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George Henning of Pacific Advisors Small Cap Fund

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Quick Take: In managing the Pacific Advisors:Small Cap Fund/A (PASMX), George Henning holds a concentrated portfolio of small companies. He focuses on undervalued stocks of companies he thinks have the potential to grow profits and sales by at least 10% to 15% over two to three years. To gain entry to the fund, a company also has to have a business plan that Henning judges to be sound.

Henning guided the $10.2 million fund to a total return of 83.2% last year, well ahead of the average small-cap value fund, which gained 42.3%, and the Standard & Poor’s 500 index, which rose 28.7%. For the three years ended in December, Pacific Advisors Small Cap returned 14.3% on average, while its peers advanced 12.6%, and the index retreated 4.1%.

The Full Interview:

George Henning, the manager of the Pacific Advisors Small Cap Fund, has been keeping his eyes peeled for transportation stocks in recent months. He reasons that they’re likely to benefit if the U.S. economy continues to improve, leading companies to ship more materials and goods.

Last June, Henning began investing in a pair of trucking firms, SCS Transportation (SCST), and U.S. Xpress Enterprises`A` (XPRSA). He thinks earnings for both can increase by 10%-15% over the next year. Henning, who prefers companies with what he judges to be sound business plans, also was impressed with the one put together by U.S. Xpress.

Henning started buying shares of both companies at around $11. U.S. Xpress stock closed today at $13.20. SCS, a former unit of Yellow Corp. (now Yellow Roadway (YELL)), closed at $17.76.

Transportation stocks account for the biggest piece of Pacific Advisors Small Cap’s assets — 17%. Elsewhere in the sector, Henning owns RailAmerica Inc (RRA), a railroad company that has been in the fund since 1994 and was ranked second in the portfolio at the end of last year.

RailAmerica, which operates short and regional lines in the U.S., Canada, South America and Australia, is the No. 2 player in its markets and has a history of making acquisitions that fatten profits, Henning says.

Although Wall Street has had concerns about the company’s debts, Henning says he’s confident it can service them. As part of its strategy to pay off bills and grow its North American business, RailAmerica today agreed to sell its 55% stake in Ferronor, a Chilean railroad, to its partner in the venture for $18.1 million.

In picking stocks, Henning looks for small companies that appear capable of growing their top and bottom lines over at least 2-3 years.

“I want to buy a stock when I think it’s pretty cheap,” adds Henning, who hunts for shares priced low compared to a company’s earnings, sales or book value. Beyond that, Henning likes companies that lead or dominate their industry or niche. He also favors those with little or no debt and that generate sufficient free cash to meet their obligations and fund growth.

Only 28-34 companies gain entry to the portfolio. “It’s hard for one person, realistically, to follow a lot of different small-cap stocks,” says Henning, who concentrates his holdings to facilitate research and to enable winners to significantly boost the fund’s returns.

Among the fund’s best performers in 2003, Henning cites America Service Group (ASGR), which held third place in the portfolio at year end. The company provides managed health care services to U.S. correctional facilities and military bases. “It’s a growth business,” says Henning. He points out, too, that the company is one of only a handful that meet states’ requirements to bid on contracts, giving it a competitive edge.

The fund’s America Service shares cost about $5 on average. The stock closed at $30.88 on Dec. 31, and has since risen to about $33.

One of Henning’s favorite stocks is Tyler Technologies (TYL), which makes software for state and local governments and school systems, including programs for appraising property, recording taxes and managing courts. “They’re the only real national player” in the field, Henning says.

Maintaining its products provides a steady revenue stream for Tyler, according to Henning, who sees it generating sales growth in the mid-20% range this year.

Another software maker, Intervoice Inc (INTV), was the fund’s No. 1 stock at the end of 2003. The company makes programs for interactive voice response systems, such as those used for telephone call centers. Henning says he initially bought the company about five years ago because he thought its technology would become popular. These days, he envisions Intervoice gaining as companies beef up spending on computer and telecommunications equipment.

To be expelled from the portfolio, a company’s financial fundamentals have to erode, or its stock has to become pricey. For example, Henning says he sold Carbo Ceramics (CRR) earlier this month because he felt its shares were fully valued. The company makes material used to get more production out of natural gas and oil wells,

Once a stock enters the portfolio, it’s likely to stay for a while, however. Henning says he expects to hold investments for 2-3 years. Pacific Advisors Small Cap’s turnover rate was 23.4% last year, compared to 69.6% for its peers.

Henning also tries to avoid frequent selling to keep capital gains distributions to a minimum. “I want to be tax-efficient,” he says.

– Richard Diennor


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