Sunday, August 20, 2017

The Pieces Are In Place For Ongoing Success At Broadcom

It's hard to complain about Broadcom's (AVGO) performance, as this top-tier semiconductor company has seen its shares rise almost 45% since my last update in late 2016. While a few stocks have done better (NVIDIA (NVDA) certainly springs to mind), Avago has by and large doubled the returns of peers like Analog Devices (ADI), Cavium (CAVM), Texas Instruments (TXN), and Xilinx (XLNX). Better still, this is not just a multiple inflation story, as Avago has continued to deliver beat-and-raise performances that support confidence in the ongoing growth potential in areas like handsets and routing/switching.

I don't believe Broadcom is strikingly cheap, but then I wouldn't expect such a large, well-known, well-followed, and well-liked company to be trading at a substantial discount. I do believe ongoing content growth at Apple (AAPL), growth of products like Tomahawk and Jericho in the datacenter, and less appreciated opportunities like its custom ASIC business can continue to support story, and it's not a bad candidate if you find yourself in a “gotta buy something” frame of mind. After all, how often do you find a company that generates more than 60% of its revenue from products where it has 60% or better market share, growth rates above the underlying end-markets, and excellent margins?

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The Pieces Are In Place For Ongoing Success At Broadcom

A Marked Improvement At Turkcell Restores Some Confidence

Shareholders of Turkcell's (NYSE:TKC) ADRs might understandably feel as though they've been cursed. Even when the company is executing very well on its strategy and seeing an exceptional improvement in results, the adverse move in the Turkish lira chews up most of the benefit. Since my last piece on Turkcell around a year ago, revenue expectations for FY 2017 have risen around 13%, and the local shares are up better 20% … and the ADRs are up less than 10%. Strong dividend payments this year sweeten the pot a bit, but Turkcell remains the sort of stock where you feel like you have to cover your eyes and peek between your fingers whenever there's news.

While I'm admittedly being a little flippant about this situation, I do believe Turkcell's strong execution over the past year deserves respect. Likewise, I think the recent trend in performance lends a great deal more credibility to management's long-term strategic view of the company. There is still a lingering shareholder dispute to resolve and ample uncertainty about Turkcell's M&A plays (not to mention plenty of uncertainty about Turkey itself), but the shares look around 20% undervalued today, and that's enough to keep me interested.

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A Marked Improvement At Turkcell Restores Some Confidence

PRA Group Has Cyclical Rebound Potential, But Execution Must Improve

When I last wrote about PRA Group (NASDAQ:PRAA), I thought the shares of this leading debt collector where undervalued on an intrinsic/fundamental basis, but that the company had a lot of work to do to rebuild confidence and convince the Street that its issues where primarily cyclical and not structural. 

Although the shares are up more than 10% in the year since, it has not been a smooth ride – the company has seen a few sharp sell-offs after quarterly earnings reports, including the roughly 25% drop that has followed the latest second quarter report. Key metrics remain under pressure, and while there are several positive drivers that argue for better results in the future, the now-consistent inconsistency of results argues for a healthy “margin of safety” discount. PRA Group shares continue to look undervalued to me, but the company badly needs to start showing improvements where it really counts.

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PRA Group Has Cyclical Rebound Potential, But Execution Must Improve

Tuesday, August 15, 2017

BRF Has A Lot Of Work Ahead To Rebuild Credibility

The nearly 25% drop in BRF's (BRFS) share price over the past year is hardly the worst part of the story; I think you could argue that the market has been relatively merciful all things considered. While I've often noted (and lamented) BRF's above-average cyclicality, I thought management had a strategy in place that would see ongoing global growth in processed/packaged food lead to more sustainable results. I was wrong on many accounts, as the company's strategy is still unclear and inconsistently managed.

I do still believe BRF has a lot of potential, but “potential” is a word that has brought many investors to sorrow. Results should improve in the second half of the year, but management has a lot left on the “to do” list – including showing that they can manage the Brazilian business to generate growth and margins and that they can make the international operations less dependent upon commodity products. There is still upside into the high teens, but BRF management has a lot of work to do to rebuild the trust that would justify such a fair value today.

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BRF Has A Lot Of Work Ahead To Rebuild Credibility

Shifting Perceptions Around Allison Transmission

When I last wrote about Allison Transmission (NYSE:ALSN) in September of 2016, I thought the shares had decent appeal as a buy-and-hold ahead of a recovery in commercial trucks, an eventual recovery in energy, and ongoing growth in commercial automatic transmission penetration rates outside of North America. The shares have exceeded my expectations since then, up about 35%, as companies like Allison and Cummins (NYSE:CMI) have benefited from improving build rates in commercial vehicles.

At today's valuation, I'm more nervous about making a “buy” call. Allison has been logging nice beat-and-raise quarters, and I think Allison's management is quite good. What's more, energy and defense are still barely contributing to results right now and should offer more in the next few years, while OUS adoption of automatic transmissions remains a long-term driver. The “but” is the prospect of accelerating timelines for the adoption of electric vehicles in the commercial space – attention on this market has increased to a point where Cummins, Daimler, Volvo, Navistar (NYSE:NAV), and even typically-conservative PACCAR (NASDAQ:PCAR) have all come out with commentary on their plans/roadmaps for future EV's. Actual adoption of EVs in commercial applications like refuse hauling, metro transit, and straight Class 8's is likely to take many years, but I'd be careful paying up for a cyclical company that could be facing meaningful market erosion within the next decade.

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Shifting Perceptions Around Allison Transmission

Management Unreliability Has Soured The GEA Group Story, But Value Remains

Eighteen months or so ago, I thought GEA Group (OTCPK:GEAGY) (G1AG.DE) looked fully valued despite the long-term attractiveness of a leading company in the food/beverage automation and equipment market. Since then, confidence in management has soured due to an extended period of underperformance and questionable moves like a substantial guidance reduction only a couple of weeks after the 2016 Capital Markets Day. 

GEA Group's dairy processing end-market, which is responsible for around 20% of sales, is likely to struggle for another year or so, but farming, food/beverage, brewing, pharmaceuticals, and industrial markets (including oil/gas) are looking better. What's more, an activist investor is now involved in the shares, which may put a little more pressure on management to up its game. 

I do have some worries about recent cost overruns on new projects and self-inflicted inefficiencies, but I believe the food and beverage markets are attractive long term and I believe GEA Group can get back to double-digit returns on capital. Even with lower assumptions regarding revenue and margins (versus my last article) and a higher discount rate, these shares now look a little undervalued and worth a look from patient investors. 

Investors should note that GEA Group's ADRs don't offer optimal liquidity, so those investors willing and able to trade on foreign exchanges may want to consider buying GEA Group shares on its home exchange.

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Management Unreliability Has Soured The GEA Group Story, But Value Remains

Sunday, August 13, 2017

How Much Better Can Lundbeck Get?

One of my core investment principles is to be slow to sell the shares of companies that have proven themselves to be well-run. Not only do the shares of well-run companies tend to garner higher multiples than might otherwise seem fair, these companies also have a knack for outperforming expectations over the long haul. 

All of that said, I am trying to find that boundary between patience, enlightened self-interest, and greed when it comes to H. Lundbeck A/S (OTCPK:HLUYY) (LUN.CO). The management of this Danish drug company has executed a masterful turnaround, and the shares are up around 37% over the past year despite multiple clinical disappointments and a very thin late-stage pipeline. There are still drivers that can support a higher price, and I am reluctant to part company with a well-run business, but at some point, even the best stocks can get expensive.

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How Much Better Can Lundbeck Get?

Another Quarterly Wobble At Multi-Color Ahead Of A Transformative Deal

Some industries make it very difficult to deliver consistent results every quarter, but I don't think that really explains the consistently inconsistent results at Multi-Color (LABL), as wobbles in quarterly growth rates have been blamed on acquisition-related hiccups (even though growth through acquisition has been a core driver for a long time), plant inefficiencies, contract changes, mix shifts, and so on. Multi-Color has likewise had a tough time showing consistent margin leverage, though the choppy trend has still been upward. 

Since my July 7 update, the company has announced the acquisition of Constantia Labels, a transformative deal, and announced another iffy quarter. Management's up-and-down execution increases the integration risks for such a large deal (not to mention the mix shift), but it is worth noting that it will be Constantia's CEO leading the company relatively soon. 

I've more or less made my peace with Multi-Color's inconsistencies, but Constantia doesn't add tremendous incremental value relative to the risk. That said, the shares do look 10% to 15% undervalued now and the company is an under-followed consolidator in a large, fragmented, and relatively recession-resistant industry.

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Another Quarterly Wobble At Multi-Color Ahead Of A Transformative Deal

Real Recoveries Are Flowing Into Parker-Hannifin's Numbers

Despite its reputation as a high-quality short-cycle play, not to mention one with significant self-help potential through business simplification and the integration of CLARCOR, Parker-Hannifin (NYSE:PH) has cooled off a bit since my last update. Although these shares have outperformed Eaton (NYSE:ETN), a fellow player in hydraulics, they've lagged other industrial stocks like Honeywell (NYSE:HON), Emerson (NYSE:EMR), and Illinois Tool Works (NYSE:ITW), as well as the S&P 500.

With fiscal 2017 in the books and improving trends across a large swath of its end-markets, Parker-Hannifin may be worth another look now. I'm worried about the overall health/valuation of the market, and I don't think Parker-Hannifin would be immune to a wide correction, but mid-single-digit revenue growth and mid-to-high FCF growth can support a fair value around $160, suggesting a high single-digit annual return even from these levels.

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Real Recoveries Are Flowing Into Parker-Hannifin's Numbers

Commercial Vehicle Skids On Surprisingly Weak Margins

The North American commercial truck market continues to improve and Commercial Vehicle Group (CVGI) had been having a great 2017 compared to other commercial truck suppliers like Cummins (CMI) and Allison (ALSN). Unfortunately, the company's efforts to restructure its operations (and reduce costs) and the recovery in off-road vehicle markets like construction have combined in an unexpectedly bad way, leading to meaningfully lower margins, a disappointing second quarter report, and a sharp drop in the stock.

The company's issues with its non-truck wire harness business aren't going to go away, and the company's 2017 margins are going to suffer for it. The bad news is that the company is going to miss out on some of the benefits of this recovery, and they're not going to get that money back. The better news is that the truck market is doing better than expected, the company is doing well in construction on a revenue basis, and the company has made good progress with operating cost reductions.

Commercial Vehicle's margin trouble does reduce the short-term fair value and likely will have the stock in the penalty box for a little while, but the decline does make the valuation more interesting again for investors with a longer-term orientation.

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Commercial Vehicle Skids On Surprisingly Weak Margins

Eaton Offers An Interesting Valuation, But A Lot Of Uncertainties

Despite a good overall run in the industrial space, Eaton (NYSE:ETN) hasn't really kept pace, as the shares have actually lagged the S&P 500 over the past year, not to mention peers like Parker-Hannifin (NYSE:PH), Honeywell (NYSE:HON), and Schneider (OTCPK:SBGSY) (Emerson (NYSE:EMR) has more or less traveled in step with Eaton). Eaton management has been relatively less upbeat than some in its peer group, and the company's organic growth has trailed its peer group for a while now. 

Eaton's above average cyclicality is an “is what it is” sort of thing, and I don't believe management is likely to undertake a major restructuring that would see it sell or spin off an entire vertical. Likewise, I don't like large-scale M&A is especially likely. Although the company should be in place to benefit from several improving end-markets, weakness in commercial construction and passenger vehicles is a concern, as well as uncertainty regarding U.S. tax and trade policy. Eaton shares look like a rare undervalued option in the industrial space (assuming 6% long-term FCF growth), but the lagging revenue growth could be a headwind for a while longer.

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Eaton Offers An Interesting Valuation, But A Lot Of Uncertainties

Accuray Looks Undervalued, But A Lack Of Execution Is A Longstanding Problem

Despite a growing database on the benefits of stereotactic radiosurgery (or SRS) with its CyberKnife system and significant improvements to its mainline Tomo platform, the unfortunate reality is that Accuray (NASDAQ:ARAY) has maintained its reputation as a company that comes up short of its guidance. Although management will hit its 5% gross order growth target for this year, fiscal 2017 will go down as another year where the company underperformed relative to management's initial expectations for the year. 

That's a sour way to begin an article, but the reality is that Accuray shares are down about 10% or so from the time of my last update, and the company continues to struggle to execute and to drive wider adoption of its core radiation oncology platforms. I do believe fair value is close to $6, and that there is considerable upside potential if management can leverage the advantages of its platforms into real sales, but I have been involved in this story for a long time, and it is getting harder to believe that “if” will become a “when”.

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Accuray Looks Undervalued, But A Lack Of Execution Is A Longstanding Problem

FirstCash Management Has Several Opportunities To Execute And Drive Value

When I last wrote about First Cash (FCFS) in October of 2016, I thought the shares offered good value despite some elevated risks. The shares have since risen around 25%, helped in no small part by a stronger Mexican peso and a solid recent trend in consumer health in Mexico.

Looking ahead, there are multiple areas where management could add value, but the move in the share price makes execution on these items much more critical for ongoing outperformance. Organic expansion into Colombia is likely to be measured at first (though management would like to acquire if possible), and the process of wringing synergies from the Cash America deal is not likely going to show much until 2018 at the earliest. First Cash shares should still be able to generate double-digit total annual returns from here (provided the company hits my high single-digit FCF growth target), but this remains a riskier-than-average name with significant exposure to Mexico's economy and currency.

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FirstCash Management Has Several Opportunities To Execute And Drive Value

Manitex Still On Its Bumpy Road To Recovery

Maybe comparisons to Icarus are a little unfair to Manitex (NASDAQ:MNTX) management, but the company has definitely paid a price for its former reliance on the oil/gas sector and using debt to fund a significant M&A expansion program during the U.S. onshore energy boom. Now, though, the company is largely through a stark restructuring effort that has seen management refocus around its core boom truck and knuckle-boom crane product lines.

The shares are about 10% since my last update, boosted by a strong positive reaction to second quarter earnings, but the shares have been pretty volatile in the meantime, with the stock price heading up above $9 earlier this year on optimism around restructuring and market recoveries. While Manitex's core markets remain skittish and volatile, it looks as though older used equipment has been largely absorbed, and the table is set for a return to growth. I don't expect a V-shaped recovery (even if a comprehensive federal infrastructure bill is passed and signed), but I do think Manitex can grow at a long-term rate in the mid-single digits and the shares can still perform as the recovery story unfolds and matures.

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Manitex Still On Its Bumpy Road To Recovery

Saturday, August 5, 2017

Neurocrine Biosciences Off To A Good Start With Ingrezza

As I've said before, quarterly earnings reports from pre-revenue biotechs are of only limited value, though they can provide some worthwhile insights and detail. Neurocrine (NBIX) is technically no longer pre-revenue, though, and the company's first commercial sales of Ingrezza suggest a good start to this important new drug. What's more, Neurocrine management laid out a credible path for ongoing development of Ingrezza for pediatric Tourette's after a disappointing Phase II result earlier this year, not to mention updates on other early-stage clinical programs. While I suppose I'm a little more comfortable with the Ingrezza launch now, I'm not changing any of my basic modeling assumptions, and my fair value remains in the mid-$60s.

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Neurocrine Biosciences Off To A Good Start With Ingrezza

"On Target" Good Enough For Wright Medical Today

Buyout speculation can do good things for a stock's price in the short term, but investors can be fickle with that sort of speculation. Between off-and-on optimism regarding a buyout and a disappointing first quarter, Wright Medical (WMGI) hadn't had the easiest run since my last update. Today the shares are up nicely in the wake of second quarter earnings, though, as investors are apparently a little more comfortable that their worst-case scenarios for the year are less likely to materialize.

The upper $20's to low $30's have long been a tricky place for me with respect to Wright Medical shares. I have no disagreement that these shares could easily fetch more in a buyout, nor that the market will sometimes pay rich multiples for fast-growing med-tech stocks, but core fundamentals-driven valuation seems more comfortably in the high $20's. The second half of this year should see accelerated revenue growth and improving margins, though, so I wouldn't ignore the possibility that earnings momentum draws more positive attention to the shares.

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"On Target" Good Enough For Wright Medical Today

Lexicon Likely Stuck For A Little While

One of the realities of biotech investing is that share prices can linger in no man's land when there's not much news to fire up the imaginations of investors. In the case of Lexicon Pharmaceuticals (NASDAQ:LXRX), a seemingly good initial launch of its first drug Xermelo is being greeted with little more than a "oh, that's nice … what else ya got?" by the market. What's more, with clinical data on sotagliflozin ("sota") more or less in hand for the Type 1 indication and a long wait for Type 2 data and/or FDA action, there's not a lot to really get the excitement going.

Lexicon shares have gone basically nowhere since my last update even though the biotech sector has done pretty well. I don't really see much to blame Lexicon for, as the clinical data that have been presented have been pretty consistent (if not a little better than expected) and the launch of Xermelo has gone well. Even so, with not a lot of mind-changing data on the way soon, it may take some patience to hang on through these doldrums. I continue to believe that Lexicon shares ought to trade in the high $20s on the basis of the value of both Xermelo and sota, but this isn't a biotech with the sort of sizzle that biotech investors often crave.

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Lexicon Likely Stuck For A Little While

ABB Has To Be Better Than This

When you find yourself slipping into the role of an apologist for a company, that's a good time to revisit whether owning the shares still makes sense. Such is the case with ABB (NYSE:ABB), as this European industrial conglomerate has managed to deliver “not good enough” performance for longer than I'd care to acknowledge. ABB's five-year, three-year, and one-year performances have been better than Emerson (NYSE:EMR), but not up the standards set by Siemens (OTCPK:SIEGY) and Rockwell (NYSE:ROK), and Schneider (OTCPK:SBGSY), too, has seemed to have its house in better order of late. Granted, these are blunt comparisons of businesses, but it does support the idea that ABB has room (and need) for improvement.

There are still bullish arguments to support ABB. I believe the company is underway with plans to make its automation business(es) even more competitive, and I think the long-term potential for electric vehicle-related charging and infrastructure equipment is meaningful. Moreover, the company has the liquidity and flexibility to execute meaningful deals if management wishes to go that route. I still believe 3%-4% long-term revenue growth is plausible (although my 5% to 6% FCF growth rate is looking more tenuous), supporting a fair value around $25.

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ABB Has To Be Better Than This

JPMorgan Doing Well In A Still-Challenging Environment

The love affair between Wall Street and JPMorgan (NYSE:JPM) has cooled slightly since my last update on the company, but only slightly, as the shares have risen 7% since mid-January – a little less than the S&P 500 and worse than Citi (NYSE:C) and Morgan Stanley (NYSE:MS), but still better than regional banks like U.S. Bancorp (NYSE:USB) and Wells Fargo (NYSE:WFC), not to mention banking indices like the KBW Bank Index.

Not everything is going perfectly, as net interest margin leverage is still modest at best across the sector and JPMorgan saw rare underperformance from its trading and i-banking operations. But JPMorgan is posting excellent loan growth and good expense leverage, and still has room to grow across businesses like consumer and business banking, as well as asset/wealth management and other fee-generating services like treasury and payments. With good near-term performance and a credible ramp toward 15% returns on tangible common equity, a share price in the low $90s is not unreasonable and still leaves the door open for high single-digit to low double-digit annual returns.

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JPMorgan Doing Well In A Still-Challenging Environment

Thursday, August 3, 2017

BB&T Enjoying A Little More Of What It's Arguably Due

It hasn't always been easy to be a patient shareholder of BB&T (NYSE:BBT) as market perception and some of management's own decisions have occasionally gotten in the way of the stock's performance. Over the last six months since my last update, though, BB&T has been outperforming many of its peers (PNC (NYSE:PNC) one of the notable exceptions) as the bank seems better-positioned for growth than before and investors come back to appreciate its quality. 

There aren't many bargains among the larger banks, and BB&T is not an exception. BB&T, U.S. Bancorp (NYSE:USB), and PNC all look to me like they are more or less in the same valuation bucket, with Wells Fargo (NYSE:WFC) looking a little undervalued but for good reasons. Should the current administration follow through and deliver on earlier hopes of reduced regulation and taxation for the sector, there could be more upside than I expect, but a fair bit of that already seems worked into the price. I think BB&T is more likely to outperform operationally than many of its peers, but I'd call it more of a high-quality hold with a total expected return in the high single digits.

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BB&T Enjoying A Little More Of What It's Arguably Due

A Year Later, It's Still 'Hurry Up And Wait' For Roche

I try not to spend too much of my writing time on well-known, well-covered names like Roche (OTCQX:RHHBY), but I do own the shares and it has been a year to the day since I've last written on this giant Swiss pharmaceutical company.

I thought the company was more or less in a holding pattern a year ago, and the shares have gone almost nowhere (on a net basis) since then, as positives like the launch and early acceptance of Ocrevus and the promising clinical data on emicizumab/ACE910 in hemophilia has been offset by progress with competitive biosimilars, mixed results from next-gen oncology compounds, and worries about lead immuno-oncology drug Tecentriq.

It's tempting to say, “Roche is Roche… and it'll all just work out in the end.” This is a well-regarded pharmaceutical company with a deep internal R&D effort that has not gone to the same excesses as some of its peers in attempting to cost-cut its way to prosperity. At the same time, we're all still learning as we go when it comes to immuno-oncology, and it is tough to say how Roche will stand against the likes of Merck (MRK), Bristol-Myers (BMY), and many others in the years to come.
I do still believe Roche is undervalued, but major upcoming updates (like Tecentriq in first-line non-small cell lung cancer) in the second half of 2017 and on into 2018 are key to the modeling assumptions that drive the fair value.

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A Year Later, It's Still 'Hurry Up And Wait' For Roche

3M Among The Crown Jewels With A Smudge

This has been an interesting earnings cycle. A lot was expected of the industrial sector, and although the companies largely came through with good reported organic revenue growth and EPS relative to expectations, more often than not the market reactions were negative. That was certainly true for 3M (MMM) which saw rare pricing weakness, minimal margin leverage, and comments from management indicating that price would be traded off for market share in the quarters to come.

3M wasn't undervalued going into earnings, and you could argue that it had been elevated to one of the “crown jewel” holdings in industrials (alongside names like Illinois Tool Works (NYSE:ITW) and Honeywell (HON), among other candidates). While none of what 3M revealed about the second quarter changes my long-term view, it's hard to argue this is a must-own given the implied total return and the option to go with (relatively) cheaper names like Danaher (DHR) or Fortive (FTV).

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3M Among The Crown Jewels With A Smudge

FEMSA Plugging Away With Its Empire-Building

FEMSA (FMX) has gotten tossed around a bit since my last update, as this large Mexican consumer products conglomerate has weathered a rattled Mexican stock market (and currency) as well as more company-specific concerns about volumes and margins. Still, the shares are up a bit over that period and still offer a little upside for patient long-term shareholders. As I said in that prior piece, the valuation isn't at a can't-miss level (or at least for investors with shorter investment horizons), but the long-term potential of this company makes it worth considering on the pullbacks.

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FEMSA Plugging Away With Its Empire-Building

Microsemi Delivering On Its Execution Promises

In my opinion, Microsemi (MSCC) is doing a good job of laying to rest whatever lingering arguments there were from bears that this company is/was “just” a serial acquisition story. Since the large PMCS deal, Microsemi has been executing on its synergy/cost-cutting targets, and the company continues to march toward its long-standing 65/35 gross margin and operating margin goals. What's more, the company is doing a decent job on revenue as well, with new products and market share gains helping to solidify the bull case.

Microsemi shares haven't done very well since my last update (down about 7% and meaningfully underperforming SOX), but then, I did think the share price was demanding back in January and that buyout expectations were a big part of the story. While a buyout of Microsemi is still a possibility (and perhaps even likely depending on your time frame), the quarter-by-quarter execution story isn't going to be so exciting, and particularly so when the company isn't leveraged to buzzy areas of the chip sector today like autos and IoT. With the shares now offering a little upside relative to my fair value estimate, they could be worth a look and particularly so, if the market/shares were to sell off again.

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Microsemi Delivering On Its Execution Promises