Atlas Copco's CMD - Not All Bad, But Not Exactly Cheerful

In contrast to the ever-sunny, “what, me worry?” attitude of some corporate management teams that would have you imagining them smiling broadly even as the car rockets over the edge of the cliff, Atlas Copco (OTCPK:ATLKY) has a reputation for playing things pretty straight. That doesn’t mean that they’re always right, but it does mean that investors can generally trust them to give as accurate an assessment of the situation as possible.

To that end, Atlas Copco’s Thursday Capital Markets Day wasn’t exactly the sort of event that’s going to get investors feeling a lot better about this stock anytime soon. While management seems to believe the downside risk in Vacuum Technique is less worrisome than some of the more bearish sell-side analysts, and Power Technique could be a bigger contributor to growth than previously expected, all in all I’d say the tone was pretty conservative for the near term.

Atlas Copco shares have fallen roughly 50% from the start of the year and I have to admit getting more and more tempted to take a position, even given the risks around key markets like semiconductors and autos. While there is definitely a risk of things getting worse before they get better, and valuation still isn’t what I’d call cheap, buying these shares on sharp pullbacks has worked out pretty well in the past and I believe that will be the case again here.

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Atlas Copco's CMD - Not All Bad, But Not Exactly Cheerful

MSC Industrial Looking To A Restructured Sales Effort To Drive Better Results

As I've discussed (and lamented) on more than one occasion, MSC Industrial's (MSM) track record over the past couple of years has not been up to snuff, with the company underperforming other distributors like Fastenal (FAST) and Grainger (GWW) in both operational and stock performance terms. Although MSC's fiscal fourth-quarter results weren't all that great, expectations had ratcheted down going into the quarter, and it looks as though a long and surprisingly disruptive sales force restructuring/retraining process should start leading to better results in the coming quarters.

Valuation on these shares is mixed, and I don't think they're a screaming bargain, though I can support an argument that the company's profitability and return on capital (and assets) justify a price into the mid-to-high $90s. The biggest issue for the stock, though, is whether MSC can start delivering better organic sales growth and drive some of the long-awaited incremental operating leverage that investors have been waiting on for some time now.

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MSC Industrial Looking To A Restructured Sales Effort To Drive Better Results

A Painful Reset As PRA Group's Performance Remains Lumpy

Even in the best of times, PRA Group (PRAA) isn't the easiest stock to own or follow. The accounting for this large collections company is challenging to learn, and the company itself can't control key performance drivers like credit quality, charged-off receivables supply, or debtors' ability to pay. On top of that, the company is in the middle of a transition period where significant investments in operating costs have yet to be recouped by improved collections across its core and insolvency portfolios.

I model PRA Group with a higher discount rate than I would normally use for a company with its track record, largely to account for the greater uncertainty in modeling. With disappointing results in the third quarter, my fair value range falls from the high-$30s to mid-$40s, down to the mid-$30s to low-$40s, but there are still multiple potentially favorable drivers in play - including increased collections efficiency, improved operating leverage, and growing receivables supply.

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A Painful Reset As PRA Group's Performance Remains Lumpy

ABB Still Spinning Its Wheels

Every investor has their “enough” point, and I’m getting there with ABB (ABB). Despite a pretty healthy environment for electrical and automation products in general, and strong market positions in many of those markets, ABB has spent a lot of its recent history going nowhere fast, pulled down by weakness in the Power Grids business, weak utility demand, and a series of ongoing restructuring and M&A integration initiatives. Comparisons to companies like Honeywell (HON) aren’t really fair, but it has been a while since ABB investors really had a lot to cheer about, and third quarter results don’t really seem to represent a break with that trend.

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ABB Still Spinning Its Wheels

Schneider Electric's Business Is Outperforming, But The Stock Really Isn't

I can’t say that Schneider Electric (OTCPK:SBGSY) has been a terrible call this year, but I expected better from this European specialist in electrical and automation products than just sector-matching performance. Even though Schneider continues to outperform its peers in terms of its financials, and management continues to offer a pretty solid near-term outlook, the Street is most definitely not all-in on this name, as concerns about the health of end-markets like commercial construction and utilities remain in place and concerns are building about factory automation demand.

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Schneider Electric's Business Is Outperforming, But The Stock Really Isn't

Commercial Vehicle Not Getting Much Love At The Peak Of The Cycle

It’s not exactly news that the market has turned its back on the auto/commercial vehicle parts sector. Allison (ALSN) is a rather glorious exception, with the shares up about 13% over the past year, and Cummins (CMI) has done better than many (down about 13%), but Commercial Vehicle Group’s (CVGI) roughly 30% decline over the past year has been pretty close to the norm for the sector, as investors worry about the near-term impact of higher input costs and the looming cliff in large truck orders and production rates.

Although I do believe that the market is discounting the future cyclicality of CVGI’s revenue and profits too harshly, it’s tough to argue with the tape and the lack of institutional coverage for this name certainly doesn’t help. I do believe the shares are significantly undervalued, but investor sentiment will likely need to improve first for autos and CVGI still needs to prove that it can maintain margin leverage in trucks and execute on long-standing plans to diversify and grow the business.

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Commercial Vehicle Not Getting Much Love At The Peak Of The Cycle

Eaton's Challenges Look More Sector/Sentiment-Specific

The call I made earlier this year for preferring Honeywell (HON) and Eaton (ETN) in the industrial/multi-industrial space had been working pretty well through October, but looks more “okayish” now that more machinery-oriented industrials like Eaton have lost some luster. Eaton’s third quarter results had some air bubbles in it, but overall there wasn’t much that worried me and I still think this is an above-average idea in the industrial space. That said, there are growing signs that the cycle is slowing and liking Eaton now means fighting the tape to at least some extent.

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Eaton's Challenges Look More Sector/Sentiment-Specific

BRF's Third Quarter Had A Few Positives

Brazil’s BRF SA (BRFS) is only just starting its turnaround process, so investors shouldn’t expect quick fixes or huge improvements in financial results right away. Likewise, I wouldn’t get too concerned about near-term challenges like a currency-driven jump in the debt ratio. Importantly, the two key profit centers (Brazil and the halal business) both had some positive news and results should improve in the coming quarters.

I continue to believe that fair value for BRF shares today is in the $6’s, but with upside into the double-digits in a couple of years if and when the company executes on its turnaround strategy. Success is far from guaranteed, though, and investors need to aware not only of the company-specific execution risks, but also the commodity and currency risks that impact this business.

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BRF's Third Quarter Had A Few Positives

Multi-Color Takes A Big Step Back On Weaker Volumes

The situation at Multi-Color (LABL) continues to erode, but in a frustrating “death by a thousand cuts” sort of way. The Constantia deal is still far from proving to be a worthwhile use of shareholder capital, and in the meantime there are valid questions emerging about management’s plan as well as their grasp of the current situation. Although I still own some shares here, and I still see a path where the shares could be worth meaningfully more down the road, it’s tough to ignore the repeated disappointments and the clearly weaker near-term growth prospects. The shares do look meaningfully undervalued, even after another cut to expectations, but investors need to realize that this under-followed company is now deep in the doghouse and probably needs at least a year to dig itself out of the hole it made for itself.

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Multi-Color Takes A Big Step Back On Weaker Volumes

Wright Medical Coming Through With Better Performance

Wright Medical (WMGI) hasn’t delivered the most consistent track record that an investor could hope for, but once again there seems to be improving momentum in the business. Not only did this extremity-focused orthopedic company deliver a decent beat relative to third quarter expectations, but management raised guidance and it looks as though the company’s efforts to improve its sales execution in lower extremities are paying off.

Wright Medical shares have been chopping upwards since the spring of this year, and it’s a little harder to make a valuation call now. There is room for the lower extremity business to outperform on better sales execution, along with ongoing strong performance in upper extremities, and I believe the injectable form of Augment could still exceed expectations, as could the recently-completed Cartiva acquisition. Likewise, it’s at least conceivable that M&A speculation could fire up again. On the flip side, steady execution has proven elusive for the company and rivals like Stryker (SYK) aren’t going to let up.

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Wright Medical Coming Through With Better Performance

A Renewed Spark At Accuray, But Follow Through Is Critical

One of the perennial challenges in investing is maintaining a healthy balance of skepticism and realism while still allowing for the possibility of upside (and avoiding poisonous cynicism), and that can be particularly challenging when you’re dealing with companies with spotty track records. Accuray (ARAY) has had moments in the past when it looked like the story was finally coming together and the company was poised to generate meaningful forward progress, but those moments were all too brief and the company has struggled to post any real growth since the merger of TomoTherapy and Accuray in 2011.

Accuray’s fiscal first quarter got things off to a good start and there are credible reasons to believe that this fiscal year could be the start of a long-awaited meaningful improvement in the company’s financials. Even modest growth expectations would support a price above $5.50 and a fair value into the high single-digits is not unreasonable, but successful execution and delivery has long proven elusive for this company and I’m not confident enough to go all-in recommending Accuray shares on a “it’s different this time … really!” thesis.

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A Renewed Spark At Accuray, But Follow Through Is Critical

Manitex's Orders Need To Be Watched, But Progress Is Evident

Manitex (MNTX) shares have inarguably been weak since my last update on this manufacturer of mobile cranes, as the shares are down about 30% and have underperformed a generally weak sector (Terex (TEX), Manitowoc (MTW), and Palfinger (OTCPK:PLFRY) are all down about 15% to 25% over the last three months). Some of that has to be the broader weakness in the market as well as growing concerns about the heavy equipment cycle, and I didn't think that Manitex was particularly cheap when I last wrote about it.

Still, I think Manitex has made a lot of progress, and although I can't dismiss the risk that the cycle is ready to roll over, I believe Manitex's margin structure and balance sheet are in much better shape now. What's more, while a roll-over in heavy equipment demand would be inarguably bad, I still like the long-term growth story of Manitex gaining share with its knuckle-boom offerings in North America in the coming years and leveraging its still-new partnership with Tadano.

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Manitex's Orders Need To Be Watched, But Progress Is Evident

Veeco Seeing A Cyclical Slump Exacerbated By End-Market Capacity Challenges

Veeco (VECO) has hardly been my favorite name in the semiconductor equipment and tool space, but I didn't expect another one-third drop in the price of the shares since my last update. While my worries about LED equipment demand seem to be playing out, weakness in advanced packaging is getting worse, and positive drivers like VCSEL and EUV tool demand seem to be playing out a little slower.

Whether it is companies/stocks like Veeco or Rudolph (RTEC) that I don't like so much or companies/stocks like Advanced Energy (AEIS) and VAT Group (OTCPK:VACNY) that I do like, it's tough to buy these stocks going into order weakness, as you never really know how steep the correction phase of the cycle will be. Although I do believe that Veeco looks undervalued even with a sharp revision to 2019 expectations, the possibility of further downward revisions can't be ruled out, and I don't like the risk/reward balance here.

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Veeco Seeing A Cyclical Slump Exacerbated By End-Market Capacity Challenges

FirstCash In A Lull, But This Should Be A Pause That Refreshes

Third quarter results from FirstCash (FCFS) were okay, but don’t suggest a particularly powerful surge or shift in operating performance anytime soon. That’s okay though, as I believe management is making several modest “course corrections” that will keep the company on a trajectory for healthy long-term growth. The U.S. operations remain a good source of cash flow with further improvement potential in the Cash America store base, while Mexico and Latin America continue to offer a long-term runway of exceptional growth potential with relatively few major competitive threats.

Valuation is still a mixed bag. I think my long-term estimate of mid-single-digit revenue growth (and low double-digit FCF growth) could have some upside, but I don’t want to make the mistake of overstating/overestimating the growth potential of Latin America as the Mexican business and matures, nor the impact of the slower-growing U.S. business. Still, with a total potential annualized return of around 10%, this isn’t a bad buy-and-hold idea.

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FirstCash In A Lull, But This Should Be A Pause That Refreshes

Lexicon Still Heavily Dependent On Its Pipeline

Although Lexicon Pharmaceuticals (LXRX) has done what many biotechs fail to do, getting a drug through the clinical trial and FDA approval processes and onto the market, the commercialization of Xermelo really hasn’t helped the company or the stock, as the shares are quite a bit lower than when the drug was first approved and launched. At the same time, Lexicon has seen other pharmaceutical companies announce relatively solid data for their SGLT-2 drugs in Type 1 diabetes, the same market that Lexicon hopes to target (in partnership with Sanofi (SNY)) with sotagliflozin (or “sota”).

I continue to believe that the market is undervaluing the opportunity Lexicon has in the diabetes space with sota, but investors are in no mood to give the benefit of the doubt to a company that has long tested their patience. Accordingly, while I do see value here (potentially significant value), this may not be the easiest way to generate alpha, particularly as the launch of sota could be more challenging than once hoped.

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Lexicon Still Heavily Dependent On Its Pipeline

Pacific Biosciences Bows Out Gracefully

After many frustrating years of commercial execution lagging the potential of the technology, Pacific Biosciences (PACB) (“PacBio”) investors have a reason to be a little more cheerful this Friday. After the close on Thursday, the company and Illumina (ILMN) announced that Illumina would buy the company in a cash deal for $8/share, a roughly 75% premium to Thursday’s close and the highest price for the shares since late 2016.

I expect at least some PacBio shareholders to be disappointed with this sale, as there certainly are arguments supporting a much larger market down the road for long-read sequencing, and PacBio has been making progress on commercial execution. Even so, I think this is a decent exit valuation, but also a good opportunity for Illumina to add long-read sequencing technology to complement its very strong position in short-read sequencing.

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Pacific Biosciences Bows Out Gracefully

Atlas Copco Hits An Air Pocket On Weaker Vacuum Results

I was worried about the possibility of weaker semiconductor orders and slowing industrial activity when I last wrote about Atlas Copco (OTCPK:ATLKY) in July, and those worries are looming even larger now. There’s no longer any real debate about weakness in the semiconductor equipment space; the argument is now about how bad it will get and how long it will last. Likewise, I think it’s becoming increasingly apparent that there are more than a few industrial end-markets that are seeing meaningful decelerations.

None of this is good news for Atlas Copco in the short-term, and there are risks of further negative revisions into 2019 if the semiconductor down-cycle turns uglier and if industrial end-markets slow further. Counterbalancing that is the reality that Atlas Copco is one of the best companies out there, and a company that I believe can do well by shareholders over the long term. The shares are still above my revised DCF-based fair value, and I don’t dismiss the risk of industrial stocks derating further, but this looks like a pretty classic watchlist opportunity to me.

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Atlas Copco Hits An Air Pocket On Weaker Vacuum Results

FEMSA Offers A Strong Core Amid Market Wobbles

As a leading consumer/retail business in Mexico, there’s no getting around the fact that currency matters to the valuation and day-to-day performance of FEMSA (FMX). The trick, if I can call it that, is balancing the usually shorter-term impacts of currency volatility with the longer-term core operating fundamentals and quality of the business. So while the recent currency pressures (not to mention greater caution regarding emerging markets) is certainly relevant, I wouldn’t lose sight of the long-term quality of this business.

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FEMSA Offers A Strong Core Amid Market Wobbles