Sometimes the best offense is a great defense — when it comes to investing as well as football. And with many stocks having reached new highs recently and still sporting elevated valuations — even after the current panicky selloff — investors should consider practicing a little defense.
One idea gaining resonance is to identify disruptive innovators with a better mousetrap that can gain market share at the expense of the competition.
“Companies with a proven record of innovating to success and disrupting the prevailing business paradigm offer investors a pathway to protection in the event of a stock market correction,” said John Maloney, chief investment officer at M&R Capital Management in New York. “Disruptive innovation, which is about much more than just technology change, can come in many shapes and sizes. And as achievers of secular growth, these disruptors have the ability to power through the ups and downs of the market,” argued Maloney.
To illustrate, here are three nontech stocks generating market share gains in the areas of manufacturing, telecom and entertainment. They are Trex (TREX), GTT Communications (GTT) and Chicken Soup for the Soul Entertainment (CSSE).
With a market cap of $3.2 billion, Trex manufactures deck boards and railings for the wood-alternative outdoor decking industry. Trex’ composite decking is essentially a replacement market, since few, if any, new homes are built with these more expensive outdoor living spaces.
Trex is the market leader in composite outdoor decking, and its management is on a quest to replace wood decks across the U.S. and globally with “green” decks that are 95 percent made of recycled wood and plastic materials.
Trex is one of the country’s largest recyclers of commercial polyethylene, carting tons of plastic wrap and bags to its manufacturing plants in Winchester, Virginia, and Fernley, Nevada, where the recycled wood and plastic material is extruded into decking boards. Trex deck boards are the only ones made largely of recycled materials and 100 percent made in the U.S.
Homeowner demand for Trex decks is burgeoning, despite the fancy price points, because they require little or no maintenance. Wood decks, on the other hand, can need annual cleaning and restaining. And then there’s the expense of replacing warped and damaged boards. According to contractors, over a deck’s lifespan, a wooden deck’s cost is five times greater than that of a Trex deck.
Based on industry data, Trex gained 4 percent additional market share of the residential composite market from 2014 to 2016. According to Trex, its market share gains continued in 2017, and it expects them to do so again in 2018.
This growth has come at the expense of other composite deck companies and the wood deck industry, which represents about 82 percent of the total decking market. Each one-point increase in market share equals $50 million in new revenues for Trex. And while the U.S. represents the vast majority of revenues, international sales have been increasing, with a particular focus on Europe and Australia.
In the third quarter of 2017, ended Oct. 30, Trex reported net sales of $140 million, an increase of 32 percent over the same quarter one year ago. Net income was $20.1 million, or 68 cents per diluted share, as compared to $7.8 million, or 26 cents per diluted share, in the third quarter of 2016.
“Through disruptive innovation, Trex has established an economic and brand moat that competitors, including the wood deck industry, find increasingly flummoxing,” said one portfolio manager and long-time Trex investor who requested anonymity due to his firm’s compliance policy. The stock closed yesterday at $108.41 a share. It was down 1.7 percent ($1.85), much better than the S&P 500’s 4.1 percent tumble on one of Wall Street’s worst days ever.
In the telecom arena, GTT Communications is credited with smart investments in the fast-growing and lucrative market for cloud networking services that support a customer base composed of large corporations with substantial information bandwidth requirements.
Competitors, such as Verizon (VZ) and AT&T (T), are viewed by some savvy investors as legacy telecom networks with technology ill-suited to today’s robust bandwidth needs and led by managements who have become distracted from the core telecom business by pursuing acquisitions of content companies, like Yahoo and Time Warner (TWX).
For instance, Walter Piecyk of investment firm BTIG, who has a “buy” rating on GTT, noted that Verizon’s global enterprise business declined by over 5 percent sequentially in the third quarter of 2017, after posting declines of 1.7 percent in each of the preceding two quarters.
In contrast, Piecyk recently raised his target price on GTT, which has a market cap of about $2 billion, to $50, following the issuance of third-quarter results. GTT reported revenue growth of 51 percent, to $198.9 million, and adjusted EBITDA increasing by 75 percent to $56.2 million. The stock closed yesterday at $43.25, down 2.8 percent, or $1.30.
GTT’s disruptor advantage is providing multinational corporations with a better way to reach the cloud through a suite of networking services that include optical transport, wide area networking, internet, voice and video support services.
With no legacy system to support, GTT’s cloud network points of presence (PoPs) are housed in the leading data centers worldwide hosted by major cloud providers such as IBM Cloud (IBM), Amazon Web Services (AMZN) and Microsoft Azure (MSFT).
Disruptive innovation has also been quite apparent in the major TV, media, cable and broadcast companies, including 21st Century Fox (FOXA), Time Warner, Sky and Viacom (VIA). For instance, Walt Disney (DIS) has recently reached an agreement to acquire Twentieth Century Fox’s entertainment assets. Fueling the economic disruption has been the digital revolution, with video streaming supplanting the TV networks’ linear programming model of fixed-schedule shows.
The obvious beneficiaries have been companies like Netflix (NFLX), Apple (AAPL) and Amazon. These stocks all boast huge valuations that even the most optimistic bull might find too rich.
So sometimes it’s better to discover the next future Netflix, and one favorite of some professional investors is Chicken Soup for the Soul Entertainment, which trades on the Nasdaq Global Market.
“Chicken Soup for the Soul Entertainment is premised on a new business model, with built-in profits, that provides TV channels with free or very low-cost quality content,” noted Lisa Thompson, who covers the company for Zacks Investment Research. “Since these shows are paid for by advertisers in advance of production, and producers are hired on a flat-fee basis, the company already has a profit locked in before production starts.”
Chicken Soup’s first TV series was “Hidden Heroes,” which is now airing on The CW Network, a broadcasting joint venture of CBS (CBS, and the parent company of CBS MoneyWatch) and Warner Bros. Entertainment, a division of Time Warner. In 2016, Chicken Soup’s second series, “Project Dad,” began to air on the TLC Network and Discovery Family.
In December, Chicken Soup’s third show, “Vacation Rental Potential,” premiered on the A&E Network. Sponsored by Expedia’s (EXPE) HomeAway, a well-known online platform for the vacation rental market, this show provides advice and guidance as buyers consider pricing, location and design options to locate a vacation home.
According to Zack’s Lisa Thompson, Chicken Soup “has disrupted the industry model by finding sponsors who fund the entire production cost in return for having their product, service or message, highlighted and integrated, thus allowing CSSE to offer this content free to networks.” She also pointed out that the company “may require the sponsor to pay $3 million-$4 million for a 12-20 episode series.”
Once produced, the show is licensed to the network, which generates fees by selling ad time. Chicken Soup retains the ownership rights, enabling it to realize other revenue by streaming the content online, selling rights overseas or offering the show to another streaming service, such as Netflix.
Last June, Chicken Soup signed entrepreneur celebrity Ashton Kutcher to serve as executive producer for two new TV series, expanding a relationship with the company that started with an exclusive distribution agreement with APlus.com, a digital media company Kutcher founded.
And in November, Chicken Soup purchased for about $5 million Screen Media Ventures, whose business operations include a film and TV content library, a content distributor and an online streaming platform, with an appraised value of over $31 million.
Chicken Soup is expected to post 2017 revenues of about $18.6 million and earnings of 42 cents a share. Zack’s Thompson, who has a $23 target price on the stock, is forecasting 2018 revenues of $36 million and earnings of 70 cents a share. The stock closed yesterday at $9, down 3 percent, or 28 cents.
