Sunday, June 24, 2018

A Buyable Dip In Cognex?

Being a value-oriented investor who loves technology, particularly industrial technology, often has me feeling like a stranger in a strange land. There’s never any shortage of “you can’t worry about valuation; you just have to buy!” comments, and it can indeed be frustrating to watch the expensive shares of great companies get ever more expensive and float up and away like a kid’s balloon.

But with great valuation often comes great volatility, and that can work for patient investors. Cognex (CGNX) is back where it was when I last wrote about the company, but I believe the company is a little better today, even if its near-term revenue growth opportunities are not. Although the risk of further declines in consumer electronics can’t be ruled out, nor declines in auto spending or issues in China, the valuation now looks close to reasonable and that may be about the best you can hope for, though I’d note the shares are not cheap by most metrics.

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A Buyable Dip In Cognex?

Air Transport Group Executing, But Headwinds Continue To Weigh

In terms "controlling what it can control", I believe Air Transport Services Group's (ATSG) management team is doing a good job. Even so, there are worries about Amazon's (AMZN) future plans for its Prime Air operations, possible competitive losses to Atlas Air (AAWW), higher rates, and access to planes continuing to weigh on the shares, which have underperformed Atlas Air quite significantly since March of this year.

I expect Air Transport to expand its business relationship with Amazon over time, but there are no guarantees. Likewise, I believe the company's efforts to expand its ground-based service and conversion businesses will pay off, but not for several years. Although the overall air cargo and leasing environment remains healthy, escalating trade disputes could threaten that and Air Transport doesn't have a great track record of free cash flow or ROIC generation. That said, there still appears to be worthwhile opportunity here for those investors who can get comfortable with the risks.

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Air Transport Group Executing, But Headwinds Continue To Weigh

SPX FLOW More Focused, But Iffy Order Flow Is A Concern

Investors are trying to figure out where industrials are headed, and SPX FLOW's (FLOW) share performance so far this year reflects a lot of that uncertainty. The market liked what management had to say at its early March investor meeting (after which the shares traded into the mid-$50's), but disappointing results and guidance across the sector had investors worried going into earnings, taking the share down into the low $40's, before the results brought some stability to the shares.

It's an interesting coincidence (and perhaps not just coincidence) that SPX FLOW's share price performance puts it almost directly in the middle of Alfa Laval (OTCPK:ALFVY), better-run and with better near-term prospects, and the rolling train wreck that is GEA Group (OTCPK:GEAGY). Although the shares seem to have a little bit of upside here, I'm concerned that the Food & Beverage business could stay weaker for longer and that management may not be able to maximize the opportunities in the power and energy rebound.

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SPX FLOW More Focused, But Iffy Order Flow Is A Concern

Milacron Delivering, But The Road Is Getting A Little Rockier

There's no question that companies opened their wallets over the last 12 months to buy capital equipment, whether to expand production capacity, replace aging machinery, or take advantage of greater efficiency with more modern equipment (or some combination), and that has benefited Milacron (MCRN), as the company has seen better demand for plastic molding equipment and an ongoing conversion toward hot runners.

With better results and higher multiples across the machinery space, Milacron's shares have done okay since my last update in May of 2016. Though the shares have sold off about 10% recently, they've still generated a double-digit return over the past year despite rising input costs offsetting a lot of the progress the company has made with operating expenses. Although I think Milacron's multiple should have room to improve from here, I'm a little more cautious on the near-term outlook for machinery investment, particularly with trade protectionism bubbling up.

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Milacron Delivering, But The Road Is Getting A Little Rockier

Sensata Shares Chopping In A Narrow Band Despite Better Sales

Sensata (ST) remains in a tough place, as many investors continue to believe that this leading player in automotive sensing and controls will struggle to generate organic growth as the auto market shifts towards electrification. Not helping matters is a pretty lackluster recent track record of organic growth and not much clear operating leverage.

I didn't think Sensata offered exciting value back in February, and the shares are down a bit since then. At this level, the valuation call is a little trickier, as I do think the shares are undervalued, but I also understand the Street's concerns about future growth and competition. A fairly robust R&D program gives me encouragement, and the shares look undervalued on the basis of margins, but I do wish there was more value apparent on the free cash flow side.

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Sensata Shares Chopping In A Narrow Band Despite Better Sales

Lackluster Assets And No Real Dynamism Continue To Weigh On CK Hutchison Holdings

It's hard enough for conglomerates to get their due, but when the assets in question aren't even that exciting, it makes it even harder to make money. That's been my issue with CK Hutchison (OTCPK:CKHUY) for a while now, as I just can't muster much enthusiasm for a so-so collection of assets in telecom, retail, infrastructure, and energy spread across the world. I wasn't all that fond of the value proposition back in January, and the shares have fallen about 15% since then - lagging not only the Hang Seng but also other conglomerates like Swire Pacific (OTCPK:SWRAY) and CITIC Ltd. (OTCPK:CTPCY).

Unfortunately, there's nothing in management's recent commentary that suggests they see much need for change. CK Hutchison isn't in the business of capital recycling and there don't seem to be many moves afoot to significantly improve any of the constituent parts of the business. I do believe the shares look relatively undervalued now, but it takes more than just a low valuation to make stocks work and my confidence level in CK Hutchison management is not high right now.

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Lackluster Assets And No Real Dynamism Continue To Weigh On CK Hutchison Holdings

Brookfield Infrastructure's Ample Liquidity Should Fuel Years Of Healthy Distribution Growth

Between a weak share price performance since the start of the year, ample liquidity, and a rich set of investment options around the world, I think this is an interesting time to look at Brookfield Infrastructure Partners L.P. (BIP). Management is methodical about allocating capital; they know what they want, and they know where their sweet spots are. With that, there aren't too many transactions in the company's history that have gone seriously sour and the company has a good track record when it comes to building value and boosting its distributions.

Investors should note that Brookfield Infrastructure is structured as a partnership and investors will get a K-1. The company offers a fair bit of easy-to-interpret information on its website, but I'd advise readers to do a little extra research to make sure they understand the tax ramifications. In any case, I think these units are worth the trouble - in addition to a yield that's close to 5%, I believe a deep pipeline of ongoing investment opportunities will support long-term distributable cash flow growth in the high single-digits to low double-digits.

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Brookfield Infrastructure's Ample Liquidity Should Fuel Years Of Healthy Distribution Growth

CapitaLand Continues To Build Out From A Strong Core

Singapore’s CapitaLand (OTCPK:CLLDY) (CATL.SI) is never going to be an “easy follow,” as the basic business model of buying land, developing it, and selling it down the line creates inherent volatility and lumpy financials. While CapitaLand has a solid track record of building value through its property development activities, the market is rarely comfortable enough with the basic model to give the shares any sort of premium, and the local shares have basically marked time between S$3 and S$4 for most of the last decade.

Although I don’t believe you get very far arguing with the market, I do think CapitaLand has generated returns above its cost of capital over the last decade, but the accounting is not simple and that outperformance is not an annual feature (CapitaLand under-earned its cost of capital by my estimation in two of the last three years and three of the last five). With management committed to more capital recycling, though, expanding into new territories and generating more recurring revenue, I believe the valuation is still appealing.

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CapitaLand Continues To Build Out From A Strong Core

The Market Doesn't Seem So Pumped About Weir

Weir Group (OTCPK:WEGRY, WEIR.L) got hit hard on the simultaneous declines in oil/gas and mineral/mining capex, and the company is now benefiting as spending recovers strongly in both markets. Although the bulk of Weir’s business is, and has virtually always been, its minerals business, the shorter-cycle oil/gas business tends to be the tail that wags the dog, with investors putting a lot of energy into worrying about near-term completions metrics, frac fleet spending, and market share trends.

Although I do have some longer-term market share concerns about the oil/gas business, I believe Weir is likely looking at a good stretch here of oil/gas and minerals order growth. I thought the shares offered about 5-10% upside back in late May of 2017, and the local shares are up about 10% since then. I still see a little upside from here, but investors should note the propensity for short-term excitement/worry about U.S. onshore activity to move the stock.

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The Market Doesn't Seem So Pumped About Weir

AXA's Accelerated Transformation Carries Bigger Risks

France's AXA (OTCQX:AXAHY) has never been afraid to do things its own way, and the company's past efforts to shift away from more capital-intensive savings-oriented life products in favor of protection-oriented products made it an early mover in what proved to be a sound strategic shift. More recently, management has been working to strip administrative costs out of operations, grow its P&C and health insurance products, shift more capital towards faster-growing regions like Asia, and begin selling down its U.S. operations. The biggest move, though, has also been the most controversial - the $15 billion-plus acquisition of XL Group (XL).

I don't fault the reasoning for making a large acquisition in P&C insurance/reinsurance, and I can see the positive leverage opportunities in acquiring a Bermuda-based reinsurer like XL Group. I'm not sure this was the right company, though, and I think at least some of the share price weakness has been a reasonable reaction to those concerns. While AXA does appear to trade at a double-digit discount to fair value, I'd just as soon own a company like Prudential plc (PUK) or Aviva (OTCPK:AVVIY) at this point.

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AXA's Accelerated Transformation Carries Bigger Risks

Dialog Semiconductor On The Clock

A year ago, the debate around Dialog Semiconductor (OTCPK:DLGNF) was whether or not there was any substance to bearish rumors and predictions that Apple (AAPL) was working on its own power management integrated circuits (or PMICs) and would use them to replace Dialog’s chips in its iPhones and other products. With Apple having since done exactly that (although not completely), now the debate is how far the substitutions will go and what Dialog can do to preserve and rebuild its business absent contributions from Apple that have historically made up 70% or more of revenue (and high-margin revenue at that).

Both Dialog and Synaptics (SYNA) have confirmed that they’re discussing a merger; while Synaptics has been a frequent-flier on sell-side “likely to be bought” charts, and there would be potential synergies in such a deal, Dialog’s iffy history in M&A doesn’t lend a lot of confidence. The good news, such as it is, though, is that the market is already pricing in a very dire outlook for this beaten-up chip company.

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Dialog Semiconductor On The Clock

A Mining Recovery Has Boosted FLSmidth Far Enough

I always find it worthwhile to have an exit strategy in mind before ever entering a position, as it is sometimes easy to get carried away when an idea is working out. To that end, FLSmidth (OTCPK:FLIDY) has developed better than I'd expected as short-term play on a mining equipment recovery, with the shares up about 15% since my January write-up even after a roughly 10% decline from a near-term high.

Although there are potential drivers of even better performance and FLSmidth's valuation isn't bad relative to many other industrials, I'm not inclined to get greedy. So, while mid-single-digit revenue growth and margin improvements can still support a high single-digit total annualized return and I believe mining orders still have room to surprise to the good, I don't see enough upside to continue pushing this as a buy idea.

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A Mining Recovery Has Boosted FLSmidth Far Enough

Alaska Air Fighting Some Competitive Headwinds

I described myself as “cautiously bullish” on Alaska Air (NYSE:ALK) earlier this year, as I was concerned that the generally positive long-term outlook for this well-run airline could be overshadowed by near-term cost/synergy and competitive capacity worries, not to mention overall late-cycle weakness in airlines. Shares have lost a little ground since then, more or less keeping pace with Delta Air Lines (NYSE:DAL) and bracketed by Southwest (NYSE:LUV) and JetBlue (NASDAQ:JBLU) on the weaker end and United (NYSE:UAL) on the better-performing end.

My basic outlook on Alaska Air really hasn’t changed that much. Higher labor costs and fuel costs are a drag on results, but management seems to be switching back to a network optimization footing, and history suggests that will generate some positive results for shareholders. I’ve been concerned for a little while that a prolonged stretch of good behavior from airlines would eventually end, and I think that may be happening now with capacity growth along the West Coast. Even so, I think low-to-mid single digit growth from Alaska Air can support a fair value above $70 and double-digit total annualized returns from here.


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Alaska Air Fighting Some Competitive Headwinds

Nervous Markets Seem To Be Weighing On USAP's Valuation

By most standards these are good times for the specialty alloy companies. The oil/gas markets are recovering, multiple industrial markets continue to expand, and aerospace orders have noticeably picked up. And yet, for companies like Allegheny (ATI), Carpenter (CRS), and Universal Stainless (USAP), it has been a somewhat choppy 2018 as improving backlogs and margin leverage are overshadowed by worries about slowing industrial growth and price momentum in the stainless steel market.

Given USAP’s strong recovery from its late 2015/early 2016 lows, it’s easy to say that a lot of the easy money has been made in the stock. What’s more, I do think there are real signs of slowing activity in multiple industrial markets and mixed signals in stainless steel. On the other hand, I don’t think USAP has reached its peak yet, as I believe there’s more business to come from the aerospace and oil/gas sectors and more margin leverage as well. At close to tangible book value and with upside to around $30, I still see appeal in this very small specialty alloy company.

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Nervous Markets Seem To Be Weighing On USAP's Valuation

Tuesday, June 19, 2018

Baked Goods Giant Grupo Bimbo Can Still Rise, But Operations Have Yet To Turn

Writing positively about Mexican baked goods giant Grupo Bimbo (OTCPK:BMBOY) (BIMBOA.MX) back in February was a horrible call, as seen by the subsequent 25% decline in the ADRs. Even though a company/stock like Grupo Bimbo ought to be defensive in a nervous Mexican market, adverse currency moves, ongoing margin pressures, and ongoing questions about management's strategic focus have continued to weigh heavily on the shares.

The sharp drop in the share price does not match a corresponding deterioration of the business, but investor confidence is easy to lose and hard to regain, and this is not a well-liked management team. Given the challenges in owning Bimbo (the ADR is illiquid, and buying local shares may be more hassle than it's worth, at least for some investors), I can't really push a strong "buy the pullback" call here. I do believe the current share price undervalues the business, I believe there will be some signs of stability in the business in the coming quarters, and I think the market jitters in Mexico will calm down, but it's tough to trust this company.

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Baked Goods Giant Grupo Bimbo Can Still Rise, But Operations Have Yet To Turn

Schneider Has Put The Pieces In Place To Drive Higher-Value Growth

Relative to what investors seem willing to pay for companies like Rockwell (ROK), Emerson (EMR), and Yaskawa Electric (OTCPK:YASKY), I'm starting to wonder if Schneider Electric (OTCPK:SBGSY) isn't in some respects an overlooked contender in some attractive markets. Not only is Schneider a leader in energy management (and with a relatively attractive mix), but it is also a strong player in both discrete and process automation and well-positioned for what looks to be a growing convergence between hardware and software in automation.

Schneider isn't exceptionally cheap, but in a market where many high-quality industrial names are quite expensive, it still looks like an interesting relative laggard on valuation. I'd really like to see a stronger ROIC here, and I believe that at least partly explains the valuation, but low-to-mid single-digit organic revenue growth can support a decent return from here.

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Schneider Has Put The Pieces In Place To Drive Higher-Value Growth

XPO Logistics Leveraging A Hot Freight And Logistics Market

One of the pleasures of following XPO Logistics (XPO) has been listening to the various and sundry comment section prophets of doom call for XPO's imminent collapse - back at $30, $50, $75, and so on. There have most definitely been some big corrections along the way, but management has demonstrated that not only can it assemble a high-quality broad-ranging freight and logistics franchise but also run it well. A debt-rich balance sheet, economic sensitivity, and a desire for more deals are all risk factors to varying degrees, but XPO has carved out strong positions in areas like truck brokerage, forwarding, less-than-truckload (or LTL) trucking, last mile logistics, and contract logistics.

Valuation is a much more significant issue for me now, though. Even if XPO Logistics can grow at a pace similar to what companies like Old Dominion (ODFL), J.B. Hunt (JBHT), Hub Group (HUBG), and C.H. Robinson (CHRW) have managed and push FCF margins into the mid-single-digits, the implied returns aren't that impressive, and the shares are likewise not all that cheap on a forward EV/EBTIDA business compared to a blended multiple based upon its end-market exposures.

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XPO Logistics Leveraging A Hot Freight And Logistics Market

Is It Too Late To Make Money With POSCO?

It’s difficult to get the timing right with cyclical stocks, as there’s often a discrepancy between what the numbers tell you and how the market actually behaves. In the case of steel, for instance, it’s common for institutional investors to start bailing once steel prices stop rising – leading to the frustrating phenomenon of strong revenue and earnings growth (as those higher prices flow through the business), low apparent multiples, and yet disappointing stock performance.

Having more than doubled from its lows in late 2015, POSCO (PKX) has indeed already enjoyed a good run, and I do have some concerns that the shares may struggle to reach apparent “fair value” if steel prices only remain steady (even if steady at very attractive and profitable levels). I do believe there’s a good argument for these shares trading at or above $100, but investors considering the shares need to be comfortable with the risk that they’re showing up late to the party and may get stuck cleaning up.

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Is It Too Late To Make Money With POSCO?

Lattice Semiconductor Looking To Go From Stabilization To Growth

It has been a rocky couple of years for Lattice Semiconductor (LSCC), including a failed attempt to sell the company to a Chinese entity, but the company has regrouped and management has stabilized the business. Now the question moves to whether or not the company’s focus on lower-cost, lower-power FPGAs for applications like robotics, security/surveillance, auto ADAS, and edge computing/networking can drive a re-acceleration to double-digit revenue growth and meaningful margin leverage.

I’m skeptical on Lattice’s prospects for attaining/maintaining double-digit revenue growth on any consistent or long-term basis, but I do believe the company’s low-power FPGA and millimeter wave technologies address real market needs and opportunities, and I believe the move to 28nm FD-SOI chip architecture can drive meaningful margin leverage. With the shares trading between my DCF and margin-based EV/revenue fair values, I believe there’s still upside here, but Lattice will need to start delivering some beat-and-raise quarters to drive truly exciting performance.

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Lattice Semiconductor Looking To Go From Stabilization To Growth

PINFRA Punished As A Proxy For Mexico's Economy

As a bond proxy for Mexico, PINFRA (OTCPK:PUODY) (PINFRA.MX) hasn’t had a very good run since my last update on the company in January. Although the local shares have modestly outperformed the broader Mexican market, the Mexican market has been weak overall on worries about the upcoming presidential election and the renegotiation of NAFTA. Add in foreign exchange weakness, and the PINFRA ADRs have posted a nasty 17% drop since that last article.

At the risk of doubling down on a bad call, I still think PINFRA is worth a closer look. Although PINFRA doesn’t have the tariff revision mechanism that benefits airport operators like Grupo Aeroportuario del Sureste (ASR) or Grupo Aeroportuario del Pacifico (PAC), it does have a strong track record of building and operating toll roads, a deep portfolio of long-lived concessions, and a strong cash flow-generating model. The risk of a sharp turn in Mexico’s economic policy is real, but I think the current discount to fair value more than compensates for that risk, and PINFRA could be a beneficiary of the leading candidate’s pledges for greater infrastructure spending.

Readers should note that the ADRs offer lousy liquidity, and may want to consider purchasing/holding the much more liquid local shares.

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PINFRA Punished As A Proxy For Mexico's Economy

Itau Unibanco In A Wobbly Recovery Cycle

With another plunge in the exchange rate, there is once again a gulf between the performance of the actual business at Itau Unibanco (ITUB) (ITUB4.SA) and the performance of the local shares and ADRs. While the local shares haven't had a great six-month run (down about 6% versus a 3% drop in the Bovespa), the ADRs have suffered far more with a roughly 17% drop.

Between an upcoming election and a recovery that has already seen some fits and starts, Brazil isn't exactly a safe market. Moreover, while Itau is arguably the best-run of the Brazilian banks and generated better than expected returns during the downturn, management has a habit of over-promising and under-delivering and needs to reinvest in the next round of growth drivers. I do believe that Itau's shares are undervalued, but there's a lot of risk and volatility that comes with this name that may overshadow the opportunity for some investors.

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Itau Unibanco In A Wobbly Recovery Cycle

Macro Worries, Sluggish Loan Growth, And Capital Generation Weighing On BBVA

Spain’s Banco Bilbao Vizcaya Argentaria (BBVA) wasn’t my favorite European bank back in December of 2017, but I’ve still been surprised to see the greater than 15% decline in the value of the ADRs, more or less matching the decline in Santander (SAN) over the same period. Loan growth and capital generation have remained lackluster, though credit quality and cost leverage are improving, and the markets are considerably more worried about the near-term outlook for the bank’s Mexican and Turkish operations.

I believe conditions in Spain are improving, and I believe Mexico will hold up better than currently expected. Turkey could get uglier from here, but I think that’s already reflected in the share price. If a high single-digit long-term earnings growth rate is still a reasonable expectation (corresponding to a low double-digit ROE), BBVA shares look meaningfully undervalued and worth a closer look.

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Macro Worries, Sluggish Loan Growth, And Capital Generation Weighing On BBVA

Ongoing Growth, At A Price, From Canadian Western Bank

Edmonton’s Canadian Western Bank (OTCPK:CBWBF) (CWB.TO) continues to execute on several of its primary growth drivers, including generating attractive commercial loan growth, building the Optimum alternative mortgage business, and continuing an ongoing shift away from a heavy legacy exposure to energy and energy-reliant markets. While the bank does have a good growth outlook, some of the concerns I had about valuation and near-term headwinds have had an impact on the share price, which is down a bit (in Canadian dollars) since my last write-up late in 2017.

If Canadian Western were an American bank, I think there would be more concerns about the company’s weak core deposit situation and its high, and rising, total cost of funding. Using debt to fund loan growth is a risky strategy, but credit quality remains strong as does operating leverage. Although the level of operating risk is a concern, these shares do look more reasonably priced and should offer a lot of earnings growth in the coming years.

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Ongoing Growth, At A Price, From Canadian Western Bank

FDA Approval Of Injectable Augment Should Give Wright Medical's Growth A Shot In The Arm

It’s a kinder, gentler FDA that the healthcare world is dealing with these days, and while I don’t believe that’s an unalloyed positive for the industry, the approval of the injectable version of Augment is definitely a positive development for Wright Medical (WMGI). Although the near-term impact to sales is likely to be on the order of 1% or so, the longer-term impact could be more significant. Coupled with a strong upper extremity business that continues to gain share and a lower extremity business that should see some re-acceleration in the second half, Wright’s outlook is brightening. If the company can get revenue growth back up to a double-digit pace, a 5x forward revenue multiple and a fair value in the mid-$30s could be back in play in a year, though I wouldn’t pay quite that much today.

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FDA Approval Of Injectable Augment Should Give Wright Medical's Growth A Shot In The Arm

South State Bank Underperforming As It Digests Its Latest Deal

Whole bank acquisitions are a time-tested strategy for growth and value creation, but it takes time to realize the value and the shares of acquirers can underperform during the integration process. Such would seem to be the case with South State Bank (SSB), which has lagged the regional bank ETF so far this year and lagged most of its similarly-sized peers. Although there’s nothing fundamentally wrong with the bank, unpredictable expenses and weak loan growth during the integration process have led to lackluster reported results.

I still believe that South State’s acquisition of Park Sterling will look like a good move in the future, but it’s clear that the market isn’t inclined to show much patience as South State restructures the acquired loan book and the deposit base. I’ve trimmed back my fair value slightly on lower near-term earnings, but I continue to believe that South State can generate double-digit long-term earnings growth and that the shares should trade closer to $100.

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South State Bank Underperforming As It Digests Its Latest Deal

BRF SA Finally Catches A Break

"Once is happenstance. Twice is coincidence. Three times is enemy action." - Ian Fleming

Between rising costs, weakening positions in once-key markets, a scandal that has closed off the EU market, and a general sense of operational disarray, BRF SA (BRFS) has continued to struggle and has lost about half of its market value since the start of the year. At long last, though, investors finally have some good news to celebrate - the company's Chairman and former CEO of Petrobras (PBR) has been named as the new CEO.

To be clear, Mr. Parente has a lot of work ahead of him, and BRF's turnaround is not going to happen overnight. Nevertheless, I see more than a few casual similarities between Petrobras and BRF at the time Mr. Parente became CEO - both companies had unacceptable levels of inefficiency and high costs, both had serious regulatory/conduct issues, both had unfocused operations, both had issues with pricing and focus, and both had troublingly high debt. While Parente's success at Petrobras is no guarantee of a successful turnaround at BRF, I believe this was the best move available to the company and could, perhaps, represent the first few at-bats in what is likely to be a nine-inning turnaround cycle.

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BRF SA Finally Catches A Break

Advanced Energy Industries Closer To The Edge

Everybody has probably seen at least one video of a person (usually a male between the ages of 15 and 40) running full-speed at some sort of barrier that the runner assumes is lightweight and/or will be easily passed through… only to discover too late (typically upon regaining consciousness) that it was actually quite solid.

I mention that as an opening to the dilemma facing Advanced Energy Industries (AEIS) investors right now. Based upon what major customers like Applied Materials (AMAT) and Lam Research (LRCX) are saying, it looks pretty likely that semiconductor equipment demand growth will slow noticeably in 2019 - but is this a "lightweight" barrier that is just a dip in a long-term growth trajectory driven by new architectures and strong demand for IoT and memory or is the industry looking at a hard stop and a return to the "normal" cyclicality of past eras?

I'm cautiously optimistic that it is more the former than the latter, and it doesn't take hefty growth assumptions to drive a worthwhile fair value here. I advised caution on AEIS back in mid-February and the shares are down slightly since then (peers like MKS Instruments (MKSI) and Comet (OTC:CHLDF) (COTN.S) have done similar-to-worse, while XP Power (OTCPK:XPPLF) (XPP.L) has done better). I think this is still a risky call - buying tech into a slowing growth cycle is tough way to make money - but it's hard to ignore a well-run company with growing end-markets (on a long-term basis) and an interesting valuation.


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Advanced Energy Industries Closer To The Edge

Yokogawa Electric Looks Undervalued, But Consider The Reasons Why

The last year has seen a strong recovery in a variety of industrial markets, but Japan's Yokogawa Electric (YOKEY) (6841.T) hasn't seen all that much benefit. One of the top players in distributed control systems (or DCS), Yokogawa's dependence upon petro-sector capex and its substandard margins have both created issues and led to lackluster performance. While the conglomerate nature of the process automation sector complicates comparisons (there's a lot more going on at Honeywell (HON) and Siemens (OTCPK:SIEGY) than process automation), Yokogawa's performance relative to companies like Emerson (EMR), Schneider (OTCPK:SBGSY), Rockwell (ROK), and HollySys (HOLI) hasn't been all that impressive, though it has at least outperformed industry-laggard ABB (ABB) over the past year.

Yokogawa shares do look undervalued on what I believe are reasonably conservative expectations, but the company's reliance on the petro-vertical is a long-term risk in my mind, and I cannot get that excited about the level of execution management has demonstrated over the years, with relatively weak margins and ROICs being the norm.

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Yokogawa Electric Looks Undervalued, But Consider The Reasons Why

Automating Chinese Factories Has Sent Yaskawa Electric On A Wild Ride

When I last wrote about Japanese automation company Yaskawa Electric (OTCPK:YASKY
) (6506.T) in the spring of 2017, I thought it was a good way to play a long-term trend in factory automation and particularly in the growing adoption of automation in China. I thought the shares were somewhat undervalued, but little did I expect the shares to triple in nine months! Since peaking in January, the shares are down about 30%, but there is still a wide spread of opinions on the sell-side regarding the fair value for these shares.

I love the Yaskawa story, and I do think the company stands to generate a lot of growth from the automation of Chinese factories. That said, I simply cannot reconcile today's valuation with any likely earnings/cash flow trajectory or relative valuation approach. The current average sell-side price target would seem to require long-term FCF growth in the high teens on an annualized basis (or a rather low discount rate), while the current share price works back to a mid-teens growth. Although not impossible to reach, I don't think that level of expectations leaves much, if any, room for error or disappointment.

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Automating Chinese Factories Has Sent Yaskawa Electric On A Wild Ride

Thursday, June 14, 2018

Excellent Results Supporting A Steep Valuation At Halma

I really like the businesses at Halma (OTCPK:HLMAF) (HLMA.L), but when I last wrote on the company in January, I thought there wasn't much room for the already-steep multiples (on both an absolute and relative) to expand much further. For a little while that call worked, with the shares losing about 10% of their value between late January and late March, but a positive late March update and renewed enthusiasm for companies exposed to the oil/gas recovery and commercial buildings sparked a big rally that has left the shares about 10% higher than they were back in late January.

I am still a big fan of Halma's business mix and management's strategy to augment its core strengths with selective M&A and greater internal investments in digital capabilities (including IoT and analytics). It's also very easy to like a company that is logging double-digit organic revenue growth and even stronger order growth. The "but" remains valuation; the shares are trading at multiples more than 50% above the company's long-term averages and close to 33% above a peer group of quality growth companies. Given the level of expectations built into the price, I'd rather err on the side of missing more of the run than risk jumping in ahead of even a partial reversion to the mean.

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Excellent Results Supporting A Steep Valuation At Halma

Fortive Following A Familiar Pattern

If you're well-acquainted with Danaher (DHR) and Roper (ROP), Fortive's (FTV) strategy is going to look pretty familiar in at least some respects. Like both Danaher and Roper, Fortive's management doesn't want to be the classic sort of industrial conglomerate and is instead pivoting towards more technology-driven markets, and particularly those with higher service/recurring revenue components. It's no surprise, of course, that Fortive would be similar to Danaher (from which it was spun out), and the company has yet to really follow Roper's SaaS focus, but in any case, Fortive management is not afraid to pay big multiples for businesses that it believes will generate attractive long-term margin profiles.

As far as the shares go, I'm not inclined to chase them here. The stock already seems to factor in healthy future cash flow growth, and I'm not willing to count on significant further expansion in short-term multiples for the industry.

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Fortive Following A Familiar Pattern

Dassault Looks Well-Placed For The Next Era Of Manufacturing, But Valuation Is Problematic

French PLM software leader Dassault Systemes (OTCPK:DASTY) is part of the reason I’m much too gray for somebody in their 40s – while I love the business that the company is in, and its leverage to the ongoing “digitalization” of the manufacturing sector, the valuation is pretty brutal for someone who considers themselves a GARP investor. Although I think investors who put more emphasis on the “Guh” part will be happy with the growth that Dassault delivers in the coming years, the valuation is just too much of a sticking point for me right now… even though it really won’t surprise me if I’m reading this three years from now and thinking, “man… I should have just bought it anyway”.

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Dassault Looks Well-Placed For The Next Era Of Manufacturing, But Valuation Is Problematic

Taking A Cue From Siemens, Rockwell Automation Partners With PTC

With Monday’s announcement of a strategic partnership between Rockwell (ROK) and PTC (PTC), two well-respected and perpetually-expensive players in industrial automation are coming a little closer together. Although this tie-up certainly won’t bring all of the benefits of an acquisition to Rockwell, integrating PTC’s strong IoT offerings with its own FactoryTalk offerings should meaningfully boost the data-gathering and analytical capabilities and advance Rockwell’s Connected Enterprise concept. Rockwell shares still don’t look cheap, but then they rarely do, and if management is right about the increasing role software will play in factory/process automation, this is an important long-term investment.

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Taking A Cue From Siemens, Rockwell Automation Partners With PTC

Alnylam Pharmaceuticals Continues To Develop Options Outside Of Amyloidosis

With a $10 billion market cap, it’s hard to call Alnylam (ALNY) overlooked, but I do believe the shares of this maturing biotech are undervalued as the company approaches a window that should see multiple new product approvals through 2020. Most recently, Alnylam has offered up some data that suggest growing opportunities outside its core amyloidosis programs.

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Alnylam Pharmaceuticals Continues To Develop Options Outside Of Amyloidosis

Broadcom Shares On Pause, But The Business Isn't

I expected some turbulence at Broadcom (AVGO) when I last wrote about the company, and that has indeed been the case, but the shares have held up reasonably well. While the SOX index is pretty much flat since the time of my last article on Broadcom, the company's shares are up close to 5% - more or less keeping pace with the Nasdaq (although the trailing one-year comparisons are much worse). Although the market has been concerned about the company's wireless business, with weak unit volumes at Apple (AAPL) and some share loss to Qorvo (QRVO), the company's wired business is still in fine shape and will likely accelerate as 2018 moves on. I continue to believe that Broadcom is among the better bargains in a sector where most of the cheaper-looking names are "scratch and dent" merchandise with some operational issues.

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Broadcom Shares On Pause, But The Business Isn't

Smiths Group Shows Its Serious About Potential Portfolio Changes

As it turns out, I was half-right - the shares have risen almost 20% since then, with the market taking notice (I believe) of the opportunities in the recovering energy sector, the expanded opportunities in detection, and the prospect for significant portfolio adjustments.

That latter point is highlighted by the acknowledgement from Smiths that it is exploring the possibility of some sort of business combination with ICU Medical (ICUI) for its medical business. While it's very early in the process, I believe Smiths' interest in making a transaction of this sort with its medical business shows that it is serious about active portfolio management and focusing on those areas where it can generate real long-term value.

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Smiths Group Shows Its Serious About Potential Portfolio Changes

Harsco Back On Offense

Harsco’s (HSC) management deserves a lot of credit for the turnaround efforts that have brought the company’s metal waste processing and reclamation business back into solid profitability, and the market has given them a lot of the credit. Now management is confident enough in the business to begin expanding it again, and the company’s acquisition of Altek moves the company into the aluminum waste processing business – a logical expansion into a large adjacent market. While the company did indeed pay up for this opportunity, the returns as the company rolls out a new platform technology should make this a good deal for shareholders down the road.

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Harsco Back On Offense

Are Somewhat Sluggish Order Comps A Risk For Hurco?

These are good days for machine tool companies, as orders have recovered nicely both in North America and in Europe driven by expanding production and the placement of aging equipment. Hurco (HURC) benefiting from this growth as well, but I'm a little concerned that the company's growth seems to be lagging industry growth in key markets like the U.S. and Germany. It's not a reason to sell yet, and the company's margins are developing pretty well, but it merits watching as I don't believe the shares are dramatically undervalued today.

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Are Somewhat Sluggish Order Comps A Risk For Hurco?

Good Weather And Better Management Have Shrunk SLC Agricola's Discount To Fair Value

Farming is a tough business, but it is a little easier in South America where favorable climate, soil conditions, and operating costs generally allow for attractive production costs for companies like Adecoagro (AGRO), Cresud (CRESY), and SLC Agricola (OTCPK:SLCJY). Even so, it has historically been difficult for SLC Agricola to generate good returns from its farming operations, as management often prioritized growth over profit and return maximization, and the stock often traded at a wide discount to its underlying fair value.

Quite a lot has changed over the past couple of years. Not only has awful weather that hurt results in 2016 switched to great weather in 2017 and early 2018 (at least in SLC Agricola’s growing areas), but management’s reprioritization around margins and returns has led to improved profits and cash flow generation. The market has noticed, with the ADRs up almost 90% in the last year and around 180% over the last two years. That has shrunk the valuation gap almost completely, and I’d call these shares fairly valued at this point.

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Good Weather And Better Management Have Shrunk SLC Agricola's Discount To Fair Value

Saturday, June 9, 2018

Is American Eagle Flying A Little Too High Again?

When I last wrote about American Eagle (AEO), I noted the odd cyclicality of this apparel retailer - particularly the stock's "habit" of bottoming out every three years and then rallying. The shares have stuck with that pattern, rallying off summer 2017 lows and gaining more than 65% since the time of that last piece. Of course, there have been fundamental factors at play too, with American Eagle posting improved store comps and ongoing growth in its e-commerce business, as well as some signs of margin leverage.

It's harder for me now to make a bullish call on American Eagle. Core physical store-level comps are improving off a low base, but margin leverage is still challenging, and I'm not confident that the company can generate the sort of long-term revenue and margin momentum needed to make a compelling valuation argument on discounted cash flow. On the other hand, there seems to be momentum with the business now and the shares are not necessarily that pricey in the context of the company's ROIC.

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Is American Eagle Flying A Little Too High Again?

Alps Electric Looking To Recover After Swallowing A Sour Apple

As one of the companies that saw a significant hit to earnings and expectations from disappointing sales of Apple’s (AAPL) iPhone X, Alps Electric (OTCPK:APELY) is in good company, but that’s hardly much comfort to investors. With weak camera actuators sales (tied to the X) leading to much lower guidance for the next fiscal year, Alps shares have lost about 10% of their value since my last update, though they are still up about 25% from my initial write-up and have done okay compared to a grab-bag of other Apple suppliers including Cirrus (CRUS), Dialog (OTCPK:DLGNF), and Skyworks (SWKS).

Alps needs a rebound in camera actuators to drive some near-term excitement, and recent reports have been somewhat encouraging. It also helps that Alps management took what I believe to be a big swing at its FY’19 guidance, leaving the door open for beat-and-raise quarters as the year moves on. What’s more, the long-term opportunity in auto components remains attractive. I’ve trimmed back my long-term revenue and FCF margins assumptions a bit, but the shares look interesting now for investors who can afford to wait for momentum to return to the financial results.

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Alps Electric Looking To Recover After Swallowing A Sour Apple

Can The ING Tortoise Grow Into A Hare?

Comparing the performance of ING Groep (ING) to watching paint dry over the last six months is unfair … to paint. At least when you watch paint dry, you’ll have something to show for it sooner or later. But with ING Groep, weak growth and overall inhospitable market towards bank stocks have combined for a nearly 20% drop since my mid-December update. Although there are plenty of poor banking performances over that time (including fellow Benelux banks ABN Amro (OTCPK:ABNRY) and KBC (OTCPK:KBCSY)), ING’s performance has been pretty weak as investors are no longer so willing to pay a premium for a bank with lackluster growth prospects and trouble meeting its return targets.

I’m still relatively bullish on ING Groep, given that I believe it is a high-quality bank that is well-managed with respect to risk and investing in some markets that can spur better growth. I don’t expect scintillating performance, but I think that if ING Groep can get long-term earnings growth into the mid-single-digits (with a 10% to 12% ROE range in line with management’s target), there is worthwhile upside in addition to a respectable dividend.

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Can The ING Tortoise Grow Into A Hare?

DBS Group's Digital Strategy Makes Dollars And Sense

What a difference less than a year makes. DBS Group’s (OTCPK:DBSDY) ADRs are up almost 50% over the last year, as investors calmed down after the energy/commodity panic of 2016 and took courage from improving loan growth, interest rate, and credit quality trends across the Asian bank sector in 2017. Even after a big run, though, the shares may have more to give. DBS Group shares look undervalued on the basis of near-term ROE prospects and if digitalization initiatives pay off in the form of increased customer acquisition/activity and lower operating costs, the long-term growth potential could be meaningfully better than what it appeared to be just a year or two ago.

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DBS Group's Digital Strategy Makes Dollars And Sense

Volume And Complexity Creating Opportunities For FormFactor

As a company leveraged to both chip production volume and the increasing complexity of chip design and packaging, FormFactor (FORM) sits in a pretty good spot within the semiconductor equipment industry. Not only is demand for FormFactor’s probe cards tied to chip production volume, but the increasing sophistication of chip designs has increased testing demands and, I believe, expanded FormFactor’s competitive moat as solutions once deemed “good enough” no longer are.

FormFactor has been weak over the past year, hurt in large part by delays in Intel’s (INTC) ramp of 10nm chips. Then again, FormFactor has added a major new customer and the shares have already recovered some lost ground on the prospects for ongoing strength in memory and improving results in the second half of 2018. With the shares still offering some upside here, this looks like a name worth further due diligence.

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Volume And Complexity Creating Opportunities For FormFactor

Sluggish Rates And Book Value Growth Limit Renaissance Re's Appeal

I wasn’t overly excited about the prospects for the shares of Renaissance Re (RNR) (“RenRe”) back in the fall of 2017, as I was concerned that renewal rate increases would disappoint even after a bad catastrophe year and that RenRe would be facing a combination of weak book value and ROE performance. RenRe shares have indeed underperformed since then, falling almost 10% since that last article (though outperforming Arch Capital (ACGL) and Lancashire Holdings (OTCPK:LCSHF) (another reinsurance/specialty insurance company with meaningful property exposure)) and slightly more over the past year.

Weak rates have indeed remained the story, and with that weak momentum in book value growth (actual contraction for three straight quarters) and barely double-digit near-term ROE prospects. While RenRe remains a great reinsurance company, with upside in the casualty/specialty business and its third-party capital management vehicles, it’s likely going to take a little longer to unlock that value and investors have to contend with the risk that over-capitalized markets will be the “new normal” for a longer time, keeping a lid on RenRe’s rate growth prospects and returns.

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Sluggish Rates And Book Value Growth Limit Renaissance Re's Appeal

Fly Leasing Looks Undervalued, But Value Creation Will Take Time

Aircraft leasing companies have done okay over the last few years (excluding Aircastle (AYR)) relative to the S&P 500, but there’s still a certain frustrating “watching paint dry” feeling with many of these stocks as they still often seem not to get their full due in terms of valuation. While AerCap (AER) and Air Lease (AL) have done a little better in that regard, Fly Leasing’s (FLY) weaker returns on assets, equity, and capital, remains a constraining factor to valuation.

The acquisition of AirAsia’s aircraft portfolio should allow Fly Leasing to start generating better results, with the influx of aircraft and revenue boosting operating efficiency and the nature of the portfolio and leases supporting a better return on equity. Successfully executing on the AirAsia transaction could support a fair value in the high teens, but a more modest set of expectations would still support a fair value 15% higher than today’s price.

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Fly Leasing Looks Undervalued, But Value Creation Will Take Time

Self-Help And Stronger End-Markets A Powerful Combo For Materion

Most specialty alloy companies have enjoyed a good run over the past year, and Materion (MTRN) has certainly been among them with a 40%-plus move since my last update on the company. Not only has aerospace demand come to life, but Materion has also seen stronger momentum from its industrial and consumer electronics customers. Making things even better, the company’s cost-reduction/efficiency moves seem to already be paying dividends, and the company’s efforts to expand its new product contributions appear to be ahead of schedule.

Materion has done better than I’d expected it would last summer, but the valuation gives me some pause. I’m not surprised that the shares look pricy in DCF terms, but the EBITDA-based valuation is a little more limiting to my enthusiasm. Materion trades at around 12x forward EBITDA and I’d be reluctant to pay much more than that (frankly, I’d be reluctant to pay that much). Strong end-markets and ongoing margin improvement can still drive higher estimates, but the multiples already look pretty fair.

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Self-Help And Stronger End-Markets A Powerful Combo For Materion

Credicorp Leading The Recovery With Strong Growth And Credit

Peru’s Credicorp (BAP) has been something of a middling performer since my last update. The shares are up about 10% since early September (excluding dividends), but then the S&P 500 is up a little more than that and you could have earned similar returns from other Andean banks like Banco de Chile (BCH) and Banco Santander-Chile (BSAC), so I don’t feel like Credicorp has really lived up to what I’d have hoped. Then again, given the weakness in the Peruvian banking sector in the second half of 2017, it’s not a terrible result either.

As things stand today, Credicorp is in that gray area of “like the company, kinda uncertain on the stock.” I think a low double-digit total return is possible from here, and I do expect double-digit long-term earnings growth, but the P/TBV is right about where I think it should be and there’s still some work for management to do building up its retail lending business and making its dividend/capital return policy more transparent.

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Credicorp Leading The Recovery With Strong Growth And Credit

Palo Alto Networks Back In The Market's Good Graces, And Outperformance Is Getting Harder

I really can't complain about how Palo Alto Networks (PANW) has been performing since my last piece on the company in late September. At the time, a sales force reorganization and probably just some of the regular "hiccups" that go with any business led at least some sell-side analysts to try get ahead of the curve and call that the beginning of the end for traditional network security vendors like Palo Alto. Since then, the shares have risen about 40% - less than Fortinet (FTNT) and CyberArk (CYBR), but good enough to pull the jerseys of Check Point (CHKP) and FireEye (FEYE) up over their heads and give them a good pummeling - while year-over-year product revenue growth has re-accelerated from 1% (in FQ3'17) and 11% (in FQ4'17) to over 30% in this last quarter.

I'm less bullish on Palo Alto shares now, but only because of the growth expectations that the Street is now taking for granted. I like the company's two recent acquisitions and its ongoing efforts to expand its capabilities in areas like endpoint security and public cloud. Likewise, I think Palo Alto has the right "corporate DNA" to continue evolving, whereas Check Point more and more looks like a living fossil. Although I wouldn't chase the shares up here, this is definitely a name I'd reconsider on a pullback.

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Palo Alto Networks Back In The Market's Good Graces, And Outperformance Is Getting Harder

Sunday, June 3, 2018

Geely Auto Has Found A New Gear

I don't write about it as often as I'd like to, but Geely Auto (OTCPK:GELYY) (0175.HK) has long been one of my favorite companies and stocks. Although there is a long list of potential reasons to avoid the name, I've been bullish on the company's prospects to drive significant unit volume growth (as well as revenue and profit growth) on the back of new product launches and leveraging a development partnership with Volvo (OTCPK:VLVLY) (which is owned by Geely's parent company).

Since my last write-up, the ADR shares have risen another 50%, outperforming others like Brilliance China (OTCPK:BCAUY), BYD (OTCPK:BYDDY), SAIC, and Great Wall (OTCPK:GWLLF), as the company's rapid share growth has propelled it to sixth place among auto brands in China (and #2 in domestic brands). Valuation today is a little less cut-and-dried than I would like. While Geely's newest launches are performing well, and the company has a number of new vehicles hitting the market this year, the shares are no longer undervalued on a cash flow basis. While EV/EBITDA does still offer some upside, I'd approach Geely with a bit more caution these days.

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Geely Auto Has Found A New Gear

Tenneco Hoping That Doubling, Then Halving, Makes 1+1=2+

Like Dana (DAN), Tenneco (TEN) looks like a vehicle supplier that's been pounded down pretty hard, and with the shares down about 25% over the past year, maybe a little too hard. There are some legitimate concerns about margin weakness and the prospect of weaker unit volumes in both the passenger and commercial vehicle businesses, not to mention the company's mixed future in the hybrid/EV world and the risks that will come with integrating Federal Mogul and then splitting the business.

Even so, I think the valuation seems to overstate those risks. It's hard for me to advocate strongly for Tenneco given its not-so-impressive FCF generation over the years, but given the possibility that the merger and split will finally unlock some of the value in Ride Performance and arguably the overly pessimistic market opinion of the Clean Air business, this is a name worth some due diligence.

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Tenneco Hoping That Doubling, Then Halving, Makes 1+1=2+

Is Dana's Curious Valuation A Buying Opportunity?

Novice investors ask, "is it cheap?", but veteran investors know that the right question is often "why is it cheap?", and that certainly is a valid question to ask about Dana (DAN). Plenty of auto and commercial vehicle suppliers have ugly year-to-date charts, and while Dana's negative 30% performance is bad, it's not dramatically worse than Tenneco's (TEN), Commercial Vehicle's (CVGI), or Meritor's (MTOR).

Dana has exposure to weakening trends in light and commercial vehicles, and some risk from electrification, and yet the valuation is kind of a head-scratcher. Unless sell-side expectations are significantly off-base (and the market's valuation seems to be a strong vote that they are), these shares should trade somewhere in the high $20s to low $30s. It's certainly true that Dana doesn't have a great history with margins or overall performance, but it seems like the Street is pricing in some low expectations, and value-oriented and contrarian investors may want to take a look.

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Is Dana's Curious Valuation A Buying Opportunity?

A Good Quarter Makes The Value Call On Multi-Color A Little Easier

It's been a tough year for Multi-Color (LABL) ("MCC"), as the shares of this leading label-maker have been trending steadily lower (down 20%) as the company has come up short on organic growth and margins. The fiscal fourth quarter was a nice reversal of the financial trend, though, and the shares responded strongly to the better results and modestly bullish guidance for the next year. While
I expect Multi-Color to continue to post relatively turbulent quarter-to-quarter performance, the shares remain undervalued if the company can manage to continue to generate low single-digit organic growth supplemented with small tuck-ins and generate ongoing margin improvements sufficient to get FCF margins into the high single-digits.

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A Good Quarter Makes The Value Call On Multi-Color A Little Easier

The Wall Of Worry Looks A Little Higher At Cummins

Every company has risks and challenges and Cummins (CMI) is no exception, even if some of those risks are pretty familiar (end-market cycles, the risk of vertical integration). While the prospect of electric trucks is a newer challenge, as is a recent product quality/warranty issue, there's really never been a time I can recall when there wasn't some threat hanging over the shares.

While I think some of the risks and worries are overstated, I don't necessarily find these shares cheap today. I could see paying up into the mid-$150s for the shares, but that's not really all that much upside given where we are in the cycle. What's more, it seems like Cummins gets a little more benefit of the doubt than other component companies - some of the same sell-side analysts who believe that electrification will crush Allison Transmission (ALSN) are more sanguine on Cummins' future in an EV world.

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The Wall Of Worry Looks A Little Higher At Cummins

BorgWarner Looks Well-Positioned And Undervalued

BorgWarner (BWA) has proved to be another interesting company and stock to watch in the auto/commercial vehicle components sector. Although BorgWarner is uncommonly well-positioned to benefit from both stricter standards for internal combustion engines (or “ICE”) and the conversion toward hybrid and electric vehicles (or EVs), this often seems to be a stock where the market is looking for an excuse to not like it.

I thought BorgWarner was a little pricey back in October of 2017, and I don’t feel like I’ve missed out on much – the shares are down a bit over that period, while other auto parts companies like Lear (LEA) and Magna (MGA) have produced double-digit returns.

With healthy content growth pushing revenue growth well ahead of underlying build rates and reasonably good wins for upcoming hybrid/EV business, I’m more interested in the valuation and the stock now. I do have some worries about more challenging comps later in the year, and BorgWarner doesn’t have as much leverage to future hybrid/EV adoption as some, but I think this is a stock worth considering today.

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BorgWarner Looks Well-Positioned And Undervalued

Allison Transmission Driving Unfamiliar Roads With Dim Headlights

Allison Transmission (ALSN) has been a fascinating stock to follow over the last year or so, perhaps not so much for the stock price action or the nature of the product, but in how the sell-side is trying to process and project the threats to the company’s strong, high-margin business in automatic transmissions for commercial vehicles. A small cadre of analysts is dutifully predicting future doom for Allison as electric vehicles become more viable for commercial applications, and in the meantime, they just waive off quarters where Allison beats their EBITDA estimates by 20% or more.

To be sure, the electrification of commercial vehicles is a very serious threat to Allison’s business as it stands today, and given that management hasn’t offered much detail on what they have cooking in R&D, it’s hard to have much confidence that they will succeed in innovating their way into the future of electric vehicles (and with attractive margins).

Fortunately for me, I don’t have to deal with an institutional sales force and pretend I have all the answers, so I’ll flatly admit that valuing Allison today is quite difficult and involves a lot more guesswork than normal. While I’d be interested in the shares when they to drop into the high-to-mid $30s, I wouldn’t chase them in the $40s given the risks that Class 8 demand could fade combined with the long-term EV uncertainties.

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Allison Transmission Driving Unfamiliar Roads With Dim Headlights

Wabtec Biggest-Ever Deal Should Be Transformative

Wabtec (WAB) has always been unusually acquisitive, but in merging with/acquiring General Electric’s (GE) Transportation business, Wabtec is bagging the biggest target available to the company. While big M&A carries big risk, Wabtec knows how to integrate deals and GE is an uncommonly opportunity-rich deal for Wabtec, as it brings the global leader in locomotives and a very strong player in services and digital/electronics to one of the leaders in components and equipment for trains. In addition to rich revenue cross-selling opportunities and expense synergies, I believe Wabtec is doing this deal at an attractive point in the cycle.

Modeling Wabtec’s post-deal financials requires more than a little guesswork, but I believe there is a solid chance that this company will be an enterprise with $10 billion in revenue and low-to-mid teen FCF margins in 2022, with mid single-digit revenue growth beyond that point. If those estimates are the right ballpark, Wabtec shares look undervalued below the triple digits.

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Wabtec Biggest-Ever Deal Should Be Transformative