month, and last week was trading at $16.75.
The real torchbearers among the most profitable companies based in the Los Angeles area are those that also appear among the ranks of companies with top five-year ROEs. Leading the pack in this category is real estate developer Newhall Land & Farming Co. with a five-year average annual ROE of 49.2 percent. Guitar Center Inc. is No. 2 with an average annual ROE of 40 percent over the past five years. Amgen Inc. follows in the No. 3 spot with a five-year average annual ROE of 32.4 percent. Next is Gemstar-TV Guide International Inc. at No. 4 with an ROE of 31.9 percent, followed by Hilton Hotels Corp., which has a five-year average annual ROE of 28.4 percent.
It could be argued that these long-term performers, which together employ tens of thousands of workers in L.A., form the core of the L.A. economy.
“It’s a pretty good representation of L.A. companies,” said Greg Range, managing director of Duff & Phelps LLC. “They tend to show evidence of solid and sustained profitability.”
While they are stable companies, Range pointed out that, “they are not necessarily going anywhere fast. We’re not loaded with hot companies. (Today’s Los Angeles) is not Silicon Valley of 1999.”
That’s for sure. There are no Internet companies on this year’s list of most profitable companies. Without profits, of course, Internet companies don’t even have an ROE.
However, the technology sector including software, communications and computers is well represented among the top 50 companies, based on fiscal 2000 ROE. Eight tech companies made the list, including Optical Communications Products, MSC Software Corp., Learning Tree International Inc. and Semtech Corp.
The energy/utilities sector had a strong showing on this year’s list from large-cap companies like Occidental Petroleum Corp. (No. 7 with an ROE of 32.8 percent) and Unocal Corp. (No. 12 with an ROE of 26.6 percent).
Occidental and Unocal also delivered strong five-year average annual ROEs of just under 20 percent to investors.
Strength in retail
The retail/apparel sector had an auspiciously strong showing on this year’s list.
“Interest rate cuts and possible tax cuts tend to trigger consumer spending in retail and apparel,” said Liz Pierce, retail analyst with Wedbush Morgan Securities.
Skechers USA Inc., the Manhattan Beach apparel company, is No. 8 among the most profitable local public companies, with a fiscal 2000 ROE of 32.6 percent. Its three-year average annual ROE was an even more impressive 49.7 percent the fourth highest of L.A. companies.
Investors are strongly supporting Skechers’ stock, which has risen steadily despite volatility in the public markets. It was trading at around $28 per share last week, a few dollars below its 52-week high of $32.20 on Feb. 26 but more than triple its 52-week low of $8.50 a share last April.
Skechers has rising revenues and earnings that paint a pretty picture of a steadily growing company.
The company reported net income of $43.7 million ($1.24 per share) for the fiscal year ended Dec. 31, roughly double its net income of $19.8 million (62 cents per share) for 1999. Its 2000 revenues were $675 million, up from $424.6 million in 1999.
Another local company in the retail/apparel sector that has had a good run and is steadily delivering strong returns on equity is Hot Topic Inc. The City of Industry owner of teen-oriented mall stores ranked 17th on this year’s list with a fiscal 2000 ROE of 23.4 percent.
“They still have great organic growth and the potential to open new stores, and they don’t have any lateral competition,” Pierce said.
The company also does a good job exploiting the relationship between teens and music, a relationship that “does not seem to go away,” Pierce said.
Hot Topic, Skechers, Guitar Center and K-Swiss Inc. (No. 35 with a fiscal 2000 ROE of 17.5 percent) are examples of retail/apparel companies that became safe havens for investors fleeing battered Internet and tech stocks.
“The flight out of tech to retail began last year and was fueled by the interest rate cuts and possible tax rate changes,” Pierce said. “A company like Hot Topic has real earnings, no debt and they can fund their expansion internally. They also have consumers with spending power, which doesn’t hurt.”
Like Hot Topic, Guitar Center has had a great ride this quarter, hitting its 52-week high of $20 per share on April 11.
“Guitar Center’s business model is fabulous, and they have a strong market niche,” said Range. “They’re also growing.”
Tech and Internet companies have not fallen totally out of favor among investors and strategists, and the exuberance this time possibly more rational may very well return.
“Great technologies will be adopted and the capital markets once they stabilize will find reasons to invest in small companies with great technology,” said David Cremin, founding partner with L.A.-based Zone Ventures.
Cremin pointed out that the rate of consumer adoption of new technologies is accelerating dramatically, and that solid tech and Internet-related companies are therefore poised for a comeback.
“Now it’s time to be stabilized and to let common sense and research drive investing not fear,” Cremin said.
