Sunday, February 11, 2018

Multi-Color Has A Large Addressable Market, But Mind The Operating Volatility

Multi-Color (LABL) is making a bad habit of posting noisy quarterly results that lead to substantial volatility in the share price. The problems are largely margin-related and have reached a level where they're overriding surprisingly strong organic growth trends in the business, and it is getting harder to believe this issue is going to resolve as the company has the not inconsiderable job of integrating a major acquisition that has a lot of different moving parts.

I had mixed feelings about the Constantia deal when it was announced and I still do - while expanding the business in Europe makes sense, I have concerns about the greater exposure to lower-margin, more commodity-like business. I would have preferred to see Multi-Color acquire more capabilities in higher-margin businesses like healthcare, but that could still come.

The "operating inefficiencies" cited by management and the more erratic margin performance has widened my fair value range on the shares, but I do believe the shares are still undervalued. Multi-Color really needs to post a few good, boring quarters and restore confidence that this combination is a real value-creating event for shareholders.

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Multi-Color Has A Large Addressable Market, But Mind The Operating Volatility

Glimpses Of Progress At Manitex

Small-cap crane manufacturer Manitex (MNTX) has become a much harder company to follow recently. Not only is this company barely followed by the Street, the company’s need to restate earnings for 2016 and 2017 means there’s not much reliable information to go on in terms of recent historical numbers.

The good news is that what information management has provided is broadly positive. Revenue is rebounding, the backlog is growing, and margins seem to be more or less where I thought they’d be. Predicting how far this recovery can take the energy and construction businesses is difficult, and the company is also doing a pretty good job of building out its PM Group business in the U.S. All told, I think today’s stock price is pretty fair and offers double-digit expected returns for a business that still has elevated operating risk.

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Glimpses Of Progress At Manitex

Lundbeck Looks Largely Played Out

I’m often sloth-like when it comes to selling positions in good companies, but it looks to me like the time to part company with H. Lundbeck A/S (OTCPK:HLUYY) (LUN.CO) may be close at hand. Despite concerted efforts to differentiate its new product portfolio, Lundbeck is struggling to gain much headway versus generics in the U.S., while generic competition continues to threaten lucrative profit centers in the mature portfolio. What’s more, the cupboards are pretty bare when it comes to the pipeline, and though management seems more positive on M&A than it has in the past, early-stage assets aren’t likely to garner much enthusiasm.

Lundbeck shares are trading around my fair value, suggesting a total return potential in the high-single digits – which really isn’t too bad today (and part of the reason I’ve been slow to sell). The announcement of a new CEO could also be a stock-moving event (in either direction), as he or she will likely have a vision for Lundbeck that offers at least some change from today. I don’t believe my low single-digit growth expectations are all that aggressive, but these shares are looking pretty “meh” after a strong run driven by new launches and rigorous cost restructuring.

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Lundbeck Looks Largely Played Out

Battered Back Below $3, PacBio's Shares Offer High-Risk Upside

If you like to trade, Pacific Biosciences (or “PacBio”) (PACB) may be right up your alley. If you’re an investor looking to play the ongoing growth in sequencing with a company that has brought differentiated technology to lab, well, this stock may well give you grey hair and some sleepless nights. These shares were at $2.50 in the spring of 2013, over $6 in the spring of 2014, in the $5-$6 range in the spring of 2015, close to $10 in the spring of 2016, in the $5’s again in the spring of 2017, and now back in the $2’s (albeit with a higher share count than in 2013).

This volatility has not come without good reasons, as PacBio has yet to really break through with its technology and products. The installed base does continue to grow, as does usage, but the adoption curve has been very unpredictable due to company missteps, budget uncertainties, and competitive offerings. While this is a very high-risk stock, I continue to believe that there are legitimate, meaningful uses for PacBio’s technology and that ongoing improvements will help reliability and drive a more consistent adoption curve. With a fair value in the $5 range, this very speculative name is worth another look today.

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Battered Back Below $3, PacBio's Shares Offer High-Risk Upside

Wednesday, February 7, 2018

Lenovo Making Progress, But It's Slow

Slow progress, sometimes frustratingly slow, continues to be the name of the game for Lenovo (OTCPK:LNVGY). Although there were signs of progress in the company’s fiscal third quarter (December) results, the ongoing operating challenges in the mobile business remain significant and there are no guarantees that the progress gained in the Data Center business can be held.

It hasn’t been very long since my last update on Lenovo, but since that time the shares have drifted about 5% lower, underperforming the Nasdaq and HP (HPQ) and basically matching Apple (AAPL) over that brief window. Stretch that window back a year or two, though, and the underperformance becomes much more apparent. That said, I don’t believe Lenovo is done for, and I believe expectations have been worn down to a point where Lenovo should be able to outperform in the coming years.

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Lenovo Making Progress, But It's Slow

Without More Revenue Growth, Check Point's Valuation Is Almost Beside The Point

Normally, investors would be happy with a company that generated more than twice as much operating income growth as revenue growth and actually reduced operating expenses. But then, software isn't a normal sector and Check Point Software Technologies (CHKP) isn't a normal company. In a sector where revenue growth is a major driver, Check Point's focus on expense discipline and organic/internal development hasn't been generating much revenue growth and hasn't helped the share price much next to Fortinet (FTNT), Palo Alto (PANW), or the Nasdaq.

One of my biggest concerns about Check Point is that the company will keep itself lashed to the mast of a ship that's not going anywhere (traditional firewall-type security) instead of taking more aggressive steps toward growth in the evolving enterprise security world. I don't doubt that Check Point has the resources to change its trajectory, but I'm not sure it has the will. With that, although the share price/value proposition is interesting, I'm nervous about buying into a lower-growth software story, given how challenging and frustrating they can be.

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Without More Revenue Growth, Check Point's Valuation Is Almost Beside The Point

A More Balanced Kirby Can Offer More Upside From Here

The past year has been a challenging one for Kirby (KEX), but I believe there is still value in the business and the shares. Although Kirby's core marine business is still seeing some difficult market conditions, management's decision to diversify further into engine/equipment servicing and construction is paying dividends with the recovery in the U.S. onshore energy market. What's more, management has been acting responsibly in its marine business, retiring older capacity, and recently committing to acquire a sizable fleet of newer assets.

The shares have climbed about 25% since my last update, but I see more value on the basis of good demand in the D&S business and recovery prospects in the marine operations. Conditions in the inland market are already getting better, but a coastal recovery is likely a 2019 driver. With mid-single-digit revenue growth and FCF margins moving toward the double-digits, KEX shares should be able to produce total annual returns in the high single-digits to low double-digits from here.

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A More Balanced Kirby Can Offer More Upside From Here

Rexnord Starting Its Cyclical Upswing

Improving end-markets across numerous industrial, consumer, and construction markets have largely mopped up most of the quality undervalued industrials stocks, and Rexnord (RXN) is no exception. The shares are up about 20% since my last update on the company, beating peers in its Process & Motion Control business like Regal Beloit (RBC) and Renold (OTC:RNOPF) and more or less matching its prime rival in Water (Watts (WTS)). Although the shares no longer appear fundamentally undervalued, the relative valuation is a little more appealing, and Rexnord's markets continue to improve, which could offer a little more appeal for less value-sensitive investors.

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Rexnord Starting Its Cyclical Upswing

Bigger And Better, South State Corp Looking To Disrupt The Southeast

South State Corp. (SSB) is following a time-tested strategy - leveraging a low-cost deposit base and strong market share in attractive markets to build a competitive commercial lending-focused banking franchise. There are growing pains throughout that process, though, and South State has yet to post strong returns on equity or capital on a consistent basis. What's more, the shares looked a little pricey around a year ago, and the shares have lagged regional bank peers since.

With Park Sterling in the fold, good organic loan growth, and strong core markets, though, I believe this is a time to revisit South State. Much larger rivals like Bank of America (BAC), BB&T (BBT), Wells Fargo (WFC), and SunTrust (STI) should not be taken lightly, but South State's low funding costs are a strategic asset, as is the company's focus on smaller commercial clients that often don't feel so well-served by the larger super-regional baking franchises. If South State can generate the mid-teens organic growth I expect, these shares look undervalued below $100.

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Bigger And Better, South State Corp Looking To Disrupt The Southeast

Buying Traffic Has Hammered Natural Grocers' Results

When I last wrote about Natural Grocers (NGVC) roughly 18 months ago, I said that I believed the shares would continue to head lower if the company couldn't reverse weak traffic trends. Management has in fact struggled to revive store traffic, and the shares are 50% lower now. Although the company is making decisions that make sense from a long-term perspective (getting more aggressive on price to drive traffic, reorienting marketing around what makes the stores different, and significantly reducing new store openings), it is still very much an open question as to whether Natural Grocers can find the right mix that will bring back traffic and allow for worthwhile margins.

I believe this latest disappointment (after fiscal first quarter earnings) has pushed the shares down to an interesting level, but there are outsized risks here. A multiple of 6.5x my 2018 EBITDA estimate will support a fair value around $8, and my DCF model suggests an even higher target, but models are not guarantees - there's a reason one of the most common words in conjunction with "earnings" is "surprise" - and this is a risky call at this point.

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Buying Traffic Has Hammered Natural Grocers' Results

Monday, February 5, 2018

Crane Seeing A Choppier Recovery

Crane (CR) has always been a little different relative to its multi-industrial peers, so I can't say that I'm all that surprised that this company's recovery has followed a different trajectory. Not that this has done the share price any harm - Crane shares are up about 100% over the past two years, better than Parker-Hannifin (PH), Dover (DOV), Emerson (EMR), and many other peers that have seen sharper boom/bust cycles.

While the recent Crane & Co. ("Crane Currency") acquisition should pay off well over time, the near-term outlook for Crane is relatively tepid, with the company expecting decent (but not market/segment-leading) growth across its businesses in 2018 and not a lot of margin leverage. Some investors may find that Crane shares still make sense on a relative value basis, but I'm not inclined to chase these shares.

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Crane Seeing A Choppier Recovery

Recovering Markets And Improving Margins Propelling IDEX

Things are pretty good these days at IDEX (IEX). Strong, and persistent, recoveries in markets like agriculture and water and ongoing growth in semiconductors have helped drive strong organic revenue growth, which the company has leveraged into improved margins across its businesses. Free cash flow generation has picked up and the outlook for 2018 is attractive.

The "but", as is the case for most multi-industrials, is valuation. If you believe in buying good companies no matter what the price/valuation and/or you're comfortable with implied returns in the mid-single-digits, maybe IDEX still meets your requirements. I'm less comfortable with valuation, though, and while IDEX is generating good results (and is likely to continue to do so in 2018), I'm not willing to pay such a high apparent price.

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Recovering Markets And Improving Margins Propelling IDEX

The Feds Put Wells Fargo In The Penalty Box

I believe most investors expected that there would be meaningful consequences for the long list of consumer banking misdeeds Wells Fargo (WFC) has racked up in recent years. After all, widespread, highly public fraud is not something that regulatory bodies can really just ignore if they want to maintain any semblance of credibility with that same public. In any case, the punishment handed down by the Fed on Friday 2 was unusual and significant.

Wells Fargo will survive the Fed's move, and the impact to earnings in 2018 and 2019 is most likely not going to be all that severe. True, it does sap the bank's earning power just as it seemed to be ramping up again, and it does carry ongoing reputational risk for the bank, but it is not a crushing (let alone killing) blow by any stretch.

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The Feds Put Wells Fargo In The Penalty Box

Saturday, February 3, 2018

Roche Drifting Ahead Of Key Data

Things aren't as dire at Roche (OTCQX:RHHBY) as the market may have you believe, but the reality is the company needs to deliver strong clinical data from multiple upcoming late-stage trials. Generics are coming after key drugs that contribute close to 40% of the company's total revenue, and investors need a reason to believe again that Roche can continue to generate worthwhile growth as these veteran contributors start to diminish.

I'm still more or less bullish on the Tecentriq opportunity at Roche, and I believe the company has made more progress with its pipeline than is reflected in the share price. The company definitely needs these upcoming trial read-outs to go well, but I believe the share price undervalues what I believe will be long-term mid-single-digit free cash flow growth.

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Roche Drifting Ahead Of Key Data

FirstCash Continuing To Make Steady, Value-Creating Progress

Leading pawn store operator FirstCash (FCFS) continues to reap the benefits of a disciplined strategy for building out its fast-growing Latin American operations and simultaneous turning around and integrating the acquired operations of Cash America in the U.S. business. That has not only shown itself in improving underlying financial results but also a higher share price, with the stock more than 70% higher than it was a year ago (versus a 36% rise in its only real publicly-traded comp, EZCORP (EZPW)).

I'm a long-term FirstCash shareholder, but it's hard to argue that FirstCash is significantly undervalued today. A more benign USD/MXN exchange rate could certainly help some, the Cash America stores could start contributing positively more quickly than I expect, and/or the LatAm expansion could be even more successful than I expect, but I think the share price is pretty close to where it ought to be considering the growth potential and the operational risk.

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FirstCash Continuing To Make Steady, Value-Creating Progress

Long Products Should Drive A Good 2018 For Nucor

These are good days to be a steel company. Even with the negative impact of higher scrap costs and import competition, revenue and margins are better than they’ve been in some time. For Nucor (NUE), it’s not just about riding the cycle (although the cycle is important), as the company has been continually invested in value-added capacity and executing tuck-in acquisitions to broaden its portfolio. With relatively healthy industrial markets and the prospect of protection from imports, 2018 is looking pretty good for Nucor and peers/rivals like Steel Dynamics (STLD), Gerdau (GGB), and Commercial Metals (CMC).

Price/valuation is a hang-up for me. While an 8x multiple on my 2018 EBITDA estimate would offer some upside (about 5%), that’s about as high as I’d go for the company. There are certainly opportunities for Nucor to outperform in 2018 and drive a higher fair value by virtue of a higher EBITDA estimate, but this isn’t my favorite steel name right now and that’s not surprising as up-cycles tend to favor lesser operators and Nucor remains among the best-run companies in the industry.

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Long Products Should Drive A Good 2018 For Nucor

Grupo Bimbo - Come For The Snacks, Stay For The 10-20% Upside

Grupo Bimbo (OTCPK:BMBOY) (BIMBOA.MX) is probably not a household name to most readers, even though this is the largest baked goods company in the world, operating in over 30 countries and selling over 13,000 products. Those who spend time in Latin American markets are probably familiar with the Bimbo bear mascot, but even those who aren’t probably recognized brands like Thomas’, Arnold, Entenmann’s, Ball Park, EarthGrains, and Sara Lee.

Bimbo didn’t have a great 2017, due in large part to weak margins, but 2018 looks to be a stronger year for the company in its two core operating regions (Mexico and U.S./Canada). While margin-dilutive remains a risk factor, margin improvements paired with modest low-to-mid single-digit revenue growth argue for a share price 10% to 20% higher than today.

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Grupo Bimbo - Come For The Snacks, Stay For The 10-20% Upside

Thursday, February 1, 2018

Silicon Labs' IoT Energizer Bunny Keeps Going

Silicon Labs (SLAB) continues to leverage its opportunities in the fast-growing IoT market, and that continues to drive good revenue and profit growth for this relatively small semiconductor stock. Silicon Labs has moved aggressively, largely through M&A, to acquire a strong portfolio in wireless (especially mesh networking and connectivity) technologies, giving it a strong position in home/consumer IoT and allowing it to "punch above its weight" relative to some of its much larger rivals.

While I continue to expect good things for SLAB's IoT business, and I believe the Infrastructure business can leverage growth in optical and 5G deployments, the valuation is not forgiving. Growth and momentum investors likely won't care about the valuation, but with the stock trading at close to five times forward revenue, it may be challenging for the company to grow fast enough to substantially expand that multiple.

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Silicon Labs' IoT Energizer Bunny Keeps Going

Dover's Ability To Create Long-Term Value Still An Open Question

Dover (DOV) reported a good fourth quarter, with a very strong top-line organic growth figure and improved margins across the business. Guidance for 2018 was also pretty positive, and Dover will be moving forward with the spin-off of its energy business ("Wellsite") and a sizable share buyback. All of that is welcome, but it doesn't really mitigate a pretty mediocre long-term track record of value creation.

Perhaps the involvement of Third Point as an investor will spur more changes. Dover is certainly not "un-fixable", but the company does need to better manage the assets it has and come up with a better unified vision for where its expertise and focus will be in the future. Although I'm clearly not a huge fan of management, and the shares aren't cheap, the return expectations here seem more reasonable than for many other multi-industrials, so less valuation-conscious investors may still find some upside.

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Dover's Ability To Create Long-Term Value Still An Open Question

Wednesday, January 31, 2018

W.R. Berkley Looking To Better Days, But The Market Is Already There

Commercial insurance companies are enjoying pretty high multiples on an historical basis, even though the market remains concerned about pressure on rates and claims inflation. W.R. Berkley's (WRB) recent performance is part of the reason I harp on valuations - although W.R. Berkley's operating results haven't been bad, the shares have lagged peers/rivals like Travelers (TRV), Hartford (HIG), and Chubb (CB) over the past year.

Looking at 2018 and beyond, I'm not bothered by W.R. Berkley's relative growth prospects. I think the company still has good growth prospects in a range of markets, and the company's more aggressive than average approach to investments (including real estate) has reliably contributed positively to income. My concern remains valuation, as the company trades at a high-teens multiple to forward EPS, and the shares seem to be factoring in a pretty exceptional level of growth.

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W.R. Berkley Looking To Better Days, But The Market Is Already There

Stryker Producing Excellent Results, But Expectations Are High

This year will be the 25th year I've followed med-tech (holy crap I'm old…), and Stryker (SYK) continues to amaze me. Apparently, Stryker never got the memo about "trees not growing to the sky" and the need to settle into a quieter middle age. In addition to pursuing growth-oriented M&A to augment existing businesses and address new markets, Stryker continues to do an excellent job of managing its long-held core businesses.

A business that performs as well as Stryker should command premium valuation, but how much of a premium? High single-digit FCF growth suggests an expected return of around 7% to 8%, and maybe that's not bad expected return/risk balance for a company like Stryker. Still, I believe the expectations are a little too high now, and I'd want a better expected return before buying in - even for one of the best-run companies out there.

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Stryker Producing Excellent Results, But Expectations Are High

Danaher Back On Track To Start 2018

It can get a little ugly when darlings lose their luster, and Danaher (DHR) took some dings in 2017, leading to underperformance relative to other multi-industrials like Fortive (FTV), Honeywell (HON), 3M (MMM), and Illinois Tool Works (ITW). Considering the last couple of quarters, though, it looks as though Danaher is back on better operational footing and that 2018 will be a more "Danaher-like" year.

Given that Danaher spun off most of its industrial exposure, I still see the risk that Danaher will underperform some of those aforementioned peers for a little longer, as industrial recoveries spur greater growth. Longer term, though, I'm not really concerned. Like Honeywell, I can't really say that Danaher is "cheap", but it does appear to be less expensive than most of its peers and something of a relative bargain.

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Danaher Back On Track To Start 2018

Datalogic Leveraging Its Product ID Know-How Into Larger, Faster-Growing Markets

Automation takes many forms, and product ID is arguably an under-appreciated part of the automation story. Italy's Datalogic SPA (OTC:DLGCF) (DAL.MI) is leveraging a strong foundation in retail data capture (scanners in particular) into new areas and gaining share in markets like manufacturing, logistics, and healthcare as more businesses turn to advanced identification technologies to improve production flows, improve accuracy/reduce errors, and lower overall operating costs.

Datalogic's ADRs are not especially liquid, but these shares are nevertheless worth a look as companies like Honeywell (HON) bring a higher profile to the opportunities to automate in areas like warehouses and logistics. With fragmented competition in the manufacturing and logistics spaces, I believe Datalogic could generate long-term revenue growth in the high single-digits with improving margins and perhaps attract the attention of larger players looking to bring more technology to factory floors and warehouses.

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Datalogic Leveraging Its Product ID Know-How Into Larger, Faster-Growing Markets

SUMCO's Rocket Ride May Not Be Over Yet

In the world of silicon wafers, two companies stand apart – Shin-Etsu (OTCPK:SHECY) and SUMCO (OTCPK:SUOPY). These two Japanese companies control close to 60% of the market between them, and an even larger share of the most sophisticated and demanding wafer types. I wrote about Shin-Etsu here, and now, it is time to take a look at SUMCO – a company that is benefitting from strong wafer price increases and healthy volumes as fabs continue to ramp up production of memory and logic chips.

SUMCO has already enjoyed a strong run and the wafer sector is cyclical. Right now, the industry is going through a significant up-cycle, but capacity additions have been restrained, and the outlook for wafer pricing over the next few years is healthy. While a lot is already in the share price, I don’t think SUMCO’s potential is tapped out just yet.

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SUMCO's Rocket Ride May Not Be Over Yet

Tuesday, January 30, 2018

Data Center Driving IDT Ahead Of New Launches And Revenue Opportunities

While it may just be a slowdown within a bullish up-cycle, many segments of the semiconductor industry have gotten more challenging recently. Investors have gotten nervous about volume growth in smartphones, particularly on the high end, and data center and communications spending has been slower to pick up than expected. Those are all key markets for Integrated Device Technology (or "IDT") (IDTI), but the company is leveraging new product cycles to continue to generate good growth.

Although valuations are generally pretty high around the semiconductor space, there does still seem to be some opportunity left for IDT to go higher, particularly if the strength in computing continues, and the company sees more growth in communications and consumer markets. I would also note that although IDT is probably close to the limits of what it can achieve for near-term margin leverage, the accretion potential to an acquirer makes this a serious candidate to be bought out.

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Data Center Driving IDT Ahead Of New Launches And Revenue Opportunities

Operational Clouds Have Opened Another Window At Alaska Air

Airlines in the U.S. have shown an uncommon level of discipline for the past decade, setting the stage for a nice boom period where most industry participants have been able to make some good money. Nothing that good lasts forever, though, and there are emerging signs that airlines are getting a little loose with capacity in the interests of competition.

With Alaska Air (ALK), there are concerns that go beyond that competitive industry backdrop. The integration of Virgin America (NASDAQ:VA) hasn't been completely smooth and it looks as though the company might be slipping a bit on much-vaunted metrics like cost control and customer experiences. All of that has led to a roughly one-third drop in the share price from its early 2017 peak and underperformance relative to some of its larger rivals.

I'm cautiously bullish on Alaska Air now. I'm bullish because I think modest growth can support a fair value in the $70s based upon both DCF and EBITDAR. I'm cautious because individual stocks don't often outperform when the entire sector goes into disfavor, and I think there could be some more bumps in the road as Virgin America is fully integrated and as rivals respond to the new, larger, more competitive Alaska Air.

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Operational Clouds Have Opened Another Window At Alaska Air

GEA Group's Struggles Look Like A Potential Window Of Opportunity

GEA Group (OTCPK:GEAGY) underscores one of the challenges in the market today – if you want to pick up shares of an industrial company at a decent (or maybe even “cheap”) valuation, you’re going to pay for it in others ways. In the case of GEA Group, that’s consistency and quality, as the company announced another miss for the fourth quarter and gave disappointing guidance for 2018.

The good news/bad news at GEA Group is that this is a generally good collection of assets that aren’t being run particularly well. With activist investors now involved, I believe there will be more pressure on management to start hitting their efficiency targets and I think the Street would generally welcome a change in management if it comes to that. Priced to generate a high single-digit return from here, I think GEA Group has some appeal, but this stock will require patience and an above-average ability to stomach some near-term volatility and disappointment.

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GEA Group's Struggles Look Like A Potential Window Of Opportunity

Asset Sensitivity Not Getting It Done For Fulton Financial

Despite above-average asset sensitivity, Fulton Financial (FULT) doesn’t seem to be making as much progress as some of its peer/rival banks. Double-digit revenue and pre-provision net revenue (or PPNR) growth in the fourth quarter certainly weren’t bad, but expectations were already high and it looks as though Fulton’s loan growth prospects have slowed.

There are still avenues by which Fulton can outperform – getting out from under its consent decrees (whenever that happens) will be a help on both the M&A and cost front, and there is more room to leverage hires made in its commercial lending group. Still, with expectations setting such a high mark, it would seem that not even double-digit earnings growth is enough to drive an exciting fair value at this point.

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Asset Sensitivity Not Getting It Done For Fulton Financial

Growth In Aerospace And An Oil & Gas Recovery Bode Well For USAP

As has been the case for other specialty alloy companies like Allegheny (ATI), Carpenter (CRS), and Arconic (ARNC), the last twelve months have been good to Universal Stainless & Alloy Products (USAP), as aircraft suppliers gear up for major product ramps and other key users like oil/gas and heavy industry recover. USAP has actually been the best performer of the lot over the past year, but I believe there is still more potential upside as orders grow, margins scale up significantly, and potential trade actions restrict import competition.

Investors should note that this is a riskier than average stock. The business is exceptionally cyclical and this really isn't a candidate for a long-term buy-and-hold approach.

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Growth In Aerospace And An Oil & Gas Recovery Bode Well For USAP

Monday, January 29, 2018

Honeywell Looking At Improving Markets And Strategic Options In 2018

I don’t exactly think that Honeywell (HON) is undervalued right now, but it is probably about as close to undervalued as I’m going to find in the large-cap multi-industrial space, or at least outside those stories that need significant self-improvement. With good growth in safety and productivity, ongoing growth in chemicals, a recovery in process automation, and improving conditions in aerospace, 2018 should be a pretty good year for Honeywell. What’s more, the company’s upcoming spin-offs should improve the overall long-term growth outlook and Honeywell has more than enough liquidity to make a significant strategic acquisition or two. Like I said, this stock is not cheap, but the implied return is a little more palatable than for many of its peers.

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Honeywell Looking At Improving Markets And Strategic Options In 2018

Atlas Copco Executing Well On Rising Tides

Having followed Atlas Copco (OTCPK:ATLKY) for quite some time, it’s hard to come up with new ways to compliment what has long been one of the best-run industrials out there. Management follows a clear model that prioritizes market leadership, close customer relationships, service and support, and a long-term focus that means they don’t fire engineers or sales reps just because of a market downturn. The results are what they are – a trailing decade of double-digit annualized free cash flow growth, double-digit returns on capital, and outperform relative to both the S&P 500 and its peer group.

And as is so often the case, the valuation on the shares is a major hang-up for me. Yes, I know there are long-term investors in stocks like Atlas Copco and peers/comps like Illinois Tool Works (ITW) (one of the few comparables to outperform Atlas over the last decade), Ingersoll-Rand (IR), Eaton (ETN) and so forth that will argue to just buy and hold irrespective of valuation, but that’s not my approach. Although I don’t expect to be able to buy Atlas Copco shares at substantial discounts to fair value, past history suggests there will be opportunities again in the future to buy in at a more reasonable level of future expectations.

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Atlas Copco Executing Well On Rising Tides

Saturday, January 27, 2018

Clockwork Excellence Of Execution From Illinois Tool Works

Stop me if you've heard this before - a well-run global conglomerate is still finding ways to generate decent organic growth and strong operating leverage, but the market already seems to be well ahead in terms of valuation. And so it goes with Illinois Tool Works (ITW). While ITW remains a strong execution story, it's hard to see value in the shares. Still, given ITW's reputation as a great operator leveraged to growth in North America and Western Europe, it won't surprise me if the valuation stays robust as long as the markets remain healthy.

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Clockwork Excellence Of Execution From Illinois Tool Works

Renewed M&A Chatter Outweighs An Okay Quarter For Microsemi

Microsemi's (MSCC) CEO made a statement not so long ago that has been repeated more than a few times recently - in the semiconductor world, you're buying until you get bought. Buyout chatter is once again swirling around Microsemi, and a deal price could easily exceed $70 for this diversified player. In the meantime, though, the company's performance continues to be a little mixed - not actually bad, but not providing the beat-and-raise momentum that investors typically want to see.

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Renewed M&A Chatter Outweighs An Okay Quarter For Microsemi

3M's Ongoing Performance Forcing A Change In Perceptions

If there's any stock that has benefited from the unwind of GE (GE) as a go-to "safe and steady" idea, I would argue it is 3M (MMM). Chronically maligned as a sluggish, short-cycle play, I believe 3M has demonstrated in the last few years that it is more nimble and less cyclical than commonly perceived. Although I cannot defend the valuation on the shares today (as is the case for so many of its peers), at least the arrow is pointing up for 3M in terms of both performance and guidance.

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3M's Ongoing Performance Forcing A Change In Perceptions

High Expectations Remain The Theme For Rockwell Automation

In turning down a rather rich bid from Emerson (EMR), Rockwell (ROK) certainly signaled that the board has a lot of confidence about where this leading automation player is heading. Although Rockwell isn't, and never has tried to be, "all things to all customers", the company's strong presence in process and hybrid automation and its emerging industrial IoT platform doesn't make that confidence completely unfounded.

As is so often the case with Rockwell, valuation continues to be my primary concern. While there are some valuation approaches that suggest Rockwell's valuation isn't excessive, it's not a bargain either, even if Emerson was willing to pay more than today's price to own the company.

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High Expectations Remain The Theme For Rockwell Automation

PINFRA Looks Undervalued, With A Healthy Growth Pipeline

Investors are clearly concerned about the future holds for Mexico, and I believe that has created a window of opportunity with Promotora y Operadora Infraestructura ("PINFRA") (OTCPK:PUODY), a major operator of toll roads in Mexico. With close to 30 toll roads in its portfolio and a high likelihood of adding more in the near future, not to mention opportunities in areas like ports, PINFRA generates very strong, repeatable free cash flows that I do not believe are as economically sensitive as the market fears.

I don't expect PINFRA to duplicate the remarkable growth it has shown over the last decade, but it doesn't need to in order to generate strong results for shareholders. Mexico needs to upgrade its infrastructure and I believe PINFRA's proven track record of execution leaves it well-placed to win bids sufficient to generate ongoing growth in the 6% to 7% range, supporting a fair value about 15% to 20% higher than today's price.

Investors should note that PINFRA's U.S. ADRs, though sponsored, are not especially liquid.

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PINFRA Looks Undervalued, With A Healthy Growth Pipeline

Alps Electric's Shift Towards Auto Will Unlock More Growth

Serving the smartphone industry, and Apple (AAPL) in particular, can be a mixed blessing. While the volume, revenue, and profit potential can be considerable, the smartphone industry is highly competitive and worries about shipment growth can create a lot of volatility. So it has been for Alps Electric (OTCPK:APELY) - while this leading component manufacturer for phones and autos has done well recently with its smartphone-facing business, worries about demand for the iPhone X have played a big role in the recent 15% drop in the share price.

I like the fact that Alps is shifting more towards auto, as I think the company has a wide range of technologies/capabilities that fit with where the auto sector is moving. Although the shares have performed pretty well since my last update (up around 40%), I think there could be another 20%-plus move in the shares as investors calm down about the smartphone business and start seeing more progress in the auto business over the next 12 months.

Investors should note that Alps' U.S. ADRs are not especially liquid.

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Alps Electric's Shift Towards Auto Will Unlock More Growth

Saddled With Investor Worries, Cemex Deserves Another Look

I’ve come across a lot of reasons not to invest in Cemex (CX), the Mexico-based global cement company. Some say the company is too complex, others that it has pursued global expansion irrespective of value, and still others that there’s just too much risk in its “value over volume” approach, particularly recently in Mexico.

I’d never argue that Cemex is a flawless investment candidate, but I’d argue the stock’s underperformance relative to peers like Martin Marietta (MLM), Eagle (EXP), LafargeHolcim (OTCPK:HCMLY), and Buzzi (OTCPK:BZZUY) is overdone. Not only is Cemex making significant strides in deleveraging, I believe there is more operating progress than commonly thought, as well as better prospects in its core Mexico and U.S. markets.

Although using free cash flow modeling for a company like Cemex is very tricky, I believe EV/EBITDA is less desirable given the importance of “I” (interest expense) as well as the fact that such a one-year metric doesn’t reward the progress I believe is to come.

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Saddled With Investor Worries, Cemex Deserves Another Look

Leadership In China Driving A Bright Future At A.O. Smith

A.O. Smith (AOS) doesn't try to do everything, but focusing on doing what it does with a high degree of operating excellence has produced great results for shareholders - the market returns over the past five and 10 years have been well ahead of the norms for other appliance companies like Whirlpool (WHR) or Electrolux (OTCPK:ELUXY), while revenue growth, margin leverage, and returns on capital stack up very favorably as well.

That's great and all, but that's in the past right?

I expect that A.O. Smith's North American business will remain a mid-single-digit grower with very healthy margins, while exceptional growth from the company's efforts in China (and, further down the road, India) should keep overall revenue growth in the high single digits for quite some time to come. A.O. Smith's excellence is well-represented in the share price, though, and it's tough to see how this is a bargain unless you have very bold expectations for future revenue growth and margin leverage.

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Leadership In China Driving A Bright Future At A.O. Smith

Acerinox Has More To Offer As A Trade

Commodity companies don't easily lend themselves to long-term buy-and-hold strategies, but they can still generate good gains for investors willing to be a bit nimbler with their moves. Acerinox (OTCPK:ANIOY) (ACX.MC) is up more than 50% from its cycle lows in 2015-2016, but these shares still appear to have some upside based on improving stainless steel demand, healthy pricing, and reasonable competition. What's more, while commodity stocks don't really trade on full-cycle cash flows, Acerinox is exiting a capex reinvestment cycle as the market is turning up - a positive development for margins and cash flows.

There is no easy answer to the "right" multiple to use in EV/EBITDA analysis, but I believe an 8x multiple is reasonable for Acerinox, given its place in the cycle and the stainless steel market. With such a multiple, the shares look about 10% undervalued with potential upside from a stronger/longer stainless up-cycle that would support even higher EBITDA estimates.

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Acerinox Has More To Offer As A Trade

Wednesday, January 24, 2018

Steel Dynamics Augmenting The Steel Up-Cycle With Its Own Excellence

One of the traits that often trips up investors in commodity stocks is the reality that it is often the inferior companies that do better during market upswings. To that end, while Steel Dynamics (STLD) remains one of the best-run steel companies out there (and frankly, one of the best companies I think I've followed), the shares have notably lagged the likes of U.S. Steel (X), AK Steel (AKS), and ArcelorMittal (MT) since the sector troughed early in 2016. Fortunately, there is some compensation - while holding cyclical stocks like Steel Dynamics is often not such a good idea, Steel Dynamics's outperformance during the downswings helps to compensate, and the shares have done far better than its peer group over the last five years.

In any case, these are good days to be a steelmaker, and I expect Steel Dynamics's own operating excellence to maximize the value in this upswing. The company has done a good job of building share in targeted markets like autos, and I see ongoing opportunities for the company to improve its portfolio over the next few years. Valuation is a little trickier, though. Modeling cyclical commodity companies is a brutal exercise (nobody saw this big recovery two or three years ago), but I don't see as much value in Steel Dynamics as I do in other metal names.

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Steel Dynamics Augmenting The Steel Up-Cycle With Its Own Excellence

A Spark At Accuray - Will It Catch Fire This Time?

The problem with small-cap radiation oncology company Accuray (ARAY) is not that it never has good quarters. The problem is that the company has never been able to put together a good run. With two pretty good quarters in the hopper, though, maybe the actions that management has taken over the past couple of years are starting to make a real difference in order flow and revenue conversion.

I'm still skeptical (and still a shareholder), but if management is playing it safe with guidance, there might be some actual momentum in the business now. I will explain my thinking later in this piece, but I'm now more comfortable with a valuation approach that suggests a fair value in the mid-$7s, making Accuray worth a look if you can take on the risk that this is yet another head fake in what has been a frustrating pattern of "two steps forward, 1.9 steps backward" for many years.

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A Spark At Accuray - Will It Catch Fire This Time?

Cerner Looking Toward New Opportunities To Drive The Next Leg Of Growth

It's hard not to respect what Cerner (CERN) has accomplished over the years. Not only is this one of the leading companies in healthcare IT, but the stock's 20% annualized return over the past 15 years is double that of the S&P 500 and about a third better than its peer group (health IT services), as the company has delivered double-digit growth in revenue and 20%-plus growth in free cash flow. All of that said, it's harder for me to make such a bullish case today, with the shares already discounting better than 10% long-term annualized free cash flow growth. Although developments like the VA contract and ongoing growth in the population health business should help stoke ongoing growth for many years to come, I'd prefer to wait for a pullback.

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Cerner Looking Toward New Opportunities To Drive The Next Leg Of Growth

Prudential PLC Marrying Strong Growth With Disciplined Capital Return

All things considered, I think the changes in the insurance markets are starting to favor P&C insurers again over life insurers, but that doesn't mean that there still aren't opportunities in the life space. Names like ageas (OTCPK:AGESY) and AXA (OTCQX:AXAHY) have done pretty well, and there is ongoing opportunity in names like Aviva (OTCPK:AVVIY). I'm also adding Prudential PLC (PUK) to this list, as I believe this company's high-growth Asian operations, better-than-assumed U.S. operation, and improvable U.K. operations all contribute to a value that is about 10% above today's price. I'd also note that Prudential PLC has prioritized returning capital to shareholders, with a 5% annual growth target and over 10% actual growth over the past decade-plus.

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Prudential PLC Marrying Strong Growth With Disciplined Capital Return

Volume Remains The Critical Driver For Insteel




Insteel (IIIN), the country's largest independent manufacturer of steel reinforcing products, is a challenging company to evaluate as an investment. On one hand, I believe this company is run along very sound lines, with management looking to drive higher value-added sales and consolidate the industry, while also distributing cash to shareholders through dividends, special dividends, and buybacks. On the other hand, this company is basically a "commodity-plus" type of business, where demand is largely outside of management's influence, where pricing spreads have significant influence, and where capacity utilization is critical to margins.

I wasn't thrilled with the valuation when I last wrote about Insteel (in September of 2016), and the stock chopped lower until starting to rebound this fall. At this point, I am cautiously optimistic/bullish on the company's prospects. Demand should improve to a level that can drive attractive capacity utilization and pricing should continue to help spreads - both of which are good for margins. Valuation remains tricky, though, as I think the company needs to get over a $110M/quarter run-rate in sales to really offer attractive upside.


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