Wednesday, October 16, 2019

First Republic's Strong Execution Shows Its Premium Is Not Just About Growth

Higher premiums typically mean higher expectations, and those expectations aren’t always just about pure growth. First Republic’s (FRC) third quarter growth wasn’t amazing (PPOP up about 6% yoy), but the extent to which the bank’s management did much better than expected in offsetting spread pressure is noteworthy to me and makes me feel better about paying more for these shares.

When I last wrote about First Republic, I thought there would be an opportunity to buy shares at a better price, and the stock did drop below $90 (briefly) about a month later. Even with the better performance shown this quarter, I’m not that comfortable paying more than $100/share for First Republic, and I’d prefer to wait in the hopes of getting another chance below $95, though I fully accept the risk that I might not get that chance.

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First Republic's Strong Execution Shows Its Premium Is Not Just About Growth

Lackluster Results At Wells Fargo, But Likely Past The Bottom In Sentiment

Wells Fargo (WFC) has been a frustrating stock for a little while now, as not only has the company been posting lackluster results (due in part, but not totally to a consent decree), but there has been ongoing uncertainty as the board searched for a new CEO. Sentiment seems to have bottomed out after second quarter results, though, with the shares up about 10% since then and outperforming the likes of Bank of America (BAC), Citi (C), JPMorgan (JPM), PNC (PNC), and U.S. Bancorp (USB).

With a new CEO in place and a lot of things that need doing, I expect a lot of activity from Wells Fargo over the next 6 to 18 months, including management changes, business restructuring, and philosophical/business priority shifts. Exactly what new CEO Charlie Scharf has in mind is unknown, but I continue to argue that Wells Fargo will be starting this restructuring from a position of strength with respect to its consumer and commercial lending franchises.

Wells Fargo shares still look undervalued, even though I expect core earnings in 2023 will be slightly lower than they were in 2018. For the longer term, I expect basically the same low single-digit growth I expect from most large banks, and I do see some potential for upside. All in all, Wells Fargo isn’t at a can’t miss price (particularly compared to quality names like JPMorgan that still have some upside), but a successful turnaround could easily support a higher price.

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Lackluster Results At Wells Fargo, But Likely Past The Bottom In Sentiment

An Okay Quarter From Citigroup Arguably Not Good Enough

Citigroup (C) did manage a beat for the third quarter, but a small beat that was definitely overshadowed by many of its large peers is not what the company/stock needs to shift sentiment in a more positive direction. I don’t want to be too harsh about a quarter that was only a little off in terms of the core drivers, but Citi management isn’t really doing much to instill confidence in a longer-term ROTCE target that the Street already finds dubious.

The good news is that I believe Citi continues to out-earn its cost of capital and will continue to do so. Surplus capital can continue to go towards share buybacks, and the company’s digital-based growth strategy has some chance of separating the company from the pack. I still believe that the slow pace of improvement could attract more aggressive pushes for restructuring and/or new management, and I believe these shares are undervalued, but again, I’ll reiterate that it’s going to take time for this to work out and a lagging large-cap bank at the end of the cycle is not typically a recipe for outsized outperformance.

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An Okay Quarter From Citigroup Arguably Not Good Enough

A Very Healthy Consumer And Strong Execution Boosting JPMorgan

Bank stocks really haven’t been in favor over the past year, as investors fret over the consequences of a reversal in the rate cycle (from tightening to easing), a likely increase in credit costs, and weaker loan growth. When it comes to JPMorgan (JPM), though, this bank’s exceptional execution continues to drive above-average results both in terms of financials and share price performance, with the stock up about 16% over the past year.

Spread pressures remain a real risk for JPMorgan, but healthy consumer metrics (including good unemployment and income numbers) help offset some of the risk. At the same time, management continues to look for growth opportunities in areas like private banking, asset management and payment technologies. JPMorgan shares still seem to have some upside, and I’m in no hurry to sell, but investors who want beefier prospective returns likely need to look elsewhere and trade off some quality for greater return prospects.

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A Very Healthy Consumer And Strong Execution Boosting JPMorgan

Gerdau Doing What It Can, But End-Market Demand Remains Soft

An ever-present challenge for commodity company management teams is that there’s only just so much they can control – ultimately end-market demand and pricing, not to mention substantial percentages of their input cost, are beyond the influence. I believe that’s relevant in the case of Brazil’s Gerdau (GGB); management has done its part to run this business about as well as could be expected, but weaker demand in key markets like Brazil and the U.S. are sapping the company’s near-term earnings power.

Management’s expectation for a better second half in 2019 now seems out of reach, but the market also appears to have adjusted since the second quarter earnings report. While Gerdau has outperformed other international steel companies like ArcelorMittal (MT) and Ternium (TX) on a year-to-date basis (“outperformed”, in this case, means “declined less”), the performance has been more ordinary since then.

The valuation and investment opportunity with Gerdau is mixed. I see more upside in Ternium, but I also think Gerdau is likely to have a better 2020 than most other steel companies on an improving Brazilian economy.

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Gerdau Doing What It Can, But End-Market Demand Remains Soft

Monday, October 14, 2019

Copa Holdings Drifting Despite Strong Performance

There's little to fault in the operating performance of Copa Holdings (CPA) since my last update, but the shares haven't moved much since then. There's always a margin of error in assessing why a stock has performed the way it has; in the case of Copa, I believe there are still some concerns about slowing economic growth in multiple Latin American markets, and perhaps some rotation away toward riskier Brazilian carriers like Azul (AZUL) and Gol (GOL) on an improving outlook/sentiment for domestic Brazilian air travel.

Whatever the reason(s), I remain bullish on Copa. Management has an excellent, almost irreplaceable network that can be serviced with a simple narrowbody fleet, and Copa management has shown an admirable knack for boosting revenue and controlling/minimizing costs. Macroeconomic risk goes with the story, but I believe the addition of the 737 MAX next year will be a positive for the company, and I still think the shares are undervalued.

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Copa Holdings Drifting Despite Strong Performance

GEA Group - A Credible Self-Improvement Plan, But No Better Than Expected

“So lie to me, but do it with sincerity” Depeche Mode, Lie To Me

Guidance is a funny thing. Nobody wants to be lied to (or at least nobody will say they want to be lied to), but given the short attention spans and short-term focus of most institutional investors, investors often seem to prefer unrealistically high targets from management teams that boost the shares in the short term, with long-term consequences be damned. To that end, GEA Group’s (OTCPK:GEAGY) (G1AG.XE) restructuring plans announced in late September had credible, sober, attainable near-to-medium-term goals, but they didn’t exceed the already-inflated expectations from the sell-side and the lingering sentiment seems to be one of disappointment.

Valuation is tricky here, and I will remind investors that successful turnarounds often exceed initial expectations, but not all turnarounds succeed. If GEA Group does only what is already in the stated plan, the company will still be relatively lackluster compared to its peer group, and the shares are only modestly undervalued (though still undervalued). If, however, GEA Group’s new management team is taking sensible bites and setting achievable goals, with greater long-term potential than is reflected in the 2022 guidance, the shares are worth more serious consideration.

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GEA Group - A Credible Self-Improvement Plan, But No Better Than Expected

Short-Term Cyclical Pressures Overshadowing Columbus McKinnon's Long-Term Potential

This isn’t the easiest time to be bullish on industrial names, and particularly those companies like Columbus McKinnon (CMCO) that are more heavily skewed to cyclically weaker end-markets likes autos, oil/gas, metal processing, and heavy industry. Management has acknowledged those cyclical pressures with lower guidance, and the shares have fallen a bit since my last update in May.

I’m still bullish on the company’s longer-term potential. Management has made meaningful progress on its restructuring program, including cost reduction, productivity improvement, and portfolio realignment, and the lends credibility to a long-term EBITDA margin target around 20% (versus the mid-teens today). I also believe Columbus McKinnon is an underappreciated emerging play as a facilitator of increased automation in heavy manufacturing and material handling. I wouldn’t be surprised if there is another cut to guidance, and investors may want to hold off in anticipation of this, but with a fair value in the low-to-mid $40’s, I see value for longer-term holders.

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Short-Term Cyclical Pressures Overshadowing Columbus McKinnon's Long-Term Potential

BBVA's Execution Still Overshadowed By Macro Worries And Rate Pressure

I wasn’t particularly keen on BBVA (BBVA) shares back in December, due to a combination of both macro challenges in markets like Mexico, Spain, Turkey, and the U.S., as well as some internal execution/value-creation issues. Since then, the shares have kept pace with other European banks, but are still down slightly.

BBVA shares do appear to offer some value here, but lower rates in Europe and the U.S. aren’t going to do the bank any favors, and there are likewise worries about an upcoming lowering cycle in Mexico. Moreover, not unlike ING (ING) and SocGen (OTCPK:SCGLY) the prospects for meaning near-term earnings growth look poor, and BBVA seems unlikely to earn its cost of equity anytime soon – all of which is bad for sentiment and relative performance. I can see some value-hunting appeal here, but I’d at least consider some other quality European bank names like ING and the Nordics (Danske, DNB, Nordea, and Swedbank) as part of the due diligence process.

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BBVA's Execution Still Overshadowed By Macro Worries And Rate Pressure

Thursday, October 10, 2019

Itau Unibanco Refocusing On The Consumer To Drive New Growth

For a variety of reasons, including less-than-responsible competition from state-controlled banks in Brazil, increasing competition from new fintech entrants, and a management team that is consistently overly positive on the prospects for the business, Itau Unibanco (ITUB) has never been my favorite Latin American bank. With Brazil’s recovery underwhelming expectations in 2019, the shares are down more than 10% over the past year and down about 8% since my last article on the company.

Brazil’s economy needs a lot of work, and it remains to be seen if the current government has the willpower to tackle a host of thorny structural issues, including pension reform. If the recovery of Brazil’s economy accelerates, Itau can do well, but I still don’t love this bank from a fundamental standpoint and while the shares don’t look expensive, I’m not all that excited about the idea of owning these shares.

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Itau Unibanco Refocusing On The Consumer To Drive New Growth

Rates Grinding Down Sentiment For ING

When I last wrote about ING Groep (ING), I wrote that “ING shares remain undervalued and could stay that way for while…”, and so it has been. The shares are down another 20% or so since then, with renewed worries about spread compression as ING is looking at negative rates in its swap portfolio, minimal deposit pricing leverage, and softening underlying macroeconomic trends.

I continue to believe ING is a high-quality, well-run bank, and I believe ING’s strategies to gain share in higher-growth markets can help support above-average loan growth. I likewise am still bullish on the bank’s ability to leverage years of investment in IT into lower operating cost run-rates in the near future. I still believe that a mid-teens fair value for ING is appropriate (ranging from around $13.50 to $16.50 depending upon methodology), but it is increasingly probable that ING may see little-to-no core earnings growth over the next five years, and it’s going to take something more than just low valuation to get investors to reconsider this name.

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Rates Grinding Down Sentiment For ING

Canadian Western Bank Looking To Growth To Counteract Increasing Macro Pressures

I continue to be impressed by how Canadian Western Bank (OTCPK:CBWBF) (CWB.TO) management addresses the challenges facing this small commercially-focused bank, even if some of the challenges are self-inflicted. While I thought the shares looked more than 20% undervalued when I last wrote about the shares, I'm a little surprised that the shares have done well since then (up close to 25%) given how negative sentiment has been for much of the past year.

Macro headwinds are accelerating; NIM compression looks probable, credit losses are likely to increase, Canada's economy is slowing, and Canadian Western's deposit mix is still not ideal. That said, the company continues to deliver strong loan growth, is reaping some benefits from a renewed focus on branch-raised deposits, and stands to see a significant benefit from the adoption of the Advanced Internal Rate Based (or AIRB) capital calculation approach. At this point, I'd call Canadian Western a middling investment idea; the shares do look a little undervalued, priced for high single-digit to low double-digit returns, but a lot is riding on the bank maintaining the strong loan growth and credit quality trends that have helped boost the stock recently.

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Canadian Western Bank Looking To Growth To Counteract Increasing Macro Pressures

Credicorp Looks Undervalued, But Its Market Is Slowing

Credicorp (BAP), Peru’s largest bank in terms of both loan and deposit share, has had a pretty so-so run of late, with the shares down about 5% over the past year, roughly matching the performance of the wider Peruvian market. Although Credicorp’s operating performance has been solid, and Peru’s economy is still in generally good shape, most of the incremental developments have been negative, with a slowing economy and slowing loan demand showing up more recently.

All bets will be off if the global economy tips over into full-blown recession, but at this point it looks like Peru will see a relatively more gentle “adjustment”. The next year may not be the strongest operating set-up for Credicorp, but I do believe the company is still well-placed for above-average growth in the years to come, and I believe management has a credible plan to reach more of Peru’s underbanked citizens and reduce costs, while also carefully expanding outside Peru. I don’t believe Credicorp is dramatically undervalued relative to the above-average operating risk, but I do believe the shares are priced for a relatively attractive low double-digit annualized return.

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Credicorp Looks Undervalued, But Its Market Is Slowing

Daifuku Emerging As A Major Player In Logistics Automation

Perfect growth stocks don't really exist, and even the best secular growth stories usually see some "turbulence" at some point. So it is with Daifuku (OTC:DFKCY) (OTC:DAIUF) (6383.T), a global leader in material handling that is applying decades of integrated material handling automation experience into the rapidly-growing e-commerce/logistics/warehouse automation market. While Daifuku has an attractive multiyear growth runway as companies increasingly look to automate their warehouse and logistics operations, the company has encountered some near-term challenges in profitably penetrating the U.S. market, while cyclical challenges in autos and electronics create their own challenges.

Daifuku is by no means a perfect story. For starters, it's not an easy stock to buy; I'd recommend owning the Japan-listed shares, but that may not be an option for all investors. I'm also concerned about the cyclicality of its auto and electronics businesses, and while I do believe the company will be able to leverage its capabilities in logistics automation to improve its operating margin profile, its present-day margins are not impressive. All of that said, I believe Daifuku is positioned for exceptional FCF growth in the coming years and the current share price looks like an interesting potential entry point for a secular growth story with long legs.

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Daifuku Emerging As A Major Player In Logistics Automation

Tuesday, October 8, 2019

Sentiment On HollySys Still Exceptionally Weak

I’ve used words like “frustrating” and “confounding” in reference to HollySys (HOLI) before, and little has really changed in that respect. Despite a relatively healthy ongoing outlook for key end-markets like power generation, chemicals, and rail in China, not to mention relatively good financial performance back in the company’s fiscal fourth quarter (calendar second quarter), HollySys shares are down another 25% or so from mid-June.

There are valid reasons to be wary of HollySys, including poor management communication and a noted lack of progress in multiyear diversification/growth initiatives. Some investors won’t touch Chinese equities, and that’s fine (at a minimum, you should educate yourself on withholding rules and the like). Likewise, some investors may not want exposure to automation at this point or want to tolerate the exceptional volatility in the rail equipment business. Still, if HollySys can maintain operating margins in the 20%’s and generate mid-single-digit revenue growth, these shares are notably undervalued.

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Sentiment On HollySys Still Exceptionally Weak

Infineon Grinding Through Its Downturn

Between elevated exposure to the weak auto market, the overall correction cycle in semiconductors, and concerns that it is overpaying for Cypress (CY), Infineon (OTCQX:IFNNY) has had a rough year. Down about 20% over the past year, Infineon has noticeably lagged the broader semiconductor sector despite a pretty solid record of financially underperforming its peers through cyclical downturns.

I’ve been more bearish on semiconductors than most sell-siders, and so far that position has been the right one. Infineon management has also been more conservative than many chip company management teams with respect to this corrective cycle, and I think that’s the smart way to play it. I think it’ll take a couple more quarters before Infineon sees real, meaningful improvement in orders and inventories, but I find the valuation to be fairly interesting here, and while Infineon may not be my favorite chip company, I like the long-term leverage to auto and industrial electrification and automation.

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Infineon Grinding Through Its Downturn

Keep An Eye On ITT Through The Reporting Season

The conversation around industrials has shifted away from whether there would be a correction/downturn and toward the question of how long it will last and how deep it will get. Specific to ITT (ITT), the company looks vulnerable to ongoing deceleration in oil/gas capex investment, project delays in the chemicals end-market, and further weakness in the broadly-defined “general industrial” category, not to mention weakness in autos. Some of this seems to be anticipated in the stock price, as the shares have more or less matched the S&P since my last update but modestly underperformed the broader industrial space.

I do believe that ITT is more on the front end of its downturn than in the middle, and I’d look to updates from companies like Emerson (EMR), Flowserve (FLS), Gardner Denver (GDI), and Chart Industries (GTLS) as to the health of oil/gas and chemicals project books, not to mention ongoing aftermarket demand. While I don’t expect any dramatic restructuring efforts from ITT, I do believe the company is well-constructed to “muddle through” the downturn and I would keep a close eye on this name for an opportunity to exploit near-term market pessimism if results/guidance disappoint the investment community. I still believe there is a credible case for a mid-to-high $60’s fair value for ITT at this point, though I do also believe there is some downside risk to earnings expectations for the next 12-24 months.

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Keep An Eye On ITT Through The Reporting Season

POSCO May Be Near A Bottom, But Sluggish Demand Remains Problematic

Like most carbon steel manufacturers, I believe there's a good chance that POSCO's (PKX) EBITDA/tonne will bottom in the near future, quite possibly in the third or fourth quarter of 2019, but I also see relatively limited prospects for a sharp near-term turnaround. While key inputs like coal and iron ore have been getting cheaper, global steel demand forecasts continue to decline, and I don't see weakening economies in the U.S. and Germany, nor the ongoing U.S.-China trade dispute, as especially supportive of a near-term improvement in steel demand.

Also like many steel companies, POSCO shares look undervalued based on long-term norms for the sector. Unfortunately, investors often ignore those norms at the tops and bottoms of the cycle, and there's a lot riding on steel companies showing that conditions have, in fact, bottomed over the next few quarters. Although I do think POSCO shares are undervalued, investors have plenty of options in the steel sector and ought to shop around carefully, particularly as POSCO doesn't have a great track record with respect to value-added reinvestment of shareholder capital.

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POSCO May Be Near A Bottom, But Sluggish Demand Remains Problematic

Ternium Seeing Heavy Near-Term Pressure, With A Tough Road To Recovery

My biggest fear for Ternium (TX) in 2019 was that macro factors, particularly the health of the industrial and non-residential construction sectors of Mexico, Argentina, and Brazil, would create greater than expected pressure on the business. That’s exactly what’s happened, as the shares have lagged the steel sector as a whole on a year-to-date business, even if they’ve done a little better than some global/emerging market competitors like Gerdau (GGB) and ArcelorMittal (MT) over the last few months.

I do believe that Ternium is likely to see its EBITDA/tonne bottom over the next quarter or two, but I’m skeptical about a sharp recovery thereafter, and I still see plenty of macro risks in Mexico, Argentina, and Brazil that could pressure the business. Although Ternium trades cheaply relative to its fundamentals (metrics like EBITDA/tonne, ROE, etc. compared to ArcelorMittal, Nucor (NUE), Steel Dynamics (STLD) and other peers), “should” only gets you so far in the market. I think Ternium has appeal for investors willing to try to predict a bottom in the steel sector, but this is a high-risk/high-return prospect.

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Ternium Seeing Heavy Near-Term Pressure, With A Tough Road To Recovery

ArcelorMittal Likely Approaching The Bottom

It’s been a pretty brutal year for steel stocks, as even protectionist policies in the U.S. and EU haven’t done much to shore up weaker pricing and demand. I’ve been pretty negative on most of these stocks, though my basic thesis of “own good names like Steel Dynamics (STLD) and Nucor (NUE) if you have to own something” has played out, as those two companies have done less worse than ArcelorMittal (MT) thus far this year.

The flip side of owning better companies in tougher times is considering worse companies when conditions start to bottom out. Although I expect ArcelorMittal to report a pretty ugly third quarter, and I don’t think the fourth quarter will be all that much better, I think ArcelorMittal’s business may be bottoming out now. To that end, I believe this global steel giant could see double-digit EBITDA growth in 2019 and solid single-digit growth in 2020 and 2021, although the risk of recession in both North America and Europe is still a significant risk factor.

I don’t have enough confidence in ArcelorMittal to call this a must-buy, but I like the company’s asset sale plans (vague as they are), the ongoing emphasize on price and margin over volume, and the potential uplift from improvements at newly-acquired Ilva. At this point, I believe ArcelorMittal shares should trade closer to $20, and this is a name for more aggressive contrarians to consider.

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ArcelorMittal Likely Approaching The Bottom

Softer Steel Markets Hitting Harsco

Harsco (HSC) didn’t have a great second quarter with respect to reported results or guidance, but I believe the 35% decline over the last three months has more to do with the ongoing weakness in the steel industry – the source of around two-thirds of Harsco’s revenue. Acquiring Clean Earth from Compass (CODI) should reduce some of the cyclicality of Harsco’s business, and Rail still has opportunities to do better, but it’s going to be tough to get the Street excited about a business tied to steel when steel stocks are themselves so weak.

Even with weaker near-term expectations, Harsco's shares look undervalued and the current set-up looks pretty good relative to where the shares have traded over the past year. I do have some concerns that the steel business could weaken further (largely on global macro weakness), but businesses like Clean Earth have gotten robust valuations from the Street in years past and even a more cautious set of expectations can support a share price in the $20s.

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Softer Steel Markets Hitting Harsco

High-End Data Center Opportunities Driving Inphi

Tech investors love growth, and with many semiconductor stocks grinding through a rut, Inphi’s (IPHI) strong double-digit growth is definitely bringing the stock plenty of the right kind of attention. Customers like Amazon (AMZN), Google (GOOGL) (NASDAQ:GOOG), and Microsoft (MSFT) continue to invest heavily into high-end data center capacity, driving strong demand for Inphi’s high-performance optical components, and the Cisco (CSCO)–Acacia (ACIA) deal could shift more DSP business toward Inphi as Acacia customers reconsider their supply chains.

I love Inphi’s business, but the stock is a little harder for me to embrace now. I thought the shares had upside back in May on the back of that above-average growth potential, but the 25% move was more than I expected. I know growth stocks can live in their own world when it comes to valuation (for a little while, at least), and I’m not betting against Inphi, but the Street already seems to be counting on a significant ramp in data center spending in 2020 and beyond.

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High-End Data Center Opportunities Driving Inphi

Sunday, September 22, 2019

Nektar Hammered On Multiple Setbacks; Core Efficacy Questions Remain Open

The last three months have been rough for Nektar Therapeutics (NKTR) and its shareholders, as the company announced significant manufacturing issues with its key lead drug, as well as a substantially reduced clinical partnership program with Bristol-Myers (BMY). On top of all that, there are still valid open questions as to whether that lead drug (bempegaldesleukin, or “bempeg”) even has a durable clinical effect.

There are very few sure things in biotech, and Nektar is no exception. I’m guardedly positive on the potential of bempeg in melanoma, but cannot rule out the risk that the ongoing pivotal study results in failure. Likewise with other late-stage clinical programs like renal cell carcinoma. While Nektar does have other products in the pipeline, they’re all early-stage and unproven, with relatively low risk-weighted probabilities of success. I do believe a risk-weighted approach still suggests Nektar is undervalued, but this is a high-risk biotech and a lot is riding on incremental clinical updates between now and the end of the year.

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Nektar Hammered On Multiple Setbacks; Core Efficacy Questions Remain Open

Alaska Air Standing Out A Bit, Though Far From Fully-Valued

The last three months have been a little kinder to Alaska Air (ALK), as the shares have outperformed its peer group by close to 10%. Deciding on the “why” for such a short-term move is always dicey, but I would like to think that maybe Alaska Air is finally getting a little credit for its strong ongoing execution, even in the face of growing concerns about excess industry capacity late in 2019 and into 2020.

Although I’m considered about the potential impact of a combination of less industry-wide discipline on capacity and a slowing U.S. economy, I believe Alaska Air is still trading below its fair value. If long-term revenue growth around 5% with high single-digit FCF margins, and/or a forward EBITDAR multiple of 6x, are credible inputs, these shares remain undervalued below $80.

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Alaska Air Standing Out A Bit, Though Far From Fully-Valued

Lundbeck Makes A Large M&A Move, But The Target Will Be Somewhat Controversial

Danish drugmaker H. Lundbeck A/S (OTCPK:HLUYY) (LUN.KO) (“Lundbeck”) made it clear that they were going to rebuild their revenue and clinical pipeline through M&A, with management highlighting around $4 billion to $5 billion in available capital and a preference for later-stage assets. After a few smaller transactions, Lundbeck finally made a big move, but management’s choice of target arguably leaves something to be desired.

Acquiring Alder BioPharmaceuticals (ADLR) gives Lundbeck a late-stage asset with minimal clinical/regulatory risk, but with significant commercial risk and not all that much pipeline extension value. Lundbeck doesn’t need Alder’s eptinezumab to be a super-blockbuster to get a worthwhile return from this deal, but it could still be challenging to carve out attractive market share as the fourth entrant into the market. With this likely-controversial deal, as well as significant patent cliff pressure and a weak pipeline, it’s harder to argue that there’s a reason for the Street to get much more positive on the shares in the near term.

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Lundbeck Makes A Large M&A Move, But The Target Will Be Somewhat Controversial

For Now, 'Okay' Will Have To Be Good Enough For Broadcom

Relative to what other companies in important end-markets like networking had already said about the June quarter (and guided for in the September quarter), Broadcom’s (AVGO) fiscal third-quarter results weren’t bad. Then again, while I have spent most of this year expecting a weaker/slower recovery in the chip sector, that wasn’t the consensus outlook, so there was still some room for Broadcom to disappoint expectations of a quick, robust turnaround.

I believe Broadcom’s core semiconductor business remains strong, and while the acquisition of Symantec’s (SYMC) enterprise security business is not without execution risks, it makes sense in the broader context of Broadcom management’s pursuit of financial engineering leverage. Broadcom's shares do still look undervalued to me, though not to a degree that would lead me to call this a “must consider” name in the space.

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For Now, 'Okay' Will Have To Be Good Enough For Broadcom

Monday, September 16, 2019

Dover's Investor Day Gives A Reassuring View Of An Improving Company

Multi-industrial Dover (DOV) has done quite well over the last year, handily outperforming most industrial peers as the Street has bought into this company’s self-help restructuring efforts. Not only has Dover taken strides toward higher margins, but the company has also become meaningfully less cyclical in the process.

I thought the shares were relatively fairly valued back at the time of second quarter earnings, and while the shares did sell off some after earnings, the stock has since recovered and has modestly outperformed its peers on renewed optimism that the trade dispute with China can come to a negotiated end. At this point, I like what Dover is doing from a structural/organizational standpoint, but I’m not all that excited about the valuation. It’s fine, I suppose, as a hold, but I’d wait in the hopes of a pullback before starting a position.

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Dover's Investor Day Gives A Reassuring View Of An Improving Company

Parker Hannifin Trying To Make Its Case For A Less Cyclical Future

I thought Parker-Hannifin (PH) had some appeal on a relative basis back in May, and while the share price performance since then hasn’t been spectacular, the shares have indeed outperformed the industrial peer group. Since that article, a few things have become clear – there’s definitely a short-cycle industrial slowdown, and Parker-Hannifin is looking to large inorganic investments in aerospace to create a less cyclical business mix.

Parker-Hannifin is more of a “show me” stock now in my opinion; management talks a good game about outgrowing peers on an organic basis and improving margins, but the company’s historical track record isn’t particularly strong. Moreover, I think management’s guide for the second half of its fiscal year 2020 (the first half of calendar 2020) could prove too optimistic. The valuation isn’t bad, and I think this is a good business, but it’s tough for me to work up much enthusiasm for a definitive buy/avoid call.

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Parker Hannifin Trying To Make Its Case For A Less Cyclical Future

Cosan Management Executing Through Trying Times And A Big Buyback Supports The U.S. Shares

Cosan Limited (CZZ) shares have continued to perform since my last update, rising almost 20% as the underlying companies continue to execute well in a challenging environment in Brazil and as management shows it’s willing to aggressively buy back shares when there’s a significant gap between Cosan Ltd. and the underlying value of Cosan SA (CSAN3.SA) and Rumo SA (RAIL3.SA).

I don’t see much reason for near-term optimism on the sugar or ethanol markets, and African swine fever is likely to continue pressuring Chinese demand for soy, but Cosan SA should still generate respectable free cash flow through this downturn due to its Comgas gas utility operations, and management has clearly shown they will support Cosan Ltd. through buybacks. The upside in Cosan Ltd. doesn’t look so exciting now, but I continue to believe this is a well-run conglomerate leveraged to economic growth in Brazil, and it would definitely be a name to reconsider at a lower level.

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Cosan Management Executing Through Trying Times And A Big Buyback Supports The U.S. Shares

Expectations For Societe Generale Have Dropped To A Point Where Outperformance Seems More Likely

There’s long been a line of thought in investing that there’s a price where almost any stock can be attractive, provided the business is a going concern. I don’t quite believe that (I’ve seen stocks languish for a decade or more), but I do believe that Societe Generale (OTCPK:SCGLY) has shored up its capital position and has finally started tackling some of its more significant lingering operational problems.

Even for a bank that generates such low returns, SocGen shares look undervalued, and I believe the expectations bar has been set so low for this bank that the odds favor some level of outperformance. The macro environment is a risk, particularly with the ECB now going back to easing, but it looks to me as though European banks in general, and SocGen in particular, has derated to a point where just “okay” performance would generate some upside.

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Expectations For Societe Generale Have Dropped To A Point Where Outperformance Seems More Likely

Valeo May Finally Be Bottoming

The best I can say about Valeo (OTCPK:VLEEY) is that the shares of this French auto parts company really haven’t done much worse than the peer group over the past year, a stretch over which only a small group of stocks like Aptiv (APTV) are up, and that the company continues to outperform underlying global build rates. Valeo remains one of the least-liked companies that I follow in terms of sell-side support, with several “Underperform/Sell” ratings on the shares.

I continue to believe that the shares reflect an overly pessimistic assessment of the company’s future, particularly given the potential of its Siemens (OTCPK:SIEGY) JV for electric vehicle components, but not unlike BorgWarner (BWA), questions have arisen as to the true value of the order book and whether future margins will live up to expectations. Management appears to have almost no credibility on the Street, and I consider this a higher-risk candidate, but I believe stabilization in the global car market next year could lead to a re-evaluation of the shares.

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Valeo May Finally Be Bottoming

Thursday, September 12, 2019

Palo Alto Networks Looks Undervalued As The Transition To Next-Gen Solutions Ramps

High multiples make for jittery investors, and even though I believe Palo Alto Networks (PANW) is undervalued, the shares do still trade at high multiples and with high embedded expectations. I believe Palo Alto management has made sound strategic moves in positioning the company for next-gen security priorities like cloud, integration/automation, and analytics, but the reality is that the next year or so could still be lumpy, and that’s not going to be great for investors who don’t like a lot of drama in stock price performance.

Although Cisco (CSCO) has improved its security business and Palo Alto has to contend with up-and-comers like Zscaler (ZS), I expect platforms like Prisma, Cortex, VM, and Demisto to drive meaningful growth that isn’t fully reflected in the share price. I consider Palo Alto a higher-risk stock, and I’m concerned about the overall level of software stock valuations, but I believe these shares should trade closer to $240 to $250.

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Palo Alto Networks Looks Undervalued As The Transition To Next-Gen Solutions Ramps

Lexicon Gets Some Clarity And Cash For Its Zynquista Diabetes Program

For a company that badly needed some good news, Lexicon Pharmaceuticals' (LXRX) announcement of a settlement with now-former partner Sanofi (SNY) for its Zynquista SGLT-1/2 inhibitor is a welcome development. While the settlement, which returns full rights to the drug back to Lexicon and includes a significant cash payment, is not a home run for the company, it is at least a meaningful improvement over a protracted legal fight with Sanofi, and the company can now look to secure a new marketing partner.

The good news for Lexicon is that the Sanofi deal still resulted in a European approval for Type 1 diabetes and a data package that will support filings for Type 2 diabetes in both the U.S. and Europe. The bad news is that further funding will be necessary to finish all of the Zynquista studies, Lexicon absolutely needs a partner to market the drug, and the company is still looking at an uphill climb to gain market share with a drug that doesn’t look particularly differentiated in Type 2 diabetes at this point.

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Lexicon Gets Some Clarity And Cash For Its Zynquista Diabetes Program

Fortive Pivoting Toward A Higher-Growth, Higher-Margin Model

Fortive (FTV) management has always espoused their belief in continuous transformation, and they're certainly living up to that philosophy. Roughly three years from the time of its split from Danaher (DHR), and about a year after the combination of its automation assets with Altra Industrial Motion (AIMC), Fortive is yet again launching a major restructuring that will see Fortive separate its retail fueling, telematics, and tool businesses into a new company, leaving the surviving Fortive more focused on higher-growth market segments with higher recurring revenue potential and potentially more robust margins.

That Fortive would make this move isn't surprising, particularly when you look at how companies like Danaher, Dover (DOV), Emerson (EMR), Honeywell (HON), and Roper (ROP) have been positioning/repositioning themselves in recent years. While bears could argue that Fortive may be doing this deal to blur some of the consequences of recent high-multiple acquisitions, I believe management has earned more credibility and benefit of the doubt than that. I wouldn't call Fortive's current valuation a "can't miss" opportunity, particularly with growing worries about the macro cycle, but the pullback does make this a name to consider.

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Fortive Pivoting Toward A Higher-Growth, Higher-Margin Model

Ciena's Story Is Steadily Improving, But The Stock Hasn't Been So Steady

I’ve written more than once that Ciena (CIEN) shares often give investors “second chances” and that there are fairly frequent gaps between the company’s performance and near-term sentiment. And here we are again – while the company beat expectations in the fiscal third quarter and continues to gain share, the combination of concerns about global spending and management’s “failure” to raise guidance has the shares down about 13% relative to my last update.

I’ve written before that I like the idea of buying Ciena shares below $40, and as of this writing, that’s where we are, so this is a name that is very high on my prospective buy list. Yes, I am concerned about the potential of slower datacenter spending, as well as lumpiness in service provider deployments, but I’m willing to accept that risk given the share gain, market growth, and margin improvement offsets. Ciena certainly wouldn’t be immune to a broader market sell-off (particularly a tech-led sell-off), but again that’s a risk that I’m willing to accept on balance.

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Ciena's Story Is Steadily Improving, But The Stock Hasn't Been So Steady

Monday, September 9, 2019

Hurco Now In The Teeth Of The Downturn

The fact that Hurco (HURC) is starting to see a sharp downturn in revenue really should be no surprise; orders went negative three quarters ago, and nothing in the global manufacturing economy has really gotten better since then. At this point, there is still a great deal of uncertainty over the shape of this downturn – will this growing “sluggishness” turn into an outright recession, or is this more of a lull in an otherwise healthy trend?

I’ve been of the opinion for about six months that there was more emerging weakness than commonly expected, and I do still see some downside risk to 2020 – particularly if the trade disputes between the U.S. and China and the U.S. and EU intensify. Specific to Hurco, management has been through this before and the company is in solid financial shape. The shares are undervalued now, but I still see some downside risk, mostly to perception/sentiment, in the industrial sector over the next couple of quarters, so investors looking at this name as an undervalued rebound play need to recognize the risk that the decline isn’t over yet.

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Hurco Now In The Teeth Of The Downturn

Grainger Executing On Margins, But The Pressures Are Increasing

Given their sensitivity to the economic cycle, it’s no great surprise that the market performance of industrial distributors like Fastenal (FAST), Grainger (GWW), and MSC Industrial (MSM) has been lackluster at best. Likewise, it makes sense that Grainger’s relatively better end-market exposure and margin performance would drive better performance than MSC, the laggard of the three.

Grainger shares don’t look expensive now, but I do still have some concerns that management may be underestimating the weakening trends underway in manufacturing end-markets and overestimating the ability of its internal programs to drive above-market growth. I think investors will have at least one more chance to buy Grainger shares at a better price in the second half of 2019, but the shares do look relatively attractive compared to Fastenal and MSC at this point.

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Grainger Executing On Margins, But The Pressures Are Increasing

BorgWarner Hammered On Near-Term Pressures And Longer-Term Doubts

Although I did see some risk to BorgWarner (BWA) from "lower for longer" weakness in the global auto market, the 20% decline since my last update seems like a somewhat extreme reaction to what was already known to be a tough operating environment. On the other hand, this is another example of how the difference between longer-term DCF-based valuation and shorter-term earnings-based valuation approaches can toss stocks around, particularly in uncertain and fearful markets.

I don't see much that has changed in BorgWarner's long-term outlook, though I will once again repeat my concern/caveat about uncertainties on the margins for future hybrid/EV wins and the pace of new vehicle launches and adoption. Although I expect the second half of 2019 will be rough, and likely 2020 too, I still like the long-term story and BorgWarner's long-term opportunity in vehicle electrification, and I think this is a good time for more patient investors with a longer horizon to do their due diligence.

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BorgWarner Hammered On Near-Term Pressures And Longer-Term Doubts

GenMark's Share Price Isn't Reflecting The Improvements In The Business

GenMark (GNMK) is a relatively late entrant into a very competitive market, but the company’s ePlex multiplex molecular diagnostics system nevertheless addresses real issues for hospitals and small reference labs, and the overall market is still under-penetrated when it comes to multiplex systems. Management needs to make sure that the company continues to roll out new panels and expand the available test menu at a good pace, but the share price doesn’t seem to give much credit for the improvements in the business relative to a year ago.

Between cash flow and forward revenue, I believe GenMark shares should trade closer to $9 - $10 than $6. An ATM facility should get the company through to positive free cash flow, but it does remain to be seen how system placements will develop over the next 6 to 12 months. Although GenMark remains a riskier than average call, I believe the share price doesn’t reflect the full value of the business.

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GenMark's Share Price Isn't Reflecting The Improvements In The Business

Wednesday, August 28, 2019

The Cycle Is Probably The Least Of 3M's Worries Now

Despite its arguably undeserved (or at least exaggerated) reputation as a “defensive growth” name, 3M (MMM) actually has a history of being one of the most sensitive names to turns in the cycle – 3M tends to see the downturn before others, and likewise tends to see the recovery. While the good news in that is that 3M may already be about halfway through the downturn (if this cycle matches past cycles), the bad news is that there are a lot of bigger challenges for 3M beyond the cycle.

Environmental liability is going to capture a lot of attention in the near-term, but I’m more bothered by the company’s troubling lack of margin leverage and recent capital allocation decisions as they pertain to M&A. 3M isn’t a bad business, and it’s not un-fixable, but it’s going to take work to fix, and the apparent returns aren’t all that exciting in that context.

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The Cycle Is Probably The Least Of 3M's Worries Now

Universal Stainless & Alloy Products Looking For Aerospace And Premium Offerings To Drive Leverage

The shares of Universal Stainless & Alloy Products (USAP) have done well since I last wrote on the company. Not only is the greater than 25% move in the stock price strong on its own, but it is also quite a bit better than other nickel alloy rivals like Carpenter (CRS) (up 10%), Haynes (HAYN), and Allegheny (ATI) over the same time period. Better still, the aerospace market opportunity continues to improve, backlog continues to build, and a collection of adverse margin headwinds shouldn’t repeat.

While I thought USAP was undervalued back in May, I was concerned about the company’s challenges in achieving long-hoped for utilization improvement and margin leverage. Those concerns are still in play, but backlog growth speaks to suppliers ramping up ahead of expected production build growth at Boeing (BA) and other aerospace OEMs. I still think USAP shares look undervalued, though, and I think the odds are improving that USAP is going to exit 2019 with more apparent business/earnings momentum and quite possibly a healthier multiple as well.

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Universal Stainless & Alloy Products Looking For Aerospace And Premium Offerings To Drive Leverage

PRA Group Showing Good (And Long Awaited) Progress

It’s been tough to stay patient with PRA Group (PRAA), particularly as management has levered up the business during a time of declining performance. It does seem, though, that improvements and investments in the business are finally showing to show up in the results, and with the longer tail to investments made in legal collections, I expect ongoing improvements for at least a few quarters.

Valuation is less compelling after the post-earnings jump. I believe a mid-$30s fair value is reasonable on the basis of my discounted cash flow, discounted core earnings, and EV/EBITDA approaches, but that doesn’t leave exceptional upside from here.

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PRA Group Showing Good (And Long Awaited) Progress

Wednesday, August 21, 2019

Expectations For Cognex Could Be Washed Out, Though Multiples Are Still Robust

Machine vision specialist Cognex (CGNX) is still looking a little bleary-eyed, as the company is absorbing a rare one-two bunch of serious deterioration in its two largest markets (autos and consumer electronics). While the revisions to near-term growth expectations have been painful, it increasingly looks as though the stage is being set for easier comps in 2020 and beyond, and although I have my doubts about the consumer electronics business, I think the auto and factory automation end-markets will recover (while logistics continues to grow nicely).

Cognex isn't dirt cheap, but it still remains a favored name in discussions of "factory of the future" stocks, and the company's machine vision capabilities make it a fairly rare asset in industrial automation. While I do think Cognex's primary end-markets aren't likely to get much worse from here, a broader sell-off in the market (or increased risk aversion) could still shrink the multiple further. On the other hand, I don't expect Cognex to ever trade at a particularly wide discount to long-term fair value, and I wouldn't advise getting too clever about trying to call a bottom here.

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Expectations For Cognex Could Be Washed Out, Though Multiples Are Still Robust

A Second Quarter Shortfall And Weakening Markets Aren't What Manitex Shares Needed

I was reluctant to give Manitex (NASDAQ:MNTX) full credit for its performance in the first quarter, and key end-markets have apparently slowed further. That, in turn, has led to a disappointing second quarter and a weak share price as the outlook for the second half is quite a bit cloudier now. Although Manitex does have credible attractive opportunities like its growing knuckle-boom crane business, I don't see the construction end-markets getting stronger from here, and I think margin leverage is going to be harder to achieve.

Compared to markets like Class 8 heavy trucks, I don't think Manitex is likely looking at an impending sharp cyclical correction, but I also don't think the company's end-markets are getting stronger. That sets up a difficult valuation/stock call, as the long-term discounted free cash flow opportunity still looks relatively attractive, but the Street tends to value machinery companies like Manitex, Manitowoc (MTW), and Terex (TEX) more on the basis of near-term margin and revenue expectations, and those don't work as much in the company's favor now.

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A Second Quarter Shortfall And Weakening Markets Aren't What Manitex Shares Needed

ABB Gets It Right With The CEO Search, But A Lot Of Work Lies Ahead

Perhaps proving that even a blind squirrel can trip over a nut once in a while, ABB’s (ABB) board of directors made one of the best decisions I’ve seen it make in a long time, announcing on Aug. 11 that it had hired Bj√∂rn Rosengren to become its next CEO. Mr. Rosengren joins ABB from Sandvik (OTCPK:SDVKY) and will assume the position on February 1, 2020.

I believe Rosengren is precisely the sort of CEO that ABB needs now, and he has relevant experience managing global multi-industrial conglomerates. What’s more, margin improvement and corporate agility are very much needed at ABB these days, and Rosengren’s record here is strong. While investors should recognize that ABB’s performance will likely get worse before it gets better, as the economic cycle turns and a new CEO brings still more disruption to operations, I believe there’s a more credible case now for owning ABB in anticipation of better results down the road.

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ABB Gets It Right With The CEO Search, But A Lot Of Work Lies Ahead

Alnylam Executing, But Concerns About Safety And Competition Linger

In terms of controlling what they can control, I believe Alnylam Pharmaceuticals (ALNY) management is doing a good job. While there has certainly been criticism of the high cash burn and the large sums that the company spends on R&D, I believe funding a robust Phase III development program is a sound strategy to build the business. In the meantime, though, the shares seemed to be dogged not only about concerns about the ongoing cash burn, but also concerns about competition and platform safety. My position remains that Alnylam is in a stronger position than the share price reflects.
 Competition is always going to be a threat (any indication worth targeting will attract competition), but I believe the safety questions are closer to resolution. With another approval likely in early 2020 and a robust late-stage platform, I still believe these shares should trade closer to $130.

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Alnylam Executing, But Concerns About Safety And Competition Linger

Tuesday, August 20, 2019

Groundhog Day At Wright Medical, As The Lower Extremity Business Disappoints

“History doesn’t repeat itself, but it often rhymes,” Mark Twain (disputed)

Wright Medical’s (WMGI) problems with its lower extremity business in the second quarter of 2019 aren’t the same as the company’s prior issues in that business, but the Street doesn’t care. The fact remains that while Wright Medical still offers comparatively attractive growth rates and operating leverage within the med-tech space, the company has shown itself to be unreliable and unpredictable, whatever the reason(s) may be, and investors hate paying premiums for unreliable performance.

This is probably the time you want to consider these shares, but it takes a patient contrarian viewpoint to do so. Wright Medical is still on its way toward gaining the top spot in shoulders, and despite the issues in the lower extremity business, the company still has a strong portfolio of next-gen technologies and products. Add in the prospects for meaningful inflection in profits over the next three to five years, and this is an interesting name to consider on this pullback even with the threat of increased competition from companies like Stryker (SYK) and Zimmer Biomet (ZBH).

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Groundhog Day At Wright Medical, As The Lower Extremity Business Disappoints

Sick Chinese Pigs Driving Healthier Profits For BRF

I have been generally bullish on the turnaround plan underway at BRF SA (BRFS), as management is bringing a great deal more operating discipline to a company that has never had much of it. Add that enhanced discipline and a greater focus on bottom line profits to a business with strong domestic market share and an underrated Middle Eastern business, and that’s why I’ve been consistent in saying that a successful turnaround could drive a meaningfully higher share price for BRF down the road.

Along the way, though, the company has picked up an unexpected tailwind from a serious outbreak of African Swine Fever (or ASF) in China. This outbreak has led to a dramatic increase in food imports into China, boosting global prices, while BRF has also started seeing lower input costs.

The ASF outbreak won’t last forever, but it is effectively “free money” for BRF and will both accelerate the turnaround process and give management more flexibility in its strategy. The improved near-term outlook supports a fair value near the double-digits, but I believe the ASF outbreak will have to get worse to support a substantially higher near-term price, though the longer-term fair value of a successful turnaround is still higher than today’s price.

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Sick Chinese Pigs Driving Healthier Profits For BRF

Lundbeck's M&A Flexibility May Be Its Greatest Asset Today

The core business of Denmark's H. Lundbeck (OTCPK:HLUYY) (LUN.KO) is more or less an "is what it is" situation; while there is still some potential upside from the company's newer portfolio of drugs, potential market-expanding studies won't read out for years. Where the upside likely lies today is in the company's M&A strategy, as the company has deployable capital of over $4 billion that could meaningfully change the outlook for the company in the mid-term and beyond.

With the exception of certain serial acquirers, I almost never factor M&A into a company's valuation, and Lundbeck is no exception. That said, it's unwise to ignore it outright. Lundbeck shares look a little undervalued as is, and it seems like sentiment is still weighted toward the bearish view that Lundbeck will pursue dilutive, value-destroying deals. To the extent that Lundbeck management can deliver a good transaction or two, then, there could be a greater upside than what would otherwise be in the business as is.

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Lundbeck's M&A Flexibility May Be Its Greatest Asset Today

FEMSA Makes A Cautious Entry Into The Brazilian C-Store Market

Investors have been expecting two things from FEMSA (FMX) for some time – entry into the fragmented Brazilian convenience store (or c-store) market and deployment of some of the company’s sizable cash pile towards growth. While the agreement between FEMSA and Cosan (CZZ) announced on Aug 6 achieves the first one (at least in part), it doesn’t really impact the second expectation to any meaningful extent.

On balance, the JV with Cosan is a reasonable strategic move. While the nature of Cosan’s c-store business isn’t going to allow FEMSA to just replicate its OXXO model in Brazil, at least not initially, it gives the company a relatively low-risk, low-cost entrance into an important market and with a strong partner. I continue to like FEMSA as an investment (and Cosan, too), but this deal won’t move the needle on financial performance or valuation in the near term.

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FEMSA Makes A Cautious Entry Into The Brazilian C-Store Market

Commercial Vehicle Looks Undervalued, But Business Likely To Deteriorate From Here

Long-term investing may be best for individual investors, but the reality is that investors have to deal with a market that is much more focused on the short term. That’s relevant to the Commercial Vehicle Group (CVGI) investment thesis, as the market tends to value auto and truck suppliers on the basis of their short-term EBITDA margins and revenues, and both of those numbers are likely to get worse for CVGI as the U.S. heavy-duty truck market corrects off a cyclical peak.

I can see some downside risk toward $6/share if the market really punishes the sector for weaker results in 2020, but I think fair value is closer to $8 to $10. That’s decent upside relative to the downside, and Commercial Vehicle has liquidity that could be invested in growth-oriented M&A, but CVGI’s valuation is not so unusual relative to the wider auto/truck parts sector and this business has been more cyclical than many of its larger peers in the past.

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Commercial Vehicle Looks Undervalued, But Business Likely To Deteriorate From Here

Accuray's 'Wait 'Til Next Year' Story Wearing Thin

It has been a long time since Accuray (ARAY) has shown any sustained momentum in the business, and it looks like the market is largely out of patience. Although the company hit an all-time high for quarterly revenue, it still can’t reliably hit the $100M/quarter order target I believe it needs to reach to achieve any real momentum in the business, and the share price is at an all-time low.

Does a record high quarterly revenue figure and a record low share price mean that there is a fundamental disconnect between the market and the company? There are a lot of good things I can say about this management team, but they haven’t been able to change the underlying competitive dynamic much (Varian (VAR) has only gotten stronger) and pretty much all of the company’s eggs are now in the “China will change things” basket.

I don’t believe Accuray’s China business will drive a fundamental shift in the business and I disagree that Accuray has particularly attractive prospects as a buyout candidate. Although I do think the shares should trade in the mid-single digits, and that’s considerably higher than today’s price on a percentage basis, this is a speculative call at this point.

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Accuray's 'Wait 'Til Next Year' Story Wearing Thin

Lexicon Pharmaceuticals Now Walking A Fine Line

Lexicon Pharmaceuticals (LXRX) management reported earnings for the second quarter on July 31 and provided a little more context and detail about the situation with Sanofi (SNY) regarding the latter’s attempt to exit the development and marketing collaboration for SGLT-1/2 drug Zynquista in diabetes. Although the update does reinforce the notion that Lexicon has some enforceable rights here, management is realistic that the collaboration is effectively over.

Lexicon is in a precarious place. Relative to cash burn, the company probably has around a year’s worth of cash left, and it seems unlikely that any legal disputes with Sanofi could be resolved that quickly. Although the pipeline has some upside potential and Zynquista could still be a marketable drug, management will really have to thread the needle for the potential value of the stock to be a relevant concern.

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Lexicon Pharmaceuticals Now Walking A Fine Line

FEMSA Plugging Along, But Not Really In Favor

Investors haven’t really been all that eager to invest in Mexico this year, and as one of the leading plays on consumer spending, FEMSA (FMX) has likewise had a lackluster performance. The underlying operating performance has remained strong, though, and stripping out the Coca-Cola FEMSA (KOF) and Heineken (OTCQX:HEINY) suggests a multi-year low valuation for the core FEMSA retail operations that, though understandable in the context of reduced near-term confidence around Mexico’s economy, still looks relatively attractive on a long-term basis.

I thought FEMSA’s valuation was “okay, but not great” back in April, but the underperformance since then has the valuation looking more interesting to me today. With management showing prudence on capital deployment and the underlying OXXO business still performing quite well, I believe this is a good time to reconsider the shares as a long-term idea, though a weaker macro outlook for Mexico remains a key near-term risk.

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FEMSA Plugging Along, But Not Really In Favor

Neurocrine Executing Very Well With Its Lead Commercial Compound

Neurocrine Biosciences (NBIX) was never set up for a great year in 2019 from a clinical data/pipeline perspective, but management is compensating so far with strong sales execution with its approved drug Ingrezza. With the company now free cash flow positive, management has a lot of options when it comes to M&A and/or in-licensing, not to mention sponsoring robust clinical programs for promising new candidates. That said, this has always been a very deliberate, patient management team and investors shouldn’t expect that to change – this is very much a “do it right” as opposed to a “do it right now” company.

I’m content to wait, as Neurocrine has shown that it can develop effective drugs, market them well, and avoid wasting resources on low-probability assets. I believe fair value for the shares is around $120, with around 70% of that from Ingrezza, but meaningful potential data-driven upside from the CAH program and possibly underestimated potential for opicapone as well.

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Neurocrine Executing Very Well With Its Lead Commercial Compound

Friday, August 2, 2019

STMicroelectronics' Content Growth Opportunity Outweighs Short-Term Cyclical Pressures

Everybody talks about companies surprising the Street, but, every once in a while, the Street has its own surprises - for instance, when investors are willing to look past near-term pressures and focus on the bigger picture. With weakness in autos and industrial markets pressuring STMicroelectronics (STM), analysts could have responded to lowered guidance for the second half of 2019 with "Hah! I told you they couldn't do those numbers!" Instead, the Street seems to be willing to look past a few bumps in the near in favor of the increasingly attractive long term.

While I'm a little surprised to see it, I agree with it. I think STMicro has a very attractive long-term story, driven by content growth and new product opportunities across a range of markets. What's more, I think this downturn has offered solid evidence that this is a new, better, more sustainably profitable company than in the past. Although I'd ideally like to pick up shares below $17.50, I think the stock can still work from here, particularly for more buy-and-hold-oriented investors.

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STMicroelectronics' Content Growth Opportunity Outweighs Short-Term Cyclical Pressures