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Get Four
|  | NOVEMBER 19, 2003
By Eric Wahlgren This Fund's China Connection Pays Off Armada's Jon Scharlau says one-third of his holdings are in U.S. companies with exposure to the Asian giant. The rest are doing pretty well, too Thirteen years ago, when portfolio manager Jon Scharlau was a college student studying abroad in Beijing, most residents got around on bicycles. These days, the Mandarin speaker notes, a striking number of Chinese are tooling around the sprawling city in late-model automobiles. It's the kind of rapid economic transformation in the world's most populous nation that inspires the Armada Small Cap Growth Fund's (ASMIX ) investment philosophy: to seek U.S. companies that have exposure to the white-hot China market, where growth could top 8% in 2003. The fund, which Cleveland-based Scharlau took over in February, 2003, was badly in need of a new direction. The portfolio had underperformed most of its peers over the last four years. These mainly bear-market years were admittedly lousy for small-cap companies, as the small fry tend to be less diversified than larger corporations. But fund-tracker Morningstar blamed the fund's especially poor returns in the past on a heavy reliance on volatile technology and health-care stocks. So far, looking East seems to be working for Scharlau. The fund is up 40.03% year-to-date, slightly besting its peers and smoking the Standard & Poor's 500-stock index by 19.65 points. Of course, performance like this hasn't been too tough to achieve, given that this year's rally has largely been led by the small caps. The real test will come as the stock market rally broadens to other asset classes. Scharlau says his fund will not disappoint, contending that the small-cap companies his team has selected are well-positioned to benefit from a global economic recovery. His arguments appear to be resonating with investors. Money is flowing to the fund, with assets now totaling about $230 million, up from $170 million at the end of last year. In a recent chat with BusinessWeek Online Reporter Eric Wahlgren, Scharlau discussed his stock picks and investing philosophy. Edited excerpts of their conversation follow: Q: Why does your fund looks for U.S.-based companies with exposure to China. A: In college, I took Mandarin Chinese and studied in China, so I'm familiar with the region. You might not think that there's that much overlap between investing in small-cap stocks and China, but you can't ignore China. It has the best growth prospects over the next decade. Companies are moving operations to China. Companies in the small-cap space tend to be component suppliers to larger companies. It's extremely important that small-cap companies have a China strategy, or can address that huge market, or can move operations to China, to take advantage of that lower cost structure. About a third of our investments have a China connection. One company that comes to mind is ChipPAC (CHPC ). It's a back-end semiconductor-equipment company that packages and tests semiconductors. They have substantial operations in Shanghai. They see customers moving testing there because the cost structure is lower, so they wanted to be there. Another company is Merix (MERX ), which makes components used in sophisticated electronics like computer servers. They moved their more commoditized business to China because of the lower cost structure. What they've retained in the U.S. is their fast lead-time manufacturing operations. It's a lot easier to do business in China than it was in the past. Overall, we believe that companies that have an effective China strategy will have a lower cost structure and a higher growth rate. Q: What are some of the other stocks you like? A: On the retail side, we like Aeropostale (ARO ), a teen retailer. They've differentiated themselves by addressing the lower end of the market. They've shown nice increasing sales trends at stores open at least one year. They had a successful back-to-school season, which historically points to a good holiday season. It's expected to grow earnings per share 25% over the next three to five years. The chain currently has 400 stores. We think it can grow to 800 or 900 stores. They're also building brand awareness. It's trading at under 20 times 2004 fiscal year earnings, which is very reasonable. Another company we like is Manugistics (MANU ), the leading provider of supply-chain management software. They should do much better in an economic upturn. Industrial companies will come back and spend money. What many other companies will focus on is improving their supply chains. They're very leveraged to the recovery, and their valuation is still very reasonable. It's trading under two times price to 2004 sales, which is on the low end for software companies. And there's Radware (RDWR ), which makes Internet switches. This company has beaten estimates for the last three quarters. When corporate spending increases, they'll see a more dramatic increase. They have a reasonable valuation. We've found that a change in $10 million in revenues would yield an extra 60 cents in earnings per share, which is pretty strong.
BW MALL
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