Thursday, February 16, 2017

Neurocrine Biosciences Building Toward Bigger Things

Quarterly reports aren't often major events for pre-commercial biotechs, though management often uses these opportunities to give updates on clinical programs. There wasn't much from Neurocrine Biosciences' (NASDAQ:NBIX) fourth-quarter report and conference call that moves the needle on valuation, but management did at least lay out some more details about its clinical programs and timelines, as well as information about the expected launch of Ingrezza later this year for tardive dyskinesia.

The biggest change in my view of Neurocrine from my last, fairly recent, update is the addition of BIAL's opicapone to the pipeline. This asset adds about a dollar to my fair value and appears to me to be the sort of lower-risk "quarters among the couch cushions" type of deal that I wish more companies would do. I continue to believe that Neurocrine's shares are undervalued and that investors can look forward to multiple events in 2017 that will lend greater clarity to the real value of the company's clinical assets.

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Neurocrine Biosciences Building Toward Bigger Things

Cielo Leveraged To A Recovering Brazil, But There Are A Lot Of Moving Parts

On the surface, Cielo (OTCQX:CIOXY) would look like a good play on Brazil's eventual economic recovery. While the merchant acquiring space in Brazil is getting more competitive, Cielo's relationships with Banco do Brasil (OTCPK:BDORY) and Bradseco (NYSE:BBD) supports strong market share and Brazil's relatively low card penetration rate suggests above-average growth potential in the years to come. Go below the surface, though, and there are a lot of competitive risks to consider, as well as potential changes to the regulatory environment that would meaningfully alter the company's business mix.

I like Cielo, and I think it's one of the better-known, higher-quality plays on Brazil. I would be careful about getting a good margin of safety going in, though, and I'm not convinced that's on offer today. While my double-digit required rate of return may be too steep and my expectation of high single-digit FCF growth may be too conservative, I think Cielo is close to fair value and the added competitive and regulatory risk factors push me a little more toward the sidelines.

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Cielo Leveraged To A Recovering Brazil, But There Are A Lot Of Moving Parts

Inconsistency And Credibility Bedevil Novadaq Technologies

Revisiting bad calls is never fun, but such is life. Novadaq (NASDAQ:NVDQ) has been quite a disappointment, with the shares down about 30% since my last write-up, and down significantly relative to the medical device space as a group over the past year (the iShares Medical Devices Index is up 32% versus Novadaq's 28% dive). While investors have worried about the potential competitive threat of larger companies like Stryker (NYSE:SYK) in the imaging space and the risk that capital spending will shrink in 2017 due to uncertainties regarding the U.S. insurance/reimbursement landscape, Novadaq has muddied the waters with yet another strategic shift and relatively poor communication with the Street.

I won't argue that Novadaq's recent switch to a more flexible sales model with less upfront capital commitment is a bad move, but it seems like the company switches strategy almost every year, and it continues to be less than fully transparent with the moving parts of its business (sales of particular line items like SPY/PINPOINT, LUNA, DermACELL, etc.). Given the recent guidance for a significantly worse fourth quarter and 2017, Novadaq is firmly back into a "show me" valuation situation.

While I think the underlying technology does work, can/will be adopted to a significant degree, and can support a $1 billion/year business, Novadaq needs to log multiple quarters of clear progress to build confidence in the story. I do think the shares are undervalued today, but I've followed stories like this before in the med-tech space and it can take a while for the business plan to get sorted out.

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Inconsistency And Credibility Bedevil Novadaq Technologies

At This Valuation, Fox Factory Has To See Its Expansion Opportunities Pay Off

Near a 52-week high and up almost 90% over the last year, Fox Factory (NASDAQ:FOXF) has done well for investors. There's certainly a lot to like in the company's progress with gross margins over the last few years, and winning business from Ford (NYSE:F) and Toyota (NYSE:TM) for new off-road trucks is certainly good for the growth story in the powered vehicle business.

The "but" is that at this sort of valuation, the company pretty much has to see all of its major drivers go right. This isn't a quality call; I think Fox Factory is a good company with a strong outlook. My problem is that it looks as though it takes a long-term compound FCF growth rate in the high teens to drive a fair value above $30 today, and that seems like a high hurdle to meet (let alone surpass).

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At This Valuation, Fox Factory Has To See Its Expansion Opportunities Pay Off

FLY Leasing Has Little To Show For Meaningful Improvement

Although FLY Leasing (NYSE:FLY) has transformed in a meaningful way since 2015, you really wouldn't know it from the share price performance. The stock is down about 10% since my last write-up on the company, and even though the intervening period hasn't been very good for any of the publicly-traded aircraft lessors (companies like AerCap (NYSE:AER), Air Lease (NYSE:AL), and Aircastle (NYSE:AYR)), FLY has been the weakest performer of this bunch.

I believe some of the underperformance can be explained by the company's weaker lease rate factor, its lower adjusted pretax margin, and its lower adjusted ROE. It's possible that the market also sees FLY Leasing as more vulnerable to a tighter credit market and an aircraft market where sale-leaseback transactions are less profitable due to an influx of capital into the market. Still, FLY has been doing better of late, and while the entire sector has been strong over the past year, FLY's lagging performance doesn't seem entirely fair. While FLY Leasing's lack of a dividend will be a negative to some investors, reallocating the capital to buybacks makes sense in this case, and I believe these shares are undervalued below $16 to $18 a share.

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FLY Leasing Has Little To Show For Meaningful Improvement

After A Successful Turnaround, What Propels Lundbeck Further?

Danish pharmaceutical company Lundbeck (OTCPK:HLUYY)(LUN.CO) has done what a lot of sell-side analysts thought they couldn't do - pair new product launches with an operational restructuring and drive a turnaround in the business. With that, the shares have more than doubled over the last three years and have outperformed a large number of the company's European peers (Ipsen (OTCPK:IPSEY) and Actelion (OTCPK:ALIOY) being notable exceptions).

Now the question turns to "what next?" and that is where the story gets a little less rosy. I do believe that there is still upside to the company's core growth portfolio (drugs like Abilify Maintena, Northera, Trintellix, and Rexulti), but most of these drugs have serious entrenched generic competition to surmount, not to mention the risk of competing novel compounds.

What's more, Lundbeck has pared down its R&D efforts to a very focused, but very limited, pipeline and new product launches are not likely to be a major driver in the near term. Further operational outperformance shouldn't be underestimated, but I would expect Lundbeck to settle into a quieter "middle age" now, and the share price appreciation is more in keeping with my typical expectation from a drug stock.

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After A Successful Turnaround, What Propels Lundbeck Further?

Tuesday, February 14, 2017

Dassault Systemes Priced Like The Leader It Is

Between strong share in its core CAD/CAE markets, good margins, healthy cash flow, and a collection of markets that the company may have only penetrated by about 10%, I understand why Dassault Systemes (OTCPK:DASTY) trades at hefty valuation multiples. What's more, when you consider the prices that companies like Siemens (OTCPK:SIEGY) and Hexagon (OTCPK:HXGBY) have paid for acquisitions in the space, I can understand why some investors are comfortable with the multiples, and particularly considering the possibility that revenue growth can be healthy for a number of years. While this is too expensive to be a core holding in my own portfolio, it's hard not to like a business that is at the heart of industrial software at a time when many companies like Honeywell (NYSE:HON) and General Electric (NYSE:GE) are talking up the importance of software and digitization in industrial markets over the next five to 10 years.

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Dassault Systemes Priced Like The Leader It Is

Capital Bank Financial Keenly Focused On Some Of The Best Bank Markets

A lot of banks have talked about using M&A to grow their presence in banking markets with attractive demographic trends like the Carolinas, Georgia, and Florida, but Capital Bank Financial (NASDAQ:CBF) has shown more commitment than most. Created amid the chaos and disruption of the credit crisis, Capital Bank's experienced management has used multiple M&A transactions to build a credible banking franchise with a solid presence in multiple attractive metro areas.

And now for the "but". There are a lot of things to like about Capital Bank - an improving deposit mix, solid loan growth (and an improving mix), asset sensitivity, and ample surplus capital to support additional M&A. The "but" is that the valuation already amply reflects all of this, and the shares only make sense to me on the basis of M&A takeout valuation, and I think management here would rather prove that it can integrate the CommunityOne deal and drive attractive synergies before considering a sale.

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Capital Bank Financial Keenly Focused On Some Of The Best Bank Markets

Gemalto In A Bruising Transition Period

It has been a while since I've written on Franco-Dutch digital security company Gemalto (OTCPK:GTOMY) (GTO.PA) (GTO.AS). I thought the shares looked interesting back in February of 2013 on the potential to benefit from growing 3G/4G adoption and the conversion to EMV chip cards, and the shares did alright in the following two years (albeit with volatility). Starting around mid-2015, though, circumstances changed dramatically for the worse in the company's mobile SIM card business, and recent pressures from the payment/EMV business have made things worse.

I believe the company, and the shares, are in a tough transition period. I don't think mobile SIM cards will ever be a driver for the business, and I'm not sold on the prospects for mobile payments and contactless EMV cards to drive meaningful long-term value. I do believe, though, that the company's position in security platform/services, enterprise security, government, and machine-to-machine can drive worthwhile growth in the years to come.

The shares do look undervalued today on the basis of revenue growth in the neighborhood of 4-5% and FCF growth around 7-9%. That said, for those who can stomach the risk of missing out, waiting a little longer to make sure there isn't another shoe to drop may be a better decision in terms of long-term risk/reward. In terms of the mechanics of buying the shares, the U.S. ADRs do trade, but there is better liquidity in the European markets and most brokers now handle these trades at reasonable prices.

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Gemalto In A Bruising Transition Period

Sunday, February 12, 2017

Forward Air Shuffling Forward

Market leadership and hard-to-replicate assets don't ensure success, as seen at Forward Air (NASDAQ:FWRD) in recent times. While the shares have been performing better of late, and there seem to be some signs of positive momentum in the business, the three-year performance compared to the S&P 500 or other transportation and logistics companies like Old Dominion (NASDAQ:ODFL), Hub Group (NASDAQ:HUBG), J.B. Hunt (NASDAQ:JBHT), and C.H. Robinson (NASDAQ:CHRW) hasn't been great, as the company has struggled to translate a bigger revenue base into better bottom-line performance metrics.

Business does seem to be improving, as FWRD's top-line performance in the fourth quarter and guidance for the first quarter were good relative to expectations, and the company is seeing long hoped-for operating leverage in its Pool Distribution business. The problem is that the share price moves have largely captured this. I think Forward Air will have its work cut out to generate long-term growth above the mid-single digits, and even if corporate tax reform reduces its tax rate to the mid-20%'s, it's hard for me to see a fair value much above $50.

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Forward Air Shuffling Forward

United Community Banks Leveraging Its Deposit Base, Capital, And Service Model Effectively

Most banks these days are telling similar stories. While larger banks are focused on tightening up spending and holding down the fort until rates increase, smaller banks are by and large trying to take advantage of healthy demand for commercial real estate and business loans, while also looking for opportunities to deploy surplus capital into M&A to grow their business.

Insofar as all that goes, United Community Banks (NASDAQ:UCBI) isn't all that unusual. Nevertheless, I think there are some attributes about this bank that do stand out. The company has tried to prioritize customer service and that may pay off in the form of stickier deposits as rates rise. At the same time, management has been focusing a lot of its attention on growing specialty lending businesses that allow it to step away from the more intensely competitive commodity lending categories. UCBI also has the benefit of serving growing communities and leveraging a relatively attractive deposit base.

Like so many banks now, it's hard for me to argue that United Community Banks shares are undervalued. That said, they do seem priced for a high single-digit total return (which isn't bad), and this bank could see additional benefits if the new president's administration comes through with plans to lower corporate taxes, reduce regulation on banks, and stimulate economic growth.

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United Community Banks Leveraging Its Deposit Base, Capital, And Service Model Effectively

Pacific Premier Bancorp Seems To Be Living Up To Its Name

Given the melt-up in bank stocks, I think it's wise to be skeptical if not downright suspicious when a bank screens as undervalued. In the case of Wells Fargo (NYSE:WFC), for instance, there's the bank's well-publicized fraudulent account issue to explain the discount, and in a few cases here and there investors can find smaller banks trading at a discount in large part because they're below the radar screen of most analysts and investors.

To be sure, my growth expectations for Pacific Premier Bancorp (NASDAQ:PPBI) aren't conservative, but I do believe the bank could double its adjusted earnings between 2017 and 2020/2021 and double them again over the ensuing five years. I like this bank's leverage to "prudently aggressive" lending and its stated desire to deploy surplus capital into M&A to further grow the business. While the shares are expensive on a tangible book basis (at least on the basis of what has normally been reasonable for the bank's ROTCE), there could be upside into the $40's as this bank's lending continues to outgrow its peers and it continues to improve its deposit base.

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Pacific Premier Bancorp Seems To Be Living Up To Its Name

CVB Financial's Valuation Looks Hard To Live Up To

There are a lot of meaningful positives that come up when evaluating CVB Financial (NASDAQ:CVBF). Not only is this the largest independent commercial-oriented bank left in Southern California, and just inside the top 20 for California banks in overall deposit share, it's a well-run bank with a conservative business plan centered around sticking to its knitting and driving continuous improvement in execution.

The "but", the issue for so many banks now, is valuation. Even if I try to model as many positives as I can reasonably think of now (a lower corporate tax rate, stronger economic growth, lower expenses from lower compliance burdens, lower deposit betas, etc.), it's still a challenge to get to a $25 fair value from discounted earnings. So while I think CVB Financial will continue to gain share in its core markets and leverage its remarkable high-quality deposit base, there's just only so much I could ever be comfortable paying for that, and I can't see how the numbers work out now.

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CVB Financial's Valuation Looks Hard To Live Up To

Okay Results From ABB Not Enough When The Market Wants A 'V-Shaped' Recovery

Investors and analysts look for 2017 to be a big rebound year have had to dodge multiple buckets of cold water as companies have reported earnings in January and February. ABB (NYSE:ABB) is the latest entrant on a list that has included companies like Honeywell (NYSE:HON), 3M (NYSE:MMM), Siemens (OTCPK:SIEGY), and Emerson (NYSE:EMR) indicating that while 2017 will likely be better than 2016, it's not going to be a year where everything is back to normal and growth returns to a level at, or above, long-term expectations.

Even though ABB's fourth quarter report wasn't that bad, the market didn't like what it heard and particularly the notes of uncertainty from ABB's management. While ABB came in a little better than I'd expected (particularly with respect to free cash flow generation), this story is playing out more or less like I thought it would from an operational perspective. I continue to look for ABB to grow revenue and FCF at long-term rates of around 3% to 6%, supporting a fair value of around $25.

Although ABB has its issues (rising competition in power grids, exposure to more commoditized segments of discrete automation, relative weakness in areas like controls and software), it also has exposure to recoveries in emerging markets like China and eventual recoveries in multiple commodity-driven markets.

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Okay Results From ABB Not Enough When The Market Wants A 'V-Shaped' Recovery

Aspen Technology Weathering The Storm, But New Opportunities Should Be Pursued

For a business that is enormously dependent upon the energy, chemical, and engineering and construction (or E&C) sectors, Aspen Technology (NASDAQ:AZPN) is holding up quite well. Credit that, I think, to the company's management team and the strong suite of value-adding software products that help process industry managers optimize their processes and enhance productivity.

Valuation is still a serious issue for me with this stock. I fully acknowledge that high-quality companies, can, do, and should trade at premium valuations, but that still leaves little room for mistake. That said, I believe Aspen would be an attractive asset to a number of companies in the process automation space, and I believe that should keep a floor in for the stock. In terms of what would change my opinion, I would very much like to see Aspen build upon its established expertise in hydrocarbon-based process industries and expand into other process industries like food/beverage, metal/mining, pulp/paper, water, and so forth. Management has indicated some interest in doing so, and I believe this could be a meaningful future driver for the company.

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Aspen Technology Weathering The Storm, But New Opportunities Should Be Pursued

Even After A Big Run, Atlas Air May Have More To Give

I didn't go into my latest round of due diligence on Atlas Air (NASDAQ:AAWW) expecting to find a bargain. While the shares couldn't sustain the spike brought about earlier in 2016 with a major agreement with Amazon (NASDAQ:AMZN), the shares did start a strong rally toward the end of summer, and the shares rose another 25% or so after the U.S. presidential election (despite the uncertain ramifications of the new administration's policies on international trade). And yet, while there are a lot of unknowns about future margins and the air cargo supply/demand balance still isn't great, these shares just might still be too cheap.

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Even After A Big Run, Atlas Air May Have More To Give

Uncertain Times Will Test Expeditors International

Expeditors International (NASDAQ:EXPD) is an uncommonly well-run company and that has led to some pretty healthy valuation multiples over the years. Now, though, investors are worried about what a new administration in Washington, D.C. could mean for international trade, not to mention concerns about shrinking margins in both the air and ocean freight businesses and ongoing investments intended to drive future market share growth.

Expeditors is more or less what seems to pass for cheap now; it's not all that cheap on an absolute basis, but it's at least reasonably priced. That said, there are meaningful uncertainties regarding the company's operating environment right now and this recent run of underperformance (six straight quarters below expectations on revenue, three on EPS) may continue a while longer. Along those lines, Expeditors' asset-light, conservative model does well in tougher times but improvements in underlying transportation/shipping markets could favor asset-heavier companies and less well-run operators that may see more margin leverage in any sort of upturn.

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Uncertain Times Will Test Expeditors International

Wednesday, February 8, 2017

Hub Group Grabbing Share, But Backfilling The Margins Is Important

I can't fault for Hub Group's (NASDAQ:HUBG) growth strategy, as the company has used acquisitions and execution to build itself to mid-teens share of the domestic intermodal market and a top-five position in the domestic truck brokerage sector. I'm not worried about the growth potential in intermodal, as I think the market is only about 25% penetrated, but I would like to see the company make more progress on profitability as margins have slipped, free cash flow has become erratic, and recent trends in ROIC aren't so favorable.

I don't see anything unfixable about Hub Group, but the shares have enjoyed a good run since the election (up about one-third) and the valuation already seems to incorporate expectations for lower corporate taxes and increased economic activity. As is too often the case, then, this looks more like a "consider on a pullback" idea today, though I suppose more momentum-inclined investors may feel differently given the recent earnings report and the prospect of more clarity on pro-business policies from the new administration.

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Hub Group Grabbing Share, But Backfilling The Margins Is Important

Tuesday, February 7, 2017

Technical problems

Sorry that last week's articles didn't get posted here until now ... there were some issues w/ the blogging platform that took time to sort out.

Fifth Third's Current Performance Underlines The Need For North Star

Whether you look at just the period since the election or the last twelve months, Fifth Third (NASDAQ:FITB) has had a pretty remarkable run in an admittedly strong tape for bank stocks. What's arguably more remarkable is that the performance has come despite minimal loan growth (up just 2% since the end of 2014) and a decline in core pre-provision earnings. Even further, I don't think there's really a meaningful metric you can look at and declare Fifth Third a top operator.

On the other hand, the market is a forward-looking entity and I won't argue that Fifth Third's prospects aren't looking better now. Guidance for 2017 doesn't call for robust growth, but it was better than expected, and management continues to position its North Star program as a major transformational effort for the business. I am not giving full credit to the North Star efforts at this point (there's still too much of a "trust us … it'll work" element to the disclosed details), but each incremental 1% of long-term adjusted earnings growth translates to about 10% incremental fair value, so there is at least a path to a higher valuation here.

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Fifth Third's Current Performance Underlines The Need For North Star

U.S. Bancorp On Track But Not On Sale

It's probably fair to say that if you tried to play a "I like the company, but the stock looks expensive" drinking game with my writing in recent months, you'd put your life at risk. Be that as it may, it remains a familiar takeaway with U.S. Bancorp (NYSE:USB) - a high-quality super-regional bank that rarely commits unforced errors, runs itself very well, and is typically recognized as a top-notch bank by investors.

Even allowing that a bank like U.S. Bancorp should trade a premium, it's hard for me to be bullish now. Management has already largely optimized the capital position and the bank's effective tax rate is low enough that corporate tax reform likely won't be a huge boost. What's more, it's not particularly asset-sensitive. There are potential positives in the form of less regulatory burden, good performance in commercial lending, and further growth in fee-generating businesses, but I wouldn't look to buy U.S. Bancorp unless it somehow fell below $50 in the near term.

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U.S. Bancorp On Track But Not On Sale

Wells Fargo Has Dug Itself Into A Hole, But It Won't Be There Forever

Sooner or later, Wells Fargo (NYSE:WFC) will move beyond its current set of problems (many of which are/were self-inflicted) and get back to the business of generating attractive returns from an exceptional retail banking franchise. The problem with "sooner or later", though, is that later can sometimes be a lot later, and there's a not-so-fine line between investing with a long-term focus on living in denial.

Certainly there are a lot of things going against Wells Fargo right now, but the bank is not falling apart and the new administration's policies are likely to be good for banks and could be particularly good for a more "regulatory-challenged" bank like Wells Fargo. These shares actually look slightly undervalued on the basis of mid single-digit long-term earnings growth, but of course there is the risk that these recent problems cause greater long-term problems than I assume.

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Wells Fargo Has Dug Itself Into A Hole, But It Won't Be There Forever

Lackluster Results Don't Help The BB&T Story

BB&T (NYSE:BBT), like almost every bank, has gotten a bump since the election. Even so, it has been outperformed by many of its peers since the election (up around 18% versus 19% to 35% for U.S. Bancorp (NYSE:USB), Fifth Third (NASDAQ:FITB), Regions (NYSE:RF), Wells Fargo (NYSE:WFC), and PNC (NYSE:PNC)), and fourth quarter results weren't a particularly strong rebuttal to the idea that BB&T has near-term growth challenges.

I believe that BB&T has been taking steps recently, and will continue do so into 2017, that will better position the company for long-term growth, but it's harder to argue that there will be incoming outperformance to support higher multiples in the near term. Although I still like this bank, I think the valuation already embeds higher growth than is expected from the likes of Fifth Third, U.S. Bancorp, PNC, and Wells Fargo, and I can't make a compelling "buy this instead of that" argument at this time.

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Lackluster Results Don't Help The BB&T Story

PNC Financial Waiting For Multiple Drivers To Get Into Gear

PNC Financial (NYSE:PNC) has had a solid run since the election, with the shares still up more than 25% from the start of November on investor enthusiasm over the prospect of lower tax rates, stronger economic growth, less regulation, and reflation. While PNC management is still finding it challenging to grow lending in the current environment, management is looking to address this issue while also looking for ways to build up its fee-generating businesses and continue on with its branch operation improvement strategy.

Modeling isn't particularly easy right now, as the Street seems more than happy to factor in the benefits of a lot of policy shifts that have been only vaguely outlined so far. To that end, I am factoring in drivers like improving spreads and lower deposit betas, but I haven't yet changed my tax rate assumptions for PNC. My assumptions work out to mid single-digit mid-term and long-term earnings growth and a low double-digit return on tangible equity, and PNC is not particularly cheap on either an absolute or relative basis.

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PNC Financial Waiting For Multiple Drivers To Get Into Gear