Monday, April 30, 2018

Roche Drifting Without Perception-Changing Data

Once tapped as the future belle of the ball due to its deep pipeline of potential add-on/combo oncology therapies, Roche (OTCQX:RHHBY) has continued to lag rivals like Merck (MRK) as investors grow more concerned that Roche's PD-L1 antibody Tecentriq will have trouble standing out from the crowd and become yet another disappointing offset to looming biosimilar erosion.

It's still early (a familiar fallback position for disappointed bulls), but Roche really needs strong data to close the gap with Merck's Keytruda, even if it is at least in part a perception gap. Roche could also really use another blockbuster or two from its pipeline, particularly one that doesn't have abundant competition. Although I continue to believe that the market is not giving Roche its due, the reality, for now, is that looming biosimilar-driven revenue erosion is a hard cloud for Roche to get out from under and it is likely to take time for perceptions to shift.

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Roche Drifting Without Perception-Changing Data

FirstCash's Balanced Growth/Value Model Continues To Work

FirstCash’s (FCFS) headline results don’t look all that impressive, but there good things going on with this large pawn lender. The company’s Latin American operations continue to generate strong growth, while the integration of a large U.S. acquisition is on pace to generate better margins and cash flows in the years to come. At the same time, lending options for FirstCash’s core customer base continue to remain relatively limited, giving the company a good addressable market to drive future growth. 

FirstCash shares have done a little better than I’d expected, but I continue to believe there’s a reasonable trade-off in place between risk and reward. Although I do not believe that the shares are shockingly cheap, I believe the prospect of high teens EPS growth and high single-digit long-term FCF growth can support a decent return.

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FirstCash's Balanced Growth/Value Model Continues To Work

FEMSA Offers Long-Term Value, But 2018 Won't Be A Banner Year

FEMSA’s (FMX) performance over both the past few months and the past year has been decidedly mediocre, as the company continues to work through some restructuring efforts at Coca-Cola FEMSA (KOF) while building up its Health (drugstores) and Fuel (gas station) operations. Add in foreign currency volatility and undeployed capital from a partial sale of its Heineken (OTCQX:HEINY) stake, and there are a lot of moving parts working against the bottom line.

I continue to believe that FEMSA is a well-run conglomerate that offers good exposure to Latin American, and particularly Mexican, consumer spending growth, but challenges in Mexico, Brazil, and the Philippines are likely to keep a lid on performance in 2018. A fair value in the neighborhood of $105 still makes this a name worth considering, but I expect the shares to mark time at least until the elections in Mexico are decided.

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FEMSA Offers Long-Term Value, But 2018 Won't Be A Banner Year

Lincoln Electric Doing Its Part, But The End-Market Outlooks Are Getting Murky

Welding market leader Lincoln Electric (LECO) has gone nowhere fast over the past year, as the market seems to be uncertain about the prospects for ongoing recoveries in the industrial markets that the company serves. Lincoln Electric is also dealing with input cost inflation while working to integrate its Air Liquide acquisition and continuing to build out its automation offerings.

Although metalworking demand still seems to be relatively healthy, I can understand investor caution regarding heavy industry and general fabrication markets, as this recovery cycle has been going on for a little while. Lincoln Electric is a very well-run company, typically producing mid-to-high teens ROICs, but it remains cyclical, and investors seem to be more and more cautious toward cyclical industrial stocks right now.

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Lincoln Electric Doing Its Part, But The End-Market Outlooks Are Getting Murky

3M Stumbles, And The Knives Come Out

If 3M (MMM) had in fact been benefiting from the unwind of General Electric (NYSE:GE) as the go-to multi-industrial name and a change in perception that it was no longer so sensitive to short-cycle movements, a lot of that has unwound since late January. 3M still has quite a lot of exposure to sectors like autos and electronics, not to mention "general industrial", and investors are increasingly worried that those businesses are now past their peaks. Add in growing worries about margin leverage, 3M's inability to cover input cost inflation, and a high valuation, and institutional shareholders are scrambling for the exits.

As I wrote in prior articles on 3M, the shares got too high on overheated enthusiasm about the economic cycle, and there is definitely a risk that perception will overcorrect in the other direction. 3M isn't yet at an obviously cheap level yet, though the shares are getting back to a high single-digit long-term implied return, provided that mid-single-digit FCF growth remains a valid long-term assumption.

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3M Stumbles, And The Knives Come Out

Turkcell's Digital Push Continues To Drive Better Growth

You wouldn't know it by the share price, but management's plans and efforts to drive growth, and more profitable growth, at Turkcell (TKC) are working well. Turkcell continues to leverage its network superiority to generate postpaid subscriber growth as well as increased data consumption, and the results are showing up in the revenue and margin performance. Turkey's overall economy remains a risk factor, as does the company's fractious ownership group, but the shares continue to look undervalued.

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Turkcell's Digital Push Continues To Drive Better Growth

TCF Financial's Specialty Lending Business Should Help Ease A Big Transition

It takes time for banks to remake themselves, but TCF Financial (TCF) is underway with what will be a multiyear process of becoming a more focused, higher-quality bank focused on middle-market depositors and specialty lending. Although there will be some headwinds from this transition, TCF's above-average asset sensitivity will ease some of those challenges. My biggest issue with TCF at this point is the valuation - while I'm on board with the idea of paying more for asset-sensitive banks at this point in the cycle, TCF has enjoyed a very strong run over the past year and banks like Comerica (CMA) and First Horizon (FHN) have fewer issues for similar premiums relative to fair value.

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TCF Financial's Specialty Lending Business Should Help Ease A Big Transition

Schneider Electric Still Not Getting Full Marks For Its Performance

The performance of French automation and electrical equipment manufacturer Schneider Electric (OTCPK:SBGSY) (SCHN.PA) remains a little confounding. The company has been producing good growth recently in comparison to peers/rivals like ABB (ABB), Eaton (ETN), Emerson (EMR), and so on, but the share price performance over the last year hasn’t been all that impressive – a little better than ABB and in line with Eaton, but certainly nothing special next to Rockwell (ROK), Emerson, or Honeywell (HON).

Of course, one-year performance numbers can only tell you so much, and comparisons to conglomerates like Honeywell aren’t entirely fair, but Schneider’s recent performance doesn’t seem to reflect much confidence in the company’s outlook.

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Schneider Electric Still Not Getting Full Marks For Its Performance

Roper Technologies Comes Through Again

Investors continue to appreciate Roper’s (ROP) M&A-driven growth and its leverage to higher-margin product categories like SaaS (including medical software), metering, and controls/instrumentation. Although industrial conglomerates on the whole haven’t had an especially good run since the fourth-quarter earnings reporting season, Roper has continued to outperform both the market and many of its peers. With good underlying market drivers, strong cash flow, and upcoming M&A deployments, the underlying drivers for Roper still look to be very much in place.

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Roper Technologies Comes Through Again

Danaher's Growing Leverage To Life Sciences Improves The Long-Term Outlook

As investors have become a little more concerned that the industrial recovery story has peaked, Danaher's (DHR) far larger skew towards health and life sciences has started looking better and better. At the risk of oversimplification, I think the greater skew toward health care/life sciences can partly explain why Danaher and Roper (ROP) have outperformed peers like 3M (MMM), Honeywell (HON), and Illinois Tool Works (ITW) over the last three months (although industrial-heavy Fortive (FTV) has led the group, so it's not a flawless hypothesis…).

Danaher doesn't look especially cheap, but that's been the norm for much of the company's history and it hasn't prevented the company from outperforming the S&P 500, as management continues to apply a proven successful model. With greater exposure toward long-term growth opportunities like diagnostics and bioproduction, I like Danaher's mix even if the valuation is not scintillating.

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Danaher's Growing Leverage To Life Sciences Improves The Long-Term Outlook

Monday, April 23, 2018

Stanley Black & Decker Looks Undervalued, But Growth And Margins Are Decelerating

I've said it many times before and I'll say it again - "buying the dip" sounds like great advice, but it can be tough to follow in practice. Outside of market-wide freak-outs (which still require a certain amount of long-term confidence and patience), those dips often come because of issues that don't necessarily look temporary or quickly solvable at the time. And so it is with Stanley Black & Decker (SWK), as the shares are off about 20% from their January high, but there has been a noticeable slowdown in the business and that second-half recovery is not assured.

I'm a little nervous that I'm expecting too much long-term FCF leverage, and there's definitely meaningful downside risk if Stanley Black & Decker can't improve FCF generation from recent levels, but I don't believe my underlying assumptions are all that aggressive and I believe growth in the Tools and Industrial segments can support a higher fair value than today's price offers.

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Stanley Black & Decker Looks Undervalued, But Growth And Margins Are Decelerating

Grainger's Strategy To Drive Better Volumes Showing Good Results

I haven’t been all that impressed with Grainger’s (GWW) strategy in recent years, and I think strategic issues are at least in part responsible for the stock’s underperformance relative to other distributors like MSC Industrial (MSM) and Fastenal (FAST) over the last three to five years. But credit where it is due – management’s most recent initiatives appear to be working out well, and the stock is quickly closing those performance gaps, having outperformed MSC, Fastenal, and HD Supply (HDS) over the last two years and especially in the last 12 months.

It remains to be seen whether Grainger can continue to leverage these improvements into ongoing sales and margin expansion. Amazon (AMZN) looms large as a threat and I think the entire industrial distribution space may find margin expansion to be more challenging than the Street expects.

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Grainger's Strategy To Drive Better Volumes Showing Good Results

Honeywell Offers Attractive Leverage To Multiple Healthy Markets

Having more or less tracked the S&P 500 lower over the past three months, the valuation on Honeywell (HON) is looking a little better these days. Not only did the company's recent investor day give more insight into long-term growth initiatives, particularly those concerning software, but also many of its major end-markets are still in attractive stages of their cycle. I wouldn't say that Honeywell's valuation is at a can't-miss level here (particularly for investors focused on the short term), but it looks pretty good to me on a long-term basis.

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Honeywell Offers Attractive Leverage To Multiple Healthy Markets

With Weak Asset Beta And Rising Deposit Beta, Signature Bank Must Drive Loan Growth

Deposit beta is getting more and more attention these days with bank stocks, but asset betas are also important, and in the case of Signature Bank (SBNY), I’m worried about the company’s net-negative leverage to further rate increases. With little-to-no juice on the NIM line and no real fee income-generating business to speak of, Signature Bank’s growth is tied to its ability to grow the loan book. Luckily for investors, there are a lot of small(ish) privately-owned businesses that feel underserved by larger banks, and Signature is taking its show on the road and looking to open private banking offices on the West Coast.

Signature Bank is a different sort of bank, but there’s only so far “different” goes in terms of valuation. I’d pay a little more for a bank that is likely to earn 14% ROTCE in 2018 and generate double-digit earnings growth over the long term, but I worry that Signature may remain out of favor a little while longer as taxi medallion credit issues and asset sensitivity weigh on sentiment.

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With Weak Asset Beta And Rising Deposit Beta, Signature Bank Must Drive Loan Growth

Rebounding Petrochemical Demand Heating Up Chart Industries

Chart Industries (GTLS) was already looking at a stronger 2018, as recoveries in the oil/gas and industrial gas markets started pushing more and more orders into the company’s backlog. On top of that, the company stands to benefit from the ongoing integration of Hudson and the expansion of its service operations. Even with a good outlook heading into 2018, Chart’s first quarter results were stronger than expected, giving another boost to a story that already had some good momentum. While I believe it is still hard to argue that Chart is significantly undervalued, better than expected financial performance can certainly raise the bar and I expect to see strong reported results for a couple more quarters (at least).

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Rebounding Petrochemical Demand Heating Up Chart Industries

BB&T Making A Slow Turn In The Right Direction

It has taken a while, but BB&T (BBT) continues to show signs of improvement and close some of the performance gap with peers like PNC Financial (PNC), Fifth Third (FITB), Comerica (CMA), Key (KEY), and U.S. Bancorp (USB) that built up over the past few years. Although lower loan growth is a disappointment, a low deposit beta and rising interest sensitivity offset it somewhat, and management is doing well on expenses and credit quality.

When it comes to valuation, I think the market has it more or less right at this point (which hasn’t often been the case). U.S. Bancorp and Wells Fargo (WFC) are cheaper (for good reasons) and PNC arguably offers better quality today for a similar level of expected return, but I believe BB&T has more self-improvement potential and more potential for higher/better earnings revisions over the next few years.

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BB&T Making A Slow Turn In The Right Direction

A Good Start To The Year For ABB, But Management Has To Build From Here

Owning ABB (ABB) continues to be an exercise in frustration, as the shares have lagged peers like Schneider (OTCPK:SBGSY), Emerson (EMR), and Siemens (OTCPK:SIEGY) so far this year, while only very slightly outperforming Rockwell (ROK). Stretch those comparisons out a couple of years and the story remains frustratingly consistent, as ABB has had to pay the price for its own self-inflicted wounds in years past.

I remain cautiously optimistic that better days lie ahead. ABB has gotten smarter lately with its M&A and has been reinvesting in areas like R&D and services to support better long-term growth. Likewise, I’m bullish on the long-term opportunities in higher-margin areas like grid automation, robotics, and EV charging. Although the company still has some fundamental mix issues to solve, ABB’s late-cycle skew and exposure to recovering industries like oil/gas and mining should help.

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A Good Start To The Year For ABB, But Management Has To Build From Here

Can Improved Operating Performance Light A Fire Under Steel Dynamics?

I didn't see a lot of upside in the shares of Steel Dynamics (STLD) after the company's fourth-quarter earnings, and with the shares up only slightly since then, I don't feel like I've missed out on much. It's not really a Steel Dynamics-specific issue, though, as Nucor (NUE) and voestalpine (OTCPK:VLPNY) have likewise underwhelmed, while Gerdau (GGB) and Ternium (TX) have outperformed. The biggest issue seems to be a version of the all-too-familiar "what you have done for me lately?" - steel prices have been strong, but the prospects for further gains seem limited, and investors often buy into rising prices and then don't stick around for the follow-through.

The valuation on Steel Dynamics is a little more interesting now, though, and the company is executing on several quick-turn projects that will augment its growth potential. There are also still longer-term opportunities including significant M&A and ongoing share gains in the market. All of that said, I'd be careful about including this stock in a long-term portfolio as the cyclical swings can be rough.

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Can Improved Operating Performance Light A Fire Under Steel Dynamics?

Thursday, April 19, 2018

Supply Issues Creating A Windfall For Alcoa

While I liked Alcoa (AA) three months ago, and thought that the company could benefit from some supply curtailments, I didn’t expect the significant market disruptions that have pushed spot aluminum prices on the LME to over $2,528/mt (versus less than $2,100 in December). Now, though, the market is dealing with section 232 limitations, problems with the Alunorte facility, and U.S. sanctions against Russian producers, pushing the markets into more substantial supply deficits.

Although Alcoa has had a good run over these last three months, and I don’t view it as a long-term holding, there may still be some worthwhile upside left at these levels.

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Supply Issues Creating A Windfall For Alcoa

U.S. Bancorp Still Getting Its House Back In Order

This has been a rough stretch for U.S. Bancorp (USB) and Wells Fargo (WFC), historically two well-loved large banks. In the case of U.S. Bancorp, I believe the ongoing underperformance in the shares represents an opportunity for long-term investors, but as I said in my previous article, it will take a few quarters for the reported results to improve. In the meantime, U.S. Bancorp continues to "muddle through" with good credit quality but iffy operating leverage.

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U.S. Bancorp Still Getting Its House Back In Order

Competition Making Growth A Little Harder For Fulton Financial

Above-average asset sensitivity and healthy credit trends continue to support Fulton Financial (FULT), but the growth angle is still looking more challenging. While the company works to get out from under consent decrees and consolidate its charters (allowing for branch consolidation and re-branding), it is seeing increasing competition in the market for both loans and deposits. Fulton has above-average earnings growth prospects, but those prospects continue to be well-reflected by the share price and I don't see a particular bargain here at this time.

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Competition Making Growth A Little Harder For Fulton Financial

Celldex Nearly Back To Square One

Once again Celldex (CLDX) shareholders have had to come to terms with a major disappointment. Following the spring 2016 announcement that the company's lead drug Rintega had failed in Phase III, Celldex announced earlier this week that its pivotal METRIC study of glembatumumab (or "glemba") failed to show clinical benefit in the treatment of triple-negative breast cancer.

With these failures, as well as the lackluster results seen in other glemba studies and in studies of varlilumab (or "varli"), I believe Celldex is almost back to square one as a biotech, with a handful of unproven Phase I assets. Given the significant development timelines Celldex is looking at, as well as the high likelihood of future dilutive financing, it looks like a difficult road ahead for these shares. While today's price arguably does understate the potential of Celldex's remaining pipeline, only the most aggressive investors should really even consider dumpster-diving for this name.

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Celldex Nearly Back To Square One

Adecoagro Continues To Invest In Growth Amid Brutal Commodity Pressures

My biggest issue with investing in Adecoagro (AGRO) has always been its vulnerability to commodity price swings, and those swings have been hammering the company and the stock over the last year. At the same time, management has continued to invest in projects that it believes will deliver meaningful long-term growth – the latest being the acquisition of Argentina’s largest dairy processor. 

Adecoagro has shown that it can run its diverse operations well, but efficient operations in sugar, ethanol, and farming can only go so far in the face of commodity price pressure. With that, the shares do still look undervalued, but the company’s exposure to commodity price risk may be too large for some investors.

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Adecoagro Continues To Invest In Growth Amid Brutal Commodity Pressures

Comerica Reaping The Benefits Of Its Unusual Business Mix

Investors continue to appreciate Comerica’s (CMA) strong leverage to this phase of the banking cycle, as the shares have continued to outperform peers even through this recent correction. Although loan growth remains lackluster, Comerica’s strong asset sensitivity remains a key driver, as does the company’s improving cost efficiency. There are certainly some cheaper names out there, but Comerica’s pre-provision income growth is likely to remain quite strong relative to its peers, and I can understand why growth-oriented would continue to want to own this name.

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Comerica Reaping The Benefits Of Its Unusual Business Mix

Wednesday, April 18, 2018

Mellanox Improving Its Execution Just As Another Cycle Seems To Be Ramping Up

Although I suspect that Mellanox (MLNX) management would be loath to admit it, the involvement of Starboard has seemed to light a fire under them with respect to margin improvement and increased candor about the business. The margin improvements are particularly notable, as they have a disproportionate impact on valuation, and it increasingly looks like these improvements are coinciding with another up-cycle in the business. All of that is good news for shareholders, though these shares have had a good run of late relative to the semiconductor sector, and I wouldn't call the valuation strikingly cheap.

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Mellanox Improving Its Execution Just As Another Cycle Seems To Be Ramping Up

AGT Food And Ingredients Still Crawling Through The Doldrums

One of the key challenges in analyzing cyclical companies is the difficulty of modeling those cyclical peaks and valleys, particularly as companies like AGT Food and Ingredients (OTCPK:AGXXF) (AGT.TO) have a tendency to overshoot in both directions. I said in my last piece that I was holding off on buying into what looked like an undervalued pulse processor in lieu of waiting for some signs of stability in the business. It’s a quarter later and I’m still waiting.

I do expect that lower pulse production in Canada and a reversal of recent exceptional harvests in India will eventually snap the cycle back in the other direction, but timing these reversals is mostly down to guesswork and asking questions like “well, how much worse can it really get?” can be an invitation to trouble.

All the same, I like AGT’s ongoing focus on value-added operations and I do believe the cycle will eventually reverse, allowing AGT to generate mid single-digit revenue growth and low single-digit FCFs. Buying here in the teens will likely work out okay, but investors considering these shares have to have an above-average risk and volatility tolerance.

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AGT Food And Ingredients Still Crawling Through The Doldrums

Tuesday, April 17, 2018

PAX Global Technology Getting Minimal Benefit Of The Doubt

Since my last write-up on PAX Global (OTCPK:PXGYF) (0327.HK) in January of this year, the shares have more or less marked time, though there was a nice run heading into fourth quarter earnings in March that ultimately faded away. Relatively speaking, though, that's not such a bad performance in what has been a tough payments technology space - while Square (SQ) has done very well so far this year, Ingenico (OTCPK:INGIY) has had a tough run (down 20%) and VeriFone (PAY), too, was drifting lower before receiving a buyout bid.

The shares remain a challenging call. While PAX is doing quite well in Brazil and surprisingly well in Europe, I do have concerns that there are long-term fundamental shifts in the market working against PAX, exacerbating its lack of a value-added service business. Likewise, the company's home market (China) remains quite difficult, and management has trading gross margin for market share across multiple geographies. If PAX management can stabilize the business and report a few clean quarters, though, I believe there's enough underlying fundamental value here to merit a closer look from more aggressive investors.

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PAX Global Technology Getting Minimal Benefit Of The Doubt

Healthy Spreads And Efficiency Driving M&T Bank

While M&T Bank (MTB) closed its Hudson City deal about two and a half years ago, the bank has continued to reshape its loan book and drive higher returns on equity. At the same time, while M&T isn’t particularly asset-sensitive, the bank’s mix of higher-yielding loans and lower-cost funding are driving attractive net interest spreads while cost discipline is pushing the efficiency ratio lower and helping boost pre-provision income.

There are a lot of positives for M&T, including those attractive spreads and ongoing expense leverage. What I don’t find so positive at this point is the value proposition – even with mid-to-high single-digit long-term earnings growth and returns on tangible equity likely to approach 20% in the near future, the shares trade at a pretty healthy valuation already.

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Healthy Spreads And Efficiency Driving M&T Bank

First Horizon's Footprint And Business Mix Should Drive Long-Term Growth

With good strategic positioning across the Southeast U.S., deal synergies, a respectable specialized lending business, and an asset-sensitive balance sheet, First Horizon (FHN) looks well-placed to deliver good growth so long as the economic cycle stays positive. That makes a softer than expected first quarter a little easier to digest, though investors should keep an eye on the competitive factors pushing up deposit betas and the still-sluggish overall environment for loan demand.

First Horizon looks priced for high single-digit to low double-digit annualized returns, which isn't bad, but I like to pay $0.90 (or less) for a dollar of value and bank stocks are no exception. To that end, there are cheaper bank stocks that I'd favor today, but First Horizon deserves a spot on a watch list and certainly doesn't seem like a bad hold now.

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First Horizon's Footprint And Business Mix Should Drive Long-Term Growth

Bank Of The Ozarks Pushing Hard For Growth

It's been a while since I've written about Bank of the Ozarks (OZRK) for Seeking Alpha, in part because there's a limit to how many different ways you can say "it's a well-run, high-growth bank, but the multiple is rich". In any case, the shares are a little under 20% from my last update (when I thought it was too pricey for me), and I've frankly done better with my positions in JPMorgan (JPM) and BB&T (BBT) over that same time.

I continue to find it difficult to get completely comfortable with the valuation on this bank, and I'm a little concerned about the aggressive pace of C&D lending at this point in the real estate cycle. Management's skill in navigating past cycles has certainly earned them the benefit of the doubt with me, and I like the long-term potential of not only replicating the specialty lending model across the country but also diversifying the loan book and building up core deposits.

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Bank Of The Ozarks Pushing Hard For Growth

Monday, April 16, 2018

MSC Industrial Still Looks A Little Underwhelming

Patience hasn't proved all that rewarding with MSC Industrial (MSM), as the shares have not only lagged peers like Grainger (GWW) and Fastenal (FAST) and suppliers like Kennametal (KMT) but are basically flat for the past year. The debate continues as to whether MSC Industrial's issues are predominantly driven by cyclical factors, or whether increased online competition and the expansion of Amazon (AMZN) into industrial distribution has permanently altered price transparency and the competitive balance.

I admit that I find it troubling that MSC reported only mid-single-digit organic growth despite Gardner's Metalworking Index hitting its highest level in seven years. A return to positive pricing was nice to see, as was the operating leverage, but this remains a "show me" story where valuation is not all that compelling.

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MSC Industrial Still Looks A Little Underwhelming

Citigroup's Valuation Masks Some Incremental Progress And Improvement

Citigroup (C), has been a middle-of-the-road performer for the last year, with peers like U.S. Bancorp (USB), Wells Fargo (WFC), and Goldman Sachs (GS) underperforming and JPMorgan (JPM), PNC Financial (PNC), and Bank of America (BAC) outperforming, and so too over the last three months as the sector has sold off. Investors continue to remain skeptical about Citigroup’s ability to hit its long-term targets and reverse a long trend of lackluster, disappointing performance.

Citigroup has earned those doubts, but I continue to believe the market is overdoing it. Even low single-digit long-term growth would support a higher price, and that is despite some actual ongoing signs of improvement. While Citi is a long way away from being my favorite bank on a quality basis, I think the relative valuation is still quite interesting.

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Citigroup's Valuation Masks Some Incremental Progress And Improvement

PNC Financial's Sluggish Quarter Looks Like Par For The Course

A weak quarter or two doesn’t really matter in the long term, other than perhaps as an opportunity to pick up shares at a more reasonable valuation. With PNC Financial’s (PNC) valuation sliding back to a more attractive level, this weak patch in the results could be such an opportunity. Although loan and revenue growth is looking softer than expected across the sector so far, PNC has multiple long-term strategies underway to grow its commercial lending, expand its consumer business, and join the top tier of banks.

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PNC Financial's Sluggish Quarter Looks Like Par For The Course

Smiths Group Looks Poised For Better Results

Over time Smiths Group (OTCPK:SMGZY) (SMIN.L) has built up a well-earned reputation for always coming up a little short. Although this U.K. conglomerate's historical performance wasn't bad in terms of margins or ROIC, the cash flow generation was weak and it was the sort of story where there was always something a little off. Likewise, while Smiths shares performed okay relative to other U.K. conglomerates, the gap with American industrial conglomerates like 3M (NYSE:MMM), Illinois Tool Works (NYSE:ITW), and Parker-Hannifin (PH) has been sizable.

Quite a bit has changed recently, as new management has returned to a philosophy of active portfolio management and R&D/innovation-driven growth. Although the results aren't showing up just yet in terms of organic revenue growth or margin expansion, I believe Smiths is on the cusp of better results that should make this a solid market-outperformer for the next couple of years.

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Smiths Group Looks Poised For Better Results

Medpace Holdings Facing Some Challenges To A Model That Has Worked Well

Medpace (MEDP) had some challenges in its first year as a publicly-traded company, as this full-service contract research organization (or CRO) saw revenue growth and margins weaken through 2017. Compounding those issues is a greater effort on the part of Medpace's larger rivals to target its core business - smaller biotechs that have historically been ill-served by the larger players in the CRO market.

Valuation is an interesting dilemma right now. It would seem that Medpace could generate high-single-digit to low-double-digit annual returns to shareholders even if it can't reaccelerate growth beyond peer/industry norms and has to absorb some additional margin pressure. While I don't expect it to be a quick (or certain) process, if management were to succeed with its efforts to reignite revenue growth there would be enough incremental return to make this a more interesting idea.

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Medpace Holdings Facing Some Challenges To A Model That Has Worked Well

Cross-Selling Can Drive Meaningful Growth For Medidata Solutions

There's really no "steady state" for growth tech companies, and while Medidata Solutions (MDSO) has built a strong business with its cloud-based platform for the management of clinical development programs, management cannot afford to rest on its laurels. That's particularly true given that revenue growth decelerated through 2017 and both subscription revenue and backlog growth came in a little slower than expected.

With around 50% share and more than 80% of the top pharma companies in hand as clients, Medidata's growth is likely to come more from expanding its share of wallet with customers and selling them on the value of its offerings beyond its core RAVE electronic data capture (or EDC) platform. Given the increasing complexity and cost of clinical development, I believe Medidata has a better than fair chance of doing that, but rising competition is a threat. Even so, while I wouldn't care Medidata conventionally cheap, the valuation is reasonable enough to merit a closer look.

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Cross-Selling Can Drive Meaningful Growth For Medidata Solutions

Execution At Kemper Still Offers Upside

A lot has changed at Kemper (KMPR) since CEO Joe Lacher was brought in to turn around this lackluster multi-line P&C and life insurance company late in 2015. While the company is by no means an industry leader in terms of its profitability, management has already delivered progress on improved underwriting quality and is in the midst of an acquisition that should meaningfully improve its position in the fast-growing non-standard auto insurance market.

Valuing Kemper is a little challenging, in part because the company’s ability to successfully integrate its acquisition and continue to improve underwriting quality are significant swing factors in the valuation. Today’s premium to book value of 1.4x looks fair in isolation, but this could readily be a $75 stock in a couple of years if management continues to execute well.

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Execution At Kemper Still Offers Upside

Inogen May Only Be Getting Started

A mid-cap med-tech company with 20%-plus revenue growth, profitable operations, positive free cash flow, and a large addressable market is going to get noticed, and so it has been for Inogen (INGN) - the shares have risen more than 70% in the past year and trounced the likes of ResMed (RMD) and Invacare (NYSE:IVC), not to mention the S&P 500, over the last three years as this company has grabbed more and more share of the growing portable oxygen market.

Although the fundamental growth story is strong, it's hard to see the appeal outside of growth and momentum as the company trades well above what I consider a reasonable cash flow-based valuation and at over 9x forward revenue. That said, if you are a valuation-insensitive growth investor looking for a momentum story, maybe this is a name to check out.

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Inogen May Only Be Getting Started

AxoGen Offers An Exciting Story At Nosebleed Prices

When the stocks of real companies go up more than 250% in a year, it’s a safe bet that there are at least two factors in play – the company has a great growth story and institutions have caught wind of it. And so it would seem with AxoGen (AXGN), where the company’s products for peripheral nerve repair are legitimately exciting, but where the growth expectations are already quite robust.

AxoGen shares seem to be pricing in a scenario where the company holds close to one-third of its addressable market in 2027 with FCF margins in the mid-20%s. That’s achievable, but it doesn’t leave much room for stumbles or disappointments. I can’t make a value case for AxoGen, but I know there are investors who care more about story and growth, and maybe there’s still some appeal here for that group.

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AxoGen Offers An Exciting Story At Nosebleed Prices

Renesas Going Through A Rocky Patch, But The Future Prospects Look Undervalued

"Buy the pullback" is one of the oft-used pieces of advice that is easier said than done but can nevertheless be profitable for patient investors. The semiconductor sector has certainly cooled, and Renesas Electronics (OTCPK:RNECY) is likely to see some weak reported results in the near-term, but this looks like a story that has some legs over the longer term.

Renesas is certainly looking at more competition in its core auto semiconductor market, but I wouldn't ignore the strong position it has built for itself in microcontrollers and SoCs, nor the opportunity to benefit from significant growth in semiconductor content in the auto sector. With mid-single-digit long-term revenue growth and low-to-mid teens operating margins, the stock looks undervalued enough today to merit a closer look.

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Renesas Going Through A Rocky Patch, But The Future Prospects Look Undervalued

US Foods Offers Double-Digit Potential As It Looks To Boost Growth And Margins

US Foods (USFD) is another good example of a business that may seem superficially simple (distributing products to food service customers like restaurants), but that involves quite a bit of detailed blocking-and-tackling details. And it is the extent to which competitors handle those details well that typically separates the long-term winners.

US Foods has done pretty well relative to the S&P 500 and its closest peer/rival Sysco (SYY) over the past year, but I believe there's a credible basis for expecting double-digit annual appreciation from here. US Foods has a large addressable market in which it can still grow (both organically and through M&A), as well as several margin-improvement opportunities. While I think today's price is a pretty fair balance between risk and reward, a pullback would make for a compelling entry point.

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US Foods Offers Double-Digit Potential As It Looks To Boost Growth And Margins

Expectations Seem Low For Swiss Re, But Not Without Cause

Swiss Re (OTCPK:SSREY), the second-largest reinsurance company in the world, has not had a very good run. Not only have the shares lagged the S&P 500 over the last one-, two-, five-, and ten-year periods, but also many of those performances compare poorly to sector peers/rivals like Munich Re (OTCPK:MURGY), Hannover Re (OTCPK:HVRRY), SCOR (OTCPK:SCRYY), and smaller players like Everest Re (NYSE:RE). Comparatively weaker ROEs do explain at least some of the underperformance, but the more important question is whether Swiss Re looks placed to do better in the coming years.

Swiss Re should be poised to benefit from rate improvements, but it remains to be seen whether management can achieve the necessary margin improvements in its casualty reinsurance and primary insurance operations. Modest expectations are an advantage in that respect, as only modest improvements in long-term ROEs can drive mid-single-digit income growth and double-digit annual shareholder returns.

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Expectations Seem Low For Swiss Re, But Not Without Cause

To Be More Than A Yield Play, Zurich Insurance Needs More Self-Improvement

With a dividend yield close to 6% and a healthy capital/solvency position, Zurich Insurance (OTCQX:ZURVY) (OTCQX:ZFSVF) (ZURN.S) is by no means a bad insurance company. With high expense ratios, high loss ratios, and weak trailing premium growth, though, it is likewise hard to say that Zurich is a particularly good insurance company. The extent to which Zurich Insurance's management can execute on cost-cutting and underwriting targets will shape the company's earnings growth potential, as "more of the same" is not going to be enough to move the shares significantly higher.

I would say that I'm cautiously optimistic on Zurich's potential from here. Shifting the business mix and delivering improved underwriting results will take time, but there is a pathway to mid-teens ROE and stronger total annual investment returns from here.

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To Be More Than A Yield Play, Zurich Insurance Needs More Self-Improvement

Sunday, April 1, 2018

voestalpine's Positive Attributes Should Become Clearer In The Coming Years

Austrian steel company voestalpine (OTCPK:VLPNY, OTC:VLPNF, VOES.VI) may be the bane of copy editors for its penchant for using only lower-case letters, but it has proven itself to be a different sort of steel company - one that reinvests continually and pursues a high-tech, high-quality strategy that emphasizes profit per ton over volume of tons sold. That philosophy, and a history of above-average ROIC generation, has allowed voestalpine to outperform many of its peers over the longer term, including the likes of Acerinox (OTCPK:ANIOY), ArcelorMittal (NYSE:MT), Nucor (NYSE:NUE), and ThyssenKrupp (OTCPK:TYEKF), though Steel Dynamics (NASDAQ:STLD) has outdone them all by a wide margin.

Steel stocks in general, and European steel stocks in particular, haven’t done so well this year, and voestalpine is down about 12% (worst among that group). I believe this is creating an interesting opportunity; although the steel cycle may be at or past its peak momentum, I believe the company’s differentiated strategy will lead to better results, and better cash flow, down the road.

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voestalpine's Positive Attributes Should Become Clearer In The Coming Years

Large Opportunities And High Expectations Battling It Out At Intersect ENT

The history of Intersect ENT (XENT) should look very familiar to long-term investors in the med-tech sector. This company came to the market all shiny and new in 2014 with an interesting, differentiated product for an underserved market (chronic sinusitis) that offered $1 billion-plus revenue potential. The stock more than doubled in its first year, but then the pace of revenue growth couldn't match what was laid out in the initial sell-side models and the shares lost almost two-thirds of their value.

Since the shares hit a late 2016 low, though, the company has been executing well. Although penetration/usage rates are slower than what was hoped for back in 2014, the pace of growth still isn't bad and the company is about to launch a new product that could add over $1 billion to its addressable market. A forward EV/revenue multiple of around 9x tells you the sort of growth expectations that are in place, but the underlying valuation isn't so unreasonable compared to the long-term opportunity.

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Large Opportunities And High Expectations Battling It Out At Intersect ENT

Zalando Building Up The Infrastructure To Be More Than Just Another Online Retailer

There’s a lot about Zalando (OTCPK:ZLNDY) that will look familiar to experienced investors – namely that tension between disruptive long-term growth and the fair price to pay today for that growth potential. Zalando has definitely made a mark in fashion e-commerce in Germany, and there is ample room to expand throughout Europe and into higher-margin services, but Amazon (NASDAQ:AMZN) looms large as a threat and more value-conscious investors may fret about how long it will take the company to earn attractive returns on the considerable sums it is putting into market and infrastructure development.

With the shares already seemingly discounting close to high teens long-term revenue growth and mid-single-digit FCF margins, I would say that expectations are already high and that this won’t appeal to many value-driven investors. On the other hand, the company continues to deliver strong growth metrics and the valuation isn’t absurd relative to what high-growth companies often get.

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Zalando Building Up The Infrastructure To Be More Than Just Another Online Retailer

Ternium Brings Strong Execution To A Strong Market

A better-than-expected steel market over the past 12-18 months has added a welcome tailwind to a story I already liked at Ternium (NYSE:TX). Although cost creep and higher working capital needs have created some near-term concerns, Ternium management has continued to do a good job managing overall profitability, while also intelligently re-investing for growth. That, in turn, has led to okay share price performance over the last year - the 22% rise in the shares, outperforming the S&P and Nucor (NYSE:NUE), but coming up a little short next to Steel Dynamics (NASDAQ:STLD), ArcelorMittal (NYSE:MT), and Gerdau (NYSE:GGB).

I don’t expect the steel market to improve as much from this point, but I still see opportunities for better results from Ternium. The CSA acquisition and internal greenfield opportunities offer volume growth opportunities, and a revised ownership agreement for Usiminas (OTC:USNMY) should allow for ongoing exposure to Brazil’s recovery. With a fair value in the mid-to-high $30s, there still appears to be value in Ternium shares even as the NAFTA renegotiation process drags on.

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Ternium Brings Strong Execution To A Strong Market

Tokai Carbon's Melt-Up May Not Be Over

Looking for "pick and shovel" plays, companies that supply and support companies that are seeing significant growth/upturns, is a time-tested strategy that continues to work. That brings me to Tokai Carbon (OTCPK:TKCBY) (5301.T), a company that is a significant player in carbon black, graphite electrodes, and fine carbon, but far from a household name. While the company has a good, and improving, business in its core carbon black operations, a supply squeeze in graphite electrodes that may persist for multiple years is adding sizzle to the story.

These shares have already tripled over the last year, so the eye-popping gains are already off the table. Even so, it looks like there's still double-digit potential left on the basis of continued pricing power in electrodes and improvements in other areas of the business - enough potential, at least, to make the shares worth a closer look.

Investors should note, though, that the ADRs are not especially liquid. In addition, as a Japanese company, foreign exchange risk is a factor that investors have to incorporate into their expectations.

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Tokai Carbon's Melt-Up May Not Be Over

A Cleaner Balance Sheet And Good Leverage Should Help Farmers Capital Bank Grow

Although you wouldn’t necessarily know it from the relative performance of other banks in its weight class, Farmers Capital (NASDAQ:FFKT) has taken some meaningful self-improvement steps over the last couple of years. These moves have put the company on a path toward better interest spreads, better efficiency ratios, and better growth prospects, all of which should support higher earnings and returns in the coming years.

The valuation argument isn’t quite as clean as I’d like it to be. The shares do look undervalued on the basis of near-term returns on equity and EPS/EPS growth, not to mention what the shares could fetch in a potential acquisition, but I’d like to see a little more discount relative to my long-term earnings growth expectations. At worst, though, this looks like a decent buy that could reward investors if 2018 results come in a little stronger than expected.

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A Cleaner Balance Sheet And Good Leverage Should Help Farmers Capital Bank Grow

The Market Still Isn't Giving Itochu Full Credit For Its Self-Improvement

Japanese trading company Itochu (OTCPK:ITOCY) has a tough act to follow - its own meaningful improvement over the past five years. The company was more willing than most of its Japanese trading peers to deemphasize commodity/resource businesses, and it moved fairly quickly here, building up non-resource businesses like its food, “machinery”, and finance operations. Those moves have led to better ROE and cash flow margin performance versus its peers, and Itochu shares have done well relative to peers like Mitsui (OTCPK:MITSY), Mitsubishi (OTCPK:MSBHY), Marubeni (OTCPK:MARUY), and Sumitomo (OTCPK:SSUMY) over that time.

Itochu’s execution has not been flawless, though, and investors are right to worry about the risk of another sizable poor investment (like CITIC (OTCPK:CTPCY)), not to mention the risk of lower long-term returns as Itochu has de-risked its business. I believe its underlying business mix, and the investment priorities that have been demonstrated over the last couple of years, argue for a higher price today, but the upcoming announcement of the company’s next three-year plan could be a significant share mover.

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The Market Still Isn't Giving Itochu Full Credit For Its Self-Improvement

Turkcell's Improved Execution And Strategy Going Unrewarded

Being a Turkcell (NYSE:TKC) shareholder has never been easy, but it has been more frustrating of late as weakness in the Turkish lira has depressed the value of the ADRs and muted the benefit of the 20%-plus increase in the value of the local shares. Going beyond currency, though, I believe there is an argument to be made that the market is still failing to give Turkcell credit for the improvements management has made - improvements that have included successful growth in 4.5G post-paid subscribers, growth in the fixed-line broadband business, growth in value-added services, and a more responsible view toward M&A.

I continue to expect high-single-digit revenue growth and mid-teens FCF growth from Turkcell as the company continues to benefit from the pre-paid to post-paid migration, greater use of data, and expanded add-on service offerings. Discounted back at current exchange rates, those cash flows support a fair value of over $12/ADR today, making Turkcell cheap enough to be worth a closer look.

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Turkcell's Improved Execution And Strategy Going Unrewarded

Fortive Accelerating Its Transformation Process

Fortive (NYSE:FTV) management had already made it clear to shareholders that they wanted services and software to be a bigger part of the future, but the pace of that transformation has been a little surprising. Between the recent transaction with Altra (NASDAQ:AIMC) and the prospect of $8 billion in M&A deployment, Fortive is certain to look different in 2020. Although this transformation carries unknowns and risks, including the extent to which the Fortive Business System is “portable” into these new target areas, the success of peers like Roper (NYSE:ROP) argues that it could be a very worthwhile shift.

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Fortive Accelerating Its Transformation Process

Broadcom Not Exactly Back To Square One

The market hasn’t been too accommodating to Broadcom (NASDAQ:AVGO) of late. Once a darling (and still well-regarded by many analysts and investors), the shares have been underperforming on a host of issues including worries about the company’s M&A policies (and its reliance on M&A), competitor actions, and the overall health of the semiconductor space.

I really have no operational concerns about Broadcom, and I think the company’s well-balanced mix will generate above-average growth in both the short term and long term. The prospect for value-adding M&A is more uncertain, though returning cash to shareholders is not a bad back-up plan. Based on mid-to-high single-digit long-term growth potential and margins in the 40%’s, I believe Broadcom shares are meaningfully undervalued now, but it will likely take some time for the dust to settle and for investors to move past worries about limitations on future M&A.

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Broadcom Not Exactly Back To Square One