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

Schneider Electric Standing Out In An Increasingly Challenging Market

A lot of investors still have a grudge against Schneider Electric (OTCPK:SBGSY) (SU.PA), due mostly I believe to a historical track record that left a lot to be desired, including an M&A policy that saw a lot of capital flowing out, reducing ROIC, and not always a lot of quality coming back in. Starting with the Invensys acquisition in 2014, though, and maybe even including Telvent in 2011, management has been making better choices and has crafted a company with a strong position in electrification and automation - two of the more attractive business areas for the industrial sector in the coming decade.

As things stand today, Schneider is one of the better-performing European multi-industrials, and I like not only the company's strong position in electrification (across residential, industrial, commercial, and data center markets) but also its improving software and control-heavy automation portfolio. With a roughly 30% year-to-date run, though, I can't be as bullish as before. I do still like this company and see it as a share-gainer in its markets for many years, but the prospective return isn't high enough.

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Schneider Electric Standing Out In An Increasingly Challenging Market

Stryker Making Excellence Look Effortless

Having covered the med-tech space for about 20 years, I can tell you that what Stryker (SYK) is doing - generating consistent mid-to-high single-digit organic growth, outgrowing its end-markets across multiple markets, and serially making value-additive deals - is not at all easy. And yet, you look at the quarter-to-quarter results Stryker has been putting together under CEO Lobo and it looks almost effortless.

I have no meaningful issues with the operational performance of Stryker. There's room for the company to do better overseas, likely some opportunities for gross margin improvement, and perhaps a few signs of competitive gains against the company in neuro and extremities, but on the whole, everything is going very well. The valuation is the problem; even though I believe Stryker is the best med-tech company out there, the valuation just doesn't work for me and my portfolio needs

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Stryker Making Excellence Look Effortless

Rockwell Automation Pressured As Short-Cycle Headwinds Spread

I don't believe there's much debate anymore about whether weakness in short-cycle industries is spreading, though longer-cycle industries have continued to hold up better (even if they're wobbling a bit) and some investors are still pinning their hopes on a second-half rebound. That's all bad news for Rockwell Automation (ROK), as this leading pure-play in industrial automation continues to see slowing markets that are sapping its growth and momentum.

The short-cycle slowdown is manageable; Rockwell has always been a cyclical business, and that's just part of the landscape. Beyond that, though, there are some interesting arguments about Rockwell's operating philosophy and its place in the future of industrial automation. I like buying proven operators when these sorts of questions crop up, but I'd rather hold off in the hope of getting another crack at the shares below $150.

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Rockwell Automation Pressured As Short-Cycle Headwinds Spread

Strong Growth In New Drugs Propelling Roche

Roche (OTCQX:RHHBY) needed a good second quarter and management delivered, with the company’s portfolio of new pharmaceuticals helping drive double-digit growth for the drug business and high single-digit growth for the business overall. Better still, the pipeline remains stocked with opportunities, and the company should average about one major read-out a month for the next 18 months.

Valuation remains attractive, particularly in light of upgraded near-term expectations. Fair value remains in the mid-$30s, and management indicated that a higher dividend should be on the way.

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Strong Growth In New Drugs Propelling Roche

Sanofi Wants Out, Dealing Lexicon's Hopes In Diabetes Another Major Blow

Lexicon Pharmaceuticals’ (LXRX) tortuous path to success in the diabetes market took another big hit late on Friday July 26, when Sanofi (SNY) issued a press release containing a brief summation of top-line results of three Phase III Type 2 diabetes studies of Zynquista and notification that it was terminating the collaboration with Lexicon to develop and market the drug for Type 1 and Type 2 diabetes. Lexicon issued its own statement shortly thereafter, casting the Phase III results in a more positive light and declaring Sanofi’s notice of termination to be invalid.

What happens now is open for debate, but it is difficult to see a positive spin for Lexicon. If Sanofi’s termination was legally invalid, Lexicon may be able to get some funding from Sanofi as part of a settlement, but forcing an unwilling partner to market a drug is effectively a non-starter. Given the significant costs to a commercial launch of a diabetes drug, the unlikelihood of another partner, and Lexicon’s iffy financial condition, this is another serious blow to a company that has already taken quite a few of them.

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Sanofi Wants Out, Dealing Lexicon's Hopes In Diabetes Another Major Blow