Wednesday, July 1, 2020

A Simplified Ownership Structure Should Help Turkcell Investors

I suppose there’s both cosmic and comic justice that one of the most Byzantine (and dysfunctional) ownership structures I’ve ever seen with a public company would involve a Turkish company – the mobile services operator Turkcell (TKC). For years, a fractious ownership structure has impaired the company’s ability to pay regular dividends, and has likely contributed to a discounted valuation relative to the underlying fundamentals.

With a series of transactions led by the Turkey Wealth Fund, those years of sometimes-childish squabbles should be over, and Turkcell investors should be able to look forward to a more consistent future for the company and its dividends. While there are still significant risks here, and some investors may actually see this transaction as adding to the risks, I believe Turkcell remains meaningfully undervalued even with the inclusion of a “Turkey discount” that reflects the elevated economic and political risks of that country.

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A Simplified Ownership Structure Should Help Turkcell Investors

Neurocrine Further Expands Its Pipeline With An Early-Stage Deal

Neurocrine Biosciences (NBIX) management has been clear that they want to reinvest the company’s growing financial resources into expanding the clinical pipeline and, eventually, the business. This has been more than just talk, with multiple deals (Idorsia (OTCPK:IDRSF), Xenon (XENE), Voyager (VYGR), Jnana) since October of 2018 that have meaningfully expanded the company’s pipeline and R&D efforts.

The latest announcement, a multi-drug R&D partnership with Takeda (TAK), is more of the same, with this partnership adding more than a half-dozen potential drugs in new therapeutic areas for the company. While the assets that Neurocrine is acquiring are higher-risk (depression and schizophrenia drugs have below-average odds of clinical and commercial success), the market opportunities are large, and the clinical assets do target some appealing underserved market opportunities.

The early stage of development limits the near-term value creation from this deal, but clinical and commercial success for one or more of the included drugs would make a meaningful contribution to Neurocrine’s future value.

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Neurocrine Further Expands Its Pipeline With An Early-Stage Deal

Monday, June 8, 2020

Hurco Not Out Of The Woods, But Investors Already Thinking Recovery

Trading below book value when I last wrote about (and recommended) the stock, Hurco (HURC) shares are up about 30% since then - more or less keeping pace with the broader industrial sector. As expected, Hurco's financials are getting pummeled by the sharp business downturn instigated by COVId-19, but investors have already started bidding up industrial stocks in expectation of a V-shaped recovery in many manufacturing sub-sectors.

While I do think Hurco will recover and that the shares are still priced for a double-digit long-term total annualized return, I'm concerned that industrial stocks have come back too far too fast. Given incremental updates on manufacturing end-markets and companies cutting spending to bare bones, I think it'll be at least another quarter or two before Hurco starts seeing evidence of a turn, but I think some of the worst-case scenario risk is leaving the table. All in all, I think Hurco is worth owning here, but I think we may see another pullback before the dust settles.

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Hurco Not Out Of The Woods, But Investors Already Thinking Recovery

Clinical Data Reaffirm That Lumasiran Will Almost Certainly Be Alnylam's Third Commercial Product

Alnylam (ALNY) is well on its way to having its third commercial product before the end of 2020. A prior release of positive top-line data from the company's pivotal ILLUMINATE-A study of lumasiran already indicated approvable efficacy, but the full data presented on Sunday June 7 added some valuable context to what should be a worthwhile commercial opportunity for the company.

As I indicated in my last article on Alnylam, I still regard this stock as a long-term holding in my portfolio, but I wasn't as excited about the near-term price performance potential in early May. With the shares down about 10% since then, the opportunity is more interesting now, though I have some modest "strategic" concerns that the strong rally in biotech relative to the S&P could leave the sector more vulnerable to near-term profit-taking as investors regain confidence in a stronger/quicker post-Covid-19 economic recovery.

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Clinical Data Reaffirm That Lumasiran Will Almost Certainly Be Alnylam's Third Commercial Product

Another Systemic Shock Creates Another Opportunity With Kirby

Barge operator Kirby (KEX) often trades at a robust premium during the good times; while the company’s historically strong operating margins and strong market share would support that to some extent, I’ve often thought that the valuation was just too rich in recent years – and the stock’s performance relative to the S&P 500 has been pretty poor over the last five years. Some of that can be tied to the company’s ill-fated expansion into fracking-related oil & gas machinery services, but some of it, I believe, is also tied to actual underlying free cash flow performance not being as robust as the valuation would other presuppose and the cyclicality of the business itself.

That may seem like a downbeat intro, but I actually think Kirby is a good company. The expansion into oil & gas within the Distribution and Services (or DES) business is an issue, but the core marine operations (inland and coastal barging) are about as solid as you could ask for, and I see little reason to believe that will change. Covid-19 has created some severe disruptions in the energy market, not to mention the economy as a whole, but I believe Kirby offers interesting long-term opportunity at this price.

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Another Systemic Shock Creates Another Opportunity With Kirby

Saturday, May 30, 2020

An Abrupt Shift In Business Will Challenge Carpenter's Self-Improvement Story

The outbreak of Covid-19 has dramatically shifted the outlooks and operating environments for many businesses, and in the case of Carpenter Technology (CRS), it's going to seriously challenge the company's recent self-improvement efforts, efforts that had seen notable product mix and margin improvements in the Specialty Alloys business. With aerospace making up about 60% of Carpenter's revenue mix and the likelihood of a multiyear recovery path given the hit to the airline sector, Carpenter is going to have its work cut out for it.

I still see opportunities for Carpenter to drive better results through self-improvement, but the next few quarters will give investors good insight into how much the company's efforts over the past few years matter in real-world downturns. Past downturns have pushed operating margins down to the low single digits, and the company will need to do better than that to support an "it's different this time" argument for a stock and a sector where it's long been difficult to earn sustained market-beating returns.

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An Abrupt Shift In Business Will Challenge Carpenter's Self-Improvement Story

Margin Improvement, Electronics, And Aftermarket Offer Some Opportunity For Wabtec

The last 12 months haven't been particularly easy for Wabtec (WAB), but the shares have more or less kept pace with the larger industrial sector, as well as peers/rivals like Caterpillar (CAT) and Knorr-Bremse (KNRRY). At the same time, management has built some early credibility on its margin-improvement story, as well as its ability to drive growth from digital electronics and aftermarket.

Wabtec is not my favorite industrial, and the freight market is going to remain challenging for a while, but it's a little strange to me that Wabtec should trade at a wider discount to fair value than many other heavy machinery names. I don't see stellar return potential here, but I do see some relative undervaluation, and I think Wabtec may be poised to outperform expectations as railroad and transit operations normalize after the COVID-19 outbreak, leaving some opportunity for upside to numbers and multiples.

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Margin Improvement, Electronics, And Aftermarket Offer Some Opportunity For Wabtec

Middleby's Premium Is Gone, But Longer-Term Demand Destruction Is A Real Concern

For some time now I’ve stayed away from Middleby (MIDD) because I thought the market gave too much of a growth premium to a stock where the underlying company really wasn’t a true growth story anymore. Relative performance has indeed been poor over the last three years or so, as the company has struggled to put together compelling growth and margin leverage despite restructuring initiatives and ongoing reinvestment in product development.

I no longer think that premium valuation is a problem here. In fact, the shares look undervalued if the company can manage long-term annualized free cash flow growth of just 3% (from 2019’s level). That should be an achievable/beatable target, but I don’t want to underplay the risk that Covid-19 will cause long-lasting demand destruction in its core market, nor that management will continue to make questionable strategic and capital allocation decisions.

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Middleby's Premium Is Gone, But Longer-Term Demand Destruction Is A Real Concern

Thursday, May 28, 2020

Columbus McKinnon Braced For The Downturn, With A New CEO To Drive Future Growth

As a company tied to industrial production, Columbus McKinnon (CMCO) is already seeing a severe hit to its business, and that’s only going to get worse in the June quarter. Looking beyond the next couple of quarters, though, the company is in a pretty strong position having successfully executed on a multiyear plan to improve manufacturing and supply chain efficiency, eliminate non-strategic businesses, and simplify the portfolio. Now the company is transitioning to more of a growth phase that will include investing in automation-enabling technologies and pursuing select M&A.

Since my last update on the company, industrial production has plunged, but the company has hired a new CEO. If low-to-mid single-digit revenue growth and low double-digit FCF margins remain reasonable long-term assumptions, Columbus McKinnon shares look undervalued today with a double-digit long-term annualized total return potential.

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Columbus McKinnon Braced For The Downturn, With A New CEO To Drive Future Growth

II-VI Looking To Flex Newly-Bought Muscle In Multiple Growth Markets

I wouldn't expect a stock that was up more than 40% over the past year and serving growth end-markets like data centers and 5G infrastructure to be undervalued, but that may yet be the case with II-VI (IIVI). There's an above-average risk here, as a lot of II-VI's value is predicated on grabbing share in markets like 3D-sensing, leveraging capabilities in advanced materials like SiC, and generating healthy margins in markets like optical components where that has historically been hard to do, but those risks seem more than balanced by the opportunity.

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II-VI Looking To Flex Newly-Bought Muscle In Multiple Growth Markets

With A Much Different Risk/Reward Outlook, Independent And Texas Capital Call Off Their Merger

The COVID-19 outbreak has created some significant disruptions for the banking sector, with almost every bank building reserves in anticipation of higher loan losses from the ensuing recessions. Those disruptions have also led to the termination of the proposed merger of equals between Independent Bank (IBTX) and Texas Capital Bancshares (TCBI), with the two parties agreeing to go their separate ways without any termination fees or other commitments.

Looking ahead, I can see both banks as candidates to be involved in future M&A, though the challenges TCBI is currently facing (including the need to find a new CEO) lead me to believe they'd more likely be a seller than a buyer. While the current valuation on TCBI does look exceptionally pessimistic, I'd prefer IBTX at this point given the greater uncertainties in TCBI's business mix.

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With A Much Different Risk/Reward Outlook, Independent And Texas Capital Call Off Their Merger
Liking ING Groep (ING) has been nothing but an exercise in frustration for years, with the recent COVID-19 outbreak only exacerbating what had been an extended period of underperformance. While ING’s credit quality and risk exposures screen relatively favorably, the bank’s heavy reliance on spread lending remains a significant risk and investors have been waiting in vain for a while now for some spark to ignite the business and the share price.

There are a lot of cheap-looking bank stocks out there now, so investors have the luxury of being picky. I do think that ING shares are trading significantly below long-term fair value, but the full impact of COVID-19 on credit quality is yet to be seen and ING has not yet named a new CEO. I believe whomever the board selects will be starting off from a period of low expectations and healthy capital, and I think the valuation is appealing, but this has been a value trap for quite some time now and that may well be the case for a while longer.

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ING May Finally Have Found Its Bottom

Analog Devices Remains Well-Run And Well-Placed To Grow

Even when you’re talking about the best of the best, valuation still matters. While I liked the quality of Analog Devices (ADI) and its differentiated growth drivers a year ago, I wasn’t so fond of the valuation. Since then, the shares have given investors a roughly 15% return, which is better than the return of the S&P 500 over that time, but well below the 40%-return of the semiconductor sector (as measured/reflected by the SOX index).

My main concern today is that the sector (and the market in general) has come back too far too quickly, leaving the risk/reward balance skewed more to the downside, and particularly if the Covid-19 recession proves to be deeper and/or longer than expected. I still really like Analog as a company, though, and I’m excited by the company’s specific growth drivers and growth opportunities, as well as its high-quality management. Valuation makes it hard for me to call this anything more than a hold, but I suppose if I had to own an expensive analog chip stock, this would be my preferred pick.

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Analog Devices Remains Well-Run And Well-Placed To Grow

Danaher: No Need To Fix What Isn't Broken

Danaher's (DHR) multiyear shift away from industrial end-markets and towards life sciences and diagnostics continues to benefit shareholders, with the stock continuing to outperform its former industrial peer group, while performing more or less in line with newer peers like Thermo Fisher (TMO). Although an upcoming CEO transition holds some modest risk, Danaher has amply demonstrated that it has a deep management bench and that it reinvests in internal executive talent development.

The only real issue, and this will be no surprise to most readers, is the valuation. Even though I assume that Danaher will actually grow faster over the next decade than the trailing 10-15 years (growing FCF at a compounded rate of around 10%), that still only suggests mid-single-digit total returns. Maybe that's enough given the above-average quality of this company, but I remain concerned about relatively limited prospects for positive re-rating with what is already a widely-loved company.

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Danaher: No Need To Fix What Isn't Broken

The New Ingersoll Rand Debuts Under Challenging Circumstances

While the combination of the former Ingersoll Rand’s non-HVAC businesses and Gardner Denver into the new Ingersoll Rand (IR) makes plenty of sense on a long-term basis, this is a tough time for this new company to make its debut. A host of short-cycle manufacturing end-markets are under significant pressure now, not to mention commodity markets like mining/metals and oil/gas, and acyclical businesses like medical/life sciences aren’t big enough to pick up the slack.

Ingersoll Rand should see its short-cycle business pick up around year-end, leading the way into a solid recovery in 2021 and beyond. Upstream oil/gas is going to be weaker for longer, I believe, but it’s now a smaller part of the overall business. On top of that are meaningful synergy and cost reduction opportunities. The “but” at the end of the road is valuation. While I do see a path to adjusted operating margins in the mid-teens and similar levels of FCF margin, the share price seems to already reflect that and I’m concerned the company could execute quite well objectively but still underwhelm from a relative price performance perspective.

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The New Ingersoll Rand Debuts Under Challenging Circumstances

Cummins: Sentiment Showing Even Wilder Swings Than The Business

Cummins (CMI) is a cyclical business, always has been and likely always will be, and yet, you still see analysts and investors who treat every cyclical peak and cyclical trough like the new normal. Sentiment has shifted significantly in the last few months, with the stock dropping close to 40% during the March panic but then shooting back up on what I believe may be premature enthusiasm that the worst of the downturn is now understood and “in the numbers”.

Make no mistake, I think Cummins is a great company, and I think management made smart choices to prepare for this downturn. I also think that while the company has been slow to invest in powertrain electrification technologies (particularly axle-centric technologies), it has made it up for that somewhat with other investments. My bigger issue is sentiment. Cummins would seem to offer a decent return now, but I think there could be another pullback after this strong rally, and that’s where I’d look to get more aggressive.

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Cummins: Sentiment Showing Even Wilder Swings Than The Business

Saturday, May 23, 2020

Dana Still Worth A Look On Better Decrementals And Recovery Potential

Up another 25% from my last write-up on the company, I still believe Dana (DAN) has more upside from here. Not only is Dana leveraged to recoveries in autos, trucks, and other commercial vehicles, but the company's surprisingly strong decremental margins so far lends a lot of credibility to management's past comments about the resilience of its margin and cash flow structure. Further down the road, Dana has a portfolio of electrification technologies that should enable it to preserve its business as manufacturers and customers shift to electric powertrains.

Low single-digit revenue growth and low-to-mid single-digit FCF margins can support a fair value in the high teens, though the near-term margin-driven EV/revenue fair value is more in the mid-teens. Either way, I think these shares offer appealing potential here even with the risk of a protracted downturn in the company's major markets.

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Dana Still Worth A Look On Better Decrementals And Recovery Potential

Rexnord Has Attractive Long-Term Drivers And Credibility On Margin Improvement

I've liked Rexnord (RXN) as an under-the-radar play on automation and institutional/industrial water for a little while, and while I thought the valuation on the shares was equivocal back in January, the stock has continued to outperform the larger industrial sector - even though "outperform" in this case means "declined less than the others". At this point, I still see attractive automation-oriented opportunities in its process and motion control business, and I believe its water business may hold up better than non-residential construction in general. I likewise still see longer-term margin/cash flow improvement opportunities as the company moves toward mid-teens FCF margins.

With ongoing outperformance, it is perhaps not so surprising that the valuation isn't outstanding. I believe Rexnord is priced for high single-digit returns at this point. That's okay, but I typically favor higher hurdle rates and I consider this more of a hold or a buy-the-dip idea than a "buy now" idea.

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Rexnord Has Attractive Long-Term Drivers And Credibility On Margin Improvement

Tenneco Still Under-Earning And Loaded With Debt

When I last wrote about Tenneco (TEN), I thought this highly-leveraged auto, truck, and commercial vehicle parts supplier was just too much of a risk relative to the potential rewards. The shares have fallen almost 60% since then, and while I think the company may be able to squeeze through these new challenges and survive, I still see significant ongoing operating issues with a company that has long generated underwhelming margins and gone deeply into debt pursuing very questionable M&A strategies.

As I said before, given the very high leverage here, even rather modest changes in long-term growth or margin assumptions (or near-term valuation multiples) can drive a meaningful change in the prospective fair value. Change my ‘21 revenue multiple by 0.025 (from 0.375x to 0.40x) and the per-share fair value jumps almost 50%. Change a model input such that the long-term average FCF margin changes by 1bp and my DCF-based fair value can change by almost 3%.

With such high leverage, a successful restructuring and turnaround at Tenneco could drive huge shareholder returns. Likewise, with such high leverage, a single management mistake (and there have been more than a few of those over the years) could conceivably spiral the company into bankruptcy. I don’t need that kind of risk, particularly in the absence of a better restructuring/turnaround plan, and I’m not looking to buy these shares today.

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Tenneco Still Under-Earning And Loaded With Debt

Hospitals Reopening, But Zimmer Biomet Needs To Stabilize Its Knee Business

I wasn’t overly fond of Zimmer Biomet (ZBH) back in early January, and the shares have modestly underperformed peers like Smith & Nephew (SNN) and Stryker (SYK) since then. The Covid-19 outbreak has certainly created an unexpected disruption for a business based largely around elective procedures, but I remain concerned about Zimmer on the more fundamental level of whether it can stop losing share to knee and hip competitors like Stryker and Johnson & Johnson (JNJ), and whether restructuring efforts can really improve the company’s long-term margin and growth outlook.

At the right price, I think the “better Zimmer” story might have legs, but today’s price looks more “okay” than compelling to me right now.

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Hospitals Reopening, But Zimmer Biomet Needs To Stabilize Its Knee Business

Leadership In Data Center Interconnect Continuing To Propel Inphi

It wasn’t that long ago that I last wrote on Inphi (IPHI), early April in fact, and the shares are up almost another 30% since then. The company did in fact produce the beat-and-raise quarter I expected, but the degree of the “raise” was startling even to me, as the company continues to benefit from physical layer upgrades in the data center.

How do you value Inphi? As is often the case, exceptional growth companies like Inphi don’t really work from a DCF standpoint and they break the models for the sort of multiples a “normal” company should get. You can turn to alternative approaches like peer multiples, but it’s tough to construct a peer group for Inphi – Nvidia (NVDA) and Silicon Labs (SLAB) would arguably belong in that group, but it’s a fairly short list.

You can also look at what the market has been willing to pay for similar growth in the past, or some combination of those approaches. It’s that latter method that I’m gravitating toward now; I won’t defend it as a particularly rigorous approach, but based upon what the market is willing to pay for the growth at companies like Nvidia and Silicon Labs now, and what it has paid for comparable growth in the past, you can get a fair value range of around $115 to $140 today.

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Leadership In Data Center Interconnect Continuing To Propel Inphi

COVID-19 Brings Komatsu Back To More Reasonable Levels

There are ample concerns about both the construction and mining end-markets now, and that can be seen in Komatsu's (OTCPK:KMTUY) 20% year-to-date share price decline, a decline more or less on par with Caterpillar (CAT) but worse than Epiroc's (OTCPK:EPOKY) performance over the period. Although construction and mining activity has held up reasonably well, major customers are far more cautious on capital spending now, and that is likely to push Komatsu's revenue, margins, and cash flows down in fiscal 2021.

The main attraction I see in Komatsu now is that it's trading at what has historically been an attractive multiple. While I do have my concerns with the company's market share in the Chinese excavator market and its leverage to coal mining, I think those issues are more than reflected in the share price. I won't claim this is the best equipment company, but I do think the risk-adjusted return potential is good enough to merit at least a spot on a watchlist.

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COVID-19 Brings Komatsu Back To More Reasonable Levels

Thursday, May 21, 2020

Nektar Seeing Modest Covid-19 Delays Ahead Of Key Trial Data

The wait goes on for Nektar (NKTR) shareholders. These shares are still well off the performance trajectory of the major biotech ETFs, though the underperformance on a year-to-date basis hasn’t been so bad. Unfortunately, with key data on its bempeg pushed to next year, investors will have to wait a little longer to see the answer to some crucial questions.

I continue to believe that the first-line melanoma indication of bempeg (in combination with Bristol-Myers’ (BMY) Opdivo) alone can support a fair value above today’s price, but there are still substantial uncertainties about this program, to say nothing of the other clinical bempeg programs. Beyond that, compounds like NKTR-255 and NKTR-358 also have worthwhile potential, but only future data read-outs will tell us how much of that “potential” is real.

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Nektar Seeing Modest Covid-19 Delays Ahead Of Key Trial Data

COVID-19 Has PNC Back On The Hunt

What a difference a pandemic makes. While PNC Financial’s (PNC) management had spent the better part of a few years now explaining why whole bank M&A no longer made sense as a growth strategy, management decided to sell its sizable stake in BlackRock (BLK) and is now openly discussing its intention to be opportunistic in bank M&A.

Good managers adapt to new circumstances, and I believe that is what PNC is doing here. If management is right about the fed funds rate staying at 0.25% or below for the next three years, there will be more than a few regional banks struggling to generate any meaningful earnings growth, and PNC is likely to have multiple options. How quickly a deal materializes is a key unknown, though, and the absence of BlackRock will be felt in the earnings until the company finds a better use for that capital.

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COVID-19 Has PNC Back On The Hunt

Lenovo Facing Familiar Headwinds, And Still Frustrating Bulls

I’ve written more than once that Lenovo (OTCPK:LNVGY) needs a driver beyond its leading PC business to change sentiment on the shares. Unfortunately, both the mobile and enterprise businesses have taken backward steps, and issues like trade tensions with China still loom large. Against that backdrop, Lenovo’s ongoing strong execution in the PC business just doesn’t seem to matter, and the shares have remained weak.

Lenovo continues to look undervalued against what I see as undemanding expectations, including 2% overall revenue growth, declining gross margins, and scant long-term FCF growth. That’s been the case for some time, though, and I think the market will need to see peace on the trade front and some evidence of momentum in the mobile and/or enterprise businesses before getting more bullish.

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Lenovo Facing Familiar Headwinds, And Still Frustrating Bulls

Covid-19 Only The Latest Challenge For HollySys

One of my biggest concerns about HollySys Automation Technologies (HOLI) (“HollySys”) for some time now has been the risk of this stock performing more as a value trap than an undervalued play on China’s automation and high-speed rail sectors. It is, after all, relatively small and under-followed by the sell-side, and management’s communication with the Street and investors has often been below average. While the shares haven’t done too badly since my last update, they have lagged other large automation names like Emerson (EMR) over the past year and beyond.

The value-vs-value trap debate remains the central issue I see with the company. While management hasn’t made the expected (or perhaps “hoped for”) progress in areas like expanding its rail operations outside China, it has been gaining share in new verticals in automation and there is still significant scope to grow the business just in China. Modest growth assumptions can support a much higher share price, but at least some of that is a bet on more consistent operations from a company that has long struggled to do precisely that.

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Covid-19 Only The Latest Challenge For HollySys

Sunday, May 17, 2020

Microchip Trading More Reasonably, And With Future Margin Leverage

Quality has never been my issue with Microchip (MCHP). I like this leading player in microcontrollers (or MCUs), but valuation has often been more difficult for me. Since my last update, though, the shares have underperformed the chip sector by about 10% and the valuation is a little more appealing. Microchip certainly has elevated debt, but I expect the company to continue generating robust cash flow and I like the company’s market exposures on balance.

Microchip isn’t a clear-cut bargain, but then I wouldn’t expect that with a company that has leading share in some tough-to-crack markets (like MCUs). I’m more interested in the valuations of chip companies more leveraged to power (namely STMicro (STM) and Infineon (OTCQX:IFNNY)), but as a quality MCU and analog play, Microchip is at least worth monitoring.

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Microchip Trading More Reasonably, And With Future Margin Leverage

Commercial Vehicle Crushed Under Covid-19

The COVID-19 pandemic has made life difficult for almost everyone, and it has made an already-challenging situation at Commercial Vehicles (CVGI) that much worse. While 2020 was never going to be a strong year given the cyclical downturn in the truck industry, the sudden, severe disruption to production has created even greater challenges for a company that wasn’t in particularly strong shape heading into this downturn.

While COVID-19 is likely to intensify the downturn that was already happening in CVGI’s primary markets, these markets will recover in time. I do expect the company to participate in that recovery, but there are other, longer-standing issues to consider here, including a chronic inability for the company to meaningfully expand its business into attractive new opportunities or generate better than low single-digit FCF margins.

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Commercial Vehicle Crushed Under Covid-19

SPX Flow: Undemanding Valuation, But Uninspiring Drivers

It’s not enough for a company’s shares to be cheap. By and large, unless there’s something within the story that can drive better performance (or at least better than expected performance), a cheap stock without drivers can stay cheap for a frustratingly long time, leading to the so-called “value trap” that is the bane of value and GARP investors.

And that’s basically my issue with SPX Flow (FLOW) in a nutshell. The shares do look undervalued, but it’s hard to find much about this business that’s really exciting. The Food & Beverage business is good and somewhat defensive, but the Industrial business is a more typical short-cycle equipment business and the overall margins don’t impress. An under-leveraged balance sheet gives management some options, but it’s tough to get excited about the operating story here.

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SPX Flow: Undemanding Valuation, But Uninspiring Drivers

Lundbeck Benefits From Covid-19 Stocking, But The Pipeline Is Still Problematic

Drug companies have been relative safe havens during this global Covid-19 outbreak, doing about 10% better than the S&P 500 since the beginning of the year, and H. Lundbeck (OTCPK:HLUYY) (LUN.CO) has more or less performed in line with the industry. First quarter results saw a boost from stocking orders that management couldn’t (or wouldn’t) quantify, but it also saw markedly lower spending that boosted reported results. All told, I’d call it “business as usual” albeit with the caveat that those stocking orders will likely depress results at some point down the line.

The biggest concern around Lundbeck remains its weak pipeline; an issue that even management acknowledges as a problem. Even if management’s efforts to restructure and improve the internal R&D efforts bear fruit, the results won’t be seen for a while, leaving the company likely needing to do more deals to backfill the pipeline – a dicey proposition given recent clinical failures of acquired assets. While these shares do appear priced for a respectable return (in the high single-digits), I’d call that fair compensation for the risks involved.

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Lundbeck Benefits From Covid-19 Stocking, But The Pipeline Is Still Problematic

Copa Looks Like One Of The Emerging Market Airline Survivors

This is unprecedented territory for airlines. While recessions, war, and natural disasters have led to airlines grounding some or all of their fleets for relatively brief periods of time, nothing like Covid-19 has been seen in living memory on a global scale. Copa Holdings (NYSE:CPA) has grounded its entire fleet, and it's hard to say what demand will look like for the remainder of 2020, but Copa has the wherewithal to survive this and emerge on the other side still capable of generating attractive, long-term results.

Obviously, there is tremendous uncertainty when it comes to modeling Copa now. Following management's guidance for capacity additions in 2020 is a good starting point, but nobody really knows what the virus will do, what global infection rates will be like, what governments will do in response, and how quickly people will be willing and able to resume air travel. Although I believe humans are very resilient and global travel will get back to normal in a few years, there's a great deal of uncertainty in the interim, and Copa has to survive that before the long-term health of the global air travel market is even a relevant driver.

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Copa Looks Like One Of The Emerging Market Airline Survivors

Wednesday, May 13, 2020

Infineon Looking At Major Drivers Across The Next Decade

Infineon (OTCQX:IFNNY) shares have done okay since my last update, beating its peer group slightly, but underperforming more recently on worries around the company’s elevated exposure to autos (Infineon is one of the most auto-exposed semis that I follow). On balance, though, nothing much has really changed – Infineon remains a strong, well-diversified chip company with meaningful positions in power, MCUs, and sensors, and good leverage to trends like auto electrification, advanced ADAS, industrial automation, and IoT.

Valuation is, I believe, in the “okay to good” range. STMicro (STM) looks a little cheaper, Texas Instruments (TXN) and NXP Semiconductors (NXPI) look more expensive, but I wouldn’t call the assumptions supporting Infineon’s valuation conservative, and I would note that Infineon’s spot on the top of multiple market share charts makes it a target for companies like STMicro and ON Semi (ON) looking to grow at its expense.

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Infineon Looking At Major Drivers Across The Next Decade

Reputation, Strategic Differentiation Supporting Illinois Tool Works

I’m not a fan of investment buzzwords (for instance, I think “dividend king” is moronic), but words like “cyclical” and “defensive” do at least give investors a simple shorthand for thinking about companies.

But then, it’s never really that simple. Take the case of Illinois Tool Works (ITW). It’s both defensive (with incredible margins) and cyclical, and that cyclicality is going to lead to some eye-popping revenue contraction in the coming quarters as the company absorbs the brunt of downturns in markets like autos, food equipment, welding, and non-residential construction.

Likewise, ITW isn’t afraid to break from the pack and manage its business in a decidedly non-defensive way – instead of worrying about minimizing decremental margins for a few quarters, ITW is going to pass on significant structural changes and is instead going to focus on taking share from smaller competitors whose scale, liquidity, or other operational attributes are forcing them to play defense.

I frankly love this move. I wish I loved the valuation as much. That’s a familiar complaint with me and this stock (and with many others who follow ITW), but it’s still relevant. Even if I assume ITW’s strategy works and they can gain share sufficient to allow them to grow the top line at rates similar to high-quality peers like Dover (DOV), Honeywell (HON), or Parker Hannifin (PH), I just can’t get the numbers to work. Of course, I thought that back in late December, and it didn’t keep the stock from outperforming its peers by better than 12%.

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Reputation, Strategic Differentiation Supporting Illinois Tool Works

MaxLinear Looks More Interesting As It Refocuses On An Area Of Strength

I had mixed feelings on MaxLinear (MXL) back in December, with most of my concerns involving valuation and the company’s real competitive position in PAM4 relative to Inphi (IPHI) and Broadcom (AVGO), and the shares haven’t had a great run since then, lagging the SOX index by more than 20%, trailing Broadcom slightly, and getting left in the dust by the runaway train that is Inphi these days.

Now MaxLinear’s situation is a little different, with the upcoming acquisition of Intel’s (INTC) Home Gateway business reducing some of the execution risk I saw, but also limiting upside from data center and 5G exposure.

I don’t love this business, but it does screen as one of the cheaper names that I follow. Moreover, I’ve seen more than a few smaller semiconductor companies do well by focusing on slower-growing markets that larger competitors have largely abandoned. All in all, then, while I have some concerns about the ongoing underperformance in Infrastructure and Industrial here, I think there’s enough undervaluation to be worth a look.

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MaxLinear Looks More Interesting As It Refocuses On An Area Of Strength

Grid Spending Keeps The Lights On For Hubbell

I thought Hubbell (HUBB) was appropriately priced back in December, and the shares have since basically tracked the larger industrial group, with quasi-comparables like Eaton (ETN) and Schneider (OTCPK:SBGSY) doing better and ABB (ABB) doing worse (I say quasi-comparables as these are large, diversified multi-industrials), while nVent (NVT) also performed worse.

Hubbell is an intriguing mix of good near-term opportunities and significant near-term challenges. I’m not bullish on the prospects for non-resi construction or oil/gas through 2022 (around 40% to 45% of the mix), but I am bullish on utility spending (35% of revenue) and the company’s leverage to potentially more V-shaped recoveries in short-cycle industrial and resi construction. The shares aren’t “can’t miss” cheap in my model, assuming long-term revenue and FCF growth in the low-to-mid single-digits, but they do look priced for high single-digit to low double-digit annualized returns that are better than most of what I see in the industrial sector now.

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Grid Spending Keeps The Lights On For Hubbell

ArcelorMittal's Low Valuation Offset By A Weak Price Outlook

One of the quirks of investing in commodity companies, and steel in particular, is that you typically want to own the inferior companies during the up-cycles. While pretty much every steel company saw share price improvement in the 2016-2018 upswing, names like ArcelorMittal (MT) and U.S. Steel (X) outperformed generally better-regarded names like Steel Dynamics (STLD) and Nucor (NUE) (though Steel Dynamics did quite well). Since the peak of steel prices, the script has flipped and ArclorMittal and U.S. Steel have noticeably lagged those other names.

I believe this second quarter will likely mark the bottom of the cycle for shipments, but I believe pricing could be lower for longer, which complicates positioning for the cycle. Lower-quality companies tend to do better when steel prices bottom and rebound, and that may not happen for several years. Consequently, while ArcelorMittal shares do seem to be trading at a very low valuation, even in the face of deteriorating near-term results, the uncertain timing of a sustained rebound in steel prices makes this a tougher call.

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ArcelorMittal's Low Valuation Offset By A Weak Price Outlook

Tuesday, May 12, 2020

Gerdau Flattened As Covid-19 Pushes Brazil's Long Steel Recovery Out At Least A Year

This had been shaping up as a good year for Gerdau (GGB), with good underlying evidence of growing steel demand on improving vehicle production in Brazil, increasing non-residential construction investment, and recovering industrial and consumer markets. Then Covid-19 swept the globe, and now Brazil’s looking at a year of GDP contraction, and probably not much GDP growth until late 2021 or 2022. On top of that, the U.S. non-residential market doesn’t look all that healthy to me over the next few years.

I do believe Gerdau is one of the better emerging market steel companies, but the headwinds in Brazil, the U.S., and the rest of LatAm are real. That makes Gerdau a riskier call in the short term, but I also do think the current share price underestimates the company’s long-term potential.

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Gerdau Flattened As Covid-19 Pushes Brazil's Long Steel Recovery Out At Least A Year

A Relatively Rare Chance To Buy Sensata At A Good Price

Sensata (ST) has long been one of those companies on my “like the company, not the stock valuation” list, and with the Covid-19 pullback this looks like a relatively rare chance to acquire shares in a leading sensor and control company at a reasonable valuation. Of course there are risks today, including the timing of the auto recovery (as well as off-road vehicles, aerospace, and industrial), Sensata’s future content opportunity/reality in hybrid and electrics, and the company’s ability to successfully add high-value markets to its overall addressable opportunity. At today’s prices, I believe investors are getting a decent return on those risks.

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A Relatively Rare Chance To Buy Sensata At A Good Price

ON Semiconductor Is A Tricky Mix Of Opportunity And Disappointment

There’s a quote I’ve long loved, apocryphally quoted to Dallas Cowboys defense lineman Randy White, that goes “Potential is a fancy French word that means you ain’t done yet!” That’s not entirely fair when it comes to ON Semiconductor (ON), but I don’t think I’m the only investor torn between the possibilities of what higher-value products like image sensors and SiC MOSFETs could do for ON and the historical realities of the company’s performance over the last few years.

Being unable to hit margin targets is a big deal with semiconductor companies, and particularly when there isn’t enough revenue out-growth to compensate. I’m likewise concerned that management is still too optimistic about its near-term prospects and may have more risk on costs and inventories. Countering that, the stock has been thumped again and appears to be trading with more reasonable expectations embedded into the price.

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ON Semiconductor Is A Tricky Mix Of Opportunity And Disappointment

Recent Outperformance Not Helping BRF All That Much

Brazil’s BRF SA (BRFS) has strung together some good quarters, but it hasn’t done the stock much good – the shares are down more than 55% from the time of my last article, underperforming U.S. protein producers like Pilgrim’s Pride (PPC) and Tyson (TSN), as well as fellow Brazilian producers like JBS (OTCQX:JBSAY) and Marfrig (OTCPK:MRRTY). While there are some macro concerns in play, including signs of increased poultry production in exporting countries, I believe BRF’s issues in its halal business and doubts about its long-term strategy in Brazil are also having an impact.

BRF shares do look undervalued, but the Covid-19 outbreak has created new challenges for a company that was only just starting to show real progress on its restructuring efforts. Management needs to sort out the issues in the halal business, but the political nature of those issues will make that challenging, and the long-term FCF margin outlook is still uncertain. While I do think today’s price undervalues the long-term opportunity, I can’t make a compelling argument that every investor really needs to bother with a quasi-commodity company operating largely in emerging markets.

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Recent Outperformance Not Helping BRF All That Much

Veeco Benefitting From Diversification, And Waiting For Orders To Rebound

If you like to trade, Veeco (VECO) may hold some appeal, as the shares seem to like to range between the high single-digits and mid-teens. From the perspective of a long-term investor, though, I continue to regard Veeco as a more middling prospect. The shares are up about 10% from my last article, when I thought the shares had some appeal/value, and have outperformed the chip space and many tool peers/comps, but now I consider the valuation to be more “fair” and the company’s longer-standing performance and competitive issues are more relevant.

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Veeco Benefitting From Diversification, And Waiting For Orders To Rebound

3M Quietly Outperforming Ahead Of A Short-Cycle Turn

I thought 3M (MMM) had some relative appeal back in January, before COVID-19 became a global pandemic, and the shares have outperformed their peer group by about 14% in that short window since. I think there are several parts to this. 3M’s leverage to N95 respirators certainly counts for some of it, but I also think 3M has outperformed on the perception that its businesses will be more likely to see an earlier recovery and that it was already underway with some restructuring activities before the downturn.

With that relative outperformance, I don’t see as much upside at this point. I don’t think COVID-19 will have a substantial long-term impact on the business, and I still expect 3M to deliver low-single-digit revenue growth, mid-single-digit FCF growth, and healthy capital returns over time. But given the relative value opportunities with names like Eaton (ETN), Emerson (EMR), Honeywell (HON), ITT (ITT), and Parker-Hannifin (PH), I can’t say that 3M is far and away the top call now, though 3M does have the advantage of relatively less exposure to problematic markets like non-residential construction, aerospace, and oil/gas.

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3M Quietly Outperforming Ahead Of A Short-Cycle Turn

Monday, May 11, 2020

Covid-19 Complicates An Already-Challenging Manitex Turnaround Story

There have been some positive developments at Manitex (MNTX) that you don’t really see in the share price, including new management, expanded distribution, and signs of momentum in the knuckle-boom crane business. On the other hand, the results are what they are, and the Covid-19 outbreak is going to have a sharp near-term impact on the business.

Manitex remains a story about internal transformation driving better long-term results, and particularly whether drivers like the knuckle-boom cranes and Tadano partnerships can drive meaningful improvement over what has been a pretty dismal track record of margins and free cash flow generation. While the shares do look undervalued on what I think are achievable long-term estimates, there are a lot of cheap stocks out there today and I won’t argue forcefully that Manitex has earned the benefit of any doubts.

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Covid-19 Complicates An Already-Challenging Manitex Turnaround Story

It's Early, But PRA Group's Business Is Holding Up Well So Far

While PRA Group’s (PRAA) first quarter results probably shouldn’t have propelled the shares higher by a third, the shares likewise shouldn’t have declined so much going into earnings – such is the chilling effect of uncertainty on investor behavior. In any case, I was surprised to see how well PRA’s business performed in the first quarter and how confident management sounded regarding the business for the remainder of 2020. Uncertainty is still the word of the moment, but the company’s operating efficiency, both in terms of collections and costs, is holding up quite a bit better than expected.

PRA Group isn’t out of the woods yet with respect to Covid-19. With only the first steps being made toward re-opening in most states, there are still a lot of unknowns regarding employment levels, earnings, and so on. Moreover, some of the decisions the company is making today (delaying legal proceedings, granting hardship relief, et al) will impact collections in the coming quarters. Still, I believe the company remains on a trajectory to generate mid-to-high single-digit long-term revenue growth with low-to-mid teens annualized free cash flow growth and adjusted mid-teens ROEs, supporting a fair value in the high $30’s today.

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It's Early, But PRA Group's Business Is Holding Up Well So Far

BorgWarner Looks Undervalued As A Post-Panic Recovery Play

BorgWarner (BWA) shares have already recouped some of the panic-selling declines, but the shares continue to trade well below what I believe to be a fair long-term assessment of the company’s value, with or without the Delphi (DLPH) deal. The process of getting auto production back on its feet will be a challenge, as will the conversion/evolution toward electric powertrains, but I believe it’s a challenge that BorgWarner is up for, and I believe buying today offers attractive long-term value.

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BorgWarner Looks Undervalued As A Post-Panic Recovery Play

Uncertainty (And Plenty Of Fear) Dominating AerCap's Valuation

Bad news is something that institutional investors can typically deal with, but uncertainty can cripple them, and when in doubt, they tend to assume the worst. Looking at AerCap (AER), there’s almost nothing but uncertainty. When will people feel like flying again (let alone when will they be allowed to?)? How many airlines will still be operating? Will AerCap be able to manage its debt maturities in the meantime? And so on.

I won’t pretend to have perfect answers to those questions (I’m still waiting for my crystal ball to come back from the shop…), but I do believe there are a few fundamental concepts you can look at now. AerCap has survived past crises, the company has adequate liquidity for at least the next two years, and so far, it seems that AerCap, banks, aircraft manufacturers, and major airlines are all working together relatively cooperatively. All bets are off if Covid-19 keeps planes grounded indefinitely, but China’s early experience suggests that’s not likely, and I believe AerCap will generate good returns from here.

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Uncertainty (And Plenty Of Fear) Dominating AerCap's Valuation

Covid-19 Just The Latest Of Many Challenges For Kennametal

It’s been a while since I’ve written on the perpetually-restructuring Kennametal (KMT), partly because it gets tedious writing about an underperforming company with serious long-term structural and competitive challenges. There have been some periods of outperformance since that last article, but for the last year or so, it’s been a rough go for the company and its shareholders.

It’s almost three and a half years later, but my investment conclusion hasn’t changed much. The shares do look undervalued even based on what I think are fairly conservative assumptions, but it’s hard to get excited about owning a company that you don’t believe in on a long-term structural basis. Does Kennametal have potential as a way to play the coming short-cycle recovery? Definitely. Would I be surprised if the shares were 10% to 25% higher a year from now? Not at all. But is this a name I’d buy and just lock away in the vault for five or more years? Also “not at all”.

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Covid-19 Just The Latest Of Many Challenges For Kennametal

Decremental Margins And Weak Muni Budgets Challenge Allison Transmission

It’s early in the downturn, but Allison Transmission (ALSN) is so far living up to Street and investor expectations. Decremental margins are going to be an issue during the downturn, but operating leverage will improve when business turns and many companies would love to have Allison’s trough FCF production at their cyclical peaks.

I do have some concerns about municipal budgets and the oil/gas market, but I’ll get to those in a moment. For now, Allison continues to look like an okay prospect. There are much cheaper names in the vehicle supplier space now, including many with less risk to eventual electrification, but Allison is a proven name with exceptional margins and relatively less balance sheet risk. For investors who’ve waited for a chance to buy in at reasonable prices, this is still an opportunity.

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Decremental Margins And Weak Muni Budgets Challenge Allison Transmission

Alnylam Pharmaceuticals Continues To Execute, Though Covid-19 Is A Near-Term Hurdle

Alnylam’s (ALNY) management simply continues to execute, logging another quarter of better than expected results and moving the pipeline forward. While Covid-19 is going to create some near-term challenges for the Onpattro franchise, it should be recoverable later in the year provided that a renewed surge in infections doesn’t prompt another round of shutdowns. On a more lingering note, though, Covid-19 is creating some trial delays that won’t be recovered, but these aren’t particularly material.

With the shares up roughly 30% from my last article a month ago, I can’t complain about the performance. I do still see some upside from here, and I personally consider this a long-term holding, but I can’t really recommend it as enthusiastically as before given the lower relative undervaluation. Given the historical volatility, though, I’d suggest keeping an eye on this for a “buy on a pullback” opportunity.

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Alnylam Pharmaceuticals Continues To Execute, Though Covid-19 Is A Near-Term Hurdle