Many investors have shied away from Amazon.com’s stock for years because of very high valuations — and have missed out on tremendous long-term gains.

But there are other ways to profit from that success, including by investing in two companies that supply Amazon














AMZN, -1.12%












  yet trade at much lower valuations and are expected to increase sales and earnings more rapidly than Amazon this year.

The two are Air Transport Services Group














ATSG, -0.08%












 and Kornit Digital














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which are favorites of Craig Richard and Doug Cartwright, who co-manage the Buffalo Emerging Opportunities Fund














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The fund was recently upgraded to a four-star rating (out of five) by Morningstar, after ending 2018 with a three-star rating. The fund managers discussed the stocks in an interview on Feb. 5.

Before looking more closely at the fund and its strategies, here are some numbers for the three companies:

Company Forward P/E Est. sales increase – 2019 Est. sales increase – 2020 Est. EPS growth – 2019 Est. EPS growth – 2020
Amazon.com Inc.














AMZN, -1.12%











61.2 18% 18% 35% 43%
Air Transport Services Group














ATSG, -0.08%











15.3 46% 11% 32% 12%
Kornit Digital














KRNT, -0.35%












 
34.8 24% 26% 57% 59%
Source:FactSet

Amazon trades at a high multiple to the consensus earnings estimate for the next 12 months among analysts polled by FactSet. The other two companies trade at much lower multiples and are expected to grow more quickly than Amazon this year. Looking at 2020 estimates, Air Transport Services Group is expected to grow more slowly than Amazon, but Kornit Digital is expected continue posting the fastest sales and earnings growth among the three.

Both of the smaller companies rely heavily on Amazon, which holds warrants to purchase shares of both. Only seven analysts cover each of the two companies.

Air Transport Services Group

Air Transport Services Group














ATSG, -0.08%












 purchases used Boeing 737, 757 and 767 airplanes, refurbishes them for freight transport and then leases them to other companies. The company, which has a stock-market value of about $1.4 billion, announced in December that it had expanded its relationship with Amazon














AMZN, -1.12%












to lease and operate 10 additional 767s, while extending agreements for the 20 767s Amazon was already leasing.

Air Transport Services supplies crews for the planes and handles maintenance, insurance and the warehousing of the Amazon products it transports. Amazon pays for the fuel.

“As it moves away from FedEx














FDX, +0.04%












 and the U.S. Postal Service, Amazon will look to outsource transportation through ATSG and its competitor Atlas Worldwide














AAWW, -2.54%












while not owning the planes because of the high capital outlay. Amazon is looking potentially to deliver packages for other parties as well,” Cartwright said.

Kornitzer Capital Management


Doug Cartwright and Craig Richard, portfolio managers with Kornitzer Capital Management.

He estimated that more than half of Air Transport Services Group’s revenue would come from Amazon once the new planes are deployed, and another 25% of revenue from DHL (a unit of Deutsche Post AG














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). 

As part of the new agreement, Amazon was granted additional warrants that give it the right to purchase 39.9% of ATSG’s common shares, rather than 33.2% under the previous deal.

Since Dec. 20 (the day before the new Amazon deal was announced), ATSG’s shares have surged 33% through Feb. 5. This means the market value of Amazon’s warrants has risen as well, which “reduces Amazon’s overall cost of doing business with ATSG,” Cartwright said.

Amazon has a similar deal (including warrants) in place with Atlas Worldwide. However, Cartwright said he and Richard steered clear of Atlas because “the balance sheet is materially worse” than that of Air Transport Services Group. “ATSG’s debt is about 1.5 times Ebitda for 2019, while Atlas’s is just under 4,” he said.

Kornit Digital

Kornit Digital














KRNT, -0.35%












 makes printing equipment used for textiles. Amazon runs three printing facilities (in Dallas, Philadelphia and Poland) using equipment and ink purchased from Kornit, a $678 million company. Amazon accounts for about 15% of the company’s revenue, while Fanatics, a seller of licensed sports merchandise, provides about 11%, Cartwright said.

“In the Dallas facility, Amazon has purchased 50 to 60 printers, at around $400,000 per printer. On average, each printer consumes about $100,000 of ink annually,” Richard said. “So ink is about 50% of revenue and ink carries an 80% gross margin, while for printer the gross margin is about 35% gross margin.”

Amazon has a warrant deal with Kornit, through which Amazon’s purchase rights for Kornit’s stock rise gradually to 9% as total product purchases approach $150 million.

Cartwright is enthusiastic about Kornit’s growth prospects not only because of the increasing demand for customized clothing that Amazon is selling, but also because Kornit plans to roll out ink that can print on polyester this year.

Currently, customized printing on polyester cannot be done with ink, as it requires high temperatures that would melt the material. So its being done through traditional screen printing, which is harmful to the environment, requires large product runs and is done in China.

“This makes Nike














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Under Armour














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 and Lululemon














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 potential customers,” Cartwright said.

The Buffalo Emerging Opportunities Fund

Buffalo Funds has $4.5 billion in assets under management and is based in Kansas City. The portfolios of its 10 mutual funds are managed by its sister firm, Kornitzer Capital Management, which oversees another $2.5 billion in private accounts. The Buffalo Emerging Opportunities Fund has about $82 million in total assets.

When selecting stocks for the fund, Richard, Cartwright and their colleagues typically identify companies with market capitalizations of $1.5 billion or less and that they believe have strong management teams, low debt and the potential to increase profit margins. They tend to be overweight technology companies compared to the Russell 2000 Growth Index














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 (the fund’s benchmark) and have little to no exposure to the biotech sector.

The fund typically holds between 50 and 70 stocks.

“When you look at companies with binary events — phase II or phase III trials — we are uncomfortable putting our investors’ money at risk,” Richard said.

The team will also do short-term trades with stocks they like when they spot an opportunity. “When markets get volatile and things go down, it’s easier for us to deploy capital because prices are low. Conversely, when prices are high, it is more difficult to earn an acceptable return for our investors,” Cartwright said.

During 2019, the S&P 500 index














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 pulled back 6.2%. The Buffalo Emerging Opportunities Fund was down 4.0%, while the Russell 2000 Growth Index was down 9.3%.

According to Richard, one reason for the fund’s outperformance last year was that its overlap with the index is only about 5%.

“What we have seen is that the names we invest in tend to be under-followed, undercovered and might not be in the index. Having less index exposure contributes to long-term outperformance because we are not following money out of the market on down days,” Richard said.

He added that the focus on companies at early growth stages means “there are not a lot of cyclical qualities” and that the fund “pretty insulated” from concerns over macroeconomics and trade negotiations between the U.S. and China.

Here’s how the fund has performed for longer periods against its Morningstar category, the Russell 2000 and the S&P 500, through Feb. 4:

Average annual return – 3 years Average annual return – 5 years Average annual return – 10 years
Buffalo Emerging Opportunities Fund 19.9% 5.7% 19.2%
Morningstar Small Growth category 17.6% 8.8% 15.6%
Russell 2000 Growth Index 16.9% 8.7% 15.6%
S&P 500 index 14.8% 11.5% 15.0%
Sources: Morningstar Direct, FactSet

Here are the fund’s top 10 holdings, as of Dec. 31:

Company Ticker Industry % of portfolio Total return – 2019 through Feb. 5 Total return – 2018 Total return – 3 Years
Community Healthcare Trust Inc.














CHCT, -0.33%











Real Estate Investment Trusts 3.00% 16% 9% 129%
LHC Group Inc.














LHCG, -1.65%











Medical/ Nursing Services 2.66% 19% 53% 226%
Cardlytics Inc.














CDLX, +1.45%











Internet Software/ Services 2.55% 53% N/A N/A
Omnicell Inc.














OMCL, -2.06%











Information Technology Services 2.52% 9% 26% 140%
8×8 Inc.














EGHT, -1.13%











Software 2.46% 3% 28% 60%
Kornit Digital Ltd.














KRNT, -0.35%











Industrial Machinery 2.37% 8% 16% 70%
Motorcar Parts of America Inc.














MPAA, -0.10%











Automotive Aftermarket 2.35% 22% -33% -35%
Nexeo Solutions Inc.














NXEO, -0.42%











Chemicals 2.25% 12% -6% -4%
Willdan Group Inc.














WLDN, +3.28%











Miscellaneous Commercial Services 2.25% -5% 46% 321%
i3 Verticals Inc. Class A














IIIV, -2.62%











Software 2.13% 3% N/A N/A
Source: FactSet

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