Wednesday, October 30, 2019

Investors Seem Refocused On Eagle Bancorp's Operations

Eagle Bancorp (NASDAQ:EGBN) was smacked hard in July on news of an investigation tied to potential related party transactions involving former CEO Ron Paul, but it seems like the market has calmed down about that issue and instead refocused on what is a pretty high-quality Washington, D.C. area growth story underpinned by healthy loan growth. Although spread compression remains an ongoing risk, the shares are up about 15% from my last article and have recovered about a third of the investigation-driven decline.

I believe Eagle shares are still undervalued, and I'm more comfortable about the possible risk from the investigation, as management has pointed to comprehensive insurance coverage for just such events. While I don't want to underplay the risk of weaker loan demand, tighter spreads, and a deteriorating credit cycle, those are more industry risks than company-specific risks, and I believe Eagle is still looking at a healthy long-term core earnings growth despite a likely low point in 2020.

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Investors Seem Refocused On Eagle Bancorp's Operations

Commerce Bancshares Richly Rewarded For Its Quality And Stability

I’ve made the point many times before that valuation doesn’t drive stocks as much as many investors seem to think – stocks don’t go up just because they’re cheap, and likewise don’t go down just because they’re expensive. I didn’t expect the nearly 15% move in Commerce Bancshares (CBSH) since my last update, but then I also didn’t expect the relatively aggressive decision to launch an accelerated share repurchase program, and in this environment, investors really love those upfront capital returns.

My core view on this bank really hasn’t changed, though. It’s an exceptionally well-run bank and an uncommonly conservatively-run bank. Although Commerce won’t suffer as much spread compression as its low-cost deposit base would otherwise suggest, I’m not going to pay more than 18 times next year’s earnings for a bank likely to grow its pre-provision profits at a very low single-digit rate for the next five years.

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Commerce Bancshares Richly Rewarded For Its Quality And Stability

Accuray Drifting, And Critical Mass Seems Far Away

Another quarter is in the books and not a lot has changed for Accuray (ARAY). This remains a perpetually frustrating story as the company has meaningfully improved the functionality of its systems, but those improvements haven’t shown up in orders, revenue, market share, or profits. While new data, reimbursement, and product enhancements could give a spark to CyberKnife, and China remains an attractive opportunity in concept, it’s going to take still more time for those to develop into real drivers.

Pre-market indications are that Accuray is going to sell off on fiscal first quarter results, but I didn’t find them all that bad. Still, I don’t see that near-term spark to shift sentiment or drive investors to take another look at the shares, so while I think Accuray probably deserves to trade closer to the mid-single-digits, the company is still a long way from critical mass in orders or revenue and catalysts are slow to emerge.

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Accuray Drifting, And Critical Mass Seems Far Away

The Market Seems Focused On Cognex's Long-Term Potential Over Short-Term Troubles

Institutional investors aren’t famous for their patience, and growth investors are typically even more unforgiving when their growth darlings come in a few ticks below expectations. And yet Cognex (CGNX), which posted over 20% year-over-year revenue contraction and once again guided down, is getting off relatively light, or at least in the immediate post-earnings period. 

Don’t get me wrong – I like Cognex and I think it’s one of the best plays on logistics automation and the “factory of the future” theme. I’m just surprised that the Street is still comfortable paying over 30x 2021 EBITDA during this cyclical downturn. I think the long-term potential return here is still okay, but I’d love a more pronounced “buy the dip” opportunity again.

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The Market Seems Focused On Cognex's Long-Term Potential Over Short-Term Troubles

FEMSA's Sluggish Margins Give Some Fodder To Bears, But The Business Is Fine

Relative to a slowing Mexican economy, particularly in the consumer sector, FEMSA’s (FMX) third quarter results were pretty good, but Wall Street doesn’t care so much and bears will no doubt fret about the still-weak same-store trends in Health, the sluggish margins at OXXO, and management’s willingness to deploy capital into non-traditional business ventures. I’m tempted to say “let them fret,” as I believe FEMSA management has proved itself many times over, but as a shareholder, of course, I’d like to see the shares trading closer to my assessment of fair value. While I do see some near-term challenges in OXXO’s margins and maybe some longer-term uncertainty in what management may do with the Coca-Cola FEMSA (KOF) stake, I still like the direction of this business and I think the ADRs should trade over $100 despite some near-term weakness in the Mexican consumer space.

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FEMSA's Sluggish Margins Give Some Fodder To Bears, But The Business Is Fine

Steel Dynamics Holding Up Through Tough Demand Conditions

I wasn’t bullish on the prospects for the U.S. steel sector when I last wrote about Steel Dynamics (STLD) and Nucor (NUE), and the additional destocking and steel price weakness that I expected back then has in fact taken place. While both Steel Dynamics and Nucor saw nasty declines into late August, the share prices have since recovered, reducing the incremental declines in the share prices to the low single digits.

As the market gets more realistic about the real health of the steel market (and the U.S. industrial economy), I get a little more bullish on Steel Dynamics, as this earning cycle has seen another $165 million come out of the average sell-side 2019 EBITDA estimate and about $225M come out of the 2020 number (after roughly $100M adjustments back during second quarter earnings). I’m still concerned about the health of the U.S. economy, the prospects for an end to the U.S.-China trade dispute, and potential competitive capacity additions, but were Steel Dynamics to take another trip toward the mid-$20’s, I’d have to consider picking the shares as a cyclical trade idea.

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Steel Dynamics Holding Up Through Tough Demand Conditions

ON Semiconductor's Performance Isn't Pretty, But Better Days Are Ahead

I had a mixed view on ON Semiconductor (ON) back in May, as I thought the shares had some appeal on drops below $20, but that there was also still a lot of risk in the outlook as I felt sell-side analysts were too bullish about a second half recovery. That’s all largely come to pass, as ON has continued to struggle with weaker demand in autos and industrials and high inventories, and sell-side expectations have headed down through the year.

Buying below $20 has worked and I continue to believe it will in the near term. I think the market overdid it with the post-earnings jump, as ON’s guidance wasn’t that good, but I guess Texas Instruments (TXN) reset the bar such that any good news was welcomed. While I still believe there are some potholes on the road directly ahead, I like ON’s long-term leverage to EVs, server/cloud power, factory automation/IoT, and renewable energy. Investors can also consider names like Infineon (OTCQX:IFNNY) and STMicro (STM) for those same reasons, but I believe a fair value in the low-to-mid $20’s is sufficient to warrant consideration.

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ON Semiconductor's Performance Isn't Pretty, But Better Days Are Ahead

Tuesday, October 29, 2019

What Drove Comerica Up Is Now Weighing It Down

It's hard enough for banks to position themselves optimally for one part of the rate cycle; getting both sides right is vanishingly rare, and so it is with Comerica (CMA). It's easy to find fault now with this bank's failure to position its balance sheet for an eventual switch from tightening to easing, but few were calling for that when Comerica's asset-sensitive balance sheet was driving double-digit core PPOP growth. What's more, a lot of the things the bank did right in recent years, including capital optimization and its successful GEAR UP expense-reduction program, have more or less robbed the bank of levers to use now to offset spread compression on this still highly rate-sensitive balance sheet.

Comerica's valuation seems to be pricing in mid-single-digit short-term earnings erosion and low single-digit long-term core earnings erosion, and I think that's harsh. Likewise, the shares trade below 9x my forward EPS estimate, which is a double-digit discount to its peer group. I can see how that would appeal to value-driven investors, but I'd also note that Wall Street demands growth and Comerica could well be looking at no PPOP growth until early in 2021, leaving the shares in "value trap" limbo.

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What Drove Comerica Up Is Now Weighing It Down

Umpqua Punished For Short-Term Challenges, But The Long-Term Opportunity Remains Attractive

Although Umpqua (UMPQ) remains one of my favorite mid-cap banks, there's no question that the company's performance since my last write-up has been poor, with the shares down about 11% and trailing its regional peer group by about 15% to 20%. That's definitely not the performance you should expect from a good bank, but I see a disconnect here - even though Umpqua has been hit hard on much weaker than expected spread margins, the pre-provision operating performance hasn't been that bad.

I've reduced my near-term earnings expectations fairly substantially as the year has gone on, but I still believe Umpqua can generate high single-digit long-term core earnings growth, and I think Umpqua will be a longer-term winner in a sector where regional and community banks are going to come under increasing pressure from larger super-regional banks that can leverage a larger base of business to compete more aggressively on price and invest huge sums in IT. I guess the current sentiment makes this a contrarian call, but with a 5% yield and what looks like an unfairly low valuation, this is a name I'm considering adding now.

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Umpqua Punished For Short-Term Challenges, But The Long-Term Opportunity Remains Attractive

Further Restructuring At Alcoa Is Welcome, But Macro Pressures Are Still In Play

All you might really need to know about how things have been going at Alcoa (AA) is that sell-side expectations for 2019 EBITDA were around $2.4 billion in January and the average estimate is now around $1.6 billion. With demand hurt by weak global auto production and slowing economies around the world, and exacerbated by the U.S.-China trade tensions, alumina and aluminum prices have disappointed relative to initial expectations, and Alcoa hasn’t been able to do nearly enough on the cost side to offset that pressure.

I feel a little bad about being hard on Alcoa, given that I think management’s recently-announced portfolio review and restructuring plans are a sound move. The problem is that this is still an overleveraged commodity company that is too far up the price curve and too much at risk to Chinese production volumes. The shares do look too cheap to me at around 4x-5x 2020 EBITDA (including pension liabilities), but too much is riding on a successful restructuring for my comfort.

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Further Restructuring At Alcoa Is Welcome, But Macro Pressures Are Still In Play

Fanuc Logs Another Weak Quarter, But The Worst May Be Over

As is the case at Yaskawa (OTCPK:YASKY), it looks like investors are pretty willing to overlook another weak quarter from Fanuc (OTCPK:FANUY), and another reduction in guidance, on the idea that the bottom has been reached and business will improve from here. While I agree with that basic philosophy, I’m still concerned about the extent to which a recovery has already been priced into the shares, as the valuation would already seem to anticipate mid-teens FCF growth on a long-term basis with a single-digit discount rate.

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Fanuc Logs Another Weak Quarter, But The Worst May Be Over

Nidec's Motor Story Looking Better And Better

I don't know that I'll ever bring myself to the point of saying "valuation doesn't matter", but companies and stocks like Nidec (OTCPK:NJDCY) (6594.TO) do sometimes push me in that direction. It's tough to see how Nidec is undervalued relative to reasonable expectations, but I believe investors need to at least consider the possibility that Nidec will generate "unreasonable" revenue and profit growth in the coming years on the back of a very strong technology portfolio in electric motors.

In the here and now, Nidec is struggling to meet sell-side earnings expectations, as stronger than expected order inflow and customer interest, particularly in auto traction motors and e-axles, lead the company to accelerate its product development and ramp up spending. I believe this will be money well spent, but Nidec's valuation wouldn't lead you to think it's exactly an undiscovered story, even if it's not a household name among U.S. investors.

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Nidec's Motor Story Looking Better And Better

Investors Should Ask If THK's Relatively Attractive Valuation Is Too Good To Be True

Veteran investors know better than to just accept every cheap-looking stock as a gift, some of them are more like a sketchy van with “Free Candy” scrawled on the side. That brings me to THK (OTCPK:THKLY), an automation supplier that has certainly recovered, but not to the same valuation extent as others like Fanuc (OTCPK:FANUY) and Yaskawa (OTCPK:YASKY) and may actually be trading at a relatively attractive valuation.

There are definitely some “buts” with THK to consider. First, just as is true for Fanuc and Yaskawa, calls for a cyclical bottom in the September quarter may be too optimistic. Second, THK has seen rivals like Hiwin gain ground by competing on price. Third, THK has a comparatively unattractive segment (the auto parts business) that lacks near-term drivers beyond underlying market recovery. Still, with semiconductor equipment demand set to improve and machine tools quite possibly bottoming, this could be a time to reconsider this name.

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Investors Should Ask If THK's Relatively Attractive Valuation Is Too Good To Be True

The Market Shrugs Off Another Weak Quarter From Yaskawa Electric

It’s certainly true that the stock market is a discounting mechanism that looks beyond current results in assessing a company’s value. But it’s also true that investors can get ahead of themselves, and particularly so with companies they like, and I think that’s the case at Yaskawa Electric (OTCPK:YASKY) now. Investors ignored another weak quarter from this leading automation player, content to assume that the bottom is in sight and results will soon start to improve from here.

I have no problem with the overall assumption that Yaskawa is bottoming out. My problem is that the market is assuming a growth rate from here that’s just too high (or using a discount rate that’s just too low), and I struggle to reconcile the likely path of Yaskawa’s earnings and cash flows with today’s valuation. I don’t like taking a negative stance on companies I like, and particularly when I do think they’re near a cyclical low, but I’m struggling to connect the valuation dots on a company already trading at over 18x FY21 EBITDA and nearly 14x FY22 EBITDA.

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The Market Shrugs Off Another Weak Quarter From Yaskawa Electric

Fire-Related Outages Sap Momentum At Universal Stainless & Alloy Products

Trying to play the up-cycle in aerospace through the specialty alloy companies has been tricky, and in the case of Universal Stainless & Alloy Products (USAP) that’s been complicated further by a fire-related production outage that made a noticeable impact on third quarter production and financial results. On top of that, the company continues to be challenged by surcharge mismatches and challenging end-market conditions in multiple key markets.

USAP shares have clearly been weak since my last update, with at least some of that weakness tied to nervousness about whether the 737 MAX delays would lead to inventory and order adjustments among aerospace customers. USAP is a tiny, almost uncovered, company and it operates in a challenging near-commodity industry, and end-market turbulence is no help. I do think that the shares trade at much too wide of a discount now, but given past challenges in out-earning its cost of capital, investors shouldn’t fool themselves into thinking this is a valuation layup.

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Fire-Related Outages Sap Momentum At Universal Stainless & Alloy Products

Carpenter Posts A Mixed Quarter, But Business Is Ramping

Driven in large part by aerospace demand and improved volume at its Athens facility, the shares of Carpenter Technology (CRS) are up about 20% since my last update on the company. That makes Carpenter a relative standout versus peers like Allegheny Technologies (ATI), Haynes (HAYN), Kaiser (KALU), and Universal Stainless (USAP), but that was a while in coming as shareholders had their patience tested by a slower than expected ramp.

I do see some risks to Carpenter, primarily from its energy and industrial markets, but on balance I like the prospects for an ongoing run of record margins in the Specialty Alloy Operations (or SAO) segment. With fair value in the low to mid $50's, I still see an argument for owning the shares, though it likely won't be a smooth upward move given concerns in the market about aerospace production schedules, the health of the oil/gas market, and so on.

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Carpenter Posts A Mixed Quarter, But Business Is Ramping

PTC Jumps On Signs That Stability And Predictability Are Coming Back

PTC (PTC) has had a rough year, with the shares down about 18% on a year-to-date basis in what has been a pretty good year for software in general and comps/peers like Ansys (ANSS) and Dassault (OTCPK:DASTY). While I thought PTC’s valuation looked somewhat demanding going into a tricky macro environment for 2019, the company’s last three quarters have been quite choppy, with a series of bookings misses and worries about the company’s ability to translate “great interest” among customers in IoT and augmented reality (or AR) into actual bookings and revenue.

PTC’s fiscal fourth quarter wasn’t flawless, and the macro environment is still challenging, but it would seem that the business has stabilized relative to management’s expectations and sell-side forecasts. While I do still see some risk in 2020 from a weaker macro spending environment, I believe PTC can grow revenue at a roughly 10% annual rate and generate significant margin expansion, supporting a higher fair value and an attractive prospective return from here.

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PTC Jumps On Signs That Stability And Predictability Are Coming Back

Sunday, October 27, 2019

STMicro Building Credibility Ahead Of A Major Ramp

I wouldn’t call STMicroelectronics' (STM) third quarter “perfect”, but it was good and not nearly as disappointing as Texas Instruments’ (TXN) update. More important, I think, is that this quarter helps build management credibility (as they guided to a stronger second half 2019 early this year), as the company continues to execute even against a worse-than-expected backdrop. With the company looking at some major product introductions/ramps over the next couple of years, including SiC MOSFETs, IGBTs, MCUs, and 3D sensors, I believe this good execution in a tough environment is quite encouraging.

I recommended picking up STM shares below $17.50, and investors got a couple of chances to do that after my last article ahead of a nearly 30% jump in the share price. The shares no longer trade below my DCF-based fair value, but buying below DCF value is usually only an option when the market has really soured on a chip company. I do still see upside from here, though, and I think it may be possible to establish a position and look to add if/when the tech sector gives you a periodic pullback.

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STMicro Building Credibility Ahead Of A Major Ramp

MSC Industrial Executes Decently Against Lowered Expectations

MSC Industrial's (MSM) management to close out its fiscal 2019 on a relatively okay note, with the company beating expectations at the core operating income line despite mounting end-market headwinds. MSC Industrial isn't doing as well on gross margin as Fastenal (FAST), and I'll talk about this later, but management is at least explicitly targeting margin improvement efforts in fiscal 2020 at both the gross margin and operating margin lines.

It's tough for an industrial distributor to make great strides during an industrial downturn, but the good ones often pick up market share during these times. I haven't been impressed with MSC Industrial's management in recent years, and this downturn would be a good time for it to pick it up and improve execution. Here in the mid-$70s, valuation is more challenging and the management really needs to execute on sustained margin improvement to justify a substantially higher price on a DCF basis, though an EV/EBITDA approach is substantially more forgiving.

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MSC Industrial Executes Decently Against Lowered Expectations

Choppy Near-Term Trends And LNG Order Uncertainty Hitting Chart Industries

With so much of Chart Industries' (GTLS) upside tied to unbooked orders for LNG capital equipment, I can understand why worries about pushed-out timelines for large LNG export facilities would be hitting the shares. On top of that, the outlook for midstream capex in 2020 isn't very good and the slowdown hitting many industrial end-markets is likely to lead to lower industrial gas orders. As LNG prices have recently hit multiyear lows, I suppose it's not so surprising that Chart shares are near a 52-week low and the shares are down more than 20% from the time of my last update.

While understandable, I'm not so sure this downturn is entirely reasonable. True, the LNG outlook has risk to it; orders could get delayed or disappear altogether under certain circumstances. But at this point, I think a lot of the LNG opportunity has been derisked; I can't say that Chart is trading just on the value of its industrial gas business, but it's pretty close - if the E&C business would grow only 2% from 2019 levels (with mid-single-digit growth from the D&S businesses), the shares would be around fair value in my model.

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Choppy Near-Term Trends And LNG Order Uncertainty Hitting Chart Industries

Pinnacle Standing Out In A Crowded Field

Markets like Tennessee, North Carolina, South Carolina, and Virginia are among the most competitive in the U.S., with established players like BB&T (BBT), Bank of America (BAC), First Horizon (FHN), and Wells Fargo (WFC) facing increasing competition from rivals like Fifth Third (FITB) and U. S. Bancorp (USB) attracted by the region’s above-average population growth and rising household income. Although that’s not great news for Tennessee’s Pinnacle Financial Partners (PNFP), this commercial-focused bank has a few tricks up its sleeve, including a differentiated corporate culture and customer service model, and some attractive specialty lending operations.

Pinnacle’s high deposit beta is a threat, as is its heavy commercial exposure and higher-cost deposit base, but I expect Pinnacle to outgrow its peer group in 2020 and over the next five and 10 years. If annualized core earnings growth in the high single digits is in fact a reasonable expectation, Pinnacle shares look undervalued below the mid-$60s.

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Pinnacle Standing Out In A Crowded Field

Share Gains And Advantageous Market Exposures Drive A Strong Result From Atlas Copco

I’ve said many times before that good companies really show their quality in downturns, and I’ve likewise said many times before that I believe Atlas Copco (OTCPK:ATLKY) is one of the best multi-industrials out there. Although I thought the shares weren’t undervalued when I last wrote about the company, the stock is up almost another 15% since then as Atlas Copco’s strong third-quarter results further polish its reputation and add some “safe haven” momentum for good measure.

I can’t really make the valuation numbers work now for Atlas, though I freely admit that stocks don’t go down just because they’re expensive (likewise, they don’t go up just because they’re cheap). The company’s full-cycle outperformance potential seems fully priced into the shares now, and this is only a name I’d be comfortable considering for my own portfolio on a pullback.

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Share Gains And Advantageous Market Exposures Drive A Strong Result From Atlas Copco

3M Grinding Through The Downturn

The Street was definitely disappointed with 3M's (MMM) results and guidance, as the company was a notable weak link in a chain of multi-industrial earnings that thus far haven't been as bad as feared. I see this as a good news/bad news situation. I believe 3M is a little further along within the downturn than many of its peers, and in that respect, I consider 3M's results something of a preview for what the multi-industrials may see in the next quarter. I also believe that 3M may be one of the earlier companies to pull out of the downturn.

3M is still a mixed investment prospect, even though I continue to own the shares. On one hand, I still like the company's broad exposure to a wide range of industrial end-markets and geographies, as well as structurally strong margins. On the other hand, I don't like the weakening margin leverage, the questionable M&A choices, and the lack of investment in growth markets. I do believe the shares have fallen to a point where they trade below long-term DCF-based fair value, and that's not a common occurrence, making this a name to consider for more patient investors.

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3M Grinding Through The Downturn

The U.K.'S Antitrust Regulator Seems Bent On Blocking The Pacific Biosciences - Illumina Deal

In new Phase 2 filings made public today (October 24), it seems clear that the U.K.’s Competition and Markets Authority (or CMA) remains hellbent on blocking Illumina’s (ILMN) acquisition of Pacific Biosciences (PACB), even though the information provided by the CMA itself seems to refute many of its core findings/concerns. While these discrepancies do undermine the CMA’s case and support those who believe there is no credible objection to the merger (myself included), it’s unclear to me if Illumina would be willing to pursue legal remedies to push this acquisition through, and of course also unclear whether such an option would work.

Although Illumina has not yet abandoned the deal, I believe it makes more sense to value PacBio on the assumption of no deal. I still believe the standalone value of PacBio to be above $6, but the path forward without Illumina will be high-risk and suitable only for very aggressive investors who can accept the very real risk that PacBio ultimately goes bankrupt.

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The U.K.'S Antitrust Regulator Seems Bent On Blocking The Pacific Biosciences - Illumina Deal

FirstCash Stumbles On A Slower Near-Term Growth Outlook In Mexico

I’ve said several times in the past that FirstCash (FCFS) is a “second chance stock”; the inherent volatility of the business, magnified by financial leverage and “market leverage” (a higher risk premium) often leads to pullbacks that while not precisely predictable, have nevertheless been pretty consistent over the years. The post-earnings drop after third quarter results looks like another such opportunity.

Weak same-store pawn loan growth is something that shouldn’t be ignored, but I believe the underlying performance of the U.S. operation is improving, and I think the pressures on the Mexican operation are only a short-term issue. With a prospective annualized return now back in the double-digits, I think this is a name for more risk-tolerant investors to consider again.

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FirstCash Stumbles On A Slower Near-Term Growth Outlook In Mexico

ABB Steps Over A Lowered Bar, But Margin Improvement Is Still Nice

The good news is that ABB (ABB) beat earnings expectations for the third quarter. The less-good news is that expectations declined meaningfully going into earnings (about 5% or so at the EBITA line in recent weeks), lowering the bar, and the order and growth outlook is still pretty unexciting over the near term.

While investors reacted positively to the third-quarter results, and I do believe there’s long-term upside for ABB shareholders, I’d caution readers not to get too bullish on the near term. I do think key short-cycle markets like autos are closer to the bottom than not, and I’m bullish on the long-term potential for incoming CEO Bjorn Rosengren to make some meaningful improvements to the business, but ABB is a self-improvement story that will play out over years, not quarters. As I said, I do see upside from here, but it’s not the most undervalued or best risk/reward opportunity of the industrials I follow.

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ABB Steps Over A Lowered Bar, But Margin Improvement Is Still Nice

Sandvik Barely Makes The Quarter, But Investors Seem Relieved

Maybe the worst is over for multi-industrials. Multiple end markets are still weakening, but investors seem to increasingly have this factored into their outlooks, as Sandvik’s (OTCPK:SDVKY) low-quality beat in the third quarter seems to have gone over fairly well with investors. I think we could still see another downturn in the shares before year-end (with the ADRs retesting the $14-$15 zone from $17 today), and the stock is not particularly cheap on a DCF, but I think the conversation around Sandvik will start to evolve toward the question of when the Machining Solutions business will bottom out and recover in 2020.

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Sandvik Barely Makes The Quarter, But Investors Seem Relieved

Friday, October 18, 2019

A Quarter At A Time, Dover Is Building A Better Reputation

Between some significant portfolio restructuring and a new management time focused on extensive margin improvement efforts, Dover (DOV) has taken some meaningful strides to improve its reputation and perception with investors. With the company continuing to execute well into an industrial slowdown/downturn, quarter by quarter, Dover is building its case as a reliable "GDP-plus" growth story with a few years of positive operating margin leverage to look forward to beyond 2019.

My primary hesitation with Dover, as with many quality industrials, is valuation. I'd rather buy Dover shares in the low $90s (the shares briefly retreated to that level after my last update), as the prospective returns at today's price aren't quite compelling enough. Still, management is quickly building a strong reputation and its diversified end-market exposure should support above-peer performance for at least a little while longer.

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A Quarter At A Time, Dover Is Building A Better Reputation

BB&T's Results And Guidance Better Than They Seem, But Return Prospects Are Modest

BB&T (BBT) shares have outperformed since my last update and over the last year, due, at least in part I believe, to the counter-cyclical earnings leverage potential of the upcoming merger with SunTrust (STI). Although investors weren’t thrilled about the earnings and guidance offered by the company this time around, I believe the underlying business trends are a little better than they otherwise seem, and I believe the company is on a decent footing for this late stage of the bank cycle.

As far as the investment angle goes, I won’t pound the table for BB&T at today’s price, but it’s a decent prospect relative to peers and rivals like JPMorgan (JPM), PNC (PNC), U.S. Bancorp (USB), and Wells Fargo (WFC). All of these names offer their own perks and challenges (JPMorgan and PNC as quality growth, U.S. Bancorp as a safe haven, Wells Fargo as a restructuring story), and I think BB&T has decent return prospects (high single-digit to low double-digit returns) as well as the potential for better-than-expected post-merger synergies and growth.

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BB&T's Results And Guidance Better Than They Seem, But Return Prospects Are Modest

Honeywell Comes Through On Margins, But Growth Lagged A Bit

I have to admit that Honeywell's (HON) lackluster share price performance over the past three months has surprised me, as I expected this well-loved multi-industrial to benefit from some "safe haven" investment flows as the data on a broader industrial slowdown continued to accumulate. Whether I underestimated how much of that had already taken place, or whether investors were a little put off by valuation, I don't know, but Honeywell has lagged its industrial peers a bit since the second quarter earnings update, though the company is still among the outperformers of the past year.

There wasn't really anything in Honeywell's third quarter that changes my view. The company's longer-cycle process businesses are holding up and aerospace should remain strong for some time. Weakness in productivity/automation should be transitory, and the company continues to do well on margins. Healthy mid-single-digit long-term FCF growth and strong margins/ROIC/ROA support a robust valuation for Honeywell shares, but I can't call these shares undervalued today.

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Honeywell Comes Through On Margins, But Growth Lagged A Bit

A No-Drama Quarter From U.S. Bancorp With Increased Capital Returns On The Horizon

If you want an exciting, dynamic bank, you don’t really look at U.S. Bancorp (USB), but if you want a steady, high-margin performer, particularly during tougher times in the banking cycle, this is a name you consider. To that end, U.S. Bancorp’s third quarter results didn’t have a lot of surprises, though the company’s decision to accelerate capital returns to shareholders was a welcome update.

Management’s recent investor day highlighted some meaningful growth opportunities for U.S. Bancorp, including ongoing investment in payment technologies, branch-lite digital-driven organic consumer banking growth, and maybe even some M&A. Pre-provision growth will probably drop to the low-single digits next year, and I’m only looking for around 3% long-term core earnings growth, but this is a very profitable, well-run bank that is trading at a reasonable valuation today.

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A No-Drama Quarter From U.S. Bancorp With Increased Capital Returns On The Horizon

PNC Financial Delivers A Low-Drama Quarter

I didn't think PNC Financial (PNC) was all that cheap coming out of second-quarter earnings, but I thought a relatively better outlook for stable, positive performance from this well-respected bank could give an edge to the shares. The shares have outperformed the sector by a small margin since then (by around 1% to 2%), and PNC's low-drama third quarter should be reassuring for investors.

Despite a less-favorable (at the moment) skew toward commercial lending, PNC has a good set of fee-generating businesses, credibility on cost leverage improvement, and organic growth opportunities as the bank continues to target new markets for its middle-market lending operation (Boston, Phoenix, Portland, and Seattle). Valuation is just "okay", with prospective long-term annualized returns in the high single digits to low double digits, but an okay price for an above-average bank isn't a bad trade-off for long-term investors.

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PNC Financial Delivers A Low-Drama Quarter

First Horizon Shares Weaker On A Less Distinguished Third Quarter

First Horizon (FHN) still doesn't seem to be getting its due, but arguing with the market only gets you so far in the short term. Although the shares had done slightly better than the peer group going into the quarter, a sell-off on the earnings report has pulled the relative performance back to the peer group.

I continue to believe that First Horizon has some useful near-term offsets to spread pressure, including a counter-cyclical trading business and cost leverage, and I like the long-term ramifications of a management team that is keenly focused on out-earning its cost of capital in all parts of the business. These shares could languish without beat-and-raise quarters, but I believe they trade at a double-digit discount to fair value and offer appeal for more patient investors.

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First Horizon Shares Weaker On A Less Distinguished Third Quarter

Roche Delivers Accelerating Growth In The Third Quarter

With concerns of biosimilar competition and revenue erosion starting to fade, the market is giving more attention to the strength of Roche’s (OTCQX:RHHBY) portfolio of newer drugs and clinical pipeline, and the shares have been outperforming. Although strong third-quarter results weren’t quite as strong as they seem at first glance, it was nevertheless a good beat-and-raise quarter and expectations for earnings growth over the next three to five years have been improving.

Still a major player in oncology, Roche has shown that it can successfully broaden its horizons into other treatment areas like neurology. Roche isn’t dramatically undervalued, but I still believe it is a worthwhile buy-and-hold idea on the strength of its portfolio and pipeline.

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Roche Delivers Accelerating Growth In The Third Quarter

Fastenal Delivers Superior Execution In A Weakening Market

The argument over what constitutes a fair premium for Fastenal (FAST) has gone on for years, and it’s not about to be solved now. I will say, though, that strong execution in a tougher market is a solid argument for the bulls, particularly with Fastenal delivering better than expected results in a third quarter marked by a more noticeable slowdown in multiple key end-markets. Although industrial stocks in general have been about as sluggish as I expected, Fastenal shares managed to do a little better before spiking up after the strong third quarter results.

My issue with Fastenal shares is pretty simple – I’m not willing to pay around 16x forward EBITDA, nor buy into a valuation that seems to require mid-teens annualized long-term FCF growth to deliver an acceptable annualized return. I do expect key end-markets to slow further, and I’m concerned about the non-residential pipeline once large projects finish up. That said, I do expect Fastenal to remain a “best of breed” in the industrial distribution sector for the foreseeable future, and investors holding Fastenal today have likely long since made their peace with the valuation issues.

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Fastenal Delivers Superior Execution In A Weakening Market

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