Thursday, March 14, 2019

The FDA's Upcoming Decision On Zynquista Is Key To Lexicon's Performance

Lexicon Pharmaceuticals (LXRX) has long been a volatile stock, even by the standards of biotech, and whether it can move out of its current doldrums has everything to do with next week’s FDA decision on Zynquista for Type 1 diabetes (or T1D). With Xermelo relegated to an “is what it is” disappointment in carcinoid-related diarrhea and other clinical candidates in early stages of development, Zynquista is the key value-driver now.

I’m still guardedly optimistic that the FDA will approve Zynquista, albeit with warnings and risk mitigation strategies, but I don’t exclude the possibility of a rejection on procedural grounds or a requirement for a risk mitigation study. Still, with what I regard as overly-discounted expectations for Zynquista in both T1D and Type 2 diabetes (or T2D), these shares still look undervalued, albeit very risky, to me.

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The FDA's Upcoming Decision On Zynquista Is Key To Lexicon's Performance

Commercial Vehicle Performing Well In A Plateauing Market

Taken in isolation, things are going well for Commercial Vehicle (CVGI), as the company’s management has executed pretty successfully on cost-optimization and business restructuring efforts. The company also has some future growth opportunities that could drive long-term revenue growth above build rates, as truck and off-road vehicle manufactures add more electrical components and systems to their vehicles. The “but” is that Commercial Vehicle’s primary markets appear to be plateauing and it may be hard for the shares to get ahead as near-term revenue growth prospects diminish.

Holding cyclical stocks through cyclical declines can be a painful test of patience. I do believe Commercial Vehicle remains undervalued, but it’s tough to say how much of the impending decline in truck production is already priced into the shares. Investors with a longer term orientation may not care, but the next year or so could be more challenging for the stock.

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Commercial Vehicle Performing Well In A Plateauing Market

Alnylam Is A Step Closer To Its Second Approved Drug

The last twelve months haven’t been particularly good in terms of market performance for Alnylam Pharmaceuticals (ALNY), and that hasn’t really changed much over the last three months either, as the shares continue to lag biotech indices. With top-line Phase III givosiran data looking good on efficacy but leaving some questions as to safety, the ENVISION study hasn’t been much of a catalyst and that may be the case for a little while longer. I do believe these shares remain undervalued, though, and offer some attractive long-term upside.

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Alnylam Is A Step Closer To Its Second Approved Drug

Neurocrine Biosciences May Have Something Interesting With NBI-74788

It’s still very early, but Neurocrine Biosciences (NBIX) might have another compelling, largely underrated, drug in NBI-74788 for congenital adrenal hyperplasia (or CAH). Although Ph IIa data does little more than work to establish proof of concept at this point, I do believe it’s enough to get sell-side analysts and investors to start doing some due diligence on what I believe could be a meaningful contributor to Neurocrine down the road.

Neurocrine shares remain undervalued, but value-drivers are looking a little more limited in the short term. AbbVie’s (ABBV) “slow and steady wins the race” approach with Orlissa might be the right way to go long term, but it could lead to some near-term disappointments in terms of growth, and neither the opicapone program or the collaboration with Voyager (VYGR) are likely to generate much near-term buzz. Still, with the shares meaningfully below my estimate of fair value, I think it’s a name to consider.

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Neurocrine Biosciences May Have Something Interesting With NBI-74788

Cognex Muddling Through Some Temporary Macro Challenges

I flagged Cognex (CGNX) back in early December as offering rare upside for a high-growth industrial, and though the shares had further to fall before bottoming on Christmas Eve, they’re still up about 20% since that early December article – outperforming its closest peer Keyence (OTCPK:KYCCF) and industrial stocks in general.

It’s a harder call to make now, though I still really like the machine vision space and continue to believe that Cognex has attractive addressable long-term growth opportunities in logistics, autos, and factory automation. I don’t believe my expectations of low double-digit revenue growth and mid-teens FCF growth over the next decade are conservative and I’m worried that there could still be another round of disappointment in consumer electronics and autos, though a negotiated trade agreement with China could brighten that outlook. I’d definitely look at Cognex again were it to pull back to mid-$40’s, but here it looks more like an attractive hold.

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Cognex Muddling Through Some Temporary Macro Challenges

Ciena Executing Well On Growing Opportunities In Telco And Data Centers

Ciena (CIEN) has been one of my preferred names whenever Wall Street skepticism starts ramping up and undermining the price, and the shares have chopped their way almost 50% higher over the past year and 70% over the past two years, handily outperforming rivals like Acacia (ACIA), Infinera (INFN), and Nokia (NOK) over those time periods. While I do think the valuation today is more demanding, or at least more reflective of Ciena’s strong execution and growing end-market opportunities, the share price isn’t unreasonable and this is absolutely a name to consider on pullbacks.

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Ciena Executing Well On Growing Opportunities In Telco And Data Centers

Keyence's Diverse Business Model Continues To Deliver

From a quality perspective, it’s hard to find many better companies in the automation-enabling space than Japan’s Keyence (OTCPK:KYCCF) (6861.T). A strong player in machine vision, sensors, control systems, and other precision equipment, Keyence is not only a leader in attractive areas like 3D vision and product ID, but it has a long history of “self-obsoleting” and moving out of increasingly competitive markets that are no longer willing to pay for innovation before they become commoditized.

The only problem with Keyence is that its qualities are well-known and typically well-reflected in the share price. I thought the shares were an okay pick back in mid-2018 for longer-term investors wanting a dependable play on automation, but I didn’t think they were particularly undervalued, and the shares have mostly just kept pace with the broader industrial sector, while underperforming Cognex (CGNX) but outperforming a fair few Japanese automation names. I think this recent run in many automation names may be underplaying the risk of further macro deterioration, and while I’d still stand behind Keyence as a long-term holding, I’d wait in the hope of a cheaper entry price.

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Keyence's Diverse Business Model Continues To Deliver

More Mixed Numbers From PRA Group

Every company/stock has a “hassle factor” attached, and I’m increasingly wondering if PRA Group (PRAA) is worth that hassle factor. The nature of the business of buying charged-off debt and then collecting on it makes for complicated modeling and sometimes-confusing reports, but the underlying takeaway is pretty simple – PRA Group just doesn’t seem to be doing it as profitably as they used to, and I’m not sure the operating environment is going to get all that much better.

There are certainly are some things that could go well for PRA Group. I believe recent purchase should have higher yields than the generation right before it, and the company’s efforts to scale up legal collections and build up its call centers is a “pay today, profit tomorrow” sort of trade-off. Although I can see upside into high $30’s to low $40’s if things go well, I’m increasingly concerned that PRA may not have as much room to improve margins as I previously believed and that the potential gains may not be worth the headaches involved.

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More Mixed Numbers From PRA Group

Slowing Orders At Hurco A Growing Risk

I always considered a cyclical slowdown at Hurco (HURC) a “when, not if” proposition, and it seems like the when is an increasingly near-term concern. Fiscal first quarter results weren’t bad, but a third consecutive decline in orders shouldn’t be ignored, particularly when major players in the machine tool market are calling for a double-digit decline in orders in 2019 and European demand appears to be weakening.

Hurco remains undervalued relative to industrial sector norms, but I’m pretty cautious about the outlook for a host of industrial sectors, including “general manufacturing” and it’s tough to get ahead owning even undervalued stocks in a weak cycle for the sector. Consequently, while I still like Hurco as a business and the valuation doesn’t appear demanding, it’s tough to recommend the shares unless you have a fundamentally more bullish view on the prospects for the North American and EU economies over the next 12-24 months.

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Slowing Orders At Hurco A Growing Risk

BRF Underway With Its Turnaround, But A Lot Of Self-Improvement Remains

BRF (BRFS) has to be glad to put 2018 behind it, as the only real positives to come out of that year will likely be the hiring of Pedro Parente as the Chairman and CEO and the decision to launch a far-reaching deleveraging and divestment program. Management’s projections for 2019 still look a little on the bullish side, but the company does have a relatively solid base in Brazil and Middle Eastern halal markets from which to rebuild the business.

I do expect margins to improve from here, but it won’t be a fast turnaround and I believe the company faces ongoing challenges from competition within the Brazilian market and protectionist measures in key export markets like Saudi Arabia. Although a successful turnaround could likely support a fair value in the double digits some years down the road, I believe a fair value in the $6 to $7 range remains reasonable today.

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BRF Underway With Its Turnaround, But A Lot Of Self-Improvement Remains

Driven By OXXO, The Core FEMSA Story Remains Attractive

FEMSA (FMX) isn’t the simplest company, nor does it offer the cleanest, most straightforward financial reports, but at its core this remains a well-run play on Latin American consumers. Underpinned by the OXXO convenience store business, I believe FEMSA has a long runway of attractive growth opportunities and the capital to further enhance its prospects. Currency moves and the health of the Mexican economy are key variables, but with a double-digit implied return on offer, I believe this remains a good candidate as a core holding for investors who want some emerging market exposure.

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Driven By OXXO, The Core FEMSA Story Remains Attractive

ABB Still Has A Lot To Do And A Lot To Prove

Owning ABB (ABB) has not been a particularly rewarding experience. While the company's decision to sell its Power Grids business to Hitachi is a sound one, and the company has attractive opportunities across its business units, a long history of underperformance relative to the opportunities available is not something investors should just ignore.

Valuation, and the idea that ABB can be/do better than this, remain the best arguments for sticking with the stock, but that's an increasingly unconvincing argument to me, and I can't really say that you should favor ABB over Eaton (ETN), Schneider (OTCPK:SBGSY), and Honeywell (HON), let alone a long list of other industrial names.

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ABB Still Has A Lot To Do And A Lot To Prove

Rexel Delivering On Its Turnaround, But Getting No Credit

In closing my last article on Rexel (OTCPK:RXEEY) (RXLSF), I commented that “turnarounds can test investor patience”, and that has certainly been true for this global electrical products distributor. The market hasn’t been too keen on many stocks in the distribution space since that last article, with stocks like Grainger (GWW) and Ferguson (OTCQX:FERGY) losing ground, but Rexel has done substantially worse, and likewise lagged the shares of electrical products companies like Eaton (ETN), Schneider (OTCPK:SBGSY), Legrand (OTCPK:LGRDY), Hubbell (HUBB).

I can understand investor concerns about slowing macro, as I too expect construction spending to slow in the EU and U.S. in 2019, and I can likewise understand concerns that Amazon’s (AMZN) efforts in the space will lead to lower margins over the long term. Still, those issues seem more than amply reflected in the share price, and I don’t think the valuation reflects the progress made in 2019, nor the benefits yet to be seen from exiting underperforming businesses and restructuring toward higher-value products.

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Rexel Delivering On Its Turnaround, But Getting No Credit

Merck KGaA Crashes Into The Versum-Entegris Tie-Up

I liked both Versum (VSM) and Entegris (ENTG) in the fall of 2018, Entegris a little moreso, on the idea that the market was overreacting to the correction cycle in semiconductors and semiconductor equipment and that underlying chip production (a key driver for Versum) was unlikely to be impacted as much as seemed to be reflected in the prices. When Versum and Entegris announced their intent to merge in late January, I thought it made a lot of sense and would create a stronger new company, led by management team (Entegris) with a lot of experience in M&A integration.

Now Merck KGaA (OTCPK:MKKGY) has pushed itself into the conversation, making an unsolicited all-cash offer that is well above the upfront value offered by the Entegris deal. Although I can see why some shareholders may prefer a stock-for-stock bid and I believe there are some regulatory risks to the Merck KGaA offer, it’s hard to argue with an all-cash offer that is well above what Versum shareholders were otherwise expecting.

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Merck KGaA Crashes Into The Versum-Entegris Tie-Up

The Strong Look To Get Stronger As JPMorgan Continues To Target Growth

Already one of the best-run companies I follow, JPMorgan Chase (JPM) has shown an uncanny ability to leverage its strengths and maintain a steady pace of process improvement while looking for new growth opportunities. There wasn’t much that was all that new in JPMorgan’s Investor Day presentations (nor in the 10-K), but when you’re already executing very well on a very good plan, there’s not much reason to change.

JPMorgan's shares remain undervalued in my view, even though I believe banks are no longer in the best part of their respective cycle. With a high-quality business that still has meaningful long-term growth opportunities, I still regard this as a core holding and I think the upside potential still leaves it as a name to consider for new investment.

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The Strong Look To Get Stronger As JPMorgan Continues To Target Growth

Wright Medical Still Walking A Tightrope, But Growth Should Pick Up

Wright Medical (WMGI) has long been a challenging med-tech investment story. On the positive side, the company has been a share gainer in shoulders, still holds a strong portfolio (and market position) in foot/ankle, and is leveraged to an underpenetrated market that should support high single-digit revenue growth for some time to come. On the other hand, sales execution has been inconsistent at best, and the company is seeing renewed competitive vigor from rivals like Integra (IART) and Stryker (SYK).

On balance, I still think there’s upside in these shares from here, but management must execute on a consistent and reliable basis to build real long-term value for shareholders, and the jury is still out on whether they’re up to the task.

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Wright Medical Still Walking A Tightrope, But Growth Should Pick Up

Danaher Adds A Jewel To Its Crown

It's not too often that you see an M&A transaction that sends the shares of both companies meaningfully higher, but Danaher's (DHR) acquisition of most of General Electric's (GE) Life Sciences business is a good move for both companies. For GE, the deal brings badly-needed cash that will help shore up the business as CEO Larry Culp tries to turn that hamstrung behemoth around. For Danaher, this is a crown jewel acquisition that meaningfully enhances the company's life sciences business (particularly in bioproduction/bioprocessing) and gives it even more exposure to a fast-growing acylical business with strong margins.

Although pricey, the GE Biopharma deal boosts Danaher's long-term growth rate and margins, and I believe management's synergy/accretion expectations are credible if not conservative. It's hard to say that Danaher is cheap, but considering the enhanced exposure to a very attractive market, I understand why the shares trade where they do.

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Danaher Adds A Jewel To Its Crown

Valeo Hits The Wall, And The Wall Falls On Top Of It

The last year was a tough one for auto parts suppliers in general, particularly after midyear and especially for European suppliers, but it was an abysmal year for Valeo (OTCPK:VLEEY) [VLOF.PA] as the shares lost about half their value on successive miss-and-lower quarters that eventually saw management's outlook for 2019 erode from double-digit growth to low single-digit growth with lower margins.

I don't believe that Valeo is fundamentally broken, but investor confidence in management clearly is, and I can't say that that is unfair. The magnitude of the guidance revisions has been significant, as has been the discrepancy with order growth and the large order write-off in China, all of which leads to ample uncertainty about the company's outlook. While I do believe that Valeo has assembled a very strong position and platform for electrification, that assembly has led to high upfront costs with the payoff coming further down the road. I do still believe that Valeo is undervalued, but this is a company that is deep in the doghouse and will need time to reemerge.

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Valeo Hits The Wall, And The Wall Falls On Top Of It