Monday, October 15, 2018

BRF Lays Out A Good Restructuring Plan, But No Quick Fixes

Investors, as a group, aren’t often the most logical creatures, so maybe there will be some disappointment at the restructuring plan that BRF SA (BRFS) management laid out on October 8 during its Brazil-based Investor Day (with a New York-based day to follow on October 10). Management didn’t offer up any quick fixes or any reason to think that the business will suddenly turn on a dime. What they did offer, though, was a very sound and credible strategy for building a stronger-for-longer company with substantial upside in both its home market of Brazil and its large foreign markets.

Valuation remains tied to the eventual long-term outcomes of this restructuring plan. If and when the restructuring activities start showing the expected benefits in 2019/2020 and beyond, I fully expect the multiple to expand again. Likewise, through that process the company will put some ugly near-term annual FCF results in its rear view mirror. While the current share price looks basically fair for what BRF is today, a more bullish outlook on that restructuring plan supports worthwhile upside for long-term investors.

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BRF Lays Out A Good Restructuring Plan, But No Quick Fixes

Ciena Sliding A Bit As The Sell-Side Rebuilds The Wall Of Worry

Ciena (CIEN) has been on a roll. Revenue rose 12% in the fiscal third quarter (beating expectations by 3%), gross margin was stronger than expected, and the company has been on a multiyear market-share-building run in both its core WDM market and in webscale. All of that has fueled a market-beating 33% run in the stock over the past year, so of course now some eager beavers on the sell-side are trying to beat the rush and downgrade early.

Wait, what?

It’s not all that uncommon to see calls that otherwise might look bold come out around this time, as there’s not much else to talk about in the weeks before third quarter earnings, and there are some near-term drivers that could weigh on Ciena’s growth. How management sets expectations coming out of this next quarter will clearly be important, as the run in the shares has somewhat emptied the tank for positive drivers.

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Ciena Sliding A Bit As The Sell-Side Rebuilds The Wall Of Worry

For ABB, It's About Cycle, Self-Improvement, And Sentiment

A laggard for some time among the industrial automation and electrification players, ABB (ABB) has at least been a little “less bad” of late as sentiment has started giving the company some credit for its later-cycle end-market exposures. Now the question is whether those promising-looking exposures will deliver actual orders in the second half of the year and drive better revenue in 2019. At the same time, there is still more than casual interest in ABB’s willingness and ability to execute on some self-help moves that would largely involve slimming down and simplifying the business.

I’ve long been an owner and supporter of ABB, and I can’t say that it has done right by me. Still, compared to peers like Emerson (EMR) and Rockwell (ROK), the valuation is undemanding and offers some upside if ABB can deliver on those sentiment-shifting improvements in orders and portfolio composition.

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For ABB, It's About Cycle, Self-Improvement, And Sentiment

Air Transport Group: Warning, Contents Have Shifted In Flight

Air Transport Group (ATSG) has chosen to alter its business in a pretty significant way with the $845 million acquisition of Omni Air. With this acquisition, Air Transport will be far more exposed to passenger-oriented ACMI and charter services, and the company will also add Boeing (BA) 777s to its owned and operated fleet.

I’m not unreservedly bullish about this deal, as I believe it adds operating complexity to a company that already had a track record of so-so execution in its core operations. It also likely takes an Amazon (AMZN) acquisition off the table (however likely that really was) and could lead Amazon to turn more toward Atlas (AAWW) as its provider of choice for future air cargo expansion needs. Adding government-funded charter services does help mitigate some of the ongoing cargo demand risks, though, and I do believe the shares remain undervalued below the mid-to-high $20’s.

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Air Transport Group: Warning, Contents Have Shifted In Flight

China Takes Another Bite Out Of IPG Photonics

When your prime market, the market where you generate close to 50% of your revenue, is in trouble, it’s tough to work around that. Such is the situation for IPG Photonics (IPGP), and this once high-flying leader in fiber lasers has gotten pummeled over the last three months on revenue and earnings weakness due to China. The latest blow came on Friday, with the company announcing that third quarter revenue and EPS were going to come in about 5% or so short of where expectations were a week ago.

IPG’s China-related risks showed up in the second quarter, and clearly they are continuing to linger, putting near-term revenue and margins very much in doubt. What’s more, it’s at least plausible to me that this period of trade squabbling between the U.S. and China is going to give a boost to Chinese fiber laser companies like Han’s Laser and Wuhan Raycus and improve their profile with Chinese manufacturing customers. Although IPG shares do look undervalued, and the multiples are lower than they’ve been in quite some time, anybody considering the shares today needs to be prepared to withstand further near-term losses until the situation bottoms out.

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China Takes Another Bite Out Of IPG Photonics

AXA Delivering On Its Pledges, And The Market Is Starting To Notice

It’s been a rough year for European insurance companies, though AXA (OTCQX:AXAHY) (AXAF.PA) seems to finally be getting a little interest. While other European insurers like Aviva (OTCPK:AVVIY) and Prudential (PUK), both of which I still happen to like, have done better over the past 12 months, the gap is shrinking and AXA has outperformed over the last six months (including meaningful outperformance relative to Generali (OTCPK:ARZGY) and Zurich Insurance (OTCQX:ZURVY) as well). I believe this renewed interest in coming as investors start to appreciate the long-term benefits of the XL Group deal, as well as the company’s commitment to execute on longer-range capital deployment plans.

I believe AXA is undervalued by a wide enough margin to be worth a serious look now, as I see double-digit appreciation potential on just mid-single-digit long-term earnings growth. Capital redeployment is a key unknown, particularly with respect to whether AXA will deleverage, return cash to shareholders, reinvest in organic growth initiatives, and/or engage in further M&A. While the late November investor day is an opportunity for management to lay out its plans for capital deployment in more detail, expectations do appear to be rising and management needs to deliver.

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AXA Delivering On Its Pledges, And The Market Is Starting To Notice

BancorpSouth On Track, With More Growth Opportunities Ahead

Since my last update on BancorpSouth (BXS), this Mississippi-based regional bank has managed to close three significant M&A transactions and meaningfully expand its lending franchise in Texas. At the same time, the bank still maintains an uncommonly good mix of low-cost core deposits and solid credit quality, as well as meaningful fee-generating businesses.

At the time of that last article, I didn’t think the valuation of BancorpSouth shares was all that exciting or likely to lead to outsized gains. Since then, the shares have basically tracked the performance of regional banks in general with surprisingly little deviation from either the SPDR S&P Regional Bank ETF (KRE) or the iShares U.S. Regional Banks ETF (IAT). And the story is largely the same today – while I do believe BancorpSouth scores well in most of the quality metrics that matter, and I believe there is significant opportunity for tuck-in/fill-in M&A within its footprint, the core growth potential isn’t exceptional and the current share price seems pretty fair at a time when banks are looking at a turn in the operating environment.

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BancorpSouth On Track, With More Growth Opportunities Ahead

Versum Leveraged To Chip Volume Growth And Innovation

On the whole, I like pick-and-shovel plays and Versum Materials (VSM) is a good example in the chip space, as this producer of specialty chemicals, gases, and other materials is heavily leveraged to ongoing growth in chip production volume and ever-increasing chip design complexity. Although Versum has some modest exposure to equipment and some volume risk from improving yields, the general outlook for Versum is healthy as a critical supplier to fabs.

Relative to Entegris (ENTG), though, I’m not quite as interested in the value proposition offered by these shares. I do think Versum is modestly undervalued, and it’s more of a play on direct chemical/material demand, but expectations might still be a little high for 2019 and I still see ongoing risk of the market being indiscriminate in selling off semiconductor-related names if (“when”, in my view) the outlook for equipment demand in 2019 worsens.

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Versum Leveraged To Chip Volume Growth And Innovation

A Rough Summer Has Knocked Calyxt Down

So far, not so good for my late June high-risk/high-reward call on Calyxt (CLXT). The “high risk” part has certainly come through promptly, but shareholders have seen the shares sell off about 25% after a summer that certainly offered more bad news than good, highlighted by the surprising resignation of the CEO in late August only a couple of months after the equally-surprising resignation of the CFO, and a decision in Europe that puts the acceptance and development of gene-edited crops at risk.

Assessing these developments is not easy. Both executives may have had disagreements with the board of directors and/or Cellectis (CLLS), which still controls the company, and those disagreements may have included the unusual business model Calyxt is pursuing with its high-oleic soybeans and other consumer-oriented products. It is also possible that they saw fundamental issues with the technology and/or its path to commercial acceptance. Unfortunately there’s really no way to know at this point, and the one remedy I do have is to increase my discount rate to account for greater risk and uncertainty.

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A Rough Summer Has Knocked Calyxt Down

Lexicon Likely Looking At Even More Competition In Type 1 Diabetes

As more and more competitor data accumulate, it’s looking like Lexicon (LXRX) is going to face significant competition in the market for SGLT inhibitors in Type 1 diabetes. Granted, it has long been my base-case assumption that Lexicon would see serious competition for its drug sotagliflozin (an SGLT-1/-2 dual inhibitor) in this large and underserved indication, but recently-presented data from Lilly (LLY) suggests that Jardiance (or empagliflozin) will be a meaningful potential threat in addition to AstraZeneca’s (AZN) Farxiga (dapagliflozin) and off-label use of SGLT-2 inhibitors already approved for Type 2 diabetes.

Lexicon could really use some good news, as the company has seen sentiment on sotagliflozin fade due to concerns about diabetic ketoacidosis (or DKA), a potentially serious side effect of SGLT inhibitor therapy, and has come up short of expectations multiple times already in the short commercial life of its only approved drug Xermelo. Although I believe Lexicon shares remain undervalued on the basis of just the potential value of sotagliflozin in Type 1 and Type 2 diabetes with partner Sanofi (SNY), shareholders could really use some positive clinical data on new compounds and a better sales trajectory for Xermelo.

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Lexicon Likely Looking At Even More Competition In Type 1 Diabetes

Smiths Group Going Nowhere Fast

It's never fun, but sometimes companies force you to conclude that your prior assumptions were just wrong (or you can take the time-tested bagholder approach of "I'm not wrong, I'm early!"). In the case of Smiths Group (OTCPK:SMGZY) (SMIN.L), I thought earlier this year that management was on the cusp of delivering the sort of results and portfolio transformations that would show a true break from its not-so-charming past trend of weak growth and questionable capital allocation/portfolio management. Since then, I just haven't seen the sort of follow-through I need to see to maintain that optimism.

To be sure, Smiths isn't a disaster, and fiscal 2018 was the first upturn in organic growth in some time. Moreover, there is still some apparent undervaluation based on what I think are fairly undemanding assumptions. If management can get its "stuff" together - drive better margins in John Crane, turn around or sell Medical, improve Detection, and lay out a more coherent strategic portfolio plan - there's still room for this stock to do better. But in the short term, I believe the disappointments of the past few weeks and months will continue to weigh on sentiment and valuation.

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Smiths Group Going Nowhere Fast

With Or Without Federal Mogul, The Street Just Doesn't Care About Tenneco Now

If you wrote up a list of outperforming auto and commercial vehicle component stocks, it would look for all intents and purposes like you were writing in invisible ink. A few companies like Aptiv (APTV) and Magna (MGA) have been less-bad than average, and Allison (ALSN) and tiny Commercial Vehicle Group (CVGI) are up strongly over the past year, but for the most part, this has been a pretty awful sector as investors have written off the passenger vehicle market for the near term, priced in the commercial truck fall-off, and continued assuming that internal combustion engines are doomed.

There might be a little hyperbole there, but not too much, and Tenneco (TEN) certainly continues to get almost no benefit of the doubt. Although second-quarter margins and margin guidance weren't great, the Street seems to be pricing these shares for ugly future margins and cash flow. Likewise, the idea that spinning off the Ride Performance and Aftermarket business will unlock any value seems to be largely dismissed at present. I really can't say that Tenneco is a top-notch idea now, but sector-wide valuations seem to be washing out, and this is a name worth watching for an eventual recovery opportunity.

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With Or Without Federal Mogul, The Street Just Doesn't Care About Tenneco Now

Teradyne's Cobot Opportunity More Than Just Hype

What makes Teradyne (TER) interesting is the combination of a high-share, margin-rich, cash-flow-generating semiconductor test business with an emerging growth story in collaborative robots (or "cobots"), a high-potential new segment of the robotics market where Teradyne has established a strong initial market share and a business plan and ecosystem that may make it harder for established robot players like Fanuc (OTCPK:FANUY), Yaskawa (OTCPK:YASKY), and ABB (ABB) to muscle Teradyne aside and replicate their traditional shares of the robotics market.

Although there will be some above-trend years and Teradyne is a net beneficiary of increasing chip content and complexity, I believe the core semiconductor test business is a solid but not spectacular business. The cobot business, though, has legitimately exciting potential and should be the key driver of what I expect to be high-single-digit long-term revenue growth and double-digit FCF growth over the next 10 years.

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Teradyne's Cobot Opportunity More Than Just Hype

MinebeaMitsumi Looks Seriously Undervalued, But There Are Significant Upcoming Challenges

Japan’s MinebeaMitsumi (“Minebea”; also sometimes written as “Minebea Mitsumi”) (OTCPK:MNBEY) (6479.T) is certainly not a household name to most investors, but this odd mix of precision machined and electrical components is a strong leader in several attractive markets, and has uncommonly robust opportunities to drive improved operating and product synergies in the coming years. At the same time, though, the company is facing some significant product cycle risk and there are no guarantees that the synergy efforts will pan out.

Minebea looks undervalued on the basis of long-term revenue growth of just 3%, but revenue could be choppy over the next several years and the margin/FCF generation improvement I expect may prove to be beyond management’s capabilities. I’d also note that these ADRs are not very liquid at all, so investors should factor that into their evaluation process (the Tokyo-listed shares are quite liquid, for investors who wish to pursue that option).

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MinebeaMitsumi Looks Seriously Undervalued, But There Are Significant Upcoming Challenges


Allison Transmission Running Over The Bears

Whatever the future may look like for Allison Transmission (ALSN) and its role in a post-electric truck world, the company is executing remarkably well today. With solid growth in its core North American truck business augmented by improving demand from energy and mining applications, as well as share gains in trucks outside North America, Allison is posting exceptional incremental margins and forcing bearish sell-siders to trot out “we’re not wrong… we’re just early” calls.

I’m not in the “the sky is going to fall” camp with Allison, but it’s a tough story to model out given the likelihood that electric trucks eventually will grab share in strong core Allison markets like dump trucks, refuse trucks, and other vocational applications like drayage. I believe a key question is whether Allison can continue to gain share in overseas markets (where penetration is low) and whether they can fight off competition from other transmission alternatives like the Cummins (CMI)/Eaton (ETN) JV.

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Allison Transmission Running Over The Bears

Wednesday, October 3, 2018

Crane Highlights Its Payment Growth Opportunities, While Fluid Handling End-Markets Improve

Above-average exposure to later-stage markets like aerospace, chemicals, energy, and municipal water is certainly not hurting Crane Co. (NYSE:CR) these days, even though the performance of its Fluid Handling business left something to be desired in the second quarter. I thought I saw some value in Crane shares when I last wrote about the company after second-quarter earnings, but I didn’t foresee the 12% jump the shares have delivered in such a relatively short time.

Management’s recent Investor Day focused on the Payment and Merchandising Technologies (or PMT) business certainly won’t hurt sentiment, as management laid out some good arguments for above-average growth. What’s more, Crane’s valve business (the bulk of Fluid Handling) should see improving results as companies like Emerson Electric (NYSE:EMR) continue to report healthy demand from key process automation end-markets like oil/gas, chemicals, and so on. I don’t find the valuation particularly cheap now, but the company’s market exposures should give it a better-than-peers chance of beat-and-raise quarters for a little while yet.

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Crane Highlights Its Payment Growth Opportunities, While Fluid Handling End-Markets Improve

Honeywell Continues To Invest In A Faster-Growing, Higher-Margin Future

Honeywell (HON) management has made no secret of its game plan for the future, nor its desire to be a leader in markets with above-average potential for revenue growth, margins, and returns on capital. In keeping with that plan, the company has already spun out Garrett Motion (GRX), will be spinning out Resideo, and just announced another promising acquisition for its warehouse automation business.

Between its very strong process automation business, its rapidly-growing warehouse automation business, underrated operations in specialty materials/chemicals and safety, and a solid (if generally well-understood) aerospace business, I find it hard not to like Honeywell. Valuation is not exactly low, but with the company consistently repositioning itself toward higher-growth, higher-margin businesses, and particularly ones where it's establishing strong market share, I continue to like Honeywell as a long-term holding.

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Honeywell Continues To Invest In A Faster-Growing, Higher-Margin Future

Wabtec Looking At A Value-Creating One-Two Punch

Accustomed as I am to thinking of Wabtec (WAB) as perennially richly-valued, which for a long time it was, it's a strange thing to be continuing to advocate for buying the shares and thinking that the market is underrating this one. I understand some of the market's skepticism and worry that the assets Wabtec is buying from GE (GE) aren't in great shape, but I believe this will be a transformative acquisition for Wabtec, and I also believe the timing couldn't be better, as the company is starting to see its freight rail markets recover.

Up about 10% from when I last wrote about the stock (and when I thought it was undervalued), I've since revised my estimates for the benefits of the GE acquisition and the ongoing recovery in the freight business (as well as some challenges in the transit business). The net effect is to boost my fair value range toward $115, with potentially more upside beyond that depending upon the strength of the freight recovery and Wabtec's ability to drive synergies from the GE deal.

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Wabtec Looking At A Value-Creating One-Two Punch

Dana Looks Pinned Under The Wall Of Worry

I was tentatively bullish on Dana (DAN) in late May of this year, but auto and commercial vehicle suppliers continue to weaken in the market, and the shares are down another 15% since then. Maybe I’m missing something big here, but I see Dana as a company with at least decent ongoing leverage to passenger vehicles, an improved position in electrification, and a solid global presence in commercial/off-road vehicles, particularly with the Oerlikon (OTCPK:OERLY) transaction. And yet, the Street continues to price this one as if there’s going to be serious long-term erosion in the business.

I freely admit that Dana doesn’t have the greatest operational track record with respect to margins, FCF generation, and/or ROIC, but the company has improved in recent years and is seemingly getting no credit for that. In a market where many auto and commercial vehicle suppliers appear to be trading below long-term fair values investors certainly have choices, but I continue to believe this name is worth a look.

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Dana Looks Pinned Under The Wall Of Worry

Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

The good times keep rolling for Emerson (EMR), as the company is enjoying a strong recovery/expansion phase in its core process markets, as catch-up spending on MRO, brownfield investments, and greenfield projects all combine for strong near-term revenue and margin improvements and a healthy outlook over the next year or two. At the same time, Emerson continues to reinvest in its business to better-position it for less cyclicality and better competitiveness in hybrid automation markets.

As was the case a few months ago, I see Emerson as a so-so value proposition, but a stronger near-term growth/momentum story. The shares don't seem unreasonably priced on forward EBITDA, but it's a little harder to see strong FCF-based undervaluation, and I think the share price performance is very much tied to ongoing momentum in orders, revenue, and margin leverage.

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Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

Turbulence Still Hitting Copa Holdings Hard

One of the last things I said about Copa Holdings (CPA) in my last article on the company was that "adverse forex and higher fuel costs could get worse before they get better", and those twin headwinds are primarily responsible for another 5% decline in the share price since the time of that article. What's more, management's recent investor day offered up a lot of evidence to support a "soft" guidance reduction for the second half of the year - in other words, investors shouldn't be surprised to see some weakness in the third quarter results and some downward margin guidance for the fourth quarter.

It's tough to recommend a stock while expectations are still moving down, particularly when sector valuations are generally predicated on the next 12 months' financial performance. I don't think Copa is the greatest idea out there for investors who need a quick gain and/or who can't or won't accept near-term losses for longer-term gains. On a longer-term basis, though, I continue to believe the valuation is pretty interesting and even those investors not willing to accept the risks and uncertainties today should keep a closer on this one for signs of stabilization over the next three to six months.

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Turbulence Still Hitting Copa Holdings Hard

Improving End-Markets And Market Share Not Enough For Cummins

Investors are definitely conflicted about machinery stocks these days, with mining and ag doing well, but a lot less enthusiasm for construction and trucking as investors worry about how the end of the cycle will play out. I didn’t see enough upside in Cummins (CMI) to want to dive in back in late May, and the market-lagging return since then doesn’t exactly have me regretting that call (though Cummins has done comparatively better than most heavy machinery names over that time).

I can’t say that I feel all that differently about Cummins now. The North American truck cycle looks like it has longer legs (into 2019), but that doesn’t really change the fundamental long-term valuation picture. Likewise with the long-awaited recovery in power gen and strength in markets like mining and oil/gas. Although the shares do look a little undervalued on a near-term basis and I like the company’s ongoing moves to invest in electrification products/technology, I just don’t see the upside to warrant taking a new position now.

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Improving End-Markets And Market Share Not Enough For Cummins

Strong Mining Markets Could Help FLSmidth Finish Strong

The mining sector has definitely recovered, but that doesn't automatically make every player in the mining sector a good pick. I wasn't too excited about the near-term trading prospects for Danish mining and cement equipment company FLSmidth (OTCPK:FLIDY) (FLS.KO) back in June, and I'm not surprised that the shares have been flat since then, while Epiroc (OTCPK:EPOKY), Komatsu (OTCPK:KMTUY), Caterpillar (CAT), and Metso (OTCQX:MXCYY) have headed higher on stronger orders and improving margins.

Although FLSmidth's second-quarter margins were oddly weak, the order recovery was solid, and there have seen been a lot of corroborating data points on the strength of the mining sector and the opportunities over the next couple of years for equipment supplies like FLSmidth. I don't find these shares cheap enough to have a lot of appeal as a long-term holding, but I think circumstances are setting up for a better performance for the shares in the last quarter of the year and more trading-oriented investors may want to take another look. For longer-term investors, visibility on better margin leverage would be/is a key gating factor to a more robust valuation.

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Strong Mining Markets Could Help FLSmidth Finish Strong

Maxwell Continues To Sorely Test Investor Patience Ahead Of Commercial Ramps

It has been clear for a while that 2018 wasn’t going to be a great year for Maxwell Technologies (MXWL), but bulls could take some solace in the idea that 2019 would see the start of meaningful ramps in long-awaited opportunities like auto ultracapacitors. While that is still a valid bull thesis in my view, the reality is that 2018 has been tougher than expected, including a higher cash burn that forced the company to move faster with a dilutive financing.

I’m frankly torn on these shares. I do genuinely believe that the company is going to see meaningful auto revenue starting in 2019 from platform wins in active suspension and ADAS backup systems and grow from there, and I do also believe in the potential in areas like rail. On the other hand, this is not a company whose execution track record leads me to want to lend any of whatever credibility I have to them. Accordingly, while I do think these shares are undervalued on the potential of the launches in 2019 and beyond, this is a consummate “caveat emptor” stock and one where you really need to do your own careful due diligence.

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Maxwell Continues To Sorely Test Investor Patience Ahead Of Commercial Ramps

Lydall Needs To Complement Good M&A With Better Internal Execution

Well off the beaten path and certainly not a strong performer over the past year, Lydall (LDL) is an interesting name to look it for what the company could be worth if management can improve their internal execution and drive some long-promised margin improvements. Lydall has a good track record with M&A, including the recent acquisition of Interface Performance, but between the challenges of the auto industry, material cost inflation, and execution issues, the company has not been performing up to its capabilities.

Betting on a company to get itself together and improve its operating performance always involves risk, and it is entirely fair for readers to question why they should bother unless and until the segment-level margin performance at least stops getting worse. That said, the valuation would seem to offer some upside based upon what I consider to be fairly conservative assumptions that leave room for upside if and when management delivers better results.

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Lydall Needs To Complement Good M&A With Better Internal Execution

Thursday, September 27, 2018

Entegris Not Getting Its Due For A Differentiated Exposure To Semiconductor Markets

Electrochemical, filtration, and material handling company Entegris (ENTG) has had a rough year, as has competitor/peer Versum Materials (VSM), though investors in semiconductor equipment stocks like AEIS (AEIS) and VAT (OTCPK:VACNY) may not exactly be overflowing with sympathy (they've had it worse). Although Entegris is much more leveraged to wafer starts than equipment orders, investors seem to have bailed out ahead of this memory-led decline in equipment orders.

Although Entegris has some exposure to equipment trends and wafer starts may not be so strong next year, I think these shares are starting to look pretty interesting. Margins should continue to head higher (driving a better EV/revenue multiple), and I see meaningful room for FCF margin expansion as Entegris leverages ongoing growth in chip production and ever-increasing chip complexity. My biggest concern is perceptual, with the risk that investors look at the worsening outlook for equipment and high lead times and just bail on all things chip-related.

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Entegris Not Getting Its Due For A Differentiated Exposure To Semiconductor Markets

Alnylam Pharmaceuticals Could Use Some Straightforward Good News

Alynlam Pharmaceuticals (ALNY) could really use some straightforward, clean, good news right now, as several of the company’s recent positive events have been “yes … but” situations. Today’s update on givosiran in acute hepatic porphyria is a case in a point. While the drug seems to be effective (as expected), with a highly statistically-significant reduction in ALA (a biomarker), the safety of the drug is likely to be a talking point until, and perhaps after, the full Phase III data package is available. On the back of some concerns about the cardiac safety profile of Onpattro (and implications for the important ALN-TTRsc02 (“sc02”) program), it’s not exactly the news investors really want to hear.

I continue to believe that Alnylam is undervalued, and that it’s pipeline of drugs for rare diseases, led by recently-approved Onpattro, will generate substantial revenue in the coming years. I’ve tweaked some of modeling assumptions, but I continue to believe that the shares should trade over $140, though there are above-average risks.

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Alnylam Pharmaceuticals Could Use Some Straightforward Good News

MRC Global Leveraging Renewed Energy Capex Investments, But Looks Undervalued

The recovery in the U.S. onshore oil & gas sector has been a significant catalyst for MRC Global (MRC), the world’s largest distributor of pipes, valves, and fittings (or PVF) and other equipment to the energy sector. With the shares up almost 70% over the past three years, the stock has easily outperformed fellow distributor NOW (DNOW), as well as the broader oil/gas services and equipment sector. The performance over the past year hasn’t been as strong, though, with NOW handily outperforming MRC Global, which I believe is due in part to greater upstream leverage.

It would appear that there is still upside in MRC shares, as the company benefits from ongoing revenue re-acceleration and improving margin leverage. I do expect the growth drivers to transition more toward the midstream and downstream businesses in the coming years, but I believe there is value here up into the low-to-mid $20’s.

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MRC Global Leveraging Renewed Energy Capex Investments, But Looks Undervalued

MidWestOne May Not Be A Growth Star, But The Story Has Some Value

The Midwest is not exactly the most attractive banking market these days, but sometimes you can find worthwhile opportunities in unusual places. That may well prove to be the case with MidWestOne Financial (MOFG), as this Iowa-based bank continues to invest in growth in larger metro areas like Denver and the Twin Cities while possibly starting to turn its eye towards consolidating its local market.
I certainly have some concerns regarding MidWestOne, including a track record that isn’t the greatest with respect to operating efficiency and credit quality, but the valuation seems to more than reflect those issues. If credit quality is indeed back on a sustainably better path and management can continue to find cost-saving deals in its local footprint, the discount here could shrink and reward shareholders.

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MidWestOne May Not Be A Growth Star, But The Story Has Some Value

SGS Needs To Verify Its Own Self-Improvement Processes

Wherever there are regulations, there’s almost always some mechanism for ensuring compliance with them, and that has created an enormous global market in testing, inspection, and certification (or TIC). The largest player in a fragmented market, Switzerland’s SGS (OTCPK:SGSOY) (SGSN.S) not only helps companies stay in compliance with all manner of laws and regulations, but also help ensure product, process, and system quality, safety, and performance. The range of services SGS offers runs the gamut from testing corn shipments to refinery process optimization to auto emissions testing to testing electronics and toys for safety.

SGS is the leading player in a field with attractive growth characteristics, and the company has a decent track record of free cash flow generation, but management has established an unfortunate recent track record of over-promising and under-delivering on margin improvement, and the shares look pretty richly-valued even factoring in a relatively more stable trajectory for earnings.

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SGS Needs To Verify Its Own Self-Improvement Processes

Seacoast Banking Making Money In The Sunshine State

A couple of years ago, Seacoast Banking (SBCF) was a “show me” story where investors were uncertain if the company could execute on opportunities to reduce costs, improve its utilization of technology, and drive better loan growth. Over the past three years, not only has Seacoast delivered on multiple growth and quality metrics, but the shares have roughly doubled since then, roughly doubling the regional bank indices and eking out a small win over CenterState (CSFL) over that time.

There are a lot of things I still find very attractive about Seacoast, including its strong core deposit franchise, its data-driven business model, and its leverage to significantly above-average growth potential in its home state of Florida. While I don’t think there are serious credit risks yet, I do have some concerns about where we are in the cycle and how that might impact a higher-multiple growth bank like Seacoast.
Although the valuation on a P/E basis isn’t bad, I find the long-term discounted earnings valuation a little stretched and I’m worried that bank multiples could re-rate lower. While I think M&A appeal is a back-stop to the valuation, I’d rather see a wider discount to fair value as compensation for some of those risks.

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Seacoast Banking Making Money In The Sunshine State

The Market Expects Relatively Little From DSP Group's Transformation

DSP Group (DSPG) is trying to do a difficult thing in the chip space and basically reinvent itself with new applications for its core competencies in voice integration and low-power functionality. Somewhat unusually for the chip group, it’s not staking its turnaround/reinvention on a sizable M&A transaction, and is instead trying to reinvest the earnings it still generates from its fading lead business in DECT/CAT-iq SoCs for cordless phones.

In targeting markets like home gateways, low-power IoT connectivity, enterprise VoIP, and voice user interface SoCs, I believe the company is making logical decisions about where it can apply its core technologies and generate better growth in the coming years. There are admittedly not really any blockbusters here, but likely enough to generate decent revenue growth and margins in the coming years. For now, though, the Street isn’t buying it, as the shares seem to trade in line with some rather lackluster expectations.

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The Market Expects Relatively Little From DSP Group's Transformation

Marinus Looks Like More Than A Me-Too

Developing safe and effective drugs is hard, and doing so in the CNS space is even harder than normal. Add in worries that your lead (and only) drug is just a “me-too” product doomed to languish in the shadow of a celebrated advance in the field, and I suppose it makes sense that Marinus (MRNS) would have well-above average volatility.

I may be fundamentally mistaken, but I believe Marinus’s drug ganaxolone is more than just an attempt to hitch a ride on the coattails of Sage Therapeutics’ (SAGE) lead drug brexanolone. While Sage will likely enjoy a meaningful head start getting its drug to market in post-partum depression, I don’t believe that lead will cripple Marinus, and I believe there’s still upside here if ganaxolone proves to be a respectable second-place finisher.

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Marinus Looks Like More Than A Me-Too

Alps Electric Worth Another Look On Improving Auto And Phone Trends

Between a near-term rebound in camera phone actuators and a longer-term opportunity in car electronics, I think this is a good time to reconsider Japan’s Alps Electric (OTCPK:APELY) (6770.T). Although the U.S. ADRs aren’t as liquid as investors might like, Alps looks undervalued below the $60’s and could have further upside as the company’s auto electronics business really starts to take off in a few years.

The biggest downside at this point would appear to be another disappointing cycle for Apple (AAPL) and its new phones, as Alps has maintained strong share in the OIS actuator market and has meaningfully operating leverage potential on higher volumes.

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Alps Electric Worth Another Look On Improving Auto And Phone Trends

nVent Needs To Use Its Independence To Drive Growth

As the former Technical Products business of Pentair (PNR), nVent (NVT) has some important positive characteristics, including well-regarded brands, strong share in certain segments of the enclosure, heat tracing, and electrical fastening markets, and strong margins. What it has historically lacked, though, is growth, and that needs to be one of management’s foremost priorities if nVent is going to be a significant success as an independent company.

Although I do expect better growth relative to nVent’s track record, I don’t see enough growth to drive a compelling valuation today. To me, the shares look more or less like many industrials – not really attractively priced unless you have a pretty bullish outlook on the U.S. cycle and the company’s ability to pass on higher costs.

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nVent Needs To Use Its Independence To Drive Growth

CenterState Banks Continues To Leverage Its Strong Florida Franchise

Long a popular target in takeover rumors, CenterState Banks (CSFL) has not only stayed independent, but has thrived over the past five years – pairing strong double-digit organic growth with an aggressive but still disciplined and coherent M&A strategy to drive above-average growth across multiple metrics. The market has certainly noticed, as the shares have roughly tripled the performance of regional banks over the last five years, while slightly outperforming over the past 12 months.

I’m a little more cautious about growth banking stories at this point in the cycle, as banks tend to peak ahead of yield curve inversion. Commercial real estate lending has gotten pretty frothy in many places, deposit betas continue to rise, and credit quality is about as good as it can get. Still, if low-to-mid teens growth is a reasonable long-term expectation, these shares may not be tapped out just yet.

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CenterState Banks Continues To Leverage Its Strong Florida Franchise

GEA Group Starting To Get Interesting

Down another 10% or so from when I last updated readers on the company, GEA Group (OTCPK:GEAGY) (G1AG.XE) has more or less lived down to my expectations as this company is largely marking time ahead of a management transition. Since that last update, though, the company has reported a decent quarter, has announced the new CEO, and has seen improvements across most of its end markets.

GEA Group still needs a lot of restructuring work, and that work is going to take years to accomplish. Still, I’m starting to think that the investment case is more interesting here. While I do incorporate business improvement expectations into my model (improvements that may not come), I believe that if GEA doesn’t make relatively quick restructuring progress, activist shareholders will push hard for a sale of the company. With a fair value of a little over $40/ADR, this may be a name for investors with the patience to hold a turnaround story to start looking into more closely.

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GEA Group Starting To Get Interesting

ATS Automation Is A Service-Enhanced Play On A Major Multiyear Trend

Automation is a popular theme, particularly in the industrial sector, but it is also a rather broad term that can encompass everything from the most advanced robots, machine vision systems, and control technologies to relatively basic motors and conveyor belts. At the end of the day, though, it’s about equipping business owners with tools that enhance productivity. As a provider of both systems and services, Canada’s ATS Automation (OTCPK:ATSAF) (ATS.TO) sits in an interesting middle ground that could prove increasingly valuable as more and more business look to automate, including smaller operators that don’t have teams of engineers to design and guide the process.

Valuation is my biggest hang-up with the shares now, as the stock has risen almost 100% over the past year and trades at a level that already anticipates some meaningful operational improvements in the years to come. Investors should also note that the U.S. ADRs are not liquid on any consistent basis, though the Toronto-listed shares are.

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ATS Automation Is A Service-Enhanced Play On A Major Multiyear Trend

With The Semi Cycle Clearly Dipping, Is It Time To Revisit AEIS?

When I last wrote about Advanced Energy Industries (AEIS), I noted that while I think this is a strong company in the power components and subsystems space, the risk of further deterioration in the near-term outlook for semiconductors and semiconductor equipment skewed the risk too negatively in view. The shares are down another 10% since then, along with a significant cut to third quarter guidance, and there is no longer much pushback from readers on whether there really is a slowdown underway.

It’s really easy to get an itchy trigger finger with high-quality plays like AEIS and VAT (OTCPK:VACNY), as it’s typically only during these downturns that you get an opportunity to buy in at better valuations, and you don’t want to miss the eventual rebound. On the other hand, it’s pretty common for analysts and investors to misjudge the length and depth of down-cycles at the beginning, and it’s frustrating to buy in at the bottom only to discover another 20% or more downside.

I continue to believe the long-term value of AEIS shares is well above current levels (in the mid-$60s to mid-$70s), but I would also point out that these shares have traded as low as 1x tangible book in the not-so-distant past, suggesting another 50% downside if things really go sour in the market. I don’t expect that to happen, and I believe the long-term drivers of chip demand remain sound, but with 2019 possibly shaping up as a tougher year too, investors considering these shares should at least go in with their eyes open to the downside risks.

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With The Semi Cycle Clearly Dipping, Is It Time To Revisit AEIS?

BorgWarner Bumping Along The Bottom In Search Of A Spark

Vehicle components supplier BorgWarner (BWA) continues to sputter along, having not really gone anywhere over the past three months after a nasty decline from the highs to start the year. BorgWarner’s peak-to-today drop has actually exceeded the overall parts sector (down 25% versus down about 15%), even though the company’s actual performance hasn’t been that bad and its positioning for the future transition to hybrids and electrics look good.

I think BorgWarner is cheap enough to warrant serious consideration, but this will probably take more patience to work out. I don’t see a big turnaround in the U.S. car market next year, and I don’t feel all that comfortable counting on a big turnaround in volume in China either. That leaves the shares in a sort of performance no man’s land. I do believe these shares will be at a higher level next year as investors start looking ahead to better auto volumes and gaining more confidence about the path forward for hybrid and electric programs.

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BorgWarner Bumping Along The Bottom In Search Of A Spark

CapitaLand Bouncing Back On Renewed Asset Recycling

I’ve lamented in the past that no matter what CapitaLand (OTCPK:CLLDY) (CATL.SI) does, the shares seem stuck between S$3 and S$4. When I last wrote about the shares, they were on their way down to retest that S$3 level and have since rebounded on good second quarter earnings, the naming of a new CEO, and ongoing steps to recycle capital into new investments, including a meaningful move into the U.S. market.

CapitaLand remains a challenging stock. The liquidity for the ADRs isn’t great (the Singapore-listed shares are far more liquid), and this is a tough stock for many investors to evaluate and model. On the other hand, CapitaLand has proven itself to be a quality developer and manager of properties in Asia with the ability to earn above its cost of capital. That is not presently reflected in the share price, and I believe there is still worthwhile upside from these levels.

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CapitaLand Bouncing Back On Renewed Asset Recycling

Mining And China Seem To Be Supporting Komatsu

Komatsu (OTCPK:KMTUY) (6301.T) has been lagging peers and rivals like Caterpillar (CAT) and Hitachi Construction Machinery (OTCPK:HTCMY) over the past couple of years, despite solid order trends at Komatsu, good initial results in its automation efforts, and further synergies to be gained from the Joy Global deal. Over the last couple of months, though, Komatsu shares have perked up a bit and risen more than 10% since my last update, on renewed enthusiasm for the mining business and the Chinese construction market.

Komatsu still looks a little undervalued, but the company has a lot riding on expanding its mining business and achieving those hoped-for synergies in the mining business. Although the construction business isn’t done yet for this cycle, the mining business really needs to step up for the shares to keep moving higher.

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Mining And China Seem To Be Supporting Komatsu

ING Settled Its Money Laundering Case, But Worries About Capital And Turkey Remain

Bulls continue to have their patience tested by ING (ING), as shares of this Dutch bank continue to suffer from an assortment of worries including loan growth, capital adequacy, and the stability of the company Turkish operations. With the shares underperforming other European banks by about 10% over the past year, though, I continue to believe the skepticism is overdone and that these shares offer attractive long-term opportunity on mid-single-digit earnings growth. While capital levels are a risk, I believe the risk is manageable and more than reflected by the 25% discount to ROTE-based fair value.

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ING Settled Its Money Laundering Case, But Worries About Capital And Turkey Remain

Ternium's Investor Day Seems To Have Restored Some Confidence

Ternium (TX) shares have had a poor year, underperforming the ADRs of ArcelorMittal (MT) and Gerdau (GGB), as well as the shares of other steel companies like Steel Dynamics (STLD). Although Ternium is looking at an attractive long-term opportunity to grow its share of the Mexican market, investors have been scared off by a host of uncertainties, including the NAFTA renegotiations, the Mexican election cycle, the deterioration of the Argentine economy, uncertainty in Brazil, weakness in Colombia, and the prospect of peaking global steel prices.

Management’s investor day earlier this month did seem to restore some confidence to investors, but the shares continue to look surprisingly cheap on a relative basis, particularly when factoring in the company’s strong margins. Although I remain concerned we’re past the peak in steel and that it will tough for any steel stock to significantly outperform, Ternium’s share price and valuation just look too low to me.

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Ternium's Investor Day Seems To Have Restored Some Confidence

OceanFirst On A Solid Footing For Future Growth

With not a lot else going on, September is a popular month for sell-side conferences and company investor/analyst days. Although these are great opportunities to learn more about companies you care about, it does tend to lead to a bit of a backlog if you follow a relatively longer list. Even so, OceanFirst Financial’s (OCFC) first-ever investor day hit a lot of the important notes on how and why I believe this New Jersey-based community bank is well on its way to above-average growth in the coming years.

The only modeling changes post-event are mostly minor and don’t move my fair value estimates meaningfully. I continue to believe that OceanFirst is undervalued and priced to generate a double-digit annualized return for several years to come.

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OceanFirst On A Solid Footing For Future Growth

Kinsale Capital Producing Great Growth From A Great Model

A pure-play excess & surplus underwriter with a strong management team, excellent technology, and a large addressable market opportunity, Kinsale Capital (KNSL) has posted some very strong premium growth in 2017 and 2018 along with good underwriting ratios. While Kinsale may well find that it needs to raise some capital to maintain its growth, I believe this company could be looking at a five to 10-year run of well above-average growth.

The “but”, as is often the case with quality growth, is valuation. Kinsale still has some upside from here if it can, in fact, deliver high teens adjusted earnings growth, but that’s a demanding bar and the shares are certainly not cheap by more conventional metrics.

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Kinsale Capital Producing Great Growth From A Great Model

Pacific Premier Lagging On Weaker Core Banking

Smaller banks have had a so-so year as a group, and Pacific Premier Bancorp (PPBI) has done worse than average, and particularly since second quarter earnings. Not only has this growing Southern California bank disappointed the Street, but the combination of weaker loan growth and weaker spreads has hit expectations. Adding to that, Pacific Premier management has made it clear that they intend to remain active in M&A at a time when it seems that many investors would prefer that banks return surplus capital to shareholders rather than expand their businesses through M&A.

I do have some near-term concerns about the commercial real estate market, where Pacific Premier does around 40% of its lending, and while the California multifamily housing market doesn’t have the same challenges as the New York area, Pacific Premier’s higher than average exposure here is a potential risk. Pacific Premier still has a higher short interest than peers, but I do believe the valuation has become much more reasonable for a very profitable, fast-growing SoCal bank.

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Pacific Premier Lagging On Weaker Core Banking

It Seems Challenging To Reconcile Selective Insurance's Performance And Valuation

Good companies deserve, and often get, a premium valuation. Although I believe Selective Insurance (SIGI) is an above-average small P&C insurer, and one with opportunities to generate better results in the coming years, I have a hard time reconciling that performance with a book value multiple well over 2x and a P/E ratio that seems to assume quite a bit more growth than I think is likely.

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It Seems Challenging To Reconcile Selective Insurance's Performance And Valuation

First Internet Bancorp Is Very Different, And Quite Possibly Meaningfully Undervalued

Indiana’s First Internet Bancorp (INBK) is definitely taking the road less traveled. With no deposit-gathering branch offices, First Internet lives up to its name as a bank that provides its services through the internet. While that hasn’t stopped the company from posting strong lending growth, with a clear focus on niche categories that larger banks don’t serve well, it has proved to be a challenging way to grow attractively-priced deposits and access to affordable funding remains a challenge and growth-limiting issue.

Valuation for First Internet is quite curious, in that it seems quite undervalued relative to its growth. I realize it’s not a particularly well-covered bank, nor very large, and the risks here are certainly above-average, but even so the shares look curiously-priced next to other small, fast-growing banks.

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First Internet Bancorp Is Very Different, And Quite Possibly Meaningfully Undervalued

Friday, September 21, 2018

S & W Seed Trying To Restructure, But Liquidity Looms As A Threat

S & W Seed (SANW) is trying to restructure away from an alfalfa market that has proven far more challenging than expected, and as I said in my last update, I like the company’s plan to expand into other crops like sorghum and sunflowers (I’m less bullish on stevia). Unfortunately, as I noted in that last piece, S&W doesn’t have much room to maneuver, as the company’s liquidity is low and access to capital is going to come on less than favorable terms to current shareholders.

I continue to believe that this stock is basically a binary bet, and I don’t tend to like to have those in my portfolio. While I think the company’s efforts to leverage new alfalfa varieties developed with Calyxt (CLXT) have promise, as does the expansion into sorghum and sunflowers, it sounds like the next year is still going to be challenging for the alfalfa business and I’m concerned about the amount of dilution the company will experience in pursuit of a business model that generate meaningful cash flow (or acquisition interest) down the line.

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S & W Seed Trying To Restructure, But Liquidity Looms As A Threat

Medtronic Steps Up With A Bigger Commitment To Robotics

Differentiation is the name of the game in the spine space today, and it seems clear that Medtronic (MDT) believes in the long-term future of robotics as a disrupting and differentiating opportunity. To that end, the company announced that it will be acquiring its partner Mazor (MZOR) in an all-cash deal that will give it full control over the future development of this leading robotics platform.

Even with the expected revenue re-acceleration in 2019 driven by the upcoming Mazor X Stealth (which brings integrated navigation to the robot), I believe Mazor is getting a fair price at over 18x estimated 2019 revenue. For Medtronic, while some investors may criticize the deal as buying the cow when they had already had a good deal in place for the milk, I believe total ownership of the platform and control over the future development path is worth paying for given the need to have a differentiated platform in the spine space today.

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Medtronic Steps Up With A Bigger Commitment To Robotics

Harder Markets Driving James River Group

James River Group (JRVR) is a relatively small specialty insurer, but it punches somewhat above its weight by focuses on attractive areas like excess & surplus and fronting. Although the company saw an uncommon negative reserve development in 2017 due to higher losses from its business with Uber, James River has moved quickly to re-underwrite that business. All told, this has historically been an insurer with strong underwriting discipline, very good expense control, and a willingness to return capital to shareholders.

Between a restructured relationship with Uber and hardening markets in several of its core excess and surplus specialties, I think James River is looking at an attractive market opportunity relative to the overall P&C market. Even though the shares haven’t done much over the past year, they don’t look strikingly cheap today, as I think a mid-$40’s price is quite fair right now.

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Harder Markets Driving James River Group

Global Payments Continues To Hit The Mark With An Increasingly Tech-Driven Platform

Fintech has continued to perform well, with investors understandably attracted to the strong earnings growth that many of these companies are generating. In the case of Global Payments (GPN), management continues to show the benefits of its tech-enabled payments model, with strong revenue growth and improving margins on lower churn. While the shares went nowhere for basically the first half of the year, strong second quarters earnings have pushed the shares up almost 30% on a year-to-date basis and up about 15% since my last update on the company.

At this point, I think the market has Global Payments more or less accurately priced, but it wouldn’t surprise me if the ongoing enthusiasm for fintech took the shares higher, particularly if third quarter earnings come in strong.

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Global Payments Continues To Hit The Mark With An Increasingly Tech-Driven Platform

Better Growth, But Sluggish Margins And Higher Leverage, At Compass

I’ve been a fairly harsh critic toward Compass Diversified Holdings (CODI) in the past, mainly because I think management takes a rich private equity-like cut, but without really delivering PE-level returns (Morningstar shows a 10-year average total annual return of just over 8.5%). While the partnership structure has certain advantages, it also is more complicated (forcing investors to deal with K-1’s) and I just don’t think the returns – whether you measure the market returns plus distributions, underlying distributable cash growth, underlying EBITDA growth, or what have you -- are up to snuff.

Nevertheless, results were a little better than I expected in the second quarter and the company continues to deploy capital at a somewhat aggressive pace. The shares are now a little below my estimate of fair value and there could be more momentum in the underlying businesses than in recent past quarters. While I don’t believe distribution growth is likely in the near term, and I would again note that partnerships are not suitable for everybody (or every account), better underlying business momentum could create some more value.

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Better Growth, But Sluggish Margins And Higher Leverage, At Compass

Thursday, September 20, 2018

First Bancshares Driving A High-Growth Plan Across The Gulf States

Mississippi’s First Bancshares (FBMS) continues to impress me with its growth strategy, and it would seem that the Street agrees, as the shares are up another 18% from when I last wrote about the bank and up close to 40% from my first article about the company on Seeking Alpha. Both of those figures put First Bancshares well ahead of the typical bank, and the company continues to execute a cogent “buy-and-build” plan that is expanding its footprint across the Gulf Coast.

I believe there are more potential gains from here, though I will say again that this is a high-growth/high-risk story within banking. Although loan growth remains healthy and there’s not nearly the same level of CRE lending competition in the Gulf that there is in areas like New York City, this is still a relatively mature part of the cycle and First Bancshares is likely going to see more competition as it pushes into markets like North Florida.

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First Bancshares Driving A High-Growth Plan Across The Gulf States

Innospec Seeing A Hiccup In Margins, But The Core Business Looks On Track

Specialty chemical companies have continued to do alright this year, as volumes and pricing have helped partly offset increasing raw material pressures. Innospec (IOSP) has been a bit of a laggard since May, though, with the company’s second quarter report hurting the share price as investors didn’t like the weaker than expected margins in the business. I had thought Innospec looked a little pricey when I last wrote about the company, but I do see some upside here as I expect the company to benefit from some lagging pricing actions. If Innospec can get the Oilfield business in better shape, there could be more meaningful upside.

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Innospec Seeing A Hiccup In Margins, But The Core Business Looks On Track

Wall Street Believes Winter Is Coming For Steel Dynamics

Metal spreads have continued to improve, but steel prices in the U.S. have come off their highs and analysts are now modeling 2018 as the peak year for Steel Dynamics’ (STLD) EBTIDA for this cycle. Fading prices and fading EBITDA expectations are never a good combo for commodity companies, and although these shares have outperformed peers on a one-year and year-to-date basis, the performance in recent months has been lackluster.

I do believe that Steel Dynamics is undervalued now and I do believe this is a relatively better place to be in the steel sector, but this looks more and more like a difficult place to make money for at least the next few quarters. Protectionist measures and a healthy economy may support a “stronger for longer” steel cycle, but I think it will be hard for these shares to significantly outperformance unless pricing and/or volumes really surprise.

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Wall Street Believes Winter Is Coming For Steel Dynamics

Nucor's Healthy Spreads Aren't Enough As The Cycle Moves Past The Peak

It’s often difficult to make money in commodity sectors when the cycle has reached and passed its peak, and that seems to be holding true for steel. Although spreads continue to improve and earnings expectations for Nucor (NUE) have continued to rise for both 2018 and 2019, the shares really haven’t gone anywhere this year as investors expect meaningful earnings erosion from here and move onto to greener pastures.

I believe it’s better to be in mini-mill and/or specialty steel companies at this point, but I’m still mostly lukewarm on Nucor. I do see some risk of overspending on M&A, as well as some vulnerability to increasing capacity, though I will emphasize again that this is a very well-run company in the sector. I continue to believe that fair value is above $70 per share, but this may be a tough place to make money unless/until there’s a reason to believe this cycle will persist beyond current expectations.

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Nucor's Healthy Spreads Aren't Enough As The Cycle Moves Past The Peak

Can A Better Second Half Drive Some Enthusiasm For ArcelorMittal?

My concerns back in the late spring about it being too late in the cycle to make good returns in steel sector appear to have played out this summer. ArcelorMittal (MT) has declined more than 10% since my last update on the company, despite a stronger-than-expected second quarter and a stronger outlook for the second half. What's more, steel prices have held up, as has demand, and spreads are still attractive. It's not just ArcelorMittal, though, as Voestalpine (OTCPK:VLPNY), U.S. Steel (X), Ternium (TX), Steel Dynamics (STLD), and Nucor (NUE) are down over that period as well, and Acerinox (OTCPK:ANIOY) is barely up.

ArcelorMittal looks very cheap on the basis of near-term EBITDA, and even looking a few years ahead to declining prices and profits suggests that today's valuation is weak relative to historical norms. At this point, I'm not really sure what's going to bring investors back to this name, as steel prices aren't likely to improve much (if at all) from here, and investors tend to bail when pricing momentum fades. So, while I do think ArcelorMittal looks unfairly cheap, the markets don't care about fair, and investors considering these shares need to be aware of the risk that this is a value trap.

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Can A Better Second Half Drive Some Enthusiasm For ArcelorMittal?