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Father-and-son crew Michael and Phillip Cook dinner run a small portfolio of small-cap shares that has generated massive returns by discovering future family names.
By Sergei Klebnikov, Forbes Employees
What do a meals waste recycling firm, a constructing supplies producer, a distillery and a Western-wear retailer all have in frequent? At first look, not a lot. However based on a household duo of traders at Memphis-based SouthernSun Asset Administration, they’re three low-profile firms with sturdy enterprise fashions and conservative funds which can be positioned to flee the doldrums wherein U.S. small–capitalization firms discover themselves.
“One of many beauties of what we do is we discover firms that do nicely even in troublesome markets as a result of they constantly have a excessive diploma of flexibility on their steadiness sheet with a transparent plan to generate returns on capital, ” says Michael Cook dinner, 66, who based the agency in 1989 and right now runs it alongside his 41-year-old son, Phillip.
They need to know: Although it hasn’t been an ideal interval for small caps, the agency nonetheless boasts a superb monitor file, up 9.4% over the previous 5 years and 17.5% within the final three, in contrast with simply 3.3% and 6.7%, respectively, for the Russell 2000 index of small-capitalization shares. Michael and Phillip’s stellar efficiency has been powered by a portfolio of firms that embody the 4 talked about above: Darling Elements (DAR), Louisiana-Pacific Corp. (LPX), MGP Elements (MGP) and BootBarn (BOOT).
Whereas Michael Cook dinner spends most of his time researching firms, Phillip handles a lot of the day-to-day administration. They run two methods: the flagship SouthernSun Small Cap fund (SSSIX), and the small- and mid-cap, SouthernSun U.S. Fairness (SSEIX). Mixed, they handle over $1 billion of belongings for a mixture of institutional companies, company pension plans, household workplaces, high-net-worth people and foundations.
Most holdings within the agency’s small-cap fund have a market capitalization of $3 billion or much less, whereas the SMID cap technique usually invests in firms of as much as $6 billion. “That stated, we would not have a tough cut-off for when we now have to promote a enterprise as a result of we prefer to let nice firms develop inside our shopper portfolios,” says Phillip.
The flagship fund’s 21-stock portfolio is up greater than 10% this yr, outpacing the Russell 2000’s 8.8%. That comes on the heels of an excellent 2022, at the very least in relative phrases, when the fund ranked prime amongst its friends, based on Morningstar, dropping simply 1%—in contrast with drops of roughly 20% for the Russell and the large-cap S&P 500.
Whereas SouthernSun boasts a stable long-term monitor file since its inception, since deciding to collectively spearhead the crew eight years in the past, father and son have constantly outperformed their benchmark—usually by a rustic mile. They handle a low-turnover, concentrated portfolio of under-the-radar companies and goal to double their invested capital roughly each half-decade.
For the reason that small-cap mutual fund’s inception in 2003, it has posted an annualized return of 13%, outpacing the Russell and the S&P indexes.
Although it has fewer belongings, SouthernSun’s SMID-cap fund has had stable outcomes as nicely—with the technique up 15% this yr, greater than double its benchmark. Over the past 5 years, the fund has returned 9% on an annualized foundation, nicely above friends.
“We’re hooked on the concept of discovering modern firms that no one has ever heard of,” says Phillip Cook dinner. They need to maintain doing it, as their winners outgrow the fund’s light-weight class. “If it’s an ideal firm, we all know it received’t be a small cap ceaselessly.”
Amongst SouthernSun’s largest wins up to now are the likes of rural-supply retailer Tractor Provide (TSCO) and fluidics system producer Idex Company (IEX) again once they had been nonetheless small caps. At the moment the businesses are price $23 billion and $16 billion, respectively.
“We purchased Idex when the corporate was price lower than a $1 billion 25 years in the past,” remembers Phillip Cook dinner. SouthernSun purchased shares of Tractor Provide, in the meantime, in October 2002 at lower than $4 a share, ultimately promoting the place in August 2012 at round $48.
Tractor Provide is particularly “typical” of SouthernSun’s investing philosophy, say the Cooks, and is what they attempt to emulate when choosing new investments.
Michael Cook dinner knew the corporate from his youthful days elevating cattle. The native farmers co-operative “didn’t at all times have all of the stuff that I wanted,” he remembers. “I began going into Tractor Provide and was utterly intrigued by the extent of experience and the way they arrange the shop.” He remembers operating again residence to analysis the corporate after which first shopping for shares when the inventory worth fell after stories of a listing administration situation in 2002.
“The mannequin was lovely—it was an actual area of interest across the pastime farmer and rural life-style,” he says. Not solely did it have little competitors, however Tractor Provide was utilizing an efficient enlargement technique of shortly organising prefabricated shops subsequent to Walmart facilities. What’s extra, when rival High quality Shops went into chapter 11, Tractor Provide seized the chance to cherry decide from amongst its places. “That exponentially modified them from a Southeastern-dominated enterprise to a broader footprint, which accelerated their push west,” says Michael Cook dinner.
The “subsequent Tractor Provide” that the Cooks are betting on is Western-apparel retailer BootBarn, an organization with a $2.6 billion market cap and one of many latest additions to their portfolio. “Identical to Tractor Provide, it’s a misleading identify—they don’t simply promote boots,” says Michael Cook dinner. “The profile of the enterprise is so harking back to Tractor Provide: They’ve an actual development algorithm with out a lot competitors and a administration crew that is aware of the way to execute on its playbook.”
BootBarn will get an enormous benefit from its capability to capitalize on the rising Western and workwear shopper market. Primarily based in California, the corporate has been slowly but steadily increasing throughout the nation—with out a lot competitors from present mom-and-pop outlets—because it sees excessive demand for its country-lifestyle merchandise. “That creates a flywheel impact because the model will get extra nicely acknowledged,” says Michael Cook dinner, who additionally likes the excessive margins on the corporate’s store-owned product strains. BootBarn’s inventory has risen 40% this yr and now trades at almost $90.
“We search for area of interest dominance and firms that do nicely in powerful occasions,” says Phillip Cook dinner. “Our smaller, extra nimble firm universe is ready to adapt to quickly altering situations significantly better than giant caps.”
Michael Cook dinner began within the enterprise on the promote aspect, working for the belief division at a regional financial institution in Memphis within the late Eighties. “I used to be very dangerous, I wasn’t a salesman however I did love doing analysis—that’s the place my journey began,” he remembers. The 1987 inventory market collapse, referred to as Black Monday, was a curveball for his profession—by the next yr, together with lots of his colleagues, he acquired a pink slip.
Whereas he knew he wished to handle cash, Michael didn’t like the concept of relocating his whole household—with three babies—to a monetary heart like New York, as a substitute selecting to remain in Memphis and make investments small sums for household and pals. He based SouthernSun in 1989 with “no expectation of making an investing behemoth.” As an alternative he centered on buying high quality firms for his modest portfolio.
“We spent the primary 15 years in whole obscurity,” says the elder Cook dinner. “Within the midst of all of it, I had the chance to essentially hone my craft and start to know what makes companies nice over lengthy intervals of time,” he provides. “I got here in with a longer-term-oriented philosophy that was very a lot knowledgeable by watching my father and grandfather’s industrial building enterprise undergo feasts and famines.”
It was after the flip of the millennium when he started to broaden the agency that he added a number of companions to run the enterprise with him in addition to including his son to the funding crew in 2006. Phillip Cook dinner’s background was in non-public fairness, working as an analyst to the CEO of Trivest Companions, a Miami-based agency centered on middle-market leveraged buyouts. As he describes it, nevertheless, he was “turned off” by the flip-it mentality—with brief holding intervals for companies—within the trade.
“Whereas non-public fairness is way longer-term on common than public markets, it’s nonetheless not like household cash that owns a enterprise and runs it for many years—our strategy has that benefit,” says Phillip. When he joined SouthernSun as an analyst, he first helped construct out the newly launched international technique, residing and understanding of Madrid. He returned to Memphis in 2008, nevertheless, after the onset of the monetary disaster.
The worldwide technique that Phillip first labored on was later shuttered in 2020—after simply 15 years. “It felt like the fitting factor to do,” he remembers of closing the fund that yr, on the heels of the Covid pandemic. “We had been satisfied that we may extra successfully discover alternatives by concentrating the agency round a singular focus—smaller cap firms within the U.S.”
Considered one of SouthernSun’s hardest challenges got here in 2014 and 2015 throughout a extreme downturn for industrials. After dropping plenty of belongings—with some purchasers withdrawing cash as a result of underperformance, Michael shuffled the construction of the agency, elevating his son to supervise day-to-day operations and portfolio administration whereas he centered on funding philosophy. The dynamic shifted to 2 folks making choices from a 4 person-team that included Michael and his earlier companions.
The restructuring—with a extra streamlined hierarchy—paid off, as efficiency rebounded sharply within the following years. There have been notably sturdy returns in 2017 and 2019: 18.3% and 35.8%—in contrast with the Russell 2000’s 12% and 23%.
“For me, working collectively has been completely incredible,” says Michael Cook dinner. “As one may think, there are at all times occasions that it’d problem a relationship, however within the grand scheme of issues we’re very likeminded in so some ways.”
Phillip says that he and his father had some clashes within the years instantly following the restructuring however they finally labored issues out by each having humility. “My father gave me the liberty to vary issues, for instance—that wasn’t simple as a result of this agency is his child,” he remembers. Whereas Phillip helped construct out issues just like the back-office infrastructure of the agency and ran day-to-day investing, Michael was in a position to spend extra time researching firms.
“On the finish of the day, we had a standard horizon—we each believed we might be one of the best small-cap traders in america and that was one thing we wished to goal for,” he says.
Beyond the agency’s newest wager on BootBarn, the Cooks have lately added Louisiana-Pacific, which has a market worth of over $4 billion, to the portfolio. They like the corporate as a result of it’s a market chief in engineered wooden siding and associated merchandise, that are beloved by contractors and sometimes offered at retailers like Dwelling Depot. The corporate has made some good acquisitions that weren’t solely at cut price basement costs as a result of a competitor’s chapter but in addition eliminated competitor provide from the market, Phillip explains, whereas additionally citing Louisiana-Pacific’s low debt of $410 million—lower than lots of its friends—and ensuing capability to self-finance development.
The agency’s largest holding in each methods is Darling Elements, a food-waste recycling firm with a market capitalization of over $9 billion, which is on the bigger aspect in relation to the typical market capitalization of firms within the portfolio. SouthernSun purchased the inventory for near $4 a share in 2005 when the corporate was price simply over $200 million and has owned it since. The shares now go for $58.
One other prime holding for the 2 funds is Dycom Industries (DY), a specialty contractor for telecom and utility firms. SouthernSun first bought shares in 2017 and constructed out the place because the inventory fell in late 2019 and early 2020. Like among the fund’s different inventory picks, Dycom has successfully used a versatile steadiness sheet to make some good acquisitions and purchase again inventory, based on Phillip Cook dinner.
SouthernSun Small Cap Fund (SSSIX) Prime Holdings:
Dealing in broadband infrastructure, the corporate is a market chief in relation to constructing networks for main telecom, cable or utility firms. “They’re the picks and shovels that get that work finished,” provides the youthful Cook dinner, who says the corporate paid a “low-cost a number of” for the acquisition of rival contractor Bigham Cable Building final month.
The Cooks additionally like distillery MGP Elements, which they’ve owned since 2020. A number one producer of American whiskey and bourbon in addition to meals elements, MGP has a clear steadiness sheet, excessive insider possession and a monitor file of good dealmaking, based on Phillip Cook dinner. He likes the corporate’s dominant market share promoting white-label merchandise to craft manufacturers everywhere in the U.S., however what is especially thrilling to him is MGP’s plans to promote its personal line of drinks at retail with higher margins. What’s extra, the specialty-ingredients enterprise has additionally proven stable development in areas like plant-based protein, he says. “It’s two nice companies in a single, each rising on their very own accord however hitting on completely different themes within the shopper market that don’t essentially transfer in line with one another.”
In relation to the broader market, father and son are unfazed by struggling small caps. “Even when we proceed in a higher-inflation atmosphere the place charges are meaningfully excessive, the companies that we like can generate money internally and usually attempt to reap the benefits of tougher intervals,” says Michael Cook dinner. “Belief me, I’d be joyful if inflation got here down and charges began dropping once more—that’s fantastic for small caps basically, but when that’s the way in which it goes it nonetheless performs very a lot into our wheelhouse.”
Phillip Cook dinner is adamant that all the pieces is lining up nicely for the small-cap universe. “Valuations look good—the hole between giant and small caps is at ranges which we haven’t seen because the dot-com period, which factors to a reversion of the imply and robust potential returns for small caps going ahead.”
He factors out that between February and Could, the Russell 2000 index had 4 straight down months, which has solely occurred 9 occasions earlier than. In all however one out of the earlier cases, common annualized returns going out one and three years had been 20% or extra.
“All of those reversions to the imply actually recommend that on the very least, folks needs to be taking income from mega cap shares and placing some further {dollars} to work in small caps,” he provides.
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