Small-cap stocks—and small-cap value stocks in particular—had a strong 4Q23, with the Russell 2000 Index up 14.0% and the Russell 2000 Value Index up 15.3%, respectively. But there are still attractively valued stocks to be found in certain areas, especially in industries that have seen recessions, where I like searching out well-run companies with strong fundamentals that make them likely to benefit in an industry rebound.

One area that fits this theme is home furnishings. The industry has been mostly sluggish following a boom during the Covid pandemic, when cocooned consumers were spending more on furniture and other home goods while supply chain issues held up deliveries. In this space, I like Haverty Furniture Companies, which has been in business since 1885 and sells mostly private brand furniture, décor, accessories, mattresses, and bedding. During the pandemic, they focused on more efficiently managing their stores by making their workforce more productive. They also concentrated on having designers in their stores, which usually results in larger customer purchases. Their stores are primarily in the Southeast U.S., which is a region with the kind of steady population growth that is favorable for a furniture business. In 2023, Haverty picked up dead store leases from Bed Bath & Beyond—which was in Chapter 11—in what the company thinks are desirable locations.

So, from an operational perspective, there’s a lot to like about the business. Financially, there is also a lot that I like. Haverty has remained profitable, positing respectable earnings in the face of lower demand—the stock trades at a P/E ratio of around 9.0x, which in my view is attractively low. The company has no debt, generates a lot of cash, and has paid special dividends in five out of the last six years. When its industry recovers, Haverty looks very well positioned to thrive.

In addition to some consumer areas, the industrial economy has also been weak, which has caused depression in the trucking sector, especially companies in less-than-truckload (LTL) transportation. LTL shipping describes freight that requires less than a full truckload trailer. In general, most LTL shipments weigh between 500 and 15,000 pounds, are shipped on pallets, and require only part of a trailer. In this space, I hold ArcBest Corporation, which is primarily an LTL shipper and has a brokerage business that arranges shipments and freight. ArcBest trades at a P/E of around 10.2x 2024 consensus estimated earnings, which compares favorably to its biggest competitors that trade at more than twice that P/E. In addition to the industry’s recession, ArcBest has a unionized workforce, unlike its major competitors. This creates a small structural disadvantage in its margins that I would expect to result in a somewhat discounted stock price —but the difference in P/Es between ArcBest and its competition looks much wider.

The liquidation of Yellow Freight in 2023 created a lot of displacement in the industry. Exactly how much of that ultimately flows to ArcBest remains to be seen against the backdrop of overall weaker demand for trucking companies. However, they are poised to pick up some of the volume from this displacement in addition to the business they will have when demand ticks up again. While I’m not expecting that recovery to occur soon, I suspect we’ll see improved demand in the second half of this year.

Certain companies in the homebuilding industry did well in 2023—but there is still a housing shortage in the U.S. that has not seen much if any improvement over the past 10 years. The Covid period also saw dramatic increases for many raw material input costs—lumber most impactfully—as supply chains were adversely affected. More recently, labor has gotten more expensive, and rising interest rates that led mortgage rates to rise have been another headwind. In this context, many of these companies have given buyers certain incentives.

These inducements historically took the form of upgrades like higher-end cabinets or countertops. In response to recent headwinds, however, many homebuilders have chosen to offer a more direct financial incentive in the form of offering mortgage buydowns, making monthly payments more affordable. There is a question as to how this incentive system may shift if rates fall. Regardless of what if any changes occur, however, the housing shortage is real and will take time to overcome.

I hold four homebuilders—two of which were top contributors in Royce Small-Cap Value Fund in 2023 as well as being top-10 holdings at the end of December: M/I Homes and PulteGroup. M/I Homes builds single-family homes primarily in the Midwest and Southeast U.S. The company has a low-debt balance sheet, steady cash flows, and strong earnings.

Perhaps counterintuitively, M/I received a lift from higher mortgage rates in 2023 as homeowners put off selling to avoid purchasing a new home at increased rates—which spurred demand for newly built homes for first-time home buyers. In addition to offering incentives, it has also reacted to headwinds by building smaller homes at lower price points. Despite its impressive performance in 2023, its stock was trading at roughly 8.1x earnings at the end of 2023.

PulteGroup builds homes all over the U.S. and benefited from this same dynamic in 2023. In my view, it is a premier company in its industry, with a management team that has a great record of effective capital allocation and that’s focused on shareholder returns. I also like that it builds a diverse set of homes—entry level, “move-up” homes, and older adult. Like M/I, it was trading at an attractive P/E at the end of 2023—roughly 9.1X—even after an impressive run in 2023.

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