Integra LifeSciences Bails Out Of A Once-Promising Growth Opportunity

Replacement joints and complementary products for the extremities make up one of the best growth markets within orthopedics, but it's not an easy market in which to sustain success - small, innovative startups are disrupting the market (including hiring away reps), while more established players like Stryker (SYK) and Wright Medical (WMGI) look to press their advantages in product development and spread of products available. It was always going to be challenging for Integra LifeSciences (IART) to become a leader here, but the company really couldn't build on its deals and has finally thrown in the towel.

Such was the performance of the extremities business that this could be addition by subtraction for Integra. At a minimum, the $200M net cash inflow reduces debt and puts management a little closer to being able to resume its growth-by-M&A strategy. All told, Integra is a tough call - the company's neuro and wound care businesses aren't bad, and the shares look a little undervalued, but this isn't a particularly fast-growing company and small/mid-cap med-techs that aren't double-digit revenue growth stories can be left behind at times.

 

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Integra LifeSciences Bails Out Of A Once-Promising Growth Opportunity

Capital One Financial Offers A Middle Ground For Quality, Value, And Risk

If you doubt the impact of stimulus on the economy, at least in the short term, take a look at Capital One Financial’s (COF) August card data, wherein charge-offs and delinquencies for both credit cards and auto loans were lower than in the year-ago period… when there was no COVID-19 and the unemployment rate was around 3.7% (instead of the 8.4% in August). While the COVID-19 recession is by no means over, and there are still plenty of questions as to what future stimulus, if any, will look like, I would argue the odds are improving that these efforts will help “tide the consumer over” until the economy recovers, leading to lower overall loan loss rates than previously expected.

Capital One remains an odd sort of bank, and really more of a bank-consumer finance hybrid. While it does make commercial and consumer loans, cards dominate the business. Likewise, while the bank does have a deposit-gathering franchise, including both branch-based banking and online operations, the overall cost of funds is still relatively high. Appreciated for what it is, I do believe that Capital One is undervalued today, but that’s the rule and not the exception these days in the banking sector, and I can see some near-term volatility risk from credit risk and capital returns.

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Capital One Financial Offers A Middle Ground For Quality, Value, And Risk

Alnylam Reports Another Positive Study Outcome, Securing More Of Its Future Revenue Growth

While the last couple of months have been a little quiet, Alnylam (ALNY) continues to make progress across its business. Positive topline results from the ILLUMINATE-B study not only should help solidify the revenue outlook for lumasiran, they also mark the first study of an RNA interference (or RNAi) therapy in a young pediatric population, with a clean safety profile possibly paving the way to future clinical opportunities. The company has also since secured some R&D financing for its vitusiran and ALN-AGT programs, and shown additional positive long-term data on Gilvaari.

Incremental as these updates may be, they’re positive additions to the story and certainly better than the alternative. I expect Alnylam to report improving trends for Onpattro in the third quarter as the situation starts to normalize after disruptions created by COVID-19, but more significant drivers like additional clinical data on ALN-AGT and the approval and launch of inclisiran are still a little further off. A lack of strong near-term drivers is a concern, but I believe Alnylam is undervalued below the $150’s and still worth buying/owning at these levels.

 

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Alnylam Reports Another Positive Study Outcome, Securing More Of Its Future Revenue Growth

Mueller Water's Upside Rests On Good Government Decisions

It's been a long time since I've published updated thoughts on Mueller Water (NYSE:MWA). I wasn't very bullish on the shares back in 2016, largely due to what I thought were inflated expectations for municipal water investment/capex spending and the Technologies segment, as well as overly ambitious expectations for margin leverage. Since then, the shares have underperformed the broader industrial group by about 30% and the S&P by about 50%, as well as more water-focused peers like Evoqua (AQUA), Watts Water (WTS), and Xylem (XYL).

I'm relatively bullish on the outlook for residential construction, including land development, and I like the company's decision to reinvest in its manufacturing base to drive stronger long-term margins. What I don't like is how much of the valuation still seems to depend upon governments at all levels (municipal, state, and federal) making smart decisions, doing the right things, and finding the funds to reinvest in upgrading critical infrastructure assets like water. I'm also still quite skeptical of the Technologies business - while products and services like monitoring software and leak detection should be popular, something is clearly not working in this business, as it hasn't produced meaningful growth in five years.

Mueller doesn't look particularly attractive on cash flow, though my model reflects my own pessimism that needed infrastructure spending will happen. Relative to Mueller's margins, ROIC, and so on, though, the shares do look undervalued.

 

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Mueller Water's Upside Rests On Good Government Decisions

East West Bancorp Not Getting Much Appreciation For Above-Average Margins And Growth Potential

With all that has happened in the wake of the COVID-19 pandemic, including a pledge from the Fed to keep rates very low into 2023, it's not so surprising that banks have underperformed. So, in that context, East West Bancorp's (EWBC) in-line-with-peers 30%-plus year-to-date plunge is perhaps likewise not so surprising. Although there are a lot of positives to this name, including its cross-border lending capabilities and strong profitability, the reality is that East West cannot escape the pressures of weaker spreads, limited loan growth, and rising credit costs.

There are a lot of banks that look undervalued today, so investors are spoiled for choice. East West doesn't skew as among the cheapest, but I think there's an argument for it as a more compelling idea on the basis of its elevated quality. With that, I believe this is still a name worth considering.

 

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East West Bancorp Not Getting Much Appreciation For Above-Average Margins And Growth Potential

IDEX Priced As The High-Quality Growth Fluid Control Story That It Is

Quality fluid control/fluid management stocks don’t often trade all that cheaply, and that’s just a fact of life in the market today. You can look at a diverse group of peers and comps for IDEX (IEX) and, for the most part, if you see an undervalued name, it’s likely because the company has outsized exposure to oil/gas and/or power gen and not as much exposure to short-cycle industrials and biopharma. So, as a high-quality name in a still-popular space, I’m not that surprised that IDEX has continued to outperform the broader industrial group since my last update, particularly as the company has taken some aggressive cost reduction moves to mitigate decremental margin pressure.

I’m comfortable with a double-digit FCF growth outlook for IDEX, with growth opportunities in life sciences and photonics offsetting some longer-term pressure in oil/gas. Short-cycle leverage here is more mixed; autos, ag, and “general industrial” should be getting better, but aerospace, oil/gas, power, and chemicals could drag on results a little longer.

Are IDEX shares cheap? Nope. Would I expect them to be? Not really, particularly with management doing a pretty good job of mitigating COVID-19-related pressures. I do still think that valuation always matters sooner or later, and I’d rather wait for a pullback than chase a name offering what appears to be mid single-digit long-term total annualized appreciation potential.

 

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IDEX Priced As The High-Quality Growth Fluid Control Story That It Is

Repligen Continues To Gain Share In The Fast-Growing Bioproduction Market

Repligen (RGEN) is about as close as I'll get to "forget the valuation and just buy", as although these shares do carry a high multiple, Repligen is a share-gainer in the fast-growing bioproduction market. Between expanding the line-up of products on offer, gaining share within its existing portfolio, and leveraging growth in antibodies and gene therapies, I see Repligen as fully capable of generating more than 20% annualized growth for some time to come, provided the company doesn't accept a buyout offer before then.

These shares have risen more than 50% since my last update, outperforming more diversified large rivals like Danaher (DHR) and Thermo Fisher (TMO) and more or less keeping pace with Sartorius (OTC:SARTF). The development of therapeutics and vaccines for COVID-19 should provide a multiyear boost to revenue, but the main opportunity here is in growing the business to address more opportunities in areas like flow control/fluid management, analytics, and possibly fermentation and cell culture media. The valuation is not low, and I'd much prefer to pick up shares on a pullback, but I don't believe high multiples are necessarily an impediment to further appreciation from here.

 

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Repligen Continues To Gain Share In The Fast-Growing Bioproduction Market

Allegion - Strong Performance Metrics, But Well-Understood Drivers And Opportunities

Looking at Allegion (ALLE), the one issue that jumps out to me is a potential lack of drivers for better-than-expected performance. Certainly, Allegion has done well in recent years, with a good track record on adjusted operating margin performance, ROICs, and outperformance versus Assa Abloy (OTCPK:ASAZY) in electromechancial locks. I believe that is all well-understood by the Street, though, and reflected in the share price, which leads me to believe that Allegion will really need stronger-than-expected underlying markets in North America and/or a relatively near-term shift towards greater share in areas like Europe and China.

Between both discounted cash flow and margin/return-driven EV/EBITDA, I don’t see Allegion as much of a bargain now, and I see more risk from weaker end-market trends than I see upside from ongoing company-specific drivers. The quality of the business definitely makes it a name to reconsider at a lower price, but that’s not the case today.

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Allegion - Strong Performance Metrics, But Well-Understood Drivers And Opportunities

Hexagon AB Is One Of The Prime Automation Players You Should Know

Although Hexagon AB’s (OTCPK:HXGBY) business mix can be a little confusing to newcomers, the company’s focus was pretty succinctly summed up on a slide from the 2019 Capital Markets Day – “position, track, and/or control anything, anywhere”. With a collection of hard-to-replicate assets in computer-aided design and simulation, strong geospatial information technology, strong metrology, and integration capabilities, Hexagon has the key software pieces (augmented/driven by some hardware) to bring end-to-end automation to a range of industries and sectors, including construction, mining, civil infrastructure management, and manufacturing.

As a predominantly industrial software company, you can look at names like Roper (ROP) to get some general sense of what valuation and Street expectations are like. These shares aren’t cheap by conventional means, but there is increasing scarcity value in industrial automation/digitalization assets, especially on the software side, and with Schneider (OTCPK:SBGSY)/AVEVA (OTCPK:AVVYY) recently paying 10x trailing sales for OSIsoft, and Emerson (EMR) paying a similar amount for Open Systems International, I can’t say that a little over 6 times trailing revenue is absurd.

 

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Hexagon AB Is One Of The Prime Automation Players You Should Know

Atlas Copco Shows Once Again That It's Serious About Automation

Increasing automation is the future of manufacturing (arguably already the present of manufacturing), and Atlas Copco (OTCPK:ATLKY) is making it increasingly clear that they do not intend to be left behind. While the company hasn’t really made that eye-popping acquisition yet, between Isra Vision (OTC:IRAVF) and now Perceptron (NASDAQ:PRCP), Atlas is putting on its water wings and wading out into much bigger seas of opportunity in metrology, machine vision, and automated manufacturing.

I like the Perceptron deal, and I believe the price paid offers relatively few risks for the company. I do also believe, though, that Atlas has bigger long-term ambitions, and we’re seeing only the first moves in a long-term strategy. Given recent updates and management commentaries, I’m not substantially more bullish on the outlook for high-quality industrials like Atlas Copco. Accordingly, while I love the business, I don’t love the valuation.

 

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Atlas Copco Shows Once Again That It's Serious About Automation

ArcelorMittal Shows Its Serious About Self-Improvement With The Sale Of Its U.S. Operations

ArcelorMittal (MT) management has been trying to convince the Street for some time that it is serious about changing how it operates – instead of trying to bigger, management is focusing far more on being better, with a much greater focus on long-term capital returns from assets. Most have been skeptical about this, including me, as there seems to be one oddly questionable decision made by management to offset every good decision.

With the Monday announcement of ArcelorMittal’s intent to sell its U.S. operations to Cleveland-Cliffs (CLF) in a cash and equity deal, I believe ArcelorMittal management has taken a very big step toward showing that it is serious. I believe the company is getting good value for suboptimal assets in a difficult market, and I like how it backs up the general idea that management is now more focused on the long-term capital returns of the business.

I was lukewarm on ArcelorMittal back in August, as I didn’t like the company’s position as a less-than-great player in a market that I believe is not going to see a lot of pricing strength. The shares have since lagged names I preferred more (including Steel Dynamics (STLD) and Ternium (TX)), but if the indicated pre-market pop holds up, that ArcelorMittal’s relative performance will have improved meaningfully. It still won’t be my preferred name, but it’s harder to stick with a bearish argument regarding management’s vision and discipline toward making this a better steel company for the long term.

 

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ArcelorMittal Shows Its Serious About Self-Improvement With The Sale Of Its U.S. Operations

With Healthy End-Markets, Advanced Energy Industries Looks Too Cheap

The market teaches you to be paranoid - if something looks too cheap, it pays to investigate further to see what you might be missing. In the case of Advanced Energy Industries (AEIS), I can understand if investors are worried about the recovery trajectory of the industrial business and perhaps that the data center business could slow, but the core semiconductor business looks strong into 2021 and I think both data center and wireless will see good results in the coming quarters.

AEIS's exposure to semiconductor equipment manufacturers virtually guarantees cyclicality in the results, and data center and wireless spending has likewise been volatile (on an over sector basis) for some time. Plus there is the integration risk from the Artesyn deal - past attempts to venture outside of semiconductor equipment have not gone well for the company. Still, even factoring in those risks, I struggle to see why Advanced Energy Industries should be priced for low-to-mid teens long-term annualized returns and trading about halfway between its 52-week high and low when its major customers aren't nearly so weak.

 

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With Healthy End-Markets, Advanced Energy Industries Looks Too Cheap

Greater Visibility To U.S. Investors Could Improve Ferguson's Valuation

The next year is likely to be a busy one for Ferguson plc (OTCQX:FERGY), as this leading distributor of plumbing and HVAC supplies takes a few more big steps towards remaking itself as a largely U.S. distribution company. Not only is the company expected to dispose of the U.K. operations, but management is also in the early stages of a process that will culminate in Ferguson’s primary listing being in the U.S. – a move that could help shrink some of its historical valuation discount to other primarily U.S. distributors.

While there are ample uncertainties tied to COVID-19 and the recession that has followed, the residential and HVAC sectors have held up better, and that should be a net positive for Ferguson. As time goes on, I expect management to continue leveraging its differentiated combined branch and B2C model to gain share, helped too by an ongoing expansion of its private label offerings. Quality distributors don’t often trade all that cheaply, but Ferguson does look undervalued by the standards of its peer group.

 

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Greater Visibility To U.S. Investors Could Improve Ferguson's Valuation

COVID-19 Creates A Windfall For PerkinElmer, And Some Of The Benefits May Linger

It may be indelicate to talk about beneficiaries of a deadly global pandemic, but the reality is that COVID-19 has created an unexpected surge in business for many life sciences companies. In the case of PerkinElmer (PKI), while the recent demand for real-time PCR workstations and kits, liquid handling systems, RNA extraction kits, and so on will fade, I believe the company may hold on to some long-term benefits, as customers have now seen what EUROIMMUN tools can do, and some will likely become long-term customers.

I expect at least a few more quarters of double-digit year-over-year revenue growth, and I’ve boosted my long-term revenue assumptions such that my long-term revenue growth rate moves up about a half-point to 6%. Longer-term opportunities remain in newborn testing (Vanadis), lab automation, lab informatics, and the OneSource management service, as well as EUROIMMUN test menu expansion. PerkinElmer is still not cheap by any standard approach, as is often the case with life sciences companies.

 

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COVID-19 Creates A Windfall For PerkinElmer, And Some Of The Benefits May Linger

COVID-19 Creating Near-Term Turbulence For Hillrom, But The Transformation Is Intact

It can take a very long time for perceptions to change, and that’s not a great thing for Hillrom (HRC) (the older “Hill-Rom” is still used in some situations), as the company continues to try to put its legacy as a slow-growing hospital bed manufacturer behind it. Two management teams have been quite aggressive in using M&A to transform the business, and while I see Hillrom today as kind of a “hodgepodge” of businesses, I do like the leverage to new communications technologies and the opportunities in areas like vision and respiratory care.

In the short term, COVID-19 is going to create some turbulence, as the company saw a meaningful increase in orders for products like ICU beds and monitoring equipment that won’t reoccur next year, and as capital budgets remain in chaos for 2021, though some of the more procedure-driven segments should recover. Longer term, I see a company leveraged to technologies to improve hospital workflows and with upside exposure to growing ex-US sales and further margin leverage

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COVID-19 Creating Near-Term Turbulence For Hillrom, But The Transformation Is Intact

Smiths Group Has Held Up Well, But Major Uncertainties Remain

I’ve had my ups and downs with Smiths Group (OTCPK:SMGZY) over the years. While I’ve liked the company’s decision to cull less competitive businesses, refocus on free cash flow, and reinvest in R&D, operating leverage has been wobbly and repeated attempts to sell the Medical business have gone nowhere due to what I believe is an inflated sense of the business’s value. So too today, while I think John Crane is an excellent business (seals, couplings, and bearings, primarily for oil/gas and industrial markets), I believe sell-side expectations for the business may be too high, and I don’t think the Street is going to love the “consistently inconsistent” results from Detection.

I do believe that Smiths may be undervalued here, but a great deal revolves around the details of the disposition of Medical. An IPO would likely be the best option, but will management accept what may be yet another rejection of their valuation of the business? Likewise, there are significant unknowns regarding taxation and how much debt the company may be able to attach to the business. Even so, I see an annualized total return potential in the high single-digits to low double-digits based upon various potential outcomes for Medical.

 

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Smiths Group Has Held Up Well, But Major Uncertainties Remain

BASF Not Getting Much Credit For An Upcoming Cyclical Recovery, Nor Its Self-Improvement Initiatives

As well-regarded as BASF (OTCQX:BASFY) is from an operational perspective, it hasn’t done its shareholders all that much good – over the last 10 and 15 years, the annual total return has lagged its peer group by more than 450bp and 150bp, and the gap to the S&P 500 is even larger. That’s even more frustrating considering the efforts management has undertaken to refine the business, buying and selling businesses to shift the mix to a less cyclical, higher-margin specialty weighting.

I believe track records are important, but only to a point. BASF management is going through a cyclical downturn now (exacerbated by COVID-19) and a capex reinvestment cycle, neither of which are great news, but the company is also going through a EUR 2 billion restructuring/self-improvement program, and I believe the share price doesn’t adequately reflect the potential upside to the restructuring and the company’s enhanced leverage to agriculture, EVs, and specialty niches in health, nutrition, coatings, and other segments. If BASF can generate long-term revenue growth around 3% and produce long-term FCF margins only slightly better than historical averages (and a greater skew toward specialty products should help), I believe these shares offer double-digit upside today.

 

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BASF Not Getting Much Credit For An Upcoming Cyclical Recovery, Nor Its Self-Improvement Initiatives

Spirax-Sarco Is A Special Industrial Company, And Certainly Priced Like It

Like Halma (OTCPK:HLMLY), Spirax-Sarco (OTC:SPXSY) is a stock that will frustrate value-driven investors. I don’t know how you question the excellence of execution at this company (feel free to try in the comments), and I can see a path for Watson Marlow continuing to generate high-single digit organic revenue growth (and 30%-plus operating margins) for some time. Likewise, I appreciate both the defensive/acyclical customer mix and the uncommon focus on customer value creation that’s woven into the business.

But we’re talking about a stock trading at around 25x 2021 EBITDA. While I think EBITDA growth could come close to the double digits over the next four to five years, and I believe double-digit long-term FCF growth is doable, I just can’t reconcile the valuation with fundamental drivers like cash flow, margins, ROIC, and so on. This isn’t a unique experience, I’ve seen it with Halma, Danaher Corp. (DHR), Roper Technologies (ROP), and other top-quality industrials, but I can’t really rest easy with a portfolio full of stocks where the valuation argument basically defaults to “trust me... it’ll all work out.”

 

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Spirax-Sarco Is A Special Industrial Company, And Certainly Priced Like It

SLC Agricola Trading At A More Interesting Valuation Today

Agriculture is a tough business, and a lot of the value in publicly traded agriculture companies like SLC Agricola (OTCPK:SLCJY) comes from waiting for the underlying value of the land to appreciate - the old saw about “nobody’s making more land” isn’t entirely true in Brazil as more land comes under cultivation, but the gist of it is true and productive farmland continues to appreciate in value. That said, SLC Agricola has shown over and over again that it can reliably earn decent returns from farming, with yields that are among the best in Brazil, through meaningful adoption of technology.

I value SLC Agricola in several ways, including a discounted cash flow model that values the farming outputs and adds in the net value of the land, an NAV approach, and a straightforward EV/EBITDA. All methods suggest that SLC Agricola is undervalued now, but these shares often trade with crop prices, so investors need to understand the elevated volatility that can go with that.

 

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SLC Agricola Trading At A More Interesting Valuation Today

Expanding Its Premium Assortment Can Drive Growth For Diageo

This is a challenging time even for the makers of consumer staples, and Diageo (DEO) is no exception, as consumption has dropped significantly outside the U.S., while the U.S. market has held up better so far as customers shift their consumption from bars and restaurants to at-home. Adding to Diageo’s challenges, though, is ongoing evidence of share loss in the U.S., placing even more importance on the company’s ability to drive effective product development, and particularly in the higher-margin premium categories.

Even with some share loss/market shift concerns, I like Diageo as a business. What I like a lot less is that there’s already a pretty healthy quality premium in the share price. Like Constellation Brands (STZ), I believe Diageo is relatively well-positioned to generate attractive long-term free cash flow growth (and strong near-term margins, ROAs, and ROICs), but a prospective total return in the mid-single-digits isn’t so appealing to me.

 

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Expanding Its Premium Assortment Can Drive Growth For Diageo

Strong New Product And New Market Development Have Driven Techtronic

Although I don't write about it often, Techtronic (OTCPK:TTNDY) has long been one of my favorite companies. The company behind brands like Milwaukee, Ryobi, and Hoover, Techtronic has shown itself to be more than just a low-cost manufacturer of power tools, as a strong product development effort has driven share gains in both the consumer/DIY market and the professional market, with the latter helping to drive strong, steady gross margin growth over the past decade-plus.

There are a lot of strong positive drivers still in place. I don't believe the company is close to exhausting its opportunities to take a share in the residential or commercial markets, and Europe is still largely an untapped market. Diversifying the manufacturing base should offer some improved long-term margin security, and newer categories like outdoor powered equipment still offer significant upside.

Unfortunately, that seems to all be in the price, particularly since the shares have rocketed higher over the past six months (up almost 115%). While I still love Techtronic from an operational perspective, I just can't get where I need to be on valuation to pound the table.

 

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Strong New Product And New Market Development Have Driven Techtronic

Otis Needs To Fill A Few Gaps But Has Meaningful Modernization Leverage

Conglomerates aren't always the best at responding to the needs of individual businesses within the group; sometimes, it simply makes more sense to reinvest cash flow in more promising businesses. Given that spin-outs can often outperform once they're out on their own and can make their own decisions (it's a phenomenon that Peter Lynch talked about a lot). Investors in Otis Worldwide (OTIS) should hope that's the case, as the company looks as though it needs to make up for some lost time and opportunities.

To be clear, Otis isn't a bad business. It's my opinion, though, that the company has been surpassed by rivals like KONE (OTCPK:KNYJY) and Schindler (OTC:SHNDY) in areas like digitalization and in the faster-growing Chinese market. Valuation already looks pretty healthy here, but that's not uncommon in the space.

 

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Otis Needs To Fill A Few Gaps But Has Meaningful Modernization Leverage

Mixed Data From ESMO Sets Up The Next Fight For Exelixis

Nothing has ever been easy for Exelixis (EXEL) or its shareholders, but few biotechs can boast multiple drug approvals, let alone building to nearly $1 billion in revenue and positive free cash flow. While the company has established strong efficacy for its primary drug Cabometyx, combo therapy with Pfizer’s (PFE) rival tyrosine kinase inhibitor (or TKI) Inlyta and Merck’s (MRK) Keytruda has been taking share in the critical renal cell carcinoma (or RCC) market, and there’s ample uncertainty as to whether the most recent data on Exelixis’s own combo will be enough to drive Cabometyx past that $1 billion threshold.

I would describe myself as “cautiously bullish” on the prospects for Exelixis and Cabometyx in first-line RCC. The data from the CheckMate-9ER study weren’t as clean and unequivocal as bulls could have hoped, but they certainly didn’t shut the door on meaningful long-term revenue growth. With a risk-adjusted fair value of $29, driven largely by my expectation of $2.4 billion in peak U.S. revenue in RCC, I do think there’s enough upside to merit a closer look at this name.

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Mixed Data From ESMO Sets Up The Next Fight For Exelixis

Constellation Brands Continuing To Leverage Its High-Value Portfolio Through The Pandemic

In some ways, I think Constellation Brands (STZ) is the opposite of Molson Coors (TAP), a stock I wrote about recently. While Molson Coors has largely kept playing the hand it has, hoping to somehow generate better results by repositioning brands in fading categories, Constellation has used aggressive portfolio transformation over the years to give it a dominant position in one of the strongest categories in alcoholic beverages (high-end beer). Where Molson Coors hasn’t seen meaningful volume growth in over a decade, it took a global pandemic to bring Constellation’s string of quarterly volume growth to an end.

I really like the portfolio Constellation has, and I respect management’s willingness to allocate and reallocate capital in response to the changes it sees in the market. Not all of those moves have been the right ones, but I believe they’ve been right more often than not (and where it really counts). The only fly in the ointment is that the company’s success is no secret. While I don’t necessarily think that Constellation is overpriced, the prospective return I see on a discounted cash flow basis is more on the order of a good hold than a new buy.

 

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Constellation Brands Continuing To Leverage Its High-Value Portfolio Through The Pandemic

IMI Plc Underappreciated For Its Short-Cycle Leverage And Self-Help Potential

A carefully-cultivated skepticism can be an investor's best friend, and when a stock looks oddly mispriced, it's entirely reasonable to wonder why. This brings me to IMI plc (OTCPK:IMIAY) (IMI.LN). I can understand why investors are worried about a fluid/motion control company leveraged to oil/gas and power, but the discount still looks a little large relative to the quality of the business, as well as leverage to more attractive opportunities in short-cycle industrial and climate. On top of that, I see ongoing self-improvement potential from cost-out actions and add-on M&A.

It's been a while since I've written on IMI. I thought it was a borderline call back in May of 2017, and the shares have underperformed the industrial group since then, while the revenue and FCF have developed pretty much as I expected (within about 2%-3% on revenue, 5% on FCF). While I see IMI's exposure to less-attractive end-markets as a drag on growth relative to peers, I do also see the shares as relatively undervalued on just 3% long-term FCF growth.

 

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IMI Plc Underappreciated For Its Short-Cycle Leverage And Self-Help Potential

Grupo Aeroportuario Del Pacifico Offers Investors A Middle Path

Among the Mexican airport operators, investors have an interesting set of choices. Grupo Aeroportuario del Sureste SAB (ASR) (“ASUR”) is seen as the most exposed to tourist traffic, generates robust non-aero revenue, and has the most international diversification. Grupo Aeroportuario del Centro Norte (OMAB) (“OMAB”) is a purely domestic player with no diversification outside Mexico and a much higher reliance on business and personal travel. Grupo Aeroportuario del Pacifico (PAC) (“GAP”), though, takes a middle ground, with some international exposure and a much more balanced mix between domestic/international travel and tourism/business/personal.

There’s an interesting range of valuations on offer today, too, though the spread is not really all that wide. I believe any of these airport operators can be expected to generate a solid long-term return, with OMAB on the high end right now. Given its more balanced business mix, I can see an argument for owning GAP as a somewhat less risky call on internal economic improvement in Mexico.

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Grupo Aeroportuario Del Pacifico Offers Investors A Middle Path

Grupo Aeroportuario Del Sureste Will Recover, But It May Be A Bumpy Ride

The COVID-19 pandemic has hit airport operators hard, as travel effectively stopped during the second quarter and is still far below anything like normal levels. While Mexico’s Grupo Aeroportuario Del Sureste SAB (ASR) (“ASUR”) has historically been prized for its strong leverage to tourist travel, its diversification, and its strong non-aero revenue (“ancillary” businesses like car rental, parking, retail, currency exchange, et al), those assets may well be liabilities in the short term as tourist traffic may be slower to recover in a COVID-19/post-COVID-19 world.

On top of that, there’s uncertainty now tied to ASUR’s renegotiation of its Master Development Plan in Mexico, essentially the concession under which it operates airports, and how capex spending will develop before that renegotiation is finalized.

I think ASUR will be fine long term from an operational standpoint. While these shares have underperformed the company’s Mexican peers Grupo Aeroportuario del Centro Norte (OMAB) ("OMAB") and Grupo Aeroportuario del Pacífico (PAC) ("GAP"), ASUR’s valuation looks more “okay” than compelling, and I still see more opportunity in OMAB today.

 

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Grupo Aeroportuario Del Sureste Will Recover, But It May Be A Bumpy Ride

New Leadership Driving New Interest In Pacific Biosciences

It's been a little wild lately for Pacific Biosciences (PACB) ("PacBio"). While there have been several strong names in life sciences over the past three months and on a year-to-date basis, including companies like 10x Genomics (TXG), Berkeley Lights (BLI), and Nanostring (NSTG), PacBio has sprinted ahead about 125% since my last update, largely, I believe, on renewed optimism around the naming of Christian Henry as the company's new CEO.

PacBio's technology is solid - I believe it has the best technology and products for long-read sequencing - but the commercial execution has never been. With Henry previously having served as Illumina's (ILMN) Chief Commercial Officer, among other roles in a long career at that leading sequencing company, I believe he brings the experience and know-how to meaningfully improve PacBio's go-to-market efforts.

With the shares so much higher now, I believe the story is more reliant on execution now than before. While I do believe Henry will lead the company to significant improvement here, it won't happen overnight, and I do still see quarter-to-quarter volatility risks. While I do still see the double-digit upside here, expectations are significantly higher.

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New Leadership Driving New Interest In Pacific Biosciences

COVID-19 Highlighting Thermo Fisher's Broad Life Sciences Exposure

There aren’t all that many companies for which COVID-19 has been a positive development, but Thermo Fisher (NYSE:TMO) (“Thermo”) has seen demand for lab consumables and testing supplies surge during the pandemic. Thermo is likewise highly leveraged to present-day R&D efforts aimed at COVID-19 therapies and vaccines, as well as future production efforts. With the biopharma industry still ramping up its bioproduction capabilities, Thermo has plenty of growth to look forward to even once the COVID-19 tailwinds ease.

You don’t go into life sciences looking for bargains; there’s the occasional hidden gem here and there, but by and large, a cheap-looking stock is cheap for a reason. That doesn’t apply to Thermo; Thermo is a top player in the field and priced accordingly. While the long-term returns suggested by discounted cash flow aren’t all that robust, the valuation isn’t so out of line for sector norms, and few companies of this size have Thermo’s growth leverage, nor its demonstrated ability to build value from M&A.

 

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 COVID-19 Highlighting Thermo Fisher's Broad Life Sciences Exposure

II-VI Seeing Expanding Opportunities And Shrinking Valuations On Optical Sector Worries

If anything, the investment case for II-VI (IIVI) is more compelling now than it was in late May, even though the share price is almost 20% lower now on market worries about the health of the optical space. Ciena (CIEN) spooked the market with commentary calling for weaker near-term Tier 1 metro equipment spending, and investors are also now more concerned about a possible slowdown in data center spending, as well as the potential ramification of U.S. actions to limit the access of Chinese companies to various components and technology.

For II-VI, though, the company is starting to see a ramp in 3D sensing and opportunities in markets like 5G and 400G data center are still in the near future (as is sensing, really). On top of that, a few small acquisitions and a licensing agreement with General Electric (GE) have quickly moved II-VI from a "picks and shovels" supplier of silicon carbide (or SiC) wafers to a potential player in chips/devices. Given a strong growth outlook in multiple markets and today's valuation, I think there's a credible case for a double-digit expected annualized return from today's price.

 

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II-VI Seeing Expanding Opportunities And Shrinking Valuations On Optical Sector Worries

Roche Deep Pipeline Continues To Support Long-Term Value Creation

While other Big Pharma companies have spent a lot of the past decade-plus more focused on financial engineering through post-M&A cost-cutting and operational leverage, Roche (OTCQX:RHHBY) has been content to continue investing in clinical assets, augmenting and supplementing that along the way with M&A focused on acquiring compounds and technologies, not cost-cutting opportunities.

The net benefit? As highlighted in a recent report from Goldman Sachs analyst Keyur Parekh, Roche has doubled its enterprise value over the past decade (almost to the day), while increasing its market cap by 2.5 times. Low double-digit annualized returns have made Roche one of the top long-term performers in the group, and management continues to invest heavily in its pipeline.

Although I think Roche has established a difficult bar for future comparisons, I believe they will continue to generate strong returns from their deep pipeline, supporting mid-to-high single-digit growth in revenue, free cash flow, and earnings per share, along with respectable returns of capital to shareholders in the form of dividends.

 

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Roche Deep Pipeline Continues To Support Long-Term Value Creation

Bailing On The U.S. Now Looks Like Prudential Plc's Best Chance For Value Creation

Realizing that you're stuck in an "addition by subtraction" situation is a humbling one for management, but I'll give credit to Prudential plc (PUK) management for not stubbornly sticking to their guns on the idea that the market undervalues the potential of the U.S. Jackson National business. Instead, management is looking to IPO this business in 2021 ahead of a full divestment, and the company's Asian operations will be the surviving business.

Weak rates, a shaky stock market, and high volatility is exactly the wrong prescription for the Jackson variable annuity business, and even if today's conditions are temporary, the reality is that Prudential plc has struggled to generate value from what has generally been a decent variable annuity business. Exiting Jackson gives management a chance to generate capital that it can more profitably reinvest in its growing Asian operations and perhaps finally shrink some of the valuation discount.

 

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Bailing On The U.S. Now Looks Like Prudential Plc's Best Chance For Value Creation

Self-Improvement Hasn't Come Fast Enough For Rotork

When I last wrote about Rotork (OTCPK:RTOXY) (ROR.L), I said that this British manufacturer of valve actuators and controls needed to accelerate product development and margin improvement efforts to support its valuation. Since then, the key oil & gas market has weakened dramatically and the shares have modestly underperformed the industrial sector. Weak organic growth remains a key concern, as although the company has made some progress on the product development front, it just hasn’t been significant enough to shift the company’s revenue mix all that much.

Rotork has good technology, and I expect electrical valve actuation technology is only going to become more valuable as 5G drives industrial IoT adoption and growth. On the other hand, I believe capex spending in the oil & gas vertical could be pressured for possibly five years, and that’s going to seriously challenge management’s capabilities. More positively, I do see Rotork as an increasingly attractive M&A target, though I’m not sure how much of a premium investors could reasonably expect to get.

 

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Self-Improvement Hasn't Come Fast Enough For Rotork

COVID-19 Intensifying Longer-Standing Issues At BBVA

I haven’t been all that positive on BBVA (BBVA) for a while, and COVID-19 certainly hasn’t helped matters. My issue with BBVA was the weak prospect for near-term core profit growth, an issue that the macro impacts of COVID-19 across BBVA’s operating footprint have only exacerbated. At the same time, my concerns about BBVA’s inability to earn out its cost of capital remain, as I see it more likely than not that the bank continues its decade-long run of sub-10% ROEs for the foreseeable future.

While I believe BBVA is an under-earning, lackluster bank, I also believe that every going concern has its fair price. Even by the well below normal valuation standards of banks today, BBVA seems undervalued on the mid-single-digit ROTCE I expect over the next couple of years. While I do expect BBVA to generate some growth over the next decade, that’s actually arguably bullish next to the near-zero growth the bank has delivered since 2006. The good news, if you can call it that, is that even no growth in core earnings between 2019 and 2029 would still support a fair value around $3.50/ADR.

 

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COVID-19 Intensifying Longer-Standing Issues At BBVA

A Slimmed-Down Siemens Looks Oddly Undervalued

It's unusual to find a quality industrial trading at a reasonable valuation these days, so the very reasonable valuation on Siemens (OTCPK:SIEGY) has me puzzled. I don't think my long-term revenue outlook for 4% growth is out of line relative to other quality automation, electrification, and healthcare plays like ABB (ABB), Eaton (ETN), Philips (PHG), and Schneider (OTCPK:SBGSY), and likewise, I don't think an outlook for long-term FCF margins in the low-to-mid teens is that bullish relative to peers, particularly considering Siemens' above-average leverage to software.

Operationally, I like a lot of what Siemens has been doing. Siemens was an early mover in the "de-conglomeritization" movement, and I think Siemens is stronger for having moved on from Osram and Siemens Energy while keeping a strong position in Siemens Healthineers (OTCPK:SMMNY). Although there are some areas where I think Siemens could upgrade its business (robotics, low-voltage, and building controls), I think Siemens is well-leveraged to a near-term recovery in industrial automation and a longer-term recovery in process automation, as well as longer-term trends like green electrification and mass transit.

 

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A Slimmed-Down Siemens Looks Oddly Undervalued

Siemens Healthineers Expanding The Business, But Self-Help Is Still Needed

Since its spin-out from Siemens (OTCPK:SIEGY) in the spring of 2018, Siemens Healthineers (OTCPK:SMMNY) has had a rather lackluster run – underperforming the med-tech space by over 20% before the announced acquisition of Varian (VAR) opened the gap even further. While Siemens Healthineers has a market-leading, and quite profitable, imaging business, investors have been disappointed by the lack of progress in the diagnostics business, and it seems fair to assume that with the need to integrate Varian and do whatever is necessary to ensure the success of that large deal, diagnostics may not get the TLC it needs for a while longer.

With the shares underperforming more significantly since the early August announcement of the Varian deal, a lot of premium has been wrung out of Siemens Healthineers shares. It’s still not significantly undervalued, but I can see the possibility of a mid-to-high single-digit annualized return from this level, and if management can deal more effectively with the issues in the diagnostics business, there could be additional upside.

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Siemens Healthineers Expanding The Business, But Self-Help Is Still Needed

Credicorp Taking Prudent Action, But COVID-19 Is Hitting Peru Hard

As leveraged plays on macroeconomic conditions, banks are quite limited in just how much they can offset economic conditions beyond their control. Peru's Credicorp (BAP) is taking some prudent actions to preserve the business, including conservative reserving and participating in government-funded stimulus programs, but the economy has shrunk about one-quarter since COVID-19 began, and that is an incredible headwind to overcome.

Peru was in relatively good shape relative to its neighbors prior to the pandemic, and while I don't think the quality of governance has deteriorated all that much, this is still a major shock to the economy that is going to have lingering effects. Offsetting that, I think Credicorp's balance sheet is in good shape, better than most Latin American banks, and I believe the company's ability to participate at multiple levels of the economy (from large corporate lending to microfinance) is an important asset. I do think Credicorp will get back to double-digit core earnings growth in time, and I believe the shares are meaningfully undervalued, but near-term risks are still significant.

 

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Credicorp Taking Prudent Action, But COVID-19 Is Hitting Peru Hard

Canadian Western Continues To Deliver On A Successful Long-Term Transformation Plan

The worst seems to be over for Canada in terms of COVID-19, but the economic impact is going to linger a while longer – there’s evidence of a recovery off the bottom, but indicators like the BMO Business Activity Index still show about a 20% gap from where the economy was prior to COVID-19. As a primarily commercial lender, the health of Canada’s economy is a direct concern for Canadian Western (OTCPK:CBWBF) (CWB.TO), and while economic activity should improve, I wouldn’t just assume the company is completely out of the woods with respect to credit.

I wasn’t excited about the prospects for Canadian Western back in December of 2019, but that was before COVID-19 whacked the entire sector. Canadian Western has done generally okay since then, and I like the recent progress on funding, but the valuation is not as appealing here as for many other banks around the world, and it’s still more of an “okay, I guess” idea for me than a compelling buy with the shares having nearly doubled from the late March lows.

 

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Canadian Western Continues To Deliver On A Successful Long-Term Transformation Plan

In A Weak Banking Sector, Investors Taking A 'Wait And See' Approach With TCF Financial

With banks trading at uncommonly low valuations - Barclays analyst Jason Goldberg calculated recent sector valuation as being in the 15th percentile of the past 35 years - you can pretty much throw a dart blindfolded and find a cheap bank. While it's true that sector performance determines a lot of individual stock performance (I've seen studies suggesting about 70%), I still believe quality eventually wins out, and I think TCF Financial (TCF) has more quality to it than the shares would seem to reflect.

The integration of the merger of equals between Chemical Financial (NASDAQ:CHFC) and TCF is off to a good start, and there are still meaningful synergies to look forward to, as management continues to target meaningful (mid-teens) savings relative to the pro forma starting point. Beyond that, though, I also see underappreciated potential to take share in its upper Midwest operating footprint, grow the commercial business through low-risk cross-selling, and remain active in M&A in the relatively near future.

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In A Weak Banking Sector, Investors Taking A 'Wait And See' Approach With TCF Financial

Citizens Financial's Discount Is Shrinking, But It's Still Too Wide Relative To The Opportunity

When talking about any bank, it’s important to remember that current bank sector valuations are far below normal and sentiment is lousy, as investors worry about the impact of the confluence of tight spreads, weak loan demand, rising credit costs, and limited expense leverage. Given all that, it may well not be until late next year before banks start trading on recovery prospects.

Even so, I continue to believe that Citizens Financial (CFG) is just too cheap at a double-digit discount to book value, particularly in the context of upside potential from balance sheet optimization, better operating leverage, and growth in fee-generating businesses. With annualized total return potential in the double digits, I believe this is a name worth considering, and I don’t see much risk to the dividend unless there’s a significant deterioration in the economy beyond what’s already expected.

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Citizens Financial's Discount Is Shrinking, But It's Still Too Wide Relative To The Opportunity

Steel Dynamics Getting More Of Its Due As Demand Starts To Recover

When I last wrote about Steel Dynamics (NASDAQ:STLD), I found it a little strange that the shares had been left behind in the short-cycle industrial recovery. Although I wasn’t, and still am not, all that bullish on pricing, given considerable under-utilized capacity in the industry and more capacity coming online in the near future, I thought upturns in steel-consuming markets like autos and heavy machinery and ongoing near-term strength in non-resi construction would support a better demand outlook.

Since then, Steel Dynamics raised guidance for the third quarter on stronger shipments to the auto and non-resi construction end-markets, and the shares have risen about 17% since then, outpacing industrial stocks and closing that gap I had seen before. With that two-month move, I see the shares now more as “fairly-valued” rather than particularly cheap, and while I wouldn’t be in a rush to sell on this momentum, I do think the risk of weaker non-resi markets in 2021-2022 remains a meaningful consideration.

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Steel Dynamics Getting More Of Its Due As Demand Starts To Recover

First Horizon Sounding A Little Better On Credit, With Integration Opportunities Ahead

Wall Street can pivot from problem to problem almost instantaneously, but for now at least it looks as though analysts and investors are in a calmer place with respect to bank credit risk, and have instead turned more toward issues like weak revenue growth prospects and limited operating leverage possibilities across the space. That may actually be a benefit for First Horizon (FHN), as I still see some legitimate questions on credit, but I believe the integration and synergies from the Iberia deal will boost the near-term growth opportunities.

Organic revenue growth is going to be a challenge for almost every bank over the next few years, but First Horizon does at least have an expanded franchise in some of the fastest-growing areas of the country, not to mention a healthy counter-cyclical capital markets business and an expanded mortgage banking operation. The pandemic and recession are likely to stretch the timeline for realizing the hoped-for synergies from the Iberia deal, and I’m still concerned about credit, but all in all I think First Horizon is in good shape, and between above-average upside and a high dividend yield (obviously the two are linked), I like this stock for more risk-tolerant investors.

 

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First Horizon Sounding A Little Better On Credit, With Integration Opportunities Ahead

Far-UVC Could Flip The Switch For Growth At Acuity Brands

The going remains tough for Acuity Brands (AYI). While I don’t really love the business, I thought back in January that the valuation seemed low relative to even modest (low single-digit) long-term growth assumptions, but the shares have since underperformed the industrial group, perhaps due to the company’s high exposure to non-residential new-build construction and relatively little exposure to green building retrofits, as the LED upgrade cycle is largely mature.

Now there’s a new potential driver to consider – Far-UVC lighting as a retrofit product for building hygiene. Unlike conventional UVC systems, Far-UVC lighting systems can kill viruses, including SARS-CoV-2, but are still safe to use while the building is occupied. Given the sheer installed base for potential retrofits, this could provide an important spark to Acuity’s story in calendar 2021 – and the stock really could use a spark, as although it continues to look undervalued on undemanding expectations, the Street has shown it really isn’t interested in commercial lighting businesses.

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Far-UVC Could Flip The Switch For Growth At Acuity Brands

COVID-19 Adds To Molson Coors' Long-Term Struggles To Reposition The Business For Growth

It’s very, very difficult to make money in the stocks of companies that aren’t growing. Low-growth stocks can work under the right circumstances, but the shares of companies with no growth, or actual erosion, rarely work out long term.

That’s my biggest hang-up with Molson Coors (TAP). I can see value in this business, but I believe management is going to continue to struggle to offset the decade-plus volume erosion in its core market categories, and high debt levels limit how aggressively Molson Coors can pursue other options to speed the pace of a portfolio refresh. If management can stem the losses in its core mainstream portfolio and drive even faster growth from new product introductions in its high-end (or “above premium”) category, there could be real upside here, but I think that will be a tough outcome to achieve.

 

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COVID-19 Adds To Molson Coors' Long-Term Struggles To Reposition The Business For Growth

With Or Without Grail, Illumina Worth Watching At These Levels

Illumina (ILMN) has built itself into the unquestioned leader in genetic sequencing, but that hasn’t done much for the stock over the last two years or so, as shares have been stuck in a roughly $100 band between $270 and $380. Not only has COVID-19 created new short-term headwinds for the company, but growth-hungry investors are increasingly questioning where the next leg of growth will come from for this company.

Illumina has made it clear that they see a significant opportunity in diagnostics, and liquid biopsies in particular, and the rumored pursuit of GRAIL (GRAL) fits with the company’s stated strategy of positioning itself for that opportunity. While GRAIL would be an expensive deal, I think it would be a sound one for the long term, and I see a lot of long-term opportunity in next-gen sequencing-based oncology diagnostics. While Illumina shares are not quite as cheap as I like, the stock is in a ballpark where I think it’s at least worth monitoring the name.

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With Or Without Grail, Illumina Worth Watching At These Levels

PINFRA Only A Passenger In Downturns, But The Value Here Is Appealing

The problem with "set it and forget it" businesses is that there's little-to-nothing that can be done by management to improve demand when business turns down, and often the cost structures don't lend themselves to meaningful short-term restructuring. That's basically the problem for PINFRA (OTCPK:PUODY) [PINFRA.MX] today, as this large Mexican toll road operator has no control whatsoever over traffic on its roads, and is basically in the passenger seat as the COVID-19 pandemic works itself out in Mexico.

The good news is that the pandemic won't last forever, and while it has done some serious harm to Mexico's already-weak economy, a large portion of PINFRA's most valuable toll roads are covered by concession agreements that contain clauses that extend the concession when traffic weakens. While delayed revenue and cash flow does impair short-term value, PINFRA isn't as vulnerable to this downturn as you might otherwise think. Moreover, Mexico's government has expressed an interest in adding even more roads, creating new long-term concession opportunities for the company.

These shares have not done especially well since my last update. While the local Mexican shares have basically kept pace with the broader Mexican market, the ADRs have been weaker (down 25%) on weaker currency. Although the recent performance underlines the reality that there is no such thing as a "safe" emerging market stock, I like PINFRA's leverage to an economic rebound and growth in Mexico.

 

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PINFRA Only A Passenger In Downturns, But The Value Here Is Appealing

M&T Bank Is Conservatively-Run And Undervalued, But Will Likely Struggle To Grow

Few banks are really in favor these days, as investors have largely abandoned the sector due to very weak near-term earnings growth prospects in an environment where rates will remain low for several years, credit costs are rising, and where loan demand is iffy at best for now. M&T Bank (MTB) has a well-earned reputation for conservative and healthy capital, both of which are strong positives at this point in the cycle, but with very weak core earnings growth prospects over the near term, this one could languish a while longer.

 

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M&T Bank Is Conservatively-Run And Undervalued, But Will Likely Struggle To Grow

Braskem Undervalued On Economic Recovery Prospects, But Debt And Operation Challenges Create Higher Risk

It’s been a while since I’ve updated my thoughts on Braskem (BAK), but it hasn’t been an easy run for the company, with the shares down more than 50% on a host of issues. When I last wrote about the company, I cited some risks from compensation claims from Alagoas, weaker spreads, issues with ethane supply, and overall economic-driven demand, and since that time pretty much every one of those issues has come home to roost.

Management deserves credit for how they’ve managed these challenges, though, and I think the market may be giving too little credit for the value of the company’s diversified feedstock supplies and attractive geographic positioning. The company’s very high leverage is an issue (and it creates some valuation complications), but I do believe these shares are undervalued enough to be worth consideration.

 

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Braskem Undervalued On Economic Recovery Prospects, But Debt And Operation Challenges Create Higher Risk

Huntington Bancorp Undervalued On Stabilizing Credit And Healthy Mortgage Demand

Between data releases from the Fed and company disclosures and comments at a recent major sell-side conference, it looks to me as though the bank sector is in better shape that the valuations would suggest. While I still see credit risk before this cycle is over, bank management teams seem more concerned about the impact of rate risk than credit risk, and operating leverage is going to be an increasingly important differentiator over the next couple of years, particularly with the Fed committed to a low-rate policy through 2023.

Specific to Huntington Bancorp (HBAN), I like the strong leverage to healthy mortgages and autos, and the decline in second-round deferrals was good to see. I also like the bank’s reserve position vis a vis Fed DFAST (Dodd-Frank Act Stress Tests) estimates, and the capital position looks healthy. Lackluster near-term operating leverage is my biggest concern, but I think the bank can get back to mid-single-digit growth in three or four years. I believe fair value is around $12.50, with some upside to around $14, and the dividend is significant (and safe, in my view). Huntington isn’t my top choice, mostly because there are equally good banks at even steeper discounts, but it’s a respectable name to consider.

 

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Huntington Bancorp Undervalued On Stabilizing Credit And Healthy Mortgage Demand

The Street Seems Ahead Of The Curve On Caterpillar's Recovery

First things first – Caterpillar (CAT) is a great company. While it operates in deeply cyclical markets and has had to withstand incoming competitive entrants from China, CAT has an almost-impossible-to-beat global distribution network and incredible brand value, not to mention leading share in a large portion of the markets where it chooses to compete and excellent margins relative to most of its competitors.

The issue I have today is a combination of valuation and Street expectation. I believe non-residential construction is likely to weaken in North America and Western Europe in 2021, and that weakness could persist into/through 2022, and I’m likewise not so bullish on near-term demand in the mining or energy sectors. With Caterpillar already trading ahead of sector trough multiples, and recent data not exactly supporting a robust near-term recovery, I’d prefer to wait for a better opportunity.

 

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The Street Seems Ahead Of The Curve On Caterpillar's Recovery

MCUs Can Be Unsung Heroes For STMicroelectronics's Long-Term Growth Story

While the stock has closed the year-to-date performance gap with the wider semiconductor group with a strong recent move, STMicroelectronics (STM) (“STMicro”) has been a bit frustrating for me, as a lot of the Street stays firmly in the “show me” camp with respect to the company’s growth and margin initiatives. I certainly understand some of the skepticism given past challenges, but I can also point to a host of other chip companies where the Street is much more willing, if not enthusiastic, to support the “it’s different this time” story.

That whinging aside, I like what I heard at the company’s recent “mini-Capital Markets Day”. I believe the company has a strong tailwind in its MCU business, and while a lot of attention has been given to the company’s leverage to auto electrification and ADAS and smartphone wins, I believe the MCU business is an overlooked growth and margin opportunity. I’m still expecting STMicro to generate mid-single-digit long-term revenue growth and double-digit FCF growth, with the company benefiting from an enhanced product mix (good for margins), improved scale, and growth opportunities in auto, industrial, and communication markets.

 

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MCUs Can Be Unsung Heroes For STMicroelectronics's Long-Term Growth Story

Dover Looking Toward Biopharma To Pump Up The Growth

Large multi-industrial conglomerates like Dover (DOV) can often be "black boxes" to individual investors, as the companies don't often publicly provide a lot of detail on the individual segments and businesses, and their IR teams are almost never interested in taking the time to walk individual investors through those details. With that in mind, I really appreciate events like Dover's recent investor meeting highlighting its Pumps and Process Solutions (P&PS) business.

In addition to what I'd call "moderately bullish" commentary on the pace of the nascent end-market recovery, Dover made it clear that M&A is a key strategic priority and that it views biopharma as a key growth market. I agree wholeheartedly, and while I think investors could be in for some sticker shock on deal multiples in this space, I think it's a great move to focus on "picks and shovels" solutions for the biopharma industry.

While Dover's guidance gives me more confidence on my numbers for the remainder of 2020, it wasn't enough to prod me to a meaningful upward revision. With the shares up another 10% since my last update, basically in line with the sector and about 5% better than the S&P 500, I don't really see the stock as cheap, but it's a high-quality in a strong sector.

 

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Dover Looking Toward Biopharma To Pump Up The Growth

The Early Returns From GEA Group's Turnaround Have Been Very Encouraging

I know it's a corporate-speak cliché, but there really is something to notions like "under-promise and over-deliver" and "plan the work, work the plan", and I think you see some of the benefits already at GEA Group (OTCPK:GEAGY) (G1AG.XE). Although I saw relatively modest near-term upside before if management "only" hit the initial targets, execution on the turnaround plan has been better than expected, and the more ambitious targets that I mentioned in that piece are now relevant to the conversation.

There's still a lot of work to be done. While management has already largely decentralized the operations, the divestitures haven't really even started, and certain projects, like the turnaround of the Liquid & Powder Technology segment, are going to take years as new management works through bad projects on the books. Still, there is a credible plan here, and I like management's decision to focus on food, beverages, and pharmaceuticals as future growth drivers (not unlike SPX FLOW (FLOW)). With low single-digit revenue growth, mid-single-digit FCF growth, and high single-digit adjusted operating margins supporting a fair value more than 20% above today's price, I still think this is a name worth considering.

 

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The Early Returns From GEA Group's Turnaround Have Been Very Encouraging

Crane Beaten Down On Weak Cyclical Leverage

There’s been a sharp divergence this year between industrials, which were hit hard in March but have largely come back, and aerospace companies which were hit hard in March and have basically stayed down ever since. While Crane (CR) is undeniably leveraged to aerospace (it was the company’s highest-margin business by far) and also leveraged to consumer/leisure more than most multi-industrials, the nearly 40% year-to-date decline in Crane’s share price seems excessive to me.

To be sure, I do have some concerns about Crane. I’m concerned that the Fluid Handling doesn’t earn the sort of margins it should for its supposed reputation and market share, and I’m likewise concerned that Crane will find it hard to break out of what has been a relatively narrow operating margin band since 2013, particularly with a longer path to normal in the aerospace business. Still, I’m only looking for long-term revenue growth on the cusp between the low and mid-single-digits, and not much margin/FCF margin improvement, and Crane looks undervalued relative to what I think are reasonable, if not conservative, assumptions.

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Crane Beaten Down On Weak Cyclical Leverage