Dialog Semiconductor - Too Good To Be True?

I don't want to like Dialog Semiconductor (OTC:DLGNF) (DLGS.XE). I don't like companies that get overwhelming amounts of revenue from a single customer, or companies with such erratic margins and no clear signs of ongoing improvement. Add in an unfocused/unclear M&A strategy and a U.S. ADR that has unusably low liquidity (the Xetra-listed shares are FAR more liquid and that's the way to invest, if you choose to do so...), and there are plenty of reasons to avoid Dialog.

And yet.

The valuation on Dialog looks a lot lower to me than it should be, even when I apply penalties to reflect the lack of diversification and so on. Even 4% to 5% long-term revenue and FCF growth would offer upside to today's price, and these shares could be meaningfully undervalued - particularly if you believe that the company can reinvest its sizable cash position into value-building M&A. Granted, if Apple (NASDAQ:AAPL) drops Dialog's PMICs then all bets are off with respect to valuation, but investors could do well from here if these renewed worries prove overdone.

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Dialog Semiconductor - Too Good To Be True?

Covestro Benefiting From A Cyclical Surge, But Trouble May Be Looming

Germany's Covestro (OTCPK:COVTY) (1COV.DE) is a pretty interesting story to me. Nobody disputes that this is one of the largest manufacturers of key chemicals like polyurethanes, polycarbonates, and specialty inputs like isocyanates. Nor does anybody dispute the ongoing long-term growth potential in markets like autos, construction, appliances, and furniture, as polyurethane and polycarbonate products offer meaningful performance advantages (insulating ability, weight, etc.).

What is very much in dispute is how much longer the good times can last. Covestro has benefited significantly from higher spreads fueled by good market growth, relatively sluggish recent capacity growth, and outages across the industry. Now, though, a fair bit of new capacity is soon to go online and is threatening to push industry operating rates down to a point where pricing will weaken.

That Covestro will see a cyclical decline seems all but assured, but the timing, depth, and length of the downturn are far less certain. Although the shares look potentially undervalued on the basis of EV/EBITDA, I've seen enough cyclical swings to know that the virtues of Covestro will be forgotten by the market if/when that cyclical decline materializes. With that, I'd rather wait for a pullback below my DCF-based fair value (which does attempt to model some cyclicality) to build a position.

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Covestro Benefiting From A Cyclical Surge, But Trouble May Be Looming

Arch Capital's Cycle-Management Capabilities Serving It Well

Arch Capital (NASDAQ:ACGL) continues to demonstrate why I regard it as among the best of the best insurance companies in the market. While the company's acquisition of AIG's (NYSE:AIG) mortgage insurance business (United Guaranty) was perhaps not universally lauded, I believe investors who understand the dynamics of the mortgage insurance and Arch Capital's strategy here will appreciate the value that it will add in the coming years - particularly as available returns in the primary insurance and reinsurance market are pretty lousy.

Arch Capital shares are up another 20% or so from when I last wrote about the company, beating broader insurance stock indices (like the Dow Jones U.S. Select Insurance Index) and other quality insurers like Chubb (NYSE:CB) and W.R. Berkley (NYSE:WRB) (XL Group (NYSE:XL) has done a fair bit better). The shares certainly aren't cheap on a conventional book value multiple basis, but I do believe and expect that Arch Capital's diversification into mortgage insurance and careful management of its insurance and reinsurance businesses can support high single-digit to low double-digit growth at a time when many other insurers are going to be hard-pressed. Granted, I don't think these shares are undervalued on a discounted earnings basis either, but they're not out of line if you believe in management's guidance and this management team has given investors few reasons for persistent pessimism.

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Arch Capital's Cycle-Management Capabilities Serving It Well

Rational AG Has Significant Growth Potential, But The Market Knows It

Companies with returns on invested capital consistently above 30%, strong market share, and the potential to continue generating double-digit growth are hardly a dime-a-dozen, and I believe Rational AG (OTC:RTLLF) (RAAG.DE) has had uncommonly good results in no small part by maintaining a narrow focus on the foodservice equipment industry. More specifically, Rational AG pioneered the combi-oven concept and continues to focus its energies around a very limited product line-up built around saving space, labor, and operating costs in the commercial kitchen.

There a lot of very important "buts" to consider. First, Rational's ADRs have virtually no liquidity, so investors will have to look overseas (and even there its low share count doesn't lead to a lot of turnover). Second, insiders control the company. Third, the valuation is quite high as investors have rewarded the shares with a generous multiple as revenue has notably accelerated. Still, there is a large market opportunity waiting for Rational outside of Europe, management has shown it can run this business very well, and Rational would be an attractive target if or when those insider owners decided to sell.

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Rational AG Has Significant Growth Potential, But The Market Knows It

PacBio Not Back To Square One, But Definitely Back To A "Show Me" Story

Good news has been hard to find at Pacific Biosciences (NASDAQ:PACB) for a while. Roche's (OTCQX:RHHBY) decision to terminate its agreement with PacBio to develop and market PacBio's technology for the clinical diagnostics market was a major setback in terms of both near-term cash flow prospects and public perception around the value of the technology platform. What's more, with the launch of the Sequel and subsequent reports on its real-world performance, PacBio has once again shown that it struggles to develop and launch systems that deliver the hoped-for performance from Day One.

PacBio shares have fallen close to 60% since my last update on the company, and it I believe the Street has soured too much on the company's prospects in core genomics research. The ongoing improvements in the performance of PacBio's systems should continue to drive adoption, but my fair value estimate of around $6 assumes mid-term revenue growth in the mid-to-high 20%'s and longer-term growth in the mid-20%'s, as well as the ability to earn strong free cash flow on revenue in the $500 million to $600 million range (similar to my expectations for diagnostics company GenMark (NASDAQ:GNMK)). There are absolutely no guarantees that PacBio can hit those targets, nor any guarantees that the markets will grow as hoped or that PacBio's technology won't be supplanted by its rivals. As a high-risk show-me story in an expensive market, though, it is at least worth a look again.

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PacBio Not Back To Square One, But Definitely Back To A "Show Me" Story

Aspen Insurance Not Operating At A Top-Notch Level

Aspen (NYSE:AHL) wasn't my favorite idea in P&C insurance back when I last wrote about the stock in early 2016 (I preferred Chubb (NYSE:CB)), as I thought the apparent undervaluation in the shares was overshadowed by some operational risks. While the shares have climbed about 10% since then, a lot of those operational risks have emerged as bigger issues, and Aspen has underperformed other insurance companies like Chubb and Travelers (NYSE:TRV), as well as the broader Dow Jones P&C Insurance Index (which is up about 25% since I last wrote about Aspen).

Aspen's "build it and they will come" strategy for insurance hasn't worked out yet, and the company has seen both higher adjusted loss ratios and higher expense ratios. The company's underwriting profitability has declined significantly and weak pricing is not going to help matters.

Aspen is shrinking its programs business and taking a harder look at expenses, but shrinking reserve releases and the prospect of claims inflation are worries. While I still believe that Aspen can get to low double-digit ROEs over the long term, and the shares are priced for high single-digit to low double-digit returns, there is still risk to those projections and it's hard for me to get excited about Aspen outside of potential M&A interest.

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Aspen Insurance Not Operating At A Top-Notch Level

Geely Still Hard On The Throttle

I've been bullish on Geely (OTCPK:GELYY)(0175.HK) for a while, but China's third-largest domestic car company has surpassed even what I regarded as bullish expectations on my part. The company's new SUV line-up has gone over well with customers, as have new sedans, and Geely's upcoming Lynk brand could take the company to yet another new level. Volume growth continues to blow away underlying market growth in China, sending the local shares up over 100% from my last write-up.

How much further can Geely go? The company's overall share in China is still only around 3%, and its share of domestic brands is still below 10%. Additional sedan launches are slated for this year, as well as significant launches for Lynk in 2017 and 2018.

The health of China's market and the sequential weakness in monthly results are both concerns, as are higher baked-in expectations and the ongoing murkiness in the company's operations vis a vis its parent company. Even so, the company seems to have made meaningful strides in addressing past engineering and marketing challenges and success outside of China could provide an unexpected new driver for growth.

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Geely Still Hard On The Throttle

Innovation And Execution A Powerful Combination For NuVasive

NuVasive (NASDAQ:NUVA) is a case in point as to why I'm a little cautious sometimes stepping away from strong growth stories driven by innovation and strong operational execution, particularly in markets/sectors that don't always have as much of those as they should. While NuVasive had a great run going into my last write-up in October, and did offer investors a brief pull-back, the shares have since climbed another 20% or so on the back of respectable financial performance and strong "in the field" innovation.

Valuation remains problematic. NuVasive is a relatively rare combination of good growth, strong margin leverage, and expanding market share, and I'm not surprised that it has become a popular go-to name in the space. That said, the shares are now pricing in a high teens FCF growth rate that may be hard to surpass. Given the history here of the market swinging too far during both the bad times and the good times, I'd be careful buying near the highs, but I'd certainly reconsider if the sector sells off on another bout of health insurance reform uncertainty and/or a company-specific shortfall in earnings/guidance.

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Innovation And Execution A Powerful Combination For NuVasive

A Refocused FARO Is Looking To Drive Better Results From Its Strong Metrology Capabilities

FARO Technologies (NASDAQ:FARO) gets included in discussions of those companies that could benefit as industrial end-markets become more automated, but the path hasn't been smooth so far. Although FARO has stronger share in industrial metrology products like arms and trackers, and has done well with its market entry into 3D scanners, the share price performance over the last five years has been poor (down more than 20%) while Perceptron (NASDAQ:PRCP), Hexagon (OTCPK:HXGBY)(HEXAb.ST), and Cognex (NASDAQ:CGNX) have done considerably better. This isn't entirely unfair either, as the company's revenue growth has been lackluster (less than 4%) and operating margins have weakened.

The company's interim CEO (and co-founder) has been shaking up FARO's operating plan, with a new focus on six primary verticals and improved expense leverage. I am concerned about the growth that management can expect from the auto and aerospace end-markets, but I believe there are worthwhile opportunities in other industrial metrology markets, as well as 3D scanning. I believe the market is currently pricing in around 10% long-term FCF growth, which seems reasonable, but this is a name worth keeping an eye on, as the shares can be volatile around earnings reports.

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A Refocused FARO Is Looking To Drive Better Results From Its Strong Metrology Capabilities

National Instruments Already Getting Ample Credit For What It Does Well

Although Wall Street often values companies on the basis of their perceived potential in the short term, it's typically a company's ability to execute that determines the long-term rewards for shareholders. That makes National Instruments (NASDAQ:NATI) a tough stock for GARP investors today; while the company's long-term revenue growth hasn't been bad, margin leverage has been elusive and returns on capital haven't been impressive. Making matters more complicated, the company's strong presence in software and its uncommon modular approach ought to be valuable points of distinction.

There are a lot of potential drivers that could lead to meaningful changes in National Instrument's future performance. The company is more aggressively targeting opportunities in semiconductor and wireless test, and the company's capabilities in embedded monitoring and control could leverage meaning growth in industrial IoT, autonomous vehicles, and other "smart machine" applications. Could is a tricky word, though, and a lot of improvement (and/or M&A potential) seems to be in today's share price.

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National Instruments Already Getting Ample Credit For What It Does Well

Can Luxfer Translate Its Skillset Into Real Results?

Leadership is a funny word - you can be the best at something, but if that "something" isn't all that valuable, then it's hard to make real money from that leadership. That's my initial impression of Luxfer (NYSE:LXFR) as I do believe this company has a strong position in specialty metal and metal products (including magnesium alloys/powders, zirconium, and aluminum/aluminum composite cylinders), but that leadership hasn't meant abundant (or reliable) cash flow, nor much in the way of strong market returns over the last five years.

I do expect management to continue to deliver innovation-driven products to the market, and I do think that there are growth opportunities in autos, aerospace, and chemical catalysts; but I'm hesitant to believe that revenue growth will come in much above the mid-single digits for any sustained period of time. The good news is that the Street really isn't expecting much - revenue growth in the 3% to 4% range and FCF margins in the high single digits can support a fair value of close to $14, as can an 8x multiple to my estimate of 2017 EBITDA. Coupled with a dividend yield close to 4% and a balance sheet that is in decent health, these underperforming shares could be worth a look for value and turnaround-oriented investors.

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Can Luxfer Translate Its Skillset Into Real Results?

Recovering Markets And Self-Help Pushing Commercial Vehicle Higher

As a shareholder, I can't complain too much about the performance of Commercial Vehicle (NASDAQ:CVGI) since my last update. With the shares up another 50% or so since late December, Commercial Vehicle has not only outpaced truck manufacturers like PACCAR (NASDAQ:PCAR) and Navistar (NYSE:NAV) but also other truck component stocks like Cummins (NYSE:CMI), Dana (NYSE:DAN), and Meritor (NYSE:MTOR). To be fair, though, longer-term performance track records still do not favor Commercial Vehicle, as the company has lagged many comparable commercial vehicle suppliers due to issues with both growth (in terms of underlying markets, market share, and volume) and margins.

Class 8 orders are growing at double-digit rates again, and many companies in the construction and ag space have pointed to signs of recovery in their respective markets. That all bodes well for Commercial Vehicle, as do ongoing efforts to diversify its customer base, gain share, and penetrate growth markets like India. It is my opinion, though, that a lot of this is reflected in the share price now. I can see some scenarios where a double-digit fair value could come to pass, but I consider that a bull-case outlook at this point. Although I do think the shares are still slightly undervalued, I would view them more as a "strong hold" as opposed to a clear buying opportunity.

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Recovering Markets And Self-Help Pushing Commercial Vehicle Higher

Materialise Addresses A Key Step In A Fast-Growing Manufacturing Opportunity

Automated manufacturing is taking on increasing significance across a range of industries, and 3D manufacturing is playing a growing role in that process. Companies like GE (NYSE:GE) have made significant investments into automated 3D manufacturing, and machine tool companies are increasingly integrating additive manufacturing capabilities into more traditional tool workstations. As more companies look to adopt 3D manufacturing for themselves, there will be more demand for software to operate those systems. That is where Materialise (NASDAQ:MTLS) comes in - while the majority of the company's revenue today comes from 3D manufacturing services, the company has a strong position in an important software segment that should drive meaningful growth.

Materialise is a small company operating in an industry that is still early in its development cycle. That's positive with respect to growth potential, but it makes modeling and valuation quite a bit more challenging.

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Materialise Addresses A Key Step In A Fast-Growing Manufacturing Opportunity

IMI Group Working On Self-Improvement Through Still-Challenging Markets

Seemingly every company is looking to streamline its supply chain, improve manufacturing efficiency, and reduce its operating overhead, but the self-improvements at IMI Plc (OTCPK:IMIAY) (IMI.L) are a little more urgent. While declines in the oil/gas, power, petrochemical, industrial automation, and commercial vehicle markets have certainly hurt, IMI also saw some self-inflicted damage from under-investment in capex and R&D, too many non-strategic assets/businesses, and a lack of integration and operational efficiency. Credit, then, to CEO Mark Selway who has been tackling these issues in recent years while also dealing with serious market headwinds.

The opportunities for self-improvement and market recoveries haven't gone unnoticed, as IMI's shares are up about 25% over the past year - less than the likes of Weir Group (OTCPK:WEGRY) and Parker-Hannifin (NYSE:PH), but on par with Rotork (OTCPK:RTOXY) and SMC (OTCPK:SMCAY). My expectations for recoveries in downstream oil/gas and power may be too conservative, but I'm looking for mid-single-digit growth in revenue and FCF from IMI. That supports a mid-to-high single-digit return at today's level, which is not bad on a relative basis but arguably not enough for a company that still has some work to do on the self-improvement front.

Readers should note that IMI's ADRs are not very attractive from a liquidity standpoint, but the London-listed shares offer ample liquidity and most quality brokerages now offer such market access.

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IMI Group Working On Self-Improvement Through Still-Challenging Markets

Sika AG's Specialty Chemical Businesses Continue To Outperform

Swiss specialty chemical company Sika (OTC:SXYAY) (OTC:SKFOF) is an interesting company in many respects. A leader in construction chemicals and a meaningful player in adhesives and sealants, with a strong position in autos, Sika has not only established a strong portfolio built on highly-focused R&D, but also established a strong business with a strong run of improving margins and returns since 2011.

"Interesting" is not an unreservedly positive word, though, and so too in this case. Sika's ADR volume is minuscule, and the company's low share count means the per-share price is quite high and likely out of reach for many individual investors. What's more, there's a dispute between the independent members of the board and an insider group that is wending its way through the Swiss court system.

Sika's shares have been relatively strong over the past few years, but the shares still appear to have a little bit of upside from here. With opportunities to meaningfully grow its business in North America and benefit from emerging market infrastructure growth, there are still opportunities for outperformance from here, but a lot is riding on shareholder-friendly resolution of the ongoing legal issues.

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Sika AG's Specialty Chemical Businesses Continue To Outperform