Thursday, November 28, 2019

Lexicon Waiting For Clarity On Its Diabetes Franchise

Lexicon Pharmaceuticals (LXRX) is now in a “hurry up and wait” limbo, as the company waits for clarity on its dispute resolution petition with the FDA regarding Zynquista in Type 1 diabetes and as investors wait for more information and clarity on the clinical profile of Zynquista in Type 2 diabetes and Lexicon’s efforts to re-partner the drug.

For now, I believe $4/share is still a pretty fair value for Lexicon shares. A manageable path to approval of Zynquista in Type 1 diabetes would be a significant value-driver for the shares, as would any improvement in the apparent clinical profile of the drug in Type 2 diabetes. Favorable data from the Xermelo biliary tract cancer study or LX9211 in pain would likewise be positives.

Said differently, there are a lot of things that could go right (and go right relatively quickly) for Lexicon and drive a much higher share price, but I believe shareholders need to go in with their eyes open to the downside risk if those favorable outcomes don’t develop.

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Lexicon Waiting For Clarity On Its Diabetes Franchise

Breaking Up Celanese Could Create Value, But It's Not The Only Way

In the get-rich quick (or at least “quicker”) world of institutional investing, firms often push companies toward actions that benefit the institutions most in the short term, including steps like cutting R&D, cutting capex, slashing headcount, leveraging the business to buy shares, and most recently, “de-conglomerating” businesses. In the particular case of Celanese (CE), though, the idea of break-up has been in play for some time, as the Street hasn’t historically given full credit for the value of this highly-integrated industrial chemical company.

I’m ambivalent about a break-up. I believe a series of deals could reap about $130 to $135/share in total value for shareholders, with no ongoing operational risk (take your money and go home). On the other hand, continuing to run Celanese with the same basic operating approach would possibly generate greater long-term gains for patient shareholders who want to stick around.

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Breaking Up Celanese Could Create Value, But It's Not The Only Way

Tuesday, November 26, 2019

Healthy New Drug Sales And A Refreshed Pipeline Helping Lundbeck Set A Bottom

Holding H. Lundbeck A/S (OTCPK:HLUYY) (LUN.CO) (“Lundbeck”) has definitely had its ups and downs; while I lightened up some during the very optimistic summer of 2018, the company has nevertheless had its challenges with multiple late-stage pipeline failures, a relatively bare cupboard in the early-stage pipeline, a CEO change, and some ongoing challenges in driving sales of branded drugs against well-established generic options.

With the shares up more than 10% from my last update (when I switched from a pretty neutral stance to a more bullish one), and encouraging news in both sales and clinical efforts, I think the bottom may be in for this part of the cycle. To be sure, Lundbeck still has a lot to prove, and a Phase I-heavy CNS pipeline is a high-risk asset, but I believe sentiment and valuation make this one a name to consider for more contrarian-minded investors.

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Healthy New Drug Sales And A Refreshed Pipeline Helping Lundbeck Set A Bottom

Both The Opportunity And Valuation At ANSYS Are Eye-Popping

I'm a big believer in paying for quality, but it's hard not to pause at the 12x-plus revenue and 39x-plus PE multiples on ANSYS (NASDAQ:ANSS) shares today. While ANSYS is an exceptional software company and is likely to see well-above-average revenue growth and operating margins over the next decade, it's tough to comfortably model the growth it will take to justify that level of expectation - that's not saying that ANSYS can't do it, but not many software companies have lived up to that level of expectation.

What should investors do with the stock, then? If you're a growth or momentum investor, you probably don't care that much about valuation anyway, so carry on with whatever metrics you like. If you're more value-conscious, though, the best I can offer now is to note that ANSYS shares have had relatively frequent double-digit pullbacks over the years, so there will likely be an opportunity to pay in at a slightly better price, though I'd never expect ANSYS to look conventionally "cheap" unless something went massively wrong in the economy and/or stock market.

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Both The Opportunity And Valuation At ANSYS Are Eye-Popping

Some Progress At American Axle, But Plenty Left To Prove

American Axle & Manufacturing (AXL) (“AAM”) has had a volatile run since my last update on the shares. I wasn’t all that favorably inclined towards the company due to its heavy reliance on the U.S. market and long-term margin/efficiency issues, but I thought the valuation assumed a pretty dire outlook. Since then, the shares are down another 20%, with the stock dropping about 50% at the worst point (hurt by the strike at GM (GM) ) and then rebounding strongly on third quarter results.

Unless you think the U.S. pickup market is going to be substantially stronger in 2020, it’s hard to get really excited about the near-term outlook. AAM has definitely made progress on its cost structure and operating flexibility, but customer and product concentration remains a risk, as does the high level of net debt. Given that leverage, AAM is the sort of stock that could work out really well if things go even moderately better than expected, but it’s also the sort of stock that could crater if demand weakens further and/or the company has execution issues that lead that heavy debt load to loom even larger.

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Some Progress At American Axle, But Plenty Left To Prove

Alnylam Pharmaceuticals Sheds Some Light On Its Expanding Early-Stage Opportunities

Although I hadn’t planned writing two articles on Alnylam Pharmaceuticals (ALNY) in close succession, the early approval of Givlaari and the subsequent R&D meeting both argued for a write-up, as both are significant to the long-term investment story.

Alnylam’s Nov 22 R&D Day was perhaps more evolutionary than revolutionary, but it confirmed what I believe are some key points to the story – management is attentive to the need to become a profitable enterprise, the company’s ongoing investments in basic chemistry continue to pay dividends, and the company has established a strong R&D platform that could produce multiple new drug candidates every year.

With expanded information on a handful of early-stage programs, I’ve raised my fair value estimate by a small amount, but the key drivers remain the commercial uptake of Onpattro, the success of trials that could enable Onpattro and vitusiran to compete in the larger AATR cardiomyopathy and mixed phenotype markets, the launch of Givlaari, and path to commercialization for lumasiran, inclisiran, and fitusiran.

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Alnylam Pharmaceuticals Sheds Some Light On Its Expanding Early-Stage Opportunities

Monday, November 25, 2019

KeyCorp Getting More Credit For Loan Growth And Expense Leverage

I had very mixed feelings about KeyCorp (KEY) back at the start of 2019, as I didn’t love the company’s far-flung franchise footprint, it’s lack of real deposit market share leverage, and largely middle-of-the-road financial metrics. On the other hand, I thought the share price and valuation was far too low even factoring all of those issues into the analysis. Since then, KeyCorp has been a strong outperformer, with the shares up 15% since that last article and outperforming its peer group by around 6% to 10% on a year-to-date basis depending on how you construct the peer list.

I still believe KeyCorp shares are undervalued. Yes, there is risk in the transition to a new CEO and the company has had its issues meeting operating leverage expectations, but loan growth is healthy and the bank’s liquidity should help partially offset some of its spread risk. I’d like to see KeyCorp take a stronger “get better or get out” hand with its footprint, but I do still see upside in the name.

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KeyCorp Getting More Credit For Loan Growth And Expense Leverage

M&T Bank Maintaining Quality, But Lagging In Operating Performance

Investors in M&T Bank (MTB) generally appreciate the bank for its conservative approach, and that’s still a valid argument – particularly at this point in the credit cycle where credit costs are starting to rise. On the other hand, M&T doesn’t have a particularly attractive fee-generating business that can offset spread pressures, and the bank’s low-cost deposit base (an important positive over the full cycle) and asset sensitivity remain more problematic. What’s more, M&T’s recent misses at the opex line undermine one of the few areas banks can try to offset spread compression.

I wasn’t overly fond of the investment prospects of M&T last time I wrote about the stock, and the shares subsequently dropped more than 10% before a rally that has taken the price back into the $160’s. While management’s apparent incrementally greater willingness to consider M&A is arguably a positive, nothing much has changed on a fundamental basis. I don’t think M&T’s expense issues will prove long-lasting, but I also don’t see a particularly compelling valuation case here either.

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M&T Bank Maintaining Quality, But Lagging In Operating Performance

Swine Fever And Self-Improvement Leading To Real Progress At BRF

The African swine fever (or ASF) epidemic that has devastated herds in China (as well as Vietnam and other Asian nations) has spiked global prices, creating a temporary windfall opportunity for exporters like BRF S.A. (BRFS) and JBS (OTCQX:JBSAY). At the same time, though, BRF has been making steady progress in its turnaround efforts and has been able to use the ASF windfall to accelerate its leverage reduction targets.

I thought BRF shares looked a little overheated in late August, but with the stock down about 15% since then, I'm more bullish on these shares. BRF still has a lot left on its "to do" list, but new management has built up some meaningful credibility, and it's easier to see the path towards a much stronger, more competitive BRF.

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Swine Fever And Self-Improvement Leading To Real Progress At BRF

Sunday, November 24, 2019

Regions Financial On Target With Its Conservative Approach

I've been making the argument for a little while now that the more conservative approach favored by Regions Financial (NYSE:RF) is the right one for the present circumstances, and also that the company's efficiency initiatives and hedging program would give the bank a solid chance of posting peer-leading pre-provision profit growth through this more challenging part of the cycle. Since my last update, the shares have modestly outperformed the bank's regional peers (by about 1% to 2%), though the trailing twelve-month performance is more ordinary - which makes sense to me as Regions' relatively better positioning is only starting to emerge here of late.

The ongoing increase in criticized loans is a worry to me, but Regions has been proactive and comparatively open in addressing its credit quality. I continue to believe that Regions is undervalued today, though Regions could certainly help its case with better revenue growth, and I believe M&A is at least a possible source of upside.

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Regions Financial On Target With Its Conservative Approach

Lattice Semiconductor Delivering Early On Several Key Promises

Up another 55% or so from my last update and 250% from my first Seeking Alpha article on the company, Lattice Semiconductor (LSCC) is a great go-to example of my investment philosophy that successful turnarounds can produce returns significantly ahead of what might seem fair or reasonable at the start of the process. Over the last two years, Lattice has not only turned over management and embraced a significantly different operating philosophy, it has delivered meaningful improvements in margins - one of the key drivers for semiconductor valuation.

I don't really think of Lattice as a turnaround anymore, as I believe the company is firmly in the midst of a transition to a growth story. In addition to opportunities in the data center and 5G base stations and auto driver assistance, I'm eager to see what the company will accomplish with its new FD-SOI platform and its AI-focused SensAI software stack.

As a growth story, I'm not quite as worried about valuation, but it is nevertheless hard to call Lattice "cheap". The shares already anticipate significant margin improvement and future revenue growth, and it's tough to make the numbers work.

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Lattice Semiconductor Delivering Early On Several Key Promises

Lincoln Electric Hanging In There Despite Weaker Volumes And Decremental Margins

Lincoln Electric (NASDAQ:LECO) shares haven't done as well as other short-cycle names like Kennametal (NYSE:KMT), Parker-Hannifin (NYSE:PH), or Rockwell (NYSE:ROK) over the last three months, but the shares are still up 10% and have outperformed the broader industrial space. Although 13-F filings do suggest that institutions have been trimming back positions, industrials have enjoyed a pretty good run as investors bought back in on the notion that the worst part of the cycle was in sight and focus would soon shift to a return to growth in 2020.

What's interesting to me is that Lincoln Electric has benefited from this same underlying trend, even though the company's weak third quarter results and cautious guidance would seem to suggest that this cycle could further room to run to the downside. Auto sector demand decelerated further and general fabrication went negative for the first point in the cycle - not typically the mark of the near-term bottom of the cycle.

I still like Lincoln Electric quite a lot as a company, and it's still a name that I'd like to own on a pullback (below $80, ideally). Right now, though the market seems quite bullish on the 2020 industrial rebound story, and I'm not comfortable buying into that story, given all of the conflicting data points out there.

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Lincoln Electric Hanging In There Despite Weaker Volumes And Decremental Margins

Better Clarity On Future Growth Drivers Could Help SPX Flow Take The Next Step

By and large, it's better to invest in the best businesses you can find, but there's a fair price for every going concern, and you can make money with lesser companies if you buy them right. With that in mind, I'd note that SPX FLOW (NYSE:FLOW) shares have outperformed the industrial sector by a decent margin since I recommended them as a "it's not a great company, but it's better than this" pick back in May.

What happens next will have a lot to do with the company's growth investment plans, including how the company chooses to uses the proceeds from its sale of the Power and Energy business. There are solid arguments for reinvesting in and further building businesses like industrial mixers, dehydration equipment, and tools, but management should at least consider expanding into more specialized pump/valve end-markets like biopharma.

With SPX's decent market performance, the shares no longer look as appealing to me. I like the prospect for better growth and margins after the P&E sale, not to mention the flexibility and options the sale may give management, but the valuation is just "okay" now, and I see some near-term risks in both the Food & Beverage and Industrial segments for a few quarters.

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Better Clarity On Future Growth Drivers Could Help SPX Flow Take The Next Step

Parker Hannifin Lowers Guidance, But Investors Assuming The Worst Is Already In Sight

As is the case with many industrials now, the Street seems to have quickly shifted to a view that the worst of this downturn is in sight for Parker Hannifin (PH). The shares are far closer to the 52-week high than the low, and have rebounded more than 10% from a pre-earnings dip in September, despite a significant revision to FY 2020 earnings expectations with the fiscal first quarter earnings report.

Industrials have done well as a group over the last three months, with Parker on the high end of the curve at nearly 20% Emerson (EMR) is one of the few that have done better). That outperformance is more than I expected, particularly in the context of management’s guidance, but the Street wants to believe in a 2020 industrial rebound story and doesn’t want to miss out. I like the steps Parker has taken to shift the business toward less-cyclical, higher-margin segments, but the expected return at today’s share price isn’t that special relative to what investors could expect from the likes of Dover (DOV), Honeywell (HON), and Rockwell (ROK) as industrial recovery stories.

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Parker Hannifin Lowers Guidance, But Investors Assuming The Worst Is Already In Sight

Thursday, November 21, 2019

Rockwell Automation Shares Spike As Investors Play A Favorite For The Recovery

While many industrial companies used the third quarter earnings cycle to talk down expectations for 2020, Rockwell Automation’s (ROK) strong beat-and-raise quarter seemed to stoke optimism that the end of this cyclical slowdown is in sight and the company will return to growth relatively soon. As a well-loved name among the industrials, that newfound optimism has launched the shares about 25% from their pre-earnings level.

When I last wrote about Rockwell, I suggested considering the shares if/when they slipped below $150, and they subsequently did for a couple of weeks. If you bought then, you’ll already sitting on healthy gains, but also holding a stock that is back to a premium valuation despite a trend of shrinking outgrowth versus the industry in recent years and plenty of concerns still in play regarding 2020. The prospective returns here aren’t the worst among what I follow, but there definitely are names with more interesting valuations.

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Rockwell Automation Shares Spike As Investors Play A Favorite For The Recovery

Alnylam Pharmaceuticals Secures Its Second Approval, And The Pipeline Is Still Attractive

With Alnylam Pharmaceuticals (ALNY) shares up almost 30% since my last update on the company, I can’t complain that the Street is undervaluing this RNAi pioneer nearly as much as before. Still, the company continues to build a strong investment case with two approvals in hand, another possible in 2020, and an increasingly attractive pipeline with expanding delivery options and potential therapeutic targets.

More than 55% of my fair value estimate for Alnylam is still tied to its ATTR amyloidosis portfolio, but compounds like Givlaari, inclisiran, fitusiran, and lumasiran are not just “also-rans”, and Alnylam management may well use its upcoming R&D day to further illuminate its clinical development priorities for the next few years. At this point, I believe Alnylam shares should trade closer to $130.

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Alnylam Pharmaceuticals Secures Its Second Approval, And The Pipeline Is Still Attractive

First Horizon Now Well-Placed For The Longer Term

I’ve written before that First Horizon (FHN) has some under-appreciated counter-cyclical drivers that should help it navigate a likely-to-be tough 2020 better than its peers, but First Horizon management has since taken a major step toward shoring up its long-term future. Not only does the merger of equals with IBERIABANK (IBKC) (“Iberia”) look attractive on its own merits, but it should give First Horizon much-needed scale and an even more attractive long-term operating footprint.

I liked First Horizon before and the Iberia deal makes the outlook even better in my view. While mergers of equals are riskier from an integration perspective, I think First Horizon is going about this the right way and the long-term potential makes the risks worth taking. I’m not really big on “top picks”, but I definitely think First Horizon is a name to consider below the high teens.

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First Horizon Now Well-Placed For The Longer Term

Neurocrine Making The Most Of A Strong Ingrezza Launch

My expectations for Neurocrine Biosciences (NBIX) have been somewhat restrained for 2019, as this biotech didn’t have a lot of clinical updates on the docket and I thought the Street had largely adjusted to the stronger-than-expected Ingrezza launch trajectory. The shares have perked up recently, though, climbing more than 15% since my last update and more than 30% from a near-term low on a wider recovery in biotech stocks.

At this point Neurocrine shares don’t look exceptionally undervalued relatively to my elevated rate of return requirements for biotechs. Then again, I’m still looking for a double-digit annualized return from here, so that’s not exactly paltry. Neurocrine’s pipeline is an “is what it is” situation today, with not much thesis-changing data likely on the way, but the FDA could grant earlier than expected approval to opicapone and management has made it clear that they’re looking for other in-licensing, partnering, and acquisition opportunities.

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Neurocrine Making The Most Of A Strong Ingrezza Launch

Lenovo Undervalued, But This May Be The New Normal

Lenovo’s (OTCPK:LNVGY) market-leading PC business looks well-placed to continue being a cash cow for the business, but management’s forays into the data center (servers) and mobile have proven to be poor capital allocation decisions. Although the data center business can likely do better in the future and the mobile business could outperform on attractive model launches, management really needs to show tangible results from its “3S” strategy if it wants to get the benefit of the doubt and better valuation multiples.

While I thought Lenovo could be due for some underperformance when I last wrote about the shares, the stock has suffered more than I expected from increased trade tensions between the U.S. and China in the interim, as well as weaker market demand for servers (particular hyperscale). Although Lenovo has consistently outperformed on margins, the market is not excited by a business still driven so significantly by the PC business. I do believe Lenovo shares are undervalued and offer a respectable dividend, but my enthusiasm for the shares is at least somewhat tempered by management’s inability to execute effectively with the server and mobile businesses.

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Lenovo Undervalued, But This May Be The New Normal

Wright Medical Gets Its Long-Awaited Bid From A Somewhat Surprising Buyer

Investors have long assumed that Wright Medical (WMGI) was a “when, not if” buyout target in the med-tech space. Indeed, any time I’ve written anything even remotely critical of the company over the years, there’s been at least one comment of, “it doesn’t matter … (CEO) Bob Palmisano” is just going to sell the company anyway.” These expectations came to fruition on Monday with the $30.75/share, $5.4 billion bid for the company from ortho giant Stryker (SYK).

I’ll admit I’m a little surprised that Stryker stepped up for this deal (for reasons I’ll explain later), but I can also see the logic. For Stryker, this is a somewhat pricey deal with sound long-term strategic positives. For Wright Medical, this is a graceful exit for a company that has continued to struggle with its sales execution in the lower extremity space despite a strong product portfolio and a strong upper extremity business.

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Wright Medical Gets Its Long-Awaited Bid From A Somewhat Surprising Buyer

Lower Rates Taking A Bite Out Of Bank OZK

Although I thought Bank OZK (OZK) looked undervalued a quarter ago, I also thought that the weak short-term outlook, driven by spread compression risk, was likely to weigh on the shares. And so it has been, with the shares down another 7% and underperforming the broader regional bank group over the last three months.

Credit quality remains very good, but spread compression was worse than the Street (and I) expected, and although I think Bank OZK has some underappreciated opportunities to offset spread compression, I do worry that just as deposit betas didn't rise as far/as quickly as expected in the up-cycle (leading to better NIMs), the reverse might be true in this part of the cycle (leading to worse NIMs). I do think expectations are quite low now and I think there is appealing long-term upside here, if, and this is a VERY big if, credit quality stays strong.

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Lower Rates Taking A Bite Out Of Bank OZK

People's United's Stability Looking More Appealing Now

When I last wrote about People’s United Financial (PBCT) I had a more or less “yeah, it’s fine … I guess” opinion about the shares, and the stock is more or less in the same place now as it was last quarter, but there was plenty of volatility in between, with a sharp 15% drop to ($14), a rally, another drop, and then another rally. That’s a surprising amount of share price volatility for a company whose management prioritizes smoothing out the operational performance.

I spent some time over the past weeks reevaluating People’s United in the context of its past performance and current valuation. Although the long-term lack of exceptional tangible book value growth is still an issue, I probably haven’t given the bank enough credit for its more defensive characteristics, and I’d note that other banks with strong defensive attributes like Commerce Bancshares (OTC:CBSH) and U.S. Bancorp (USB) can enjoy more robust valuations than their growth rates would otherwise seem to support.

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People's United's Stability Looking More Appealing Now

Zions Doing The Right Things, But The Cyclical Headwinds Are Stiff

Given the sheer number of banks out there, I can’t really say that Zions Bancorporation (ZION) has improved itself the most over the last three, five, and/or 10 years, but they’re definitely one of the more striking success stories among the mid-cap banks I follow, as management has worked hard to improve credit quality and profitability while hanging on to one of the best deposit franchises in the business.

For all of the things that Zions is doing right, the reality is that this is a highly asset-sensitive bank in an easing cycle, and it is likely going to take about five years or so for Zions to regain its 2018 level of core earnings. Zions isn’t alone in that, but it may be challenging to own this bank over the next year or so in the face of weak pre-provision profit results and a valuation that is already pretty fair.

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Zions Doing The Right Things, But The Cyclical Headwinds Are Stiff

Strong Performance And Transformation Driving Ingersoll-Rand

My early May call on Ingersoll-Rand (IR) is about as close as I typically get to a “valuation doesn’t matter” call with industrials, as I thought the company’s strong execution and healthy underlying market exposures set the stage for good ongoing relative performance. Since then I wouldn’t say that Ingersoll-Rand’s performance has shot the lights out, though the stock has continued to outperform the wider industrial sector.

I continue to believe the merger of IR’s Industrial business with Gardner Denver (GDI) makes sense (and a more competitive player against Atlas Copco (OTCPK:ATLKY) ), and I likewise continue to believe that Ingersoll-Rand is reshaping itself into a strong player in a market with a strong long-term outlook. Valuation remains a hang up; while I do believe that IR’s stronger reported growth and healthy margins can support the stock during this industrial downturn, the long-term prospective returns aren’t as appealing to me.

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Strong Performance And Transformation Driving Ingersoll-Rand

Longer-Cycle Businesses Supporting Eaton

Eaton (ETN) has been one of my preferred industrial names for a little while now, partly due to the company’s particular end-market exposures, but also due to what I thought was a general underappreciation of the company’s positive qualities. That position has held up fairly well, as Eaton shares have outperformed its industrial peers over the last six months, including well-loved Honeywell (HON), and continued to report relatively healthy results in an increasingly difficult market.

I do expect Eaton’s growth to slow, but margins are holding up better and I still see some upside in the shares. I always encourage investors to shop around, and I’m a little concerned about overall valuation levels in the sector, but Eaton still looks no worse than okay.

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Longer-Cycle Businesses Supporting Eaton