Truckload Could Have Some Upside, But Heartland Express Is Harder To Love As The Play On It

Although transports aren't a bad way to play economic recoveries, the stocks of truckload trucking companies can be frustrating if you're not familiar with them. Stocks often trade up in anticipation of higher rates, then sell off when those rates actually materialize. To that end, spot truckload rates are about 30% higher than a year ago (and were recently up 40%), but Knight-Swift (KNX), Werner (WERN), and Heartland (HTLD) are all 10% to 20% off of recent peaks, even though contracting pricing should improve by double digits relatively early in 2021.

I do think that the truckload sector is likely undervalued today and offers a pretty good upside/downside trade-off, but I'm not sure Heartland is the best play on that opportunity relative to Knight-Swift and Werner. Heartland had a good long-term track record where profitability is concerned, but margins have been falling for over 15 years on a core basis and are now pretty close to Knight-Swift's and Werner's. Heartland also paid a high price to build a national footprint and has yet to really successfully leverage that footprint.

The bull/bear debate basically comes down to this - Knight-Swift and Werner likely offer "safer" upside, but if pricing really firms up next year and Heartland has finally found the right combination to unlock the potential of its footprint, there's more upside here. This is not a well-liked stock, though, and the long-term differences in stock returns between Heartland, Knight-Swift, and Werner aren't just a fluke.

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Truckload Could Have Some Upside, But Heartland Express Is Harder To Love As The Play On It

Synovus Shares Finally Performing As Worst-Case Scenarios Roll Off

Having expressed some frustration in my last article at consistently recommending Synovus (SNV) only to see the shares underperform, the recent run of outperformance is a welcome change. Bank sector valuations are still low, but investors seem willing to do a little “risk on” investing in the sector, particularly where there have been outsized concerns about credit quality, reserves, and capital/dividends. It’s still much too early to declare an “all clear”, particularly as charge-offs usually peak about five to nine quarters after a recession starts, but with the economy recovering and the stimulus efforts seen to date, the worst-case credit scenarios are rolling out of models and valuations.

Synovus still has some things to prove to the Street, but I like management’s blended prioritization of operating efficiency and targeted loan growth across its Southern footprint. Low single-digit core earnings growth can still support a fair value near $30, and while there are some better return prospects elsewhere (including Citizens (CFG), First Horizon (FHN), and Zions (ZION)), the return potential here is still good enough to consider seriously.

 

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Synovus Shares Finally Performing As Worst-Case Scenarios Roll Off

Zions Bancorp: Weak PPOP Prospects Masking An Increasingly Interesting Valuation

 One of my core investment principles is that valuation is not a driver - "cheap" stocks don't go up just because they're cheap, and likewise expensive stocks don't go down just because they're expensive. Zions Bancorp (ZION) is getting cheaper and cheaper, and I do believe that the Street is overlooking the significant changes management has made to the business over the last decade, but the market usually only believes credit improvement stories at the end of a cycle and Zion's pre-provision profit (or PPOP) growth prospects over the next few years are not very good. I wrote previously that I didn't think Zions was set up to perform well, and the shares have fallen another 10% since then, underperforming the peer group. The prospective returns are getting pretty attractive now, but I do still worry that weak growth leverage over the next few years will remain a headwind to share price appreciation.

 

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Zions Bancorp: Weak PPOP Prospects Masking An Increasingly Interesting Valuation

Regions Financial Delivers One Of The Better All-Around Performances So Far

Conservatism seems to be suiting Regions Financial (RF) right now, and the bank is getting more appreciation and recognition for its meaningful fee-generating business, its hedging position, and its optionality to offset weak revenue with further cost reductions.

In my last article, I said that I thought Regions “is materially undervalued”, but I thought it would take a little longer for the Street to warm up to the name. Since then, the shares up 20%, handily beating its peer group. Although Regions has come further faster than I expected, the shares still look meaningfully undervalued, and this remains a name worth considering, though one that still doesn’t have what I’d call a top-tier pre-provision profit profile over the next few years given ongoing spread and loan demand pressures.

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Regions Financial Delivers One Of The Better All-Around Performances So Far

Commerce Bancshares Delivers Better Results From Its Strong Balance Sheet And Business Mix

Third quarter results highlight yet again that Commerce Bancshares' (CBSH) premium valuation isn't without merit, as the bank once again leveraged its low-cost deposit base and differentiated business mix to deliver better results than its peer group. Commerce remains flush with capital that can be deployed into growth M&A, while the credit situation remains very good.

Interest in the banking sector has picked up a bit in recent months, and with a slight shift toward "risk on", Commerce has lagged the sector a bit since my last update. Perception and sentiment remain the biggest risks I see here. Commerce is thought of as a very high-quality conservative bank, and it tends to outperform in the bad times, but I'm increasingly of the mind that the bank's underlying long-term growth potential has been underappreciated (myself included). Should Commerce be left behind in a "flight from quality" when investor interest returns to banks, this would definitely be a name to revisit.

 

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Commerce Bancshares Delivers Better Results From Its Strong Balance Sheet And Business Mix

Auto Restocking Drives A Tighter Sheet Steel Market For Steel Dynamics, But Capacity Remains A Threat

The U.S. steel industry saw better operating conditions in the third quarter than I'd expected, due in part to auto OEMs and suppliers restocking their inventories and also due to a somewhat unusual level of discipline among market participants that has kept more capacity offline. With its very efficient operating assets, Steel Dynamics (STLD) has been able to stay active when others haven't, allowing the company to benefit from better sheet prices.

I'm still cautious on the sector going into 2021, though. I do expect non-residential demand to weaken and oil/gas demand to stay weak. Auto demand should be better, but with more than a third of industry sheet capacity offline, I believe pricing power could be at risk as these higher prices will, ultimately, coax some restarts.

I've liked Steel Dynamics for a little while, but with the shares up more than a third since my April article, I see STLD shares as more of a "hold" than a "buy", and my preferences lean more towards names like Acerinox (OTCPK:ANIOY) and Ternium, as well as non-steel names like Alcoa (AA). While I do still believe this is an absolute top-notch player in the space, I don't like the combination of potentially weaker non-resi demand and oncoming supply increases (both reactivated capacity and new capacity).

 

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Auto Restocking Drives A Tighter Sheet Steel Market For Steel Dynamics, But Capacity Remains A Threat

Dover Delivers Yet Again And Looks Well-Placed To Leverage This Uncertain Recovery

I've said it before, but it bears repeating - quarter by quarter, Dover (NYSE:DOV) builds the case that it's one of the best multi-industrials in North America and arguably underappreciated on its qualities. In addition to a diverse mix of businesses that should be able to outgrow underlying global growth, Dover also has some ongoing margin improvement and inorganic growth opportunities (harnessing the balance sheet to acquire complementary businesses).

Valuation is the hang-up. I think industrials are looking more and more expensive, and the mid-single-digit prospective return I see from Dover is quite a bit lower than my preferred entry point. On the other hand, if you believe that the S&P 500 itself is likely to generate a 6% to 8% long-term return from here, a similar prospective return from a company that I believe is better than the average S&P 500 company is not such a bad setup.

 

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Dover Delivers Yet Again And Looks Well-Placed To Leverage This Uncertain Recovery

Destocking And High Fixed Operating Leverage Hammer Hexcel

When I wrote about Hexcel (NYSE:HXL) after second quarter earnings, I thought the shares weren’t so attractive as the rally in the shares had largely captured the “it’s really not that bad” trade, but I didn’t expect what third quarter earnings had in store. Turns out, it really is that bad, but it just took a little longer to come through in the financials. Some of this was probably anticipated in the steady decline of the share price from the mid-$40s starting back in June, and the 6% decline on Tuesday was a somewhat restrained reaction.

With no guidance from management, at least a couple more quarters of serious destocking, significant decremental margins, and no real reason to expect a near-term upturn in widebody aircraft builds, it’s going to be tough to build a bull argument on these shares. I think there’s an argument to be made for a fair value in the mid-$30s (around where the shares are today), but with minimal leverage to aftermarket revenue opportunities, not enough space/defense exposure to really matter, and no clarity on the near-term outlook, I’d want a pretty good discount to that mid-$30s target before taking the plunge.

 

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Destocking And High Fixed Operating Leverage Hammer Hexcel

Philips Still Reaping A COVID-19 Tailwind, As Procedure Counts Recover

Dutch med-tech conglomerate Philips (NYSE:PHG) is an interesting position right now. The company has reaped some benefit from the COVID-19 pandemic in its ventilator and monitoring business, and the company’s image-guided therapies business should be levered to the profitable elective procedure growth that hospitals want to encourage, but imaging is going to be under pressure a little while longer on strained hospital capex budgets. At the same time, the company is exiting a multiyear period of impressive gross margin improvement, but still has work to do on SG&A and R&D.

Even with concerns about an overhang in the imaging business, I went positive on Philips in early September, and the shares have risen about 10% since then, beating the market and the med-tech space over that small period. I’m still pretty bullish on these shares; I’d like to see more leverage to the sorts of elective procedures that hospitals are keen to grow, but I also do see meaningful operating margin improvement potential that doesn’t seem to be in the share price.

 

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Philips Still Reaping A COVID-19 Tailwind, As Procedure Counts Recover

Lennox's Strong Performance Smacks Into High Expectations

If these early reports and reactions are any indication, it's going to be an interesting earnings season. Sandvik (OTCPK:SDVKY) reports pretty lackluster results in its SMS division and the market responds with "don't worry, you'll get 'em next time!" and Lennox (LII) has a very strong quarter and the market responds with "yeah … I dunno."

Now, to be fair, not only are the addressed markets very different but so too are also the valuations, with HVAC companies like Lennox trading at quite high multiples going into the quarter. Still, I think the market is likely overestimating the risk to continued residential HVAC growth in 2021 (and beyond) while still being a bit too casual about the risk of weaker commercial new-builds (offset, though, by opportunities in energy efficiency and air quality retrofits).

I thought Lennox was pricey after second quarter results, and with the shares having largely tracked the industrial sector since then (dipping below with the post-earnings sell-off), I don't feel any different. I appreciate the strengths and appeal of the HVAC market, but not at these multiples and I'd still prefer Daikin (OTCPK:DKILY) in the HVAC space.

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Lennox's Strong Performance Smacks Into High Expectations

The Market Shrugs Off Disappointing Orders From VAT Group

It seems increasingly clear to me that investors really want the semiconductor rally to stay solidly in place. I say this because some highly-valued equipment companies, including ASML (ASML) and VAT Group (OTCPK:VACNY) (VAT.S), have certainly posted less-than-perfect quarters/guidance and the markets have largely shrugged it off. More typically, higher valuations mean higher expectations and you’d often see bigger hits to the stocks on these apparent stumbles.

VAT Group shares (the Swiss shares) have underperformed the SOX since my last update, but not enough to make it a clear-cut bargain just yet. I love the company’s strong share in vacuum valves – not commanding, perhaps, but well over 50% and well ahead of rivals – and I expect ongoing increases in vacuum intensity in future generations of chips. I’m comfortable with a premium valuation for special stories (ASML certainly fits), but I’d need to see a greater pullback from VAT before stepping up, particularly in light of weak guidance.

Investors should note that VAT Group ADRs have poor liquidity; the shares listed on the Swiss exchange offer much better liquidity and many brokers now make international trading relatively painless.

 

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The Market Shrugs Off Disappointing Orders From VAT Group

Kansas City Southern Leveraging Volume Recoveries And Self-Improvement

With management having reported rejected a buyout bid worth $208/share, the pressure is on Kansas City Southern (KSU) management to show that they can drive even more value for shareholders staying independent. The third quarter was a step in the right direction, as the company benefited from a significant sequential improvement in volumes, including a strong recovery in cross-border traffic, as well as ongoing efficiency efforts tied to precision-scheduled railroading (or PSR).

I’m bullish on KSU’s above-average growth potential from its Mexican rail network and cross-border traffic, and I’m likewise bullish on the potential of higher margins from those PSR efforts. That said, I think the reported $208/share bid was a pretty fair offer and it’s tough for me to get a near-term (12-month) fair value much beyond $215 without a materially better near-term outlook for the U.S. and Mexican economies.

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Kansas City Southern Leveraging Volume Recoveries And Self-Improvement

Improving Freight Demand Creates Material Hurdles For J.B. Hunt

File this under "be careful what you wish for" - while J.B. Hunt (JBHT) traded sharply higher from March to August on expectations of a sharp recovery in the U.S. freight market, that turn created some significant operational challenges for J.B. Hunt and the company wasn't fully up to the task, leading to weaker than expected results in a recovering market.

On one hand, the rail and warehouse congestion issues and labor shortages are understandable issues that would have challenged any company. On the other hand, isn't the argument for paying a double-digit multiple to EBITDA for J.B. Hunt based on the company's expertise in handling and smoothing over freight logistics challenges? I'm tempted to look at this as a "buy the pullback" opportunity, if not for management's warnings that the congestion/frictional issues that hit the third quarter are going to continue into the fourth quarter and that margins would be under pressure until next year's spring repricing cycle (so, Q2'21).

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Improving Freight Demand Creates Material Hurdles For J.B. Hunt

Sandvik Outperforms On Margins, But Weak Industrial Orders Are A Concern

If more industrial companies report quarters like Sandvik’s (OTCPK:SDVKY, SAND.ST) third quarter, I’m not sure that the rally in industrial will hold. The stronger-than-expected margins were certainly welcome, and margins are an underappreciated driver of multiples in the sector, but meaningful shortfalls in Machining Solutions (or SMS) orders and revenue highlight that the industrial recovery is not yet on firm footing. Add in the impact of new lockdowns in Europe due to COVID-19 and you do have a good case for some concern about near-term demand in a variety of industrial end-markets.

I liked the better results from Sandvik’s mining operations, and again, the margin performance across the business (including SMS) was certainly worth praising. With Sandvik having underperformed the broader industrial group since my last update, I’m a little more interested in these shares as a short-cycle industrial recovery play, but I’m going to wait to see what other industrials report and what management offers investors at the upcoming November capital markets day in terms of long-term strategic initiatives and targets.

 

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Sandvik Outperforms On Margins, But Weak Industrial Orders Are A Concern

Taiwan Semiconductor Finds A New Gear On Strong Leading-Edge Demand

When I wrote about TSMC (TSM) (“Taiwan Semiconductor Manufacturing Company”) after second-quarter earnings, I wrote that while the apparent return potential on offer wasn’t bad for a high-quality tech company, I wanted to wait for a pullback. While 10%-plus pullbacks aren’t so rare in TSMC’s history, that was a vain hope given the hot demand for leading-edge (7nm and 5nm) chips for smartphone and data center applications, and TSMC shares are another 30% higher now.

Expectations remain high, but given virtually no spare capacity, increasing scale benefits at 5nm, and no near-term reason to expect weaker demand from customers like Advanced Micro Devices (AMD), Apple (AAPL), Broadcom (AVGO) at the most advanced nodes, not to mention ongoing issues at Intel (INTC), it’s hard to say that those expectations aren’t attainable. TSMC shares now trade at around a 10% premium to SOX versus a historical small discount (0%-10%), but that premium has been as high as 35% in the past. I’m not calling for a near-term tumble in the shares, but this is now definitely more of a near-term earnings momentum story than a long-term value story.

 

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Taiwan Semiconductor Finds A New Gear On Strong Leading-Edge Demand

Macro Issues Loom Over Commercial Metals' Ongoing Self-Help Story

In the days before COVID-19, I liked Commercial Metals (CMC) as a mispriced steel asset leveraged to better underlying pricing power, a still-healthy non-residential construction market, and ongoing self-help potential as the company continued to leverage production and distribution optimization opportunities. While the stock outperformed its steel peers for most of 2020, it underperformed the S&P 500, and recently, Steel Dynamics (STLD) and Cleveland-Cliffs (CLF) have pulled ahead in terms of returns since that prior article.

Although the valuation still looks out of whack, it’s harder to recommend Commercial Metals when the outlook for non-residential construction is deteriorating. A federal infrastructure stimulus bill would be a big help, but that is most likely a 2021 event (if then...), and I’m concerned that pricing could be weaker on softer demand. I do see this as one of the more interesting price/value opportunities, but those macro worries do hold back some of my enthusiasm.

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Macro Issues Loom Over Commercial Metals' Ongoing Self-Help Story

Weaker Credit Numbers Don't Help The Bullish Citizens Financial Argument

A key question coming out of Citizens Financial’s (CFG) third-quarter results is whether this bank is going through its credit cycle sooner than other banks, or whether it will see a materially worse credit quality cycle. “Sooner, not worse” is a credible argument, but this wasn’t a well-loved bank going into earnings, and without an upgrade to cost-cutting expectations or other near-term sources of improved results, the bears have a little more ammunition in the short term.

I’m still bullish on Citizens Financial. My argument has never been predicated on Citizens Financial being one of the best banks (it’s not), but rather on the bank being better than what’s reflected in the valuation. Citizens still has a strong middle-market lending franchise, opportunities to grow fee-generating businesses, and opportunities to improve operating leverage. With what I believe is a line of sight to double-digit ROTCE even in a near-zero rate environment, I don’t believe that Citizens should trade at a nearly 20% discount to tangible book.

 

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Weaker Credit Numbers Don't Help The Bullish Citizens Financial Argument

U.S. Bancorp Focusing On Costs To Offset Spread Income Headwinds

Third quarter results (and guidance) from the large banks underline why I've been preferring banks with meaningful non-spread income sources and/or meaningful operating leverage - in an environment where spread income growth is so difficult, these other areas can drive above-peer pre-provision growth. And so it remains for U.S. Bancorp (USB), where healthy fee-based income and operating leverage helped drive a better-than-expected result for the third quarter.

I was neutral on USB last time around as more of a "slow and steady wins the race" pick, and the shares have since tracked just a bit better than the sector. I like management's more aggressive stance on operating costs and I do still see some options on the M&A side if management wants to go that way. As far as valuation goes, having underperformed most of its peers on a year-to-date basis, I'm seeing a little more relative value here, but I wouldn't call it my favorite idea among larger banks (it's tough to beat JPMorgan (JPM) there).

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U.S. Bancorp Focusing On Costs To Offset Spread Income Headwinds

Despite Rising Prices And Good Management Execution, Alcoa Can't Get Any Love

It’s fair to wonder what more Alcoa (AA) has to do, or can do, to change sentiment on the Street. Global overproduction of aluminum remains a real threat, but LME spot prices have improved 16% since the end of the second quarter and Alcoa’s EBITDA margin improved 340bp and the shares are down about 4% as of this writing from when I last wrote about the shares on July 16.

Management continues to improve the house, but the neighborhood remains one that investors don’t want to visit (let alone invest in), despite improving prices, shortages in areas like beverage cans, and improving trends in other end-markets like autos. I absolutely do not look at Alcoa has a long-term holding, but with a near-term fair value in the $17 range, it’s harder to ignore an attractive potential short-term trade.

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Despite Rising Prices And Good Management Execution, Alcoa Can't Get Any Love

Westamerica Offers Safety, But At The Cost Of Upside

San Rafael-based Westamerica Bancorporation (NASDAQ:WABC) has always been a different sort of bank. With an intensively conservative underwriting approach, Westamerica is quite happy not to make loans and instead direct its ultra-low-cost deposit base into securities, while keeping operating expenses as low as possible. This strategy has minimized loan losses for Westamerica, but it also has limited earnings growth, making Westamerica a somewhat countercyclical bank that tends to outperform when typical banks struggle.

I can appreciate the "sleep well at night" aspect to Westamerica, and I do believe there will be good long-term dividend growth here over the years to come. But, with bank valuations near historical lows, I don't think this is a great time to be playing defense, and I think Westamerica is likely to lag in terms of total returns over the next three to five years.

 

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Westamerica Offers Safety, But At The Cost Of Upside

Washington Federal May Be A Little Undervalued, But There's Not A Lot To Argue For It As A Buy

It's been a while since I've updated my thoughts on Washington Federal (NASDAQ:WAFD), a Seattle-based bank with over 230 branches across eight states. I wasn't all that bullish on the bank back in 2016, as I was concerned about the ongoing deposit share loss and scale challenges competing with larger banks as the company looked to diversify its loan book into commercial lending. Since then, the shares have lagged regional bank indices by about 5% to 10%, depending upon which index you use.

I remain concerned about share loss in the core Seattle and Washington markets, but the core deposit mix has improved, and management has made real progress in diversifying the loan book without material erosion in credit quality. Management has also been aggressive in returning capital to shareholders, with meaningful share buybacks and dividend payments. This isn't a bad bank, but the return potential still strikes me as pretty pedestrian today, and I don't really see the sort of sticky, low-cost deposit franchise that would make this a high-priority acquisition target, though expense synergies could certainly appeal to a bank with a meaningful existing franchise in the Western U.S.

 

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Washington Federal May Be A Little Undervalued, But There's Not A Lot To Argue For It As A Buy

Truist Doesn't Exactly Impress, But The Business Is On Track And The Valuation Is Reasonable

With most banks limited in what they can do to generate spread-based growth, the bullish argument for Truist (TFC) over the next few years rests significantly on this bank’s ability to generate better fee-based income and operating synergies from the BB&T-SunTrust combination. Although third quarter results did show okay fee-based revenue, the operating synergy number left a little to be desired, and it looks like the bank may have to pay more upfront to drive longer-term benefits.

I’m still a believer in the long-term benefits of the deal that created Truist, but there is definitely a “show me” element to this story and third quarter results don’t really help. With a fair value in the mid-$40’s, Truist has broadly the same return potential I see from JPMorgan (JPM) and/or PNC Financial (PNC), and those are arguably cleaner stories. I still own these shares myself, but I won’t say they’re inarguably the best pick among the large banks today.

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Truist Doesn't Exactly Impress, But The Business Is On Track And The Valuation Is Reasonable

PacWest's Strong Core Profitability Overshadowed By Credit Concerns

It’s early in the third quarter reporting cycle, but LA’s PacWest Bancorp (PACW) is not standing out in a good way. Weaker revenue on greater spread pressure is not a surprise, but credit quality remains a real concern, as PacWest has above-average exposure to sectors under greater strain from COVID-19.

When I last wrote about PacWest, in the days before COVID-19, I was concerned about the bank’s ability to profitably grow loans, and the risk that this would be/become a “value trap”. Since then, the dividend has been cut, credit quality looms as a larger threat, and the shares have declined about 50% - far worse than regional bank peers.

PacWest is a more challenging stock call now. On one hand, this is a very profitable bank with a fairly healthy capital situation. On the other hand, while I do think reserves are adequate, I am nevertheless concerned about the risk of increasing credit strain in the CRE portfolio, as well as a more prolonged hit to loan demand. With a fair value in the mid-$20’s, this name looks a lot more interesting now, but investors should be aware of the above-average risk that goes with that appreciation potential.

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PacWest's Strong Core Profitability Overshadowed By Credit Concerns

Intuitive Surgical Delivers A Beat, But Procedure Recoveries Seem To Be Lagging

Like Johnson & Johnson (JNJ), Intuitive Surgical (ISRG) bested sell-side expectations for the third quarter, but it wasn't a completely clean beat, as I expect analysts and investors to continue fretting about the pace of the volume recovery in elective/non-emergent procedures. While the long-term outlook for further penetration of robot-assisted surgery is positive, those procedure counts and hospital capital budgets in 2021 could present some near-term risks.

Intuitive Surgical is one of those stocks that trades beyond any rational discussion of valuation. It's basically the only game in town in robotic surgery (excluding orthopedics), and while that will change over time, I expect Intuitive to remain the dominant player in the market. With that, I see double-digit long-term revenue growth as attainable, as well as adjusted FCF margins close to 30%. With the shares well ahead of med-tech valuation norms, the value proposition really comes down to how much you want to pay for a company that will likely have more than 50% share in an addressable market that could reach $18 billion by the end of the decade.

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Intuitive Surgical Delivers A Beat, But Procedure Recoveries Seem To Be Lagging

Revenge Of The Clones: Roche Takes A Hit From Biosimilars, But Worthwhile Value Remains

Complacency can be a dangerous thing, and with Roche (OTCQX:RHHBY) doing quite well before the COVID-19 pandemic, it looks like analysts may have gotten a little complacent about the ongoing impact of biosimilar competition. Roche’s third quarter miss certainly wasn’t a welcome development, but it changes little about the long-term outlook, particularly given healthy results from the new drug portfolio and a healthy pipeline. In the shorter term, demand for COVID-19 testing should keep a healthy tailwind at the back of the diagnostics business.

I continue to believe that Roche shares are undervalued below the high $40s. With a healthy pipeline and strong internal R&D effort, as well as the capacity to acquire high-potential assets, I’m not concerned about Roche’s ability to generate mid-single-digit cash flow growth on a long-term basis, and I expect further improvements to the dividend. Given the return potential, I think Roche is very much worth considering at these levels for investors who want quality growth.

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Revenge Of The Clones: Roche Takes A Hit From Biosimilars, But Worthwhile Value Remains

PNC Financial's Long-Term Qualities Seem Less Than Fully Appreciated

If you look at how PNC Financial (PNC) shares have traded this year, you might think it was “just another bank”. Given that the management team has shown itself to be a good steward of shareholder capital, I don’t believe that’s fair.

Clearly, the macro environment matters; rates are going to be low for a while, and the market is clearly worried about a “second wave” of COVID-19 shutdowns, uncertainty over further stimulus, and turmoil around the election. Still, for patient investors with a longer-term horizon, I think PNC offers decent return potential.

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PNC Financial's Long-Term Qualities Seem Less Than Fully Appreciated

ASML Continues To Execute, And The Sell-Side Keeps Pushing Higher Targets

From time to time you’ll see sell-side analysts put themselves through contortions that would make an acrobat reach for the Advil, and that often happens when they feel the need to justify ever-higher price targets for strong operating stories that have already breached prior targets. That seems to be the case today with ASML (ASML), as the sell-side has defended a lower 2021 outlook from this highly-valued semiconductor equipment supplier as “providing certainty and confidence”.

Let me be clear – I love ASML’s business and would be happy to own it at the right price. I just think it’s interesting to see how other analysts will justify their price targets when valuation gets extreme. I found these shares too expensive last quarter and they have since underperformed the NASDAQ and the SOX, and have actually declined a bit. Although the shares certainly aren’t a bargain by conventional means, it’s a name to watch if this recent tech correction accelerates.

 

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ASML Continues To Execute, And The Sell-Side Keeps Pushing Higher Targets

Johnson & Johnson Curiously Valued In A Still-Healthy Med-Tech Sector

I've learned to be suspicious of apparent bargains among ultra-cap companies, and there are certainly enough moving parts to Johnson & Johnson (JNJ) to fill a small library of articles. Even so, while I can understand some concerns about growth and pipeline, as well as headline risks from lawsuits, JNJ shares look surprisingly interesting in a market where a lot of drug and device stocks enjoy elevated multiples.

For the short term, I expect worries to be focused on the pause of the Phase III COVID-19 vaccine trial, headline risk, and a potentially underlying stall in procedure recoveries. I also expect some concerns about the drug pipeline and JNJ's ability to offset patent expirations with internal R&D productivity. Even with that all factored in, a prospective high-single-digit return from a reliable performer isn't something to ignore.

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Johnson & Johnson Curiously Valued In A Still-Healthy Med-Tech Sector

First Republic's Differentiated Model Continues To Stand Out During Challenging Times

Business models matter in banking, and First Republic (FRC) is different in all the right ways. Underpinned by a focus on high-net-worth individuals and disciplined underwriting (low LTVs, long-term customer relationships, et al), First Republic has not only continued to produce far below average credit losses, but also strong spread lending growth in a time of effectively zero rates and weak loan demand.

If you bought in with my April piece on First Republic, you're sitting on a roughly 30% gain that is not only ahead of the banking sector, but comfortably ahead of the S&P 500 as well. With that outperformance, the "easy" undervaluation is gone, but I continue to be impressed by First Republic's loan pipeline growth and the company's methodical approach to gaining share in a still under-penetrated metro-centered HNW market. First Republic's model doesn't require a lot of branches, and its customers tend to come back again and again (to grow their businesses). I don't find the valuation as compelling now as before, but the prospective total return is still in the double-digits (barely), and I wouldn't be in a hurry to sell out of this position.

 

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First Republic's Differentiated Model Continues To Stand Out During Challenging Times

Full Valuation And A Timorous Recovery Aren't A Good Combo For Fastenal

While I liked short-cycle recovery plays earlier this year (and names like Parker Hannifin (PH) did pretty well), in recent months I’ve been getting more concerned that valuations were starting to overshoot the likely path of the recovery, setting the stage for potential disappointments and re-ratings. Fastenal’s (FAST) basically inline quarter and negative market reaction isn’t enough to claim “vindication” on that call, but with both Fastenal and Yaskawa (OTCPK:YASKY) seeing inconsistent recovery trends and large banks seeing soft C&I loan demand, I am concerned that shorter-cycle names could re-rate through the rest of the year.

Valuation is never an easy discussion with Fastenal, as a premier share-gaining company is worth a premium. So, I’m not surprised that the shares trade above a DCF-based fair value, though the implied long-term returns are worrisomely low. Looking at the typical premium Fastenal has enjoyed over the past three years, you can argue for a 17.5x multiple on forward EBITDA, but that only gets you to a fair value around $43.

 

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Full Valuation And A Timorous Recovery Aren't A Good Combo For Fastenal

Yaskawa's Results Suggest A More Uncertain Recovery Than The Valuation

I expect that third quarter commentary will be all over the map where industrial companies are concerned, with some markets in some regions improving, but not a lot in the way of universal or reliable trends. That was certainly the case for Yaskawa Electric’s (OTCPK:YASKY) fiscal second quarter earnings (for the quarter that ended at the end of August), as semiconductor and smartphone-related demand remained healthy, but demand recoveries elsewhere were sporadic or regional at best.

Yaskawa’s shares have had mixed performance since my last update, with the ADRs doing a bit better on forex moves, but both the ADRs and the local shares underperforming the industrial sector as a whole. I thought the shares were in the “too far, too fast” bucket before, and that’s still basically my feeling now. While I’m bullish on the longer-term opportunities in servos, inverters, and robots, that’s amply reflected in the share price. As more of a directional/momentum play on China, I understand investor interest in Yaskawa, but the financials do give some reason for pause.

 

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Yaskawa's Results Suggest A More Uncertain Recovery Than The Valuation

Citigroup Keeps Tripping Over Itself, But Trades At An Undemanding Valuation

Despite a lot of support on the sell-side and what would otherwise seem to be an excessively low valuation, Citigroup (C) just can’t make any headway. The latest operational issue, consent orders tied to meaningful shortfalls in the company’s operational practices, only further erodes the already-shaky position Citi held with many investors and likewise shows that even after years of efforts to reposition and restructure the bank, there are still significant deficiencies.

I can understand why investors may see the Citi news and be reminded of Wells Fargo (WFC). While I would argue the underlying cause of the Citi orders was less about moral turpitude and more about ineptitude, I don’t think “we’re not corrupt, we’re just inept” is a particularly compelling defense. Citi continues to trade at a very wide discount to apparent fair value, but I’m increasingly worried that this bank may never earn its cost of equity capital on a sustained basis, and while banks in that situation can still outperform, it’s a much steeper hill.

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Citigroup Keeps Tripping Over Itself, But Trades At An Undemanding Valuation

JPMorgan Delivers, But Macro Factors Loom Large

Once again JPMorgan Chase (JPM) did its part, with a strong performance on the pre-provision line despite ongoing (and unexpectedly high) spread pressure. Unfortunately, macro issues are still significant, with investors worried about a still-fragile recovery, weak commercial borrowing, and election cycle uncertainties.

I continue to believe that JPMorgan shares are undervalued and offer a solid double-digit annualized long-term return. Even if rates never move higher (a highly unlikely event in my view), there’s a good argument for a mid-teens ROTCE that would support a fair value in the range of $110 to $115. With ongoing organic growth opportunities and some eventual uplift from rates, I think the fair value is higher still, and I continue to believe this is a good bank to own through all cycles

 

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JPMorgan Delivers, But Macro Factors Loom Large

DNB More Leveraged Than Other Nordics To Healthy Ongoing Commercial Loan Demand

Nordic banks stand out in a lot of positive ways. They’re well-capitalized, generally have good efficiency ratios, and usually run relatively conservatively. They also skew much better than average where credit quality is concerned; between the underlying health of the Nordic economies and underwriting discipline, Nordic banks will likely make it through the COVID-19 recession with lower cumulative losses than most other banks across Europe.

Still, there are differences and distinctions among them. DNB (OTCPK:DNHBY) is more leveraged to corporate lending than its peers and appears to have a riskier portfolio as well. The bank is also less leveraged to non-spread sources of income, but generates healthy pre-provision profits that can cover a lot of losses. With so-so return prospects relative to its peers, DNB isn’t my favorite pick among the Nordic banks, but investors with a more bullish outlook on Norway’s economy may find more to like here.

 

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DNB More Leveraged Than Other Nordics To Healthy Ongoing Commercial Loan Demand

Skandinaviska Enskilda Banken's Reliance On Healthy Corporate Activity Is A Risk Factor To Watch

So far, it would seem that the Nordic economies are holding up well through the pandemic. How quickly economic activity recovers, particularly with larger corporations, is a key swing factor for Skandinaviska Enskilda Banken (OTCPK:SVKEF) (SEBa.ST) ("SEB"). With iffier credit quality, fee-based income tied to corporate activity, a recent strategy of the trading margin for market share, and less operating leverage potential, I believe SEB stands out among Nordic banks as one of the more reliant upon a relatively prompt rebound to healthy corporate activity, and I'm not sure that's the best call now.

Were SEB trading more cheaply, I'd be less concerned about the bank's need for growth. As is, while I don't think the shares are overvalued (European banks in general still trade close to historical lows), they don't stand out to me among the peer group as being particularly attractively-priced today.

 

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Skandinaviska Enskilda Banken's Reliance On Healthy Corporate Activity Is A Risk Factor To Watch

Better Guidance Fails To Boost GenMark, As The COVID-19 Story No Longer Surprises

One of the warning signs for me with stocks is when good news fails to move the shares. GenMark Diagnostics (GNMK) guided to a third-quarter revenue number that was 10% higher than expected, and the shares have done basically nothing on an otherwise good day for the stock market. While gross margin commentary was perhaps a bit soft, the growth in revenue and placements should have otherwise been good news.

At this point, I believe the COVID-19 opportunity is well-understood, and there are still substantial questions as to whether or not the systems installed to meet the surge in COVID-19 testing will remain in regular use once the pandemic fades. That issue may be tested sooner than some expect, as antigen-based testing is likely to grow considerably from here and become the dominant testing approach for COVID-19.

If the market is truly transitioning to a "post-COVID-19" view on GenMark, a forward revenue multiple of around 5x to 6x on 10% to 15% three-year revenue growth seems reasonable. That still leaves upside for GenMark, and this could be a worse-than-average flu season, but I believe upside is now increasingly reliant on the company's ability to show follow-through adoption of the blood culture panels to maintain high levels of utilization and test consumption.

 

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Better Guidance Fails To Boost GenMark, As The COVID-19 Story No Longer Surprises

Clean Credit And Efficient Operations Support A Healthier Multiple For Swedbank

With fear and uncertainty the order of the day in European banks, investors have shown a definite willingness to pay up for perceived quality. Swedbank (OTCPK:SWDBY) fits the bill, with a business that is heavily weighted toward Swedish mortgages and high-quality corporate lending, an efficient cost structure, and ample surplus capital. While I see less growth potential for Swedbank than some of its Nordic peers (not to mention other European banks), a low single-digit core earnings growth rate is still enough to support a double-digit potential annualized return for a company that I believe has well below-average credit risk through this cycle.

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Clean Credit And Efficient Operations Support A Healthier Multiple For Swedbank

Upgraded Guidance Boosts The Dialog Semiconductor Bull Argument

Demand for consumer electronics like tablets, notebooks, and wearables continues to be healthy given the work-from-home and overall "stay-at-home" trend, and that's continuing to boost the results at Dialog Semiconductor (OTCPK:DLGNF). Not only did management guide to a healthy beat relative to the sell-side for the third quarter, but it also said that strength has continued on into the fourth quarter.

I was bullish before on Dialog, and I'm still bullish after this little run-up in the shares. I believe the Street continues to undervalue the company's sub-PMIC content opportunities with Apple's (NASDAQ:AAPL) iPhones, as well as opportunities in areas like battery management and charging. Longer-term opportunities in IoT are definitely more "show me" stories, as is the possibility of the company using partnerships with Xilinx (NASDAQ:XLNX) and Renesas (OTCPK:RNECY) to leverage its power management capabilities into auto market segments like ADAS and infotainment. With the shares offering attractive upside on the sub-PMIC business and heavily discounted long-term estimates of IoT and auto sales, I believe these shares are attractive.

The reported liquidity on Dialog ADRs is not good, but more and more brokers have made trading in European markets easy and relatively cost-effective.

 

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Upgraded Guidance Boosts The Dialog Semiconductor Bull Argument

Improving Auto Demand And Increased Likelihood Of Change Driving New Interest In ON Semiconductor

I've had an odd "relationship" with ON Semiconductor (ON) over the years, with management's inability to hit margin targets (and inability to drive margin leverage) and questionable M&A decisions factoring prominently into the negative side. On the other hand, I've always liked the potential of what ON could be under the right circumstances, and the shares have done pretty well since my last two positive write-ups (in a strong market for chip stocks, I'll note).

With the CEO on his way out, I think ON Semiconductor's capacity for change is higher now than ever before, and apparently I'm not the only one who sees upside in a differently-run ON, as Starboard has also gotten involved as an investor. On top of all that, guidance updates from companies including Sensata (ST), STMicro (STM), and NXP (NXPI) have all confirmed an improving environment for the key auto end-market.

At today's price, there's still some upside in ON, but the story is transitioning from undervalued on the basis of what it is to maybe undervalued on the basis of what it can become. Successful turnarounds can unlock a lot of value (often a lot more than seems apparent in the early stages), but I'd be careful about putting the cart too far ahead of the horse, as ON still has a host of significant issues to navigate.

 

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Improving Auto Demand And Increased Likelihood Of Change Driving New Interest In ON Semiconductor

Marvell Management Uses Its Analyst Day To Talk Up The Growth Story

It’s not really fair to say that Marvell (MRVL) is “doubling down” on its growth opportunities in the data center and 5G, but management definitely structured their analyst day on October 8 to highlight Marvell’s transformation into a growth story. While this will come at a modest cost to margin (historically an underappreciated driver of semiconductor stock multiples), this is a growth-driven market today and the messages coming out of the analyst day shouldn’t do any harm to the already-robust multiples for these shares.

Strategically I like what Marvell is doing. I like the opportunities to leverage Cavium IP for data center DPUs and likewise the opportunities to leverage its Cavium and Avera IP into custom ASICs. Auto Ethernet opportunities are shaping up, and 5G should provide strong growth for several years. The issue is the price and the multiples. I was already expecting double-digit revenue growth over the next five years (and close to 9% growth over the next 10 years), and the presentation didn’t support a strong outlook for margins. At over 31x ’22 EPS and 26x ’23 EPS, it’s tough to say that the growth potential is going unappreciated.

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Marvell Management Uses Its Analyst Day To Talk Up The Growth Story

Xilinx Spikes On A Rumored AMD Bid

Maybe one of the surest signs that things are starting to get back to normal is the M&A cycle firing up again in the semiconductor space. It had been quiet for a while, but then there was the July bid from Analog (ADI) for Maxim (MXIM) and then September’s Nvidia (NVDA) bid for Arm Holdings. Now the Wall Street Journal reports that there may be another significant M&A deal in the works, with Advanced Micro Devices (AMD) reportedly in “advanced talks” to acquire Xilinx (XLNX) for something north of $30 billion.

I’ve liked Xilinx’s business for a while, and I see some significant growth opportunities for the company in areas like data center and 5G, with specific drivers like server acceleration, SmartNICs, antennae, and O-RAN. The immediate overlap with AMD is a little sketchy at first glance, and the businesses are very different (different product cycles, different customer bases, different development processes, et al), but Xilinx would definitely fit in with AMD’s desire to grow the data center business, and FPGA companies are scarce assets.

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Xilinx Spikes On A Rumored AMD Bid

Canon's Valuation Reflects Serious Concerns About Growth And Margins

Dividends aren’t the be-all and end-all of a company’s quality, but I would still argue that Canon’s (NYSE:CAJ) first dividend cut in 33 years is a pretty accurate reflection of the ongoing challenges at this Japanese conglomerate. Despite a high level of ongoing R&D, Canon’s revenue has fallen over the last five, 10, and 15 years, and the long-term average FCF margin has been basically static, as management hasn’t moved aggressively enough to transition more of its businesses to “cash cow” status.

Canon is not without hope – I see worthwhile potential in businesses like commercial printing, medical, and nanoimprint lithography – but the company’s ability to execute is in serious doubt. The shares do look undervalued today, but absent more dramatic progress on cost-cutting, I’m concerned this will be a value trap for investors.

 

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Canon's Valuation Reflects Serious Concerns About Growth And Margins

Nordea Not Dramatically Undervalued, But Also Not Likely To Disappoint

The way a lot of bank stocks are priced today, you'd think the sector was doomed. True, rates at or near zero and weak loan demand are likely to put a serious crimp in growth over the next few years, but the significant discounts to tangible book look excessive. Nordic banks like Nordea (OTCPK:NRDBY), then, stand out as definite exceptions. With healthier balance sheets and better prospects for pre-provision profit growth, Nordea and its peers don't trade at anywhere near the same discount as most European banks.

I'd call Nordea's valuation fair today, and I can understand the appeal as a "safe haven" given the bank's very strong capital position, its diversification across markets, and self-help opportunities like cost leverage. Nordea is likely to be allowed to resume dividends relatively soon, and while I think there are far better return opportunities elsewhere, Nordea qualifies as a "sleep well at night" type of bank stock.

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Nordea Not Dramatically Undervalued, But Also Not Likely To Disappoint

Takeda Broadens Its Rare Disease Portfolio By Partnering With Arrowhead

Takeda (TAK) has identified both rare diseases and gastrointestinal diseases (or GI) as key areas of interest and R&D focus. On Thursday morning, Takeda put even more money on the table, signing a partnership agreement with Arrowhead Pharmaceuticals (ARWR) for its ARO-AAT RNA interference (or RNAi) drug for alpha-1 antitrypsin-associated liver disease (or AATLD).

With Arrowhead having a multiyear head start, and recently producing very encouraging data from a small Phase II cohort, this is a promising deal for Takeda. Given the mechanisms of action, RNAi drugs should have relatively lower late-stage failure rates, and the market opportunity in AATLD could be in the several billions of dollars. While Takeda’s size does limit the materiality of this deal to a point, an upfront investment of $300M for the chance at a multibillion-dollar drug is a deal worth doing, and for Arrowhead this yet another Big Pharma partnership to help validate a striking clinical comeback with a new delivery technology.

 

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Takeda Broadens Its Rare Disease Portfolio By Partnering With Arrowhead

Banco de Sabadell Dogged By Weak Earnings And A Heavily Discounted Valuation

One of the most common pieces of advice you’ll find on investing is not to buy stocks on the expectation of a buyout. Personally, I’d attach an asterisk to that – it’s fine to buy a stock where a takeout is a credible part of the thesis, but make sure you can live with owning the stock on its own merits, at least for a while. That brings me to Banco de Sabadell (OTCPK:BNDSY) (SAB.MC) – a top-five bank in Spain that is struggling to deal with weak spreads, elevated loan losses, and a weak UK subsidiary.

Banco de Sabadell has been linked to both BBVA (BBVA) and Santander (SAN) as a potential merger partner, and further consolidation of the Spanish banking sector would make sense for either bank – Sabadell would expand their business lending operations and create some meaningful cost-reduction opportunities.

As I’ve said in the past, banks that sit at either end of the return on tangible common equity curve (especially high or low) can trade at distorted multiples relative to more “normal” peers, and that’s the case here. With weak growth prospects over the next few years, Sabadell trades at less than 20% of its tangible book value. I don’t love Sabadell, and I think it’s tough to generate long-term gains in banks that can’t earn their cost of equity, but I do think the valuation and capital can support a speculative play on a buyout bid.

 

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Banco de Sabadell Dogged By Weak Earnings And A Heavily Discounted Valuation

Despite Significant Near-Term Growth Challenges, Danske Bank Looks Undervalued Today

With negative bond yields across much of Europe and historically low valuations in the banking sector, it’s not hard to find apparent bargains among European banks. The real trick here, though, is separating the real bargains from the likely value traps. I don’t want to underplay the risk that weak rates will have a lasting negative impact on earnings, but I believe Danske Bank (OTCPK:DNKEY) is undervalued today on the basis of low-to-mid single-digit pre-provision profit growth over the next three to five years, a solid collection of fee-generating businesses, and above-average credit quality.

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Despite Significant Near-Term Growth Challenges, Danske Bank Looks Undervalued Today

Daikin's Global HVAC Franchise Is One To Watch

Most readers are going to be at least passingly familiar with major HVAC companies like Carrier (CARR), Lennox (LII), and Trane (TT), but Daikin (OTCPK:DKILY) (6367.T) is likely less familiar, even though it is the leading HVAC company in the world by a healthy margin and one of the largest players in the U.S. (through the Goodman brand, mostly). While Daikin has the favorable exposure to strong residential activity in the U.S. and green building retrofits in the U.S. and Europe, there’s also an above-average growth angle here from Daikin’s large exposure to growing Asian markets, including, but not limited to, China.

There really aren’t any “cheap” HVAC stocks in my opinion (though Johnson Controls (JCI) is looking a bit more interesting), but I think Daikin is priced reasonably enough relative to its growth prospects to be worth considering. With what I expect will be mid-single-digit revenue growth and high single-digit FCF growth, as well as healthy margins, I see high single-digit total annualized return potential.

I also want to note that the U.S. ADRs are pretty liquid, with a 90-day average daily volume of over 76,000 shares.

 

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Daikin's Global HVAC Franchise Is One To Watch

Pernod Ricard Not Exactly Cheap, But Multiple Growth Drivers Are Attractive

You shouldn’t go into the alcoholic beverage sector looking for bargains; there are some here and there, but generally there are reasons for those and “undiscovered gems” are few and far between. Still, if you can get comfortable with “growth at a reasonable price”, maybe Pernod Ricard (OTCPK:PDRDY) (“Pernod”) is worth a look. While the stock is more expensive than I’d like from a cash flow perspective, the high margins can support a healthy forward EBITDA multiple, and I like the multi-pronged growth opportunities that Pernod Ricard has.

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Pernod Ricard Not Exactly Cheap, But Multiple Growth Drivers Are Attractive

Brown-Forman Outperforming Peers And Priced Accordingly

It takes a crisis to prove out a strategy, and thus far through the pandemic, Brown-Forman’s (BF.B) brand-building capabilities have served the company well. While different reporting calendars due create some challenges with comparability, Brown-Forman’s underlying sales performance has been a clear standout in a sector where many companies reported 30%-plus declines.

Valuation is the main issue I see, as “stretched” doesn’t really do it justice and Brown-Forman almost makes Remy Cointreau (OTCPK:REMYY) look reasonably valued. While Brown-Forman does have excellent margins and ROICs (both of which contribute to a justifiable peer premium), I don’t see enough here in terms of growth or further margin leverage to support this premium.

 

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Brown-Forman Outperforming Peers And Priced Accordingly

Infineon Highlights The Meaningful Opportunities Ahead In The Auto Business

With over 40% of its revenue coming from the auto sector, Infineon (OTCQX:IFNNY) is heavily dependent not just on the nascent recovery in auto builds around the world, but on the future trajectory of hybrid/EV car development, as well as the inclusion of increasingly sophisticated driver safety systems. Considering Infineon’s strong existing position in a range of existing markets - #1 in auto power, #2 in auto sensors, #3 in auto microcontrollers (or MCUs), and #1 in IGBTs (auto and non-auto) – there’s every reason to expect Infineon to leverage meaningful auto content growth over the next decade from both electrification and automation.

Infineon’s recent presentation on its auto business was more evolutionary than revolutionary, but there were some interesting takeaways, including the expectation for meaningful upcoming SiC award announcements. While Infineon management didn’t upgrade its quarterly guidance during the October 5 call, recent announcements from Sensata (ST) and STMicro (STM) should increase investor confidence in the possibility/likelihood of a beat-and-raise quarter. Given relative valuation, I still prefer STMicro to Infineon, but improving end-market demand in autos and factory automation/industrial should increase the odds of upward revisions over the next 12-18 months.

 

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Infineon Highlights The Meaningful Opportunities Ahead In The Auto Business

Sika Flexing Its Strengths, And The Street Has Taken Notice

I’ve said it before, including in reference to Sika (OTCPK:SXYAY, SIK.S), but it bears repeating - low valuation doesn’t make stocks go up and high valuation doesn’t make them go down. While Sika hardly looked cheap when I last updated my thoughts on the company, solid execution through the pandemic, increasing expectations of green building retrofits, growing optimism on margin targets, and increased Street coverage have all contributed to another 40% or so move up in the share price.

I can’t tell you that Sika is cheap by any fundamentals-based approach. I can say, though, that this is an uncommonly well-run company with significant growth opportunities in all of its core markets, as well as meaningful margin leverage potential. With “green building” now a hot secular trend, I don’t think valuation multiples are all that important to the stock for the time being. I do believe “the time being” is a key caveat though; while I do believe that Sika is an excellent company with a great future, I do also believe that valuation matters over the long term, and it’s hard to see how this stock re-rates substantially higher.

 

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Sika Flexing Its Strengths, And The Street Has Taken Notice

Lackluster Growth And Margins Remain Major Issues For AngioDynamics

In med-tech, you had better either have robust revenue growth or solid margins or the market isn’t going to want to have much to do with you. That’s been the issue for AngioDynamics (ANGO) for some time, predating COVID-19 by years, and it’s harder to stick with the argument that the latest collection of products is going to meaningfully change that long-term pattern.

I can understand why investors might be bullish on products like AngioVac, Auryon, and NanoKnife, as well as the potential for better share in vascular access, and think that this time will be different. Unfortunately, limited marketing capabilities are an issue, and while products like AngioVac do indeed offer good growth, it’s off a low base and the core business just isn’t all that attractive. Although mid single-digit revenue growth and longer-term FCF margins in the low-to-mid teens could support a good total return from here, I believe AngioDynamics is going to need to provide visibility on a path to double-digit EBITDA margins before the Street is going give a meaningfully better multiple to the shares.

 

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 Lackluster Growth And Margins Remain Major Issues For AngioDynamics

Landis+Gyr May Be Undervalued, But It Needs A New Strategy

There’s a good reason a lot of industrial companies are prioritizing software and services – over the long term, it’s hard to maintain strong value generation from a hardware-based model. That’s something that Landis+Gyr (OTCPK:LDGYY) (LANDI.S) (“L+G”) has learned the hard way, as this leading manufacturer of smart electricity meters has had a generally lackluster track record as a public company apart from a brief, great run in 2019.

The core hardware that L+G offers just isn’t all that lucrative, and with an increasingly mature end-market, volume growth isn’t going to help. At the same time, I believe the company has underinvested in software tools and systems for utility customers, missing out on grid management and automation opportunities that would have been a natural fit with the hardware side of the business.

Low single-digit growth assumptions can support a decent-looking return from here, but I’m concerned that L+G may not be able to hit even those targets without a more significant rethink of its business. L+G has the resources to rebuild through internal investment and M&A, but it will likely take time to establish new drivers for the business.

 

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Landis+Gyr May Be Undervalued, But It Needs A New Strategy

Campari Stands Out As An Odd Duck In The Liquor Pond

If you think about what investors prize these days in the alcoholic beverage space – leverage to growing emerging markets, leverage to premium (especially super-premium brands), leverage to off-premise consumption – then Davide Campari-Milano (OTCPK:DVDCY) (“Campari”) has... very little of that. What it does have, though, is strong organic growth, and I believe that is largely responsible for the robust valuation of this company.

I certainly see organic growth potential, and I think Campari has done a laudable job of shifting its marketing message during COVID-19 to drive increased at-home consumption. Still, for a company with what I see as less prospective revenue growth and margin leverage than more reasonably-priced players like Pernod Ricard (OTCPK:PDRDY), I don’t quite understand the valuation here.

 

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Campari Stands Out As An Odd Duck In The Liquor Pond

Remy Cointreau - A Premium Distiller Trading At A Premium Price

Premiumization, or shifting a product portfolio mix toward higher-priced and typically higher-margin products, is an inescapable word in discussions of alcoholic beverage companies, and for good reason – in the developed world, premiumization in spirits has driven almost all the market growth over the last decade. Premiumization is a significant driver in emerging markets as well, with premium (as well as “above-premium”) products seeing 5% to 10% better growth, on average, than the underlying category prior to COVID-19.

For Remy Cointreau (OTCPK:REMYY) (RCOP.PA), a spirits company that is almost completely premium-focused, that premiumization trend is a significant positive tailwind. Even so, the company is attempting to broaden its revenue mix by focusing more attention on neglected products, and management is also shifting its focus from price management toward margin management, with a robust operating margin target of 33% for the end of this decade.

Remy competes with some significant rivals, and the company’s focus on the cognac segment could be a risk in markets where consumer tastes are more fickle. My bigger concern is valuation; while low interest rates support a robust EBITDA multiple for the sector, Remy trades at a premium within the sector that I’m not convinced is completely merited.

 

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Remy Cointreau - A Premium Distiller Trading At A Premium Price