BRF Lays Out A Good Restructuring Plan, But No Quick Fixes

Investors, as a group, aren’t often the most logical creatures, so maybe there will be some disappointment at the restructuring plan that BRF SA (BRFS) management laid out on October 8 during its Brazil-based Investor Day (with a New York-based day to follow on October 10). Management didn’t offer up any quick fixes or any reason to think that the business will suddenly turn on a dime. What they did offer, though, was a very sound and credible strategy for building a stronger-for-longer company with substantial upside in both its home market of Brazil and its large foreign markets.

Valuation remains tied to the eventual long-term outcomes of this restructuring plan. If and when the restructuring activities start showing the expected benefits in 2019/2020 and beyond, I fully expect the multiple to expand again. Likewise, through that process the company will put some ugly near-term annual FCF results in its rear view mirror. While the current share price looks basically fair for what BRF is today, a more bullish outlook on that restructuring plan supports worthwhile upside for long-term investors.

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BRF Lays Out A Good Restructuring Plan, But No Quick Fixes

Ciena Sliding A Bit As The Sell-Side Rebuilds The Wall Of Worry

Ciena (CIEN) has been on a roll. Revenue rose 12% in the fiscal third quarter (beating expectations by 3%), gross margin was stronger than expected, and the company has been on a multiyear market-share-building run in both its core WDM market and in webscale. All of that has fueled a market-beating 33% run in the stock over the past year, so of course now some eager beavers on the sell-side are trying to beat the rush and downgrade early.

Wait, what?

It’s not all that uncommon to see calls that otherwise might look bold come out around this time, as there’s not much else to talk about in the weeks before third quarter earnings, and there are some near-term drivers that could weigh on Ciena’s growth. How management sets expectations coming out of this next quarter will clearly be important, as the run in the shares has somewhat emptied the tank for positive drivers.

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Ciena Sliding A Bit As The Sell-Side Rebuilds The Wall Of Worry

For ABB, It's About Cycle, Self-Improvement, And Sentiment

A laggard for some time among the industrial automation and electrification players, ABB (ABB) has at least been a little “less bad” of late as sentiment has started giving the company some credit for its later-cycle end-market exposures. Now the question is whether those promising-looking exposures will deliver actual orders in the second half of the year and drive better revenue in 2019. At the same time, there is still more than casual interest in ABB’s willingness and ability to execute on some self-help moves that would largely involve slimming down and simplifying the business.

I’ve long been an owner and supporter of ABB, and I can’t say that it has done right by me. Still, compared to peers like Emerson (EMR) and Rockwell (ROK), the valuation is undemanding and offers some upside if ABB can deliver on those sentiment-shifting improvements in orders and portfolio composition.

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For ABB, It's About Cycle, Self-Improvement, And Sentiment

Air Transport Group: Warning, Contents Have Shifted In Flight

Air Transport Group (ATSG) has chosen to alter its business in a pretty significant way with the $845 million acquisition of Omni Air. With this acquisition, Air Transport will be far more exposed to passenger-oriented ACMI and charter services, and the company will also add Boeing (BA) 777s to its owned and operated fleet.

I’m not unreservedly bullish about this deal, as I believe it adds operating complexity to a company that already had a track record of so-so execution in its core operations. It also likely takes an Amazon (AMZN) acquisition off the table (however likely that really was) and could lead Amazon to turn more toward Atlas (AAWW) as its provider of choice for future air cargo expansion needs. Adding government-funded charter services does help mitigate some of the ongoing cargo demand risks, though, and I do believe the shares remain undervalued below the mid-to-high $20’s.

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Air Transport Group: Warning, Contents Have Shifted In Flight

China Takes Another Bite Out Of IPG Photonics

When your prime market, the market where you generate close to 50% of your revenue, is in trouble, it’s tough to work around that. Such is the situation for IPG Photonics (IPGP), and this once high-flying leader in fiber lasers has gotten pummeled over the last three months on revenue and earnings weakness due to China. The latest blow came on Friday, with the company announcing that third quarter revenue and EPS were going to come in about 5% or so short of where expectations were a week ago.

IPG’s China-related risks showed up in the second quarter, and clearly they are continuing to linger, putting near-term revenue and margins very much in doubt. What’s more, it’s at least plausible to me that this period of trade squabbling between the U.S. and China is going to give a boost to Chinese fiber laser companies like Han’s Laser and Wuhan Raycus and improve their profile with Chinese manufacturing customers. Although IPG shares do look undervalued, and the multiples are lower than they’ve been in quite some time, anybody considering the shares today needs to be prepared to withstand further near-term losses until the situation bottoms out.

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China Takes Another Bite Out Of IPG Photonics

AXA Delivering On Its Pledges, And The Market Is Starting To Notice

It’s been a rough year for European insurance companies, though AXA (OTCQX:AXAHY) (AXAF.PA) seems to finally be getting a little interest. While other European insurers like Aviva (OTCPK:AVVIY) and Prudential (PUK), both of which I still happen to like, have done better over the past 12 months, the gap is shrinking and AXA has outperformed over the last six months (including meaningful outperformance relative to Generali (OTCPK:ARZGY) and Zurich Insurance (OTCQX:ZURVY) as well). I believe this renewed interest in coming as investors start to appreciate the long-term benefits of the XL Group deal, as well as the company’s commitment to execute on longer-range capital deployment plans.

I believe AXA is undervalued by a wide enough margin to be worth a serious look now, as I see double-digit appreciation potential on just mid-single-digit long-term earnings growth. Capital redeployment is a key unknown, particularly with respect to whether AXA will deleverage, return cash to shareholders, reinvest in organic growth initiatives, and/or engage in further M&A. While the late November investor day is an opportunity for management to lay out its plans for capital deployment in more detail, expectations do appear to be rising and management needs to deliver.

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AXA Delivering On Its Pledges, And The Market Is Starting To Notice

BancorpSouth On Track, With More Growth Opportunities Ahead

Since my last update on BancorpSouth (BXS), this Mississippi-based regional bank has managed to close three significant M&A transactions and meaningfully expand its lending franchise in Texas. At the same time, the bank still maintains an uncommonly good mix of low-cost core deposits and solid credit quality, as well as meaningful fee-generating businesses.

At the time of that last article, I didn’t think the valuation of BancorpSouth shares was all that exciting or likely to lead to outsized gains. Since then, the shares have basically tracked the performance of regional banks in general with surprisingly little deviation from either the SPDR S&P Regional Bank ETF (KRE) or the iShares U.S. Regional Banks ETF (IAT). And the story is largely the same today – while I do believe BancorpSouth scores well in most of the quality metrics that matter, and I believe there is significant opportunity for tuck-in/fill-in M&A within its footprint, the core growth potential isn’t exceptional and the current share price seems pretty fair at a time when banks are looking at a turn in the operating environment.

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BancorpSouth On Track, With More Growth Opportunities Ahead

Versum Leveraged To Chip Volume Growth And Innovation

On the whole, I like pick-and-shovel plays and Versum Materials (VSM) is a good example in the chip space, as this producer of specialty chemicals, gases, and other materials is heavily leveraged to ongoing growth in chip production volume and ever-increasing chip design complexity. Although Versum has some modest exposure to equipment and some volume risk from improving yields, the general outlook for Versum is healthy as a critical supplier to fabs.

Relative to Entegris (ENTG), though, I’m not quite as interested in the value proposition offered by these shares. I do think Versum is modestly undervalued, and it’s more of a play on direct chemical/material demand, but expectations might still be a little high for 2019 and I still see ongoing risk of the market being indiscriminate in selling off semiconductor-related names if (“when”, in my view) the outlook for equipment demand in 2019 worsens.

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Versum Leveraged To Chip Volume Growth And Innovation

A Rough Summer Has Knocked Calyxt Down

So far, not so good for my late June high-risk/high-reward call on Calyxt (CLXT). The “high risk” part has certainly come through promptly, but shareholders have seen the shares sell off about 25% after a summer that certainly offered more bad news than good, highlighted by the surprising resignation of the CEO in late August only a couple of months after the equally-surprising resignation of the CFO, and a decision in Europe that puts the acceptance and development of gene-edited crops at risk.

Assessing these developments is not easy. Both executives may have had disagreements with the board of directors and/or Cellectis (CLLS), which still controls the company, and those disagreements may have included the unusual business model Calyxt is pursuing with its high-oleic soybeans and other consumer-oriented products. It is also possible that they saw fundamental issues with the technology and/or its path to commercial acceptance. Unfortunately there’s really no way to know at this point, and the one remedy I do have is to increase my discount rate to account for greater risk and uncertainty.

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A Rough Summer Has Knocked Calyxt Down

Lexicon Likely Looking At Even More Competition In Type 1 Diabetes

As more and more competitor data accumulate, it’s looking like Lexicon (LXRX) is going to face significant competition in the market for SGLT inhibitors in Type 1 diabetes. Granted, it has long been my base-case assumption that Lexicon would see serious competition for its drug sotagliflozin (an SGLT-1/-2 dual inhibitor) in this large and underserved indication, but recently-presented data from Lilly (LLY) suggests that Jardiance (or empagliflozin) will be a meaningful potential threat in addition to AstraZeneca’s (AZN) Farxiga (dapagliflozin) and off-label use of SGLT-2 inhibitors already approved for Type 2 diabetes.

Lexicon could really use some good news, as the company has seen sentiment on sotagliflozin fade due to concerns about diabetic ketoacidosis (or DKA), a potentially serious side effect of SGLT inhibitor therapy, and has come up short of expectations multiple times already in the short commercial life of its only approved drug Xermelo. Although I believe Lexicon shares remain undervalued on the basis of just the potential value of sotagliflozin in Type 1 and Type 2 diabetes with partner Sanofi (SNY), shareholders could really use some positive clinical data on new compounds and a better sales trajectory for Xermelo.

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Lexicon Likely Looking At Even More Competition In Type 1 Diabetes

Smiths Group Going Nowhere Fast

It's never fun, but sometimes companies force you to conclude that your prior assumptions were just wrong (or you can take the time-tested bagholder approach of "I'm not wrong, I'm early!"). In the case of Smiths Group (OTCPK:SMGZY) (SMIN.L), I thought earlier this year that management was on the cusp of delivering the sort of results and portfolio transformations that would show a true break from its not-so-charming past trend of weak growth and questionable capital allocation/portfolio management. Since then, I just haven't seen the sort of follow-through I need to see to maintain that optimism.

To be sure, Smiths isn't a disaster, and fiscal 2018 was the first upturn in organic growth in some time. Moreover, there is still some apparent undervaluation based on what I think are fairly undemanding assumptions. If management can get its "stuff" together - drive better margins in John Crane, turn around or sell Medical, improve Detection, and lay out a more coherent strategic portfolio plan - there's still room for this stock to do better. But in the short term, I believe the disappointments of the past few weeks and months will continue to weigh on sentiment and valuation.

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Smiths Group Going Nowhere Fast

With Or Without Federal Mogul, The Street Just Doesn't Care About Tenneco Now

If you wrote up a list of outperforming auto and commercial vehicle component stocks, it would look for all intents and purposes like you were writing in invisible ink. A few companies like Aptiv (APTV) and Magna (MGA) have been less-bad than average, and Allison (ALSN) and tiny Commercial Vehicle Group (CVGI) are up strongly over the past year, but for the most part, this has been a pretty awful sector as investors have written off the passenger vehicle market for the near term, priced in the commercial truck fall-off, and continued assuming that internal combustion engines are doomed.

There might be a little hyperbole there, but not too much, and Tenneco (TEN) certainly continues to get almost no benefit of the doubt. Although second-quarter margins and margin guidance weren't great, the Street seems to be pricing these shares for ugly future margins and cash flow. Likewise, the idea that spinning off the Ride Performance and Aftermarket business will unlock any value seems to be largely dismissed at present. I really can't say that Tenneco is a top-notch idea now, but sector-wide valuations seem to be washing out, and this is a name worth watching for an eventual recovery opportunity.

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With Or Without Federal Mogul, The Street Just Doesn't Care About Tenneco Now

Teradyne's Cobot Opportunity More Than Just Hype

What makes Teradyne (TER) interesting is the combination of a high-share, margin-rich, cash-flow-generating semiconductor test business with an emerging growth story in collaborative robots (or "cobots"), a high-potential new segment of the robotics market where Teradyne has established a strong initial market share and a business plan and ecosystem that may make it harder for established robot players like Fanuc (OTCPK:FANUY), Yaskawa (OTCPK:YASKY), and ABB (ABB) to muscle Teradyne aside and replicate their traditional shares of the robotics market.

Although there will be some above-trend years and Teradyne is a net beneficiary of increasing chip content and complexity, I believe the core semiconductor test business is a solid but not spectacular business. The cobot business, though, has legitimately exciting potential and should be the key driver of what I expect to be high-single-digit long-term revenue growth and double-digit FCF growth over the next 10 years.

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Teradyne's Cobot Opportunity More Than Just Hype

MinebeaMitsumi Looks Seriously Undervalued, But There Are Significant Upcoming Challenges

Japan’s MinebeaMitsumi (“Minebea”; also sometimes written as “Minebea Mitsumi”) (OTCPK:MNBEY) (6479.T) is certainly not a household name to most investors, but this odd mix of precision machined and electrical components is a strong leader in several attractive markets, and has uncommonly robust opportunities to drive improved operating and product synergies in the coming years. At the same time, though, the company is facing some significant product cycle risk and there are no guarantees that the synergy efforts will pan out.

Minebea looks undervalued on the basis of long-term revenue growth of just 3%, but revenue could be choppy over the next several years and the margin/FCF generation improvement I expect may prove to be beyond management’s capabilities. I’d also note that these ADRs are not very liquid at all, so investors should factor that into their evaluation process (the Tokyo-listed shares are quite liquid, for investors who wish to pursue that option).

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MinebeaMitsumi Looks Seriously Undervalued, But There Are Significant Upcoming Challenges

Allison Transmission Running Over The Bears

Whatever the future may look like for Allison Transmission (ALSN) and its role in a post-electric truck world, the company is executing remarkably well today. With solid growth in its core North American truck business augmented by improving demand from energy and mining applications, as well as share gains in trucks outside North America, Allison is posting exceptional incremental margins and forcing bearish sell-siders to trot out “we’re not wrong… we’re just early” calls.

I’m not in the “the sky is going to fall” camp with Allison, but it’s a tough story to model out given the likelihood that electric trucks eventually will grab share in strong core Allison markets like dump trucks, refuse trucks, and other vocational applications like drayage. I believe a key question is whether Allison can continue to gain share in overseas markets (where penetration is low) and whether they can fight off competition from other transmission alternatives like the Cummins (CMI)/Eaton (ETN) JV.

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Allison Transmission Running Over The Bears

Crane Highlights Its Payment Growth Opportunities, While Fluid Handling End-Markets Improve

Above-average exposure to later-stage markets like aerospace, chemicals, energy, and municipal water is certainly not hurting Crane Co. (NYSE:CR) these days, even though the performance of its Fluid Handling business left something to be desired in the second quarter. I thought I saw some value in Crane shares when I last wrote about the company after second-quarter earnings, but I didn’t foresee the 12% jump the shares have delivered in such a relatively short time.

Management’s recent Investor Day focused on the Payment and Merchandising Technologies (or PMT) business certainly won’t hurt sentiment, as management laid out some good arguments for above-average growth. What’s more, Crane’s valve business (the bulk of Fluid Handling) should see improving results as companies like Emerson Electric (NYSE:EMR) continue to report healthy demand from key process automation end-markets like oil/gas, chemicals, and so on. I don’t find the valuation particularly cheap now, but the company’s market exposures should give it a better-than-peers chance of beat-and-raise quarters for a little while yet.

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Crane Highlights Its Payment Growth Opportunities, While Fluid Handling End-Markets Improve

Honeywell Continues To Invest In A Faster-Growing, Higher-Margin Future

Honeywell (HON) management has made no secret of its game plan for the future, nor its desire to be a leader in markets with above-average potential for revenue growth, margins, and returns on capital. In keeping with that plan, the company has already spun out Garrett Motion (GRX), will be spinning out Resideo, and just announced another promising acquisition for its warehouse automation business.

Between its very strong process automation business, its rapidly-growing warehouse automation business, underrated operations in specialty materials/chemicals and safety, and a solid (if generally well-understood) aerospace business, I find it hard not to like Honeywell. Valuation is not exactly low, but with the company consistently repositioning itself toward higher-growth, higher-margin businesses, and particularly ones where it's establishing strong market share, I continue to like Honeywell as a long-term holding.

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Honeywell Continues To Invest In A Faster-Growing, Higher-Margin Future

Wabtec Looking At A Value-Creating One-Two Punch

Accustomed as I am to thinking of Wabtec (WAB) as perennially richly-valued, which for a long time it was, it's a strange thing to be continuing to advocate for buying the shares and thinking that the market is underrating this one. I understand some of the market's skepticism and worry that the assets Wabtec is buying from GE (GE) aren't in great shape, but I believe this will be a transformative acquisition for Wabtec, and I also believe the timing couldn't be better, as the company is starting to see its freight rail markets recover.

Up about 10% from when I last wrote about the stock (and when I thought it was undervalued), I've since revised my estimates for the benefits of the GE acquisition and the ongoing recovery in the freight business (as well as some challenges in the transit business). The net effect is to boost my fair value range toward $115, with potentially more upside beyond that depending upon the strength of the freight recovery and Wabtec's ability to drive synergies from the GE deal.

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Wabtec Looking At A Value-Creating One-Two Punch

Dana Looks Pinned Under The Wall Of Worry

I was tentatively bullish on Dana (DAN) in late May of this year, but auto and commercial vehicle suppliers continue to weaken in the market, and the shares are down another 15% since then. Maybe I’m missing something big here, but I see Dana as a company with at least decent ongoing leverage to passenger vehicles, an improved position in electrification, and a solid global presence in commercial/off-road vehicles, particularly with the Oerlikon (OTCPK:OERLY) transaction. And yet, the Street continues to price this one as if there’s going to be serious long-term erosion in the business.

I freely admit that Dana doesn’t have the greatest operational track record with respect to margins, FCF generation, and/or ROIC, but the company has improved in recent years and is seemingly getting no credit for that. In a market where many auto and commercial vehicle suppliers appear to be trading below long-term fair values investors certainly have choices, but I continue to believe this name is worth a look.

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Dana Looks Pinned Under The Wall Of Worry

Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

The good times keep rolling for Emerson (EMR), as the company is enjoying a strong recovery/expansion phase in its core process markets, as catch-up spending on MRO, brownfield investments, and greenfield projects all combine for strong near-term revenue and margin improvements and a healthy outlook over the next year or two. At the same time, Emerson continues to reinvest in its business to better-position it for less cyclicality and better competitiveness in hybrid automation markets.

As was the case a few months ago, I see Emerson as a so-so value proposition, but a stronger near-term growth/momentum story. The shares don't seem unreasonably priced on forward EBITDA, but it's a little harder to see strong FCF-based undervaluation, and I think the share price performance is very much tied to ongoing momentum in orders, revenue, and margin leverage.

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Emerson Seeing Very Healthy Process Markets And Reinvesting In Hybrid Competitiveness

Turbulence Still Hitting Copa Holdings Hard

One of the last things I said about Copa Holdings (CPA) in my last article on the company was that "adverse forex and higher fuel costs could get worse before they get better", and those twin headwinds are primarily responsible for another 5% decline in the share price since the time of that article. What's more, management's recent investor day offered up a lot of evidence to support a "soft" guidance reduction for the second half of the year - in other words, investors shouldn't be surprised to see some weakness in the third quarter results and some downward margin guidance for the fourth quarter.

It's tough to recommend a stock while expectations are still moving down, particularly when sector valuations are generally predicated on the next 12 months' financial performance. I don't think Copa is the greatest idea out there for investors who need a quick gain and/or who can't or won't accept near-term losses for longer-term gains. On a longer-term basis, though, I continue to believe the valuation is pretty interesting and even those investors not willing to accept the risks and uncertainties today should keep a closer on this one for signs of stabilization over the next three to six months.

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Turbulence Still Hitting Copa Holdings Hard

Improving End-Markets And Market Share Not Enough For Cummins

Investors are definitely conflicted about machinery stocks these days, with mining and ag doing well, but a lot less enthusiasm for construction and trucking as investors worry about how the end of the cycle will play out. I didn’t see enough upside in Cummins (CMI) to want to dive in back in late May, and the market-lagging return since then doesn’t exactly have me regretting that call (though Cummins has done comparatively better than most heavy machinery names over that time).

I can’t say that I feel all that differently about Cummins now. The North American truck cycle looks like it has longer legs (into 2019), but that doesn’t really change the fundamental long-term valuation picture. Likewise with the long-awaited recovery in power gen and strength in markets like mining and oil/gas. Although the shares do look a little undervalued on a near-term basis and I like the company’s ongoing moves to invest in electrification products/technology, I just don’t see the upside to warrant taking a new position now.

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Improving End-Markets And Market Share Not Enough For Cummins

Strong Mining Markets Could Help FLSmidth Finish Strong

The mining sector has definitely recovered, but that doesn't automatically make every player in the mining sector a good pick. I wasn't too excited about the near-term trading prospects for Danish mining and cement equipment company FLSmidth (OTCPK:FLIDY) (FLS.KO) back in June, and I'm not surprised that the shares have been flat since then, while Epiroc (OTCPK:EPOKY), Komatsu (OTCPK:KMTUY), Caterpillar (CAT), and Metso (OTCQX:MXCYY) have headed higher on stronger orders and improving margins.

Although FLSmidth's second-quarter margins were oddly weak, the order recovery was solid, and there have seen been a lot of corroborating data points on the strength of the mining sector and the opportunities over the next couple of years for equipment supplies like FLSmidth. I don't find these shares cheap enough to have a lot of appeal as a long-term holding, but I think circumstances are setting up for a better performance for the shares in the last quarter of the year and more trading-oriented investors may want to take another look. For longer-term investors, visibility on better margin leverage would be/is a key gating factor to a more robust valuation.

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Strong Mining Markets Could Help FLSmidth Finish Strong

Maxwell Continues To Sorely Test Investor Patience Ahead Of Commercial Ramps

It has been clear for a while that 2018 wasn’t going to be a great year for Maxwell Technologies (MXWL), but bulls could take some solace in the idea that 2019 would see the start of meaningful ramps in long-awaited opportunities like auto ultracapacitors. While that is still a valid bull thesis in my view, the reality is that 2018 has been tougher than expected, including a higher cash burn that forced the company to move faster with a dilutive financing.

I’m frankly torn on these shares. I do genuinely believe that the company is going to see meaningful auto revenue starting in 2019 from platform wins in active suspension and ADAS backup systems and grow from there, and I do also believe in the potential in areas like rail. On the other hand, this is not a company whose execution track record leads me to want to lend any of whatever credibility I have to them. Accordingly, while I do think these shares are undervalued on the potential of the launches in 2019 and beyond, this is a consummate “caveat emptor” stock and one where you really need to do your own careful due diligence.

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Maxwell Continues To Sorely Test Investor Patience Ahead Of Commercial Ramps

Lydall Needs To Complement Good M&A With Better Internal Execution

Well off the beaten path and certainly not a strong performer over the past year, Lydall (LDL) is an interesting name to look it for what the company could be worth if management can improve their internal execution and drive some long-promised margin improvements. Lydall has a good track record with M&A, including the recent acquisition of Interface Performance, but between the challenges of the auto industry, material cost inflation, and execution issues, the company has not been performing up to its capabilities.

Betting on a company to get itself together and improve its operating performance always involves risk, and it is entirely fair for readers to question why they should bother unless and until the segment-level margin performance at least stops getting worse. That said, the valuation would seem to offer some upside based upon what I consider to be fairly conservative assumptions that leave room for upside if and when management delivers better results.

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Lydall Needs To Complement Good M&A With Better Internal Execution