Tuesday, March 24, 2020

Amid Intense Macro Uncertainty, PRA Group Executing Well

To at least some extent, the Covid-19 outbreak in North America and Europe is an “all bets are off” event for PRA Group (PRAA) that massively complicates modeling over the next year or two. It’s pointless to attempt to collect on debts incurred by people who have no income, and there is still significant uncertainty as to whether there will be additional shelter-in-place orders around the country and when the country will be back to “business as usual”.

It’s not completely accurate to say that PRA Group can just hunker down and wait for conditions to improve – there are ongoing costs to operate the business – but the company’s receivables don’t expire to any meaningful extent. Sooner or later, people will be able to pay again and although Covid-19 is going to limit the company’s near-term earnings potential, the longer-term outlook is still fairly good, particularly so given the progress made in building up the company’s digital and legal collections capabilities.

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Amid Intense Macro Uncertainty, PRA Group Executing Well

Lexicon Pharmaceuticals Moving On From Diabetes And Pivoting Toward Clinical Candidates

While I’m sure die-hards will claim that Lexicon Pharmaceutical’s (LXRX) sotagliflozin still has a future, the company’s recent announcement that it would shut down the SCORED and SOLOIST long-term studies and indefinitely postpone an NDA filing due to an inability to find a partner, after getting its second appeal to the FDA on the Type 1 indication rejected, essentially brings that program to a close.

Theoretically Lexicon could still find a partner for this drug, but the reality is that it’s done as a meaningful contributor to the story. Still, the company’s cupboard is not entirely bare; management has reported encouraging retrospective efficacy for Xermelo in neuroendocrine tumors (or NET), will be reporting initial efficacy data for Xermelo in biliary tract cancer (or BTC) later this year, and will be starting a Phase II proof of concept study in diabetic peripheral neuropathy later this year.

The loss of sotagliflozin is meaningful, but the clinical potential of Xermelo and the pain drug LX9211 can support a fair value above today’s price. Investors should note, though, that these are high-risk opportunities and the company’s balance sheet/funding situation is far from ideal.

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Lexicon Pharmaceuticals Moving On From Diabetes And Pivoting Toward Clinical Candidates

Hurco's Balance Sheet Will Carry It Through These New Headwinds

I had been more bearish, or at least more cautious, than a lot of analysts regarding the outlook for manufacturing stocks in 2020 given the still-weak underlying end-market trends and the prospects of election year disruptions, but I certainly didn’t have the huge Covid-19 impact in my models. With the pandemic impacting economic activity around the globe, investors find themselves in what is basically an “all bets are off” environment when it comes to manufacturing equipment companies like Hurco (HURC).

Hurco’s strong balance sheet is likely its best asset today, as the company’s strong net cash position will help it push on through this unexpected new headwind. Although a downturn on par with fiscal 2009 (when revenue dropped by more than half) isn’t my base-case assumption yet, the company could survive that and demand will eventually recover in key markets like Germany, the U.S., and Italy. I certainly can’t promise that there’s no more downside at this level, but Hurco has navigated tough times before and I expect it will do so again.

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Hurco's Balance Sheet Will Carry It Through These New Headwinds

Monday, March 2, 2020

The Ugly Market Selloff Brings Lincoln Electric Back Into A Long-Term Buy Range

It takes a lot to knock well-respected, high-quality stocks down to attractive valuations, and this ugly market selloff is doing just that for many stocks, including Lincoln Electric (LECO). Make no mistake, current conditions are pretty challenging for this leading welding company, and whatever recovery may come in 2020 is not likely to be particularly strong. Still, this is a company that has been through this before (many times, actually), has a business plan that gives it a lot of cost flexibility, and is going to emerge from this correction in solid condition.

The biggest issues I see with recommending Lincoln here and now are the questions of how the recovery will look and how much further downside there could be from here. I’ve been generally more bearish than most Street analysts on the outlook for the 2020 short-cycle recovery, and Lincoln management’s commentary does seem to support the idea of a shallower recovery (at least in 2020). With that, there could still be some risk to estimates (particularly if Covid-19 pushes the U.S. into recession). Likewise, markets tend to go too far to the good and bad, so I cannot rule out the risk that Lincoln shares will get even cheaper before finding a floor.

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The Ugly Market Selloff Brings Lincoln Electric Back Into A Long-Term Buy Range

In An Ugly Market, Cognex Looking Better

In writing on Cognex (CGNX) in the past, I’ve said that whatever circumstances it would take to make this leading machine vision company look undervalued, they would probably look pretty ugly. And here we are – whether Covid-19 is a valid reason for a widespread market sell-off or just an excuse for institutions to sell off expensive stocks, it has driven a lot of quality names to much more reasonable valuations.

Cognex certainly has near-term risk. Capex in the auto sector remains weak and Cognex management believes that both auto and consumer electronics capex may not rebound strongly in 2020. Economic concerns and the election cycle could likewise weigh on logistics capex investing. Longer term, Cognex now has a new rival to worry about, and so on. Point being, there’s always going to be a reason not to buy Cognex (or almost any stock, really), but I believe that this is a relatively rare chance to buy Cognex at a price that at least appears reasonable on a long-term basis.

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In An Ugly Market, Cognex Looking Better

Veeco Looks More Interesting After A Big Pullback

Veeco (VECO) shares have remained quite volatile since my last update; volatility in smaller, under-covered semiconductor equipment names isn’t that unusual, and the coronavirus outbreak adds yet another factor to the mix. On the other hand, Veeco’s fourth quarter results were pretty good and the business seems to be on track to return to profitability later this year. Add in some interesting longer-term opportunities like tools for EUV mask blanks, VCSEL production, and GaN deposition, and I can see reasons for considering these shares.

Not unlike many other equipment providers, these shares have been hammered since Valentine’s Day, with the stock down almost a third from their high. Veeco isn’t my favorite name for many reasons, including the fact that I see it as more of a hodgepodge of tools and market opportunities and I question the long-term margin potential, but there’s a fair price for all going concerns, and I think Veeco is likely trading below that price now.

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Veeco Looks More Interesting After A Big Pullback

OXXO Carrying The Load For FEMSA

FEMSA (FMX) shares haven’t been particularly strong lately (even before the recent market-wide selloff), and I believe at least part of the reason is increasing investor concern over the company’s capital allocation decisions. Acquisitions in the pharmacy and fueling space have yet to really deliver, and now the company is going even further afield to invest in wholesaling and logistics in the U.S. and Brazil. On the other hand, the core OXXO business remains a fortress business for FEMSA, generating significant cash flow that buys the company time for these other investments to mature and deliver.

While the share price has declined to a point where the valuation seems very attractive, capital allocation worries remain. Between recent rumors of a potential acquisition in Brazil and a U.S. bond issuance, nobody really believes that FEMSA is done putting capital to work in M&A. While these concerns are valid, FEMSA management’s historical performance should earn it more benefit of the doubt than it is getting, and I believe the shares remain quite attractive.

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OXXO Carrying The Load For FEMSA

The Hits Keep Coming For ING

Dutch multinational bank ING Groep (ING) had already been testing investors’ patience for a while, as the bank has struggled to meet cost targets and offset widely-known rate pressures across its business. While fourth quarter results do hint at stabilization in the business, the subsequent announcement that the CEO Ralph Hamers was leaving for greener pastures at UBS (UBS) was yet another challenge that the company, the stock, and the shareholders really didn’t need.

There’s only so many times you can make a “just be patient, it’ll get better” call on a name, and ING is arguably past that point. With the shares lagging the broader European bank sector over the last couple of years, this has been a bad call. What’s more, this recent market correction has brought many banks down to more interesting valuations, so investors have plenty of choices now. ING still looks undervalued, but it’s likely going to take beat-and-raise quarters before sentiment shifts, and nothing about the macro environment suggests that’s particularly likely.

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The Hits Keep Coming For ING

Turkcell Remains A Good House In A Very Unpopular Neighborhood

Not only is emerging market telco a largely out-of-favor sector, but Turkcell (TKC
) also continues to be hurt by the relative unpopularity of Turkey as an investment destination. I’ve discussed the many and varied issues with Turkey in prior articles and I won’t rehash that here other than to say that there remain substantial valid concerns about the health of Turkey’s economy and the quality of the government. Even so, Turkcell continues to execute well, with strong performance in the consumer post-paid and fiber businesses.

Turkcell still looks undervalued to me, but it also still looks like a potential value trap unless and until the situation in Turkey improves. Positive ongoing execution will certainly help sentiment, and the dividend outlook is likewise good, but even if Turkcell is one of the best options in Turkey today, that’s only worth so much.

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Turkcell Remains A Good House In A Very Unpopular Neighborhood

HollySys Gaining Share In Automation, But Volatility, Execution, And Covid-19 Remain Risks

The HollySys (HOLI) story is no less frustrating than it was a quarter ago, as the company posted mixed fiscal second quarter results, but also appeared to continue to gain share in China’s process automation market. Margins may well remain under pressure for some time, as the company continues to show a willingness to trade margins for market share in automation and as it continues to reinvest in R&D in both the automation and rail businesses.

As for the shares, they continue to look undervalued, with the stock at a five-year low in terms of price/book and EV/EBITDA. This is a profitable business that consistently generates solid free cash flow and sports a healthy balance sheet. Still, it is not particularly well-followed, it’s not particularly large, and the company’s performance has been erratic (and communication with investors has been far less than perfect). Investors attracted to the story and low apparent valuation would do well to at least be aware of the “value trap” risk here, even though the company is leveraged to some attractive trends, including a growing emphasis on self-sufficiency within China’s automation market.

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HollySys Gaining Share In Automation, But Volatility, Execution, And Covid-19 Remain Risks

Ternium Hammered On Risk Aversion And Economic Uncertainty

Ternium’s (TX) performance since my last update has not been good, with the shares down about 17%. That’s better than the performance of steel peers like ArcelorMittal (MT), Nucor (NUE), and Steel Dynamics (STLD), but “less bad” is only worth so much. Honestly, I found the reaction to the company’s fourth quarter miss relatively restrained, but now there are a lot of worries about what the coronavirus may mean for a number of economies, and that’s on top of what was already a lot of uncertainty about the outlook for Mexico in 2020.

I still like the long-term value proposition here, but buying into sharp market declines often feels like playing chicken with a freight train. Ternium remains a well-run steel company with above-average profitability and exposure to attractive markets, but this is not a good stock for nervous investors.

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Ternium Hammered On Risk Aversion And Economic Uncertainty

Near-Term Market Issues Open A Window Of Opportunity At ITT

Good stocks don’t tend to get, or stay, very cheap for very long, and while there are still some meaningful short-term risks for ITT (ITT), the recent declines look like an opportunity to consider. Not only does ITT serve some attractive long-term process markets, but the opportunities to gain share in automotive friction are still significant, and there are some appealing margin improvement drivers that management is working on now.

I don’t know whether Monday’s sell-off on coronavirus fears will continue, or whether this is a long-awaited correction in what I’ve seen as frothy multi-industrial valuations, but with ITT’s prospective annualized return now above 10%, I see enough upside to take a more bullish position on these shares.

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Near-Term Market Issues Open A Window Of Opportunity At ITT