Do small cap stocks like MATX make sense right now?

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As the new year gets started, I’m seeing a lot of analysts and experts talking about reasons the stock market should be able to continue following the upward trend that is now pushing into its eleventh year. If that is true, it becomes more and more tempting to start thinking about expanding our view of the stocks we pay attention to, so we can consider more useful investing opportunities. The temptation for a value-oriented investor is just as real, because even as the market pushes to new highs, you have to fight the temptation to jump on the bandwagon. That reality can make it harder to stay disciplined and selective about the actual opportunities you decide to work with.

The problem with that temptation isn’t really all that different from staying fully invested at the top of an extended bull market; nobody really knows if or when a reversal is going to come, and so the risk that you’re going to be wrong – in either direction – is incrementally higher at those extremes. It’s one thing to recognize that a stock might look like it carries a good value proposition, but quite another to be able to work with a reasonable expectation that the stock should be worth more in the long-term than it is today. Remember, sometimes a cheap stock is just a cheap stock, which means that sometimes the market is actually telling you all you need to know about the company when you see its stock trading at deep discounts.

Another temptation that is pretty easy to give into is to work with smaller companies, because they usually trade at somewhat lower prices than their bigger brethren, and when they pop, they often pop in a pretty big way. In and of itself, that isn’t bad, and I don’t mind admitting that when I find a small-cap stock with a good combination of fundamental strength and nice value, I don’t hesitate to find a way to work with it. The caveat, however for me is that both of those elements have to be working together. If they don’t both point in the same direction, I’ll usually put the stock aside and look for something else.

At the beginning of this week an interesting stock came across my desk via the different screening tools I like to use. Matson Inc. (MATX) is very likely not a stock you’re familiar with, because the company’s operations in the United States are limited to Guam, Hawaii, and Alaska, while the rest of their business comes from island economies throughout the South Pacific and Micronesia. This is a small-cap transportation company with a very specific niche, but that is down nearly 25% from its November 2018 high. Sounds tempting, right? Add to that the fact that the bargain case for MATX is very attractive, and you have exactly the kind of temptation that I’ve learned to approach very carefully. Should this stock be something for you to pay attention to? I’ll let you decide.

Fundamental and Value Profile

Matson, Inc. (Matson) is a holding company. The Company provides ocean transportation and logistics services. The Company operates through two segments: Ocean Transportation and Logistics. Its Ocean Transportation business is conducted through its subsidiary, Matson Navigation Company, Inc. (MatNav). MatNav is an asset-based business that provides ocean freight transportation services to the domestic economies of Hawaii, Alaska and Guam, and to other island economies in Micronesia and in the South Pacific. Matson’s fleet consists of approximately 20 owned and over three chartered vessels, including containerships, combination container/roll-on/roll-off ships, roll-on/roll-off barge and barges equipped with cranes. Matson’s Logistics business is conducted through Matson Logistics, Inc. (Matson Logistics or Logistics), a subsidiary of MatNav. Matson Logistics is an asset-light business that provides multimodal transportation services. MATX’s current market cap is $1.7 billion.

Earnings and Sales Growth: Over the last twelve months, earnings and sales both declined, with earnings down nearly -13.5%, and sales almost -3%. In the last quarter, earnings increased a little more than 95%, while sales improved by 2.55%. The company’s margin profile is narrow, but showing signs of strength; over the last twelve months, Net Income was 3.93% of Revenues over the past year and improved in the last quarter to about 6.32%. The quarterly number appears to be adequate for now, but it’s also worth noting that versus about a year ago, both of these numbers have declined. That appears to be a sign that costs are increasing, which could continue to be a stumbling block in the quarters ahead.

Free Cash Flow: MATX’s free cash flow is modest, but adequate at $85.2 million. That translates to a Free Cash Flow Yield of 5.04%.

Debt to Equity: MATX has a debt/equity ratio of 1.28. High leverage isn’t unusual in a lot of industries, and it isn’t categorically bad; however, when I consider small-cap stocks, high debt loads are another red flag. In the last quarter, the company reported $23.6 million in cash and liquid assets, versus a little over $1.02 billion in long-term debt. Liquidity appears to be an issue; given their narrow profit margins, there is very little room for error.

Price/Book Ratio: there are a lot of ways to measure how much a stock should be worth; but one of the simplest methods that I like uses the stock’s Book Value, which for MATX is $18.51 and translates to a Price/Book ratio of 2.08. Their average Price/Book Value ratio is 2.82, which means the stock is significantly undervalued, by about 33%. By contrast, however, the stock is trading about -16.5% above its historical Price/Cash Flow average. The two averages together offer a long-term target price somewhere between $32 and $52 per share. That’s a wide range between the two values, and since the lower end is below the stock’s current price, it doesn’t translate to a range that I believe makes the value proposition compelling.

Technical Profile

Here’s a look at the stock’s latest technical chart.

Current Price Action/Trends and Pivots: The chart above shows the last two years of price movement for MATX. Since the beginning of the year, the stock has dropped about -4.8%, and is a couple of dollars above the 38.2% Fibonacci retracement line. While the long-term trend, as shown by the diagonal red line on the chart, is up, the stock’s current momentum is decidedly bearish, which means that the stock is likely to continue dropping to test support around $36.50, inline with the 38.2% retracement line. Resistance is back at the stock’s most recent pivot high, which is also near its 52-week high a little above $42.

Near-term Keys: There could be some useful, short-term, momentum-based opportunities in the stock, depending on whether it finds support in the near term, or continues to follow its current momentum path. If it keeps dropping, there could be an opportunity to short the stock or consider buying put options with an eye on $36.50 as a quick-hit profit target. A pivot low, followed by a rebound higher anywhere between the stock’s current price and $36.50, however, could offer a useful signal to think about buying the stock or using call options to ride bullish momentum back to the stock’s last high around $42. While MATX’s fundamentals are generally solid, I don’t believe the stock offers a compelling value at its current price. I would prefer to see Net Income, Free Cash Flow, and available cash improve as well as to see a material reduction in debt before I take the stock’s value proposition more seriously.

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