Five Questions With… C. Kevin Garland, Partner, The Sterling Group

1. Sterling focuses on basic industrial companies whose performance could be better. Does that imply distressed companies?

Truly distressed companies, to us, have an additional level of risk that we are not comfortable taking. We look for reasonably solid companies that have good products, customers and employees, but are still well short of their potential in producing cash flow. Areas for improvement could include procurements, operating cost controls, pricing practices, add-ons, and about a dozen others. We evaluate about 20 areas for potential improvement. For us, the bigger the gap between current performance and the company’s potential, the more excited we get.

2. How specifically do you go about improving your companies?

We have a four-step process here that’s been developed over 28 years. It starts with alignment of interest with management teams, which means deep and heavy stock and option ownership from our managers. The next step is having a multi-day, off-site strategy session where we identify the key strategic direction for the company. That’s followed by the development of 15 to 20 specific operational value improvement initiatives around the areas I mentioned earlier. The final step is getting together with management once a month to review each initiative in detail.

3. How will market conditions affect your strategy in the coming months and years?

We’re very encouraged by the current and future environment. Prices in the middle market have come down as compared to recent years. But more importantly, deficiencies in company performance have been further illuminated by the recent recession. It turns out that a lot of companies that looked like they were doing well were just riding the strong markets. So I think our operating expertise is at a real premium right now because of the difficult environment companies are in.

4. U.S. manufacturing is on the decline. How has that trend affected your investments?

For every manufacturing company we look at, we do an extensive review of both the international threats and opportunities, and we’ve avoided numerous acquisitions for fear of import threats. But we’ve actually found more opportunities for international growth in our companies than risk of import. For instance, with Hudson Products (a maker of heat exchanger equipment), we expanded sales into Saudi Arabia and China through a joint venture and the creation of a new plant. That helped us expand the business and we made more than 6x our money in less than two years.

5. What subsectors in U.S. manufacturing are seeing significant growth?

We’ve got our eye on companies that provide products and services to improve our nation’s infrastructure, such as water and waste water, power generation, even bridge repair. We also have a lot of interest in packaging, much of which will continue to be domestically produced. We’ve already had successful investments in both those areas. We made more than 4x our money on Exopack (a flexible packaging provider), more than 7x on HydroChem (a provider of industrial cleaning services), and about 4x on North American Energy Partners (which is engaged in civil construction projects).