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

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

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

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