As Credit Stabilizes, Signature Bank's Growth Story Comes Into Play

Recommending Signature Bank (SBNY) in 2020 wasn't the most popular call, and indeed this CRE-heavy lender did suffer through much of the year due to worries about the bank's exposure to multifamily and retail property in the New York City area. Since the election, though, the shares have rocketed up on increased confidence tied to COVID-19 vaccines (and the prospect of a return to more normal economic activity in 2H'21), and the shares have outperformed its peer group on a three-month, 12-month, and three-year basis.

Signature is not fully out of the woods yet, and 2021 will almost certainly see higher charge-offs, but 2021 will also see the company putting more of its under-utilized liquidity to work. What's more, I believe investors will see meaningful growth in C&I and specialty lending over the next few years, as well as growth in fee-generating businesses like its specialty mortgage servicing and SigNet digital banking platform. All told, I believe Signature is priced for double-digit long-term annualized total returns, and though it's a riskier-than-average bank, it's still worth a look after this big run.

 

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As Credit Stabilizes, Signature Bank's Growth Story Comes Into Play

3M Leveraging The Early Recovery, With Further Room For Self-Improvement

Despite its reputation as an early cyclical mover, 3M (MMM) hasn’t gotten a lot of love lately in a market that couldn’t seem to get enough of cyclical stories, as industrials continued to perform well through the end of 2020 and into 2021. While 3M has definitely perked up since its fourth quarter earnings report, it had spent most of the last three months lagging the broader industrial space, including good recovery names like Eaton (ETN), Emerson (EMR), ITT (ITT), and Parker-Hannifin (PH).

While some of the underperformance may be due to perception around 3M’s risk to PFAS legislation and litigation, I believe it’s also due at least in part to the choppy recovery we’ve seen so far across industrial and healthcare markets. Some end-markets, like autos, have definitely started to improve, but many othes have shown decidedly mixed performance.

I believe 3M will enjoy a couple years of above-trend growth as the global economy recovers, and I believe the latest restructuring effort will provide another boost to margins. I’d still like to see a more dramatic restructuring (exiting some less promising and lower return businesses and moving into more attractive markets), but if 3M can hit my long-term of just modestly above-GDP revenue growth and two or three points of FCF margin leverage, the shares look like a comparatively rare bargain in the industrial space.

 

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3M Leveraging The Early Recovery, With Further Room For Self-Improvement

Hexcel's Price Anticipates The Eventual Recovery

Market sentiment is a funny thing. About six months ago, I was making the case for stocks like AerCap (NYSE:AER) and Copa (NYSE:CPA) on the basis of Wall Street significantly overestimating the long-term damage to the airline and aerospace sectors and underestimating how willing people would be to travel again once they were allowed to do so. Now, since the election and the launch of effective COVID-19 vaccines, it seems like I have to shift the other way and point out that while those sectors will recover, it is still going to take time.

Specific to Hexcel (HXL), these shares have moved up about a third since my last update on the company, more or less keeping pace with other suppliers like Howmet (NYSE:HWM) and Woodward (NASDAQ:WWD), while lagging Spirit (NYSE:SPR) and outperforming Airbus (OTCPK:EADSY) and Boeing (NYSE:BA). I do believe that Hexcel's business is bottoming out, and I see no real risk that the business won't survive this downturn. Still, unless there's a stronger/quicker re-acceleration in widebody build-rates than I currently expect, I feel like Hexcel is a little ahead of itself in the mid-$40's.

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Hexcel's Price Anticipates The Eventual Recovery

Accuray Is Seeing Green Shoots For Its Large China Opportunity

It’s been a long, frustrating wait for shareholders, but Accuray (ARAY) investors are at long last seeing the company start to deliver on at least some of its opportunity in the Chinese radiation oncology market. In addition to starting to recognize real revenue in that huge market, Accuray has continued to deliver on an underappreciated innovation drive and some of those advancements should start impacting orders, sales, and profits in the relatively near future.

Accuray shares have shot up almost 80% since my last (positive) write-up on the company. As I’m not changing my model after a quarter that was close to in-line with my expectations, that makes the valuation argument a little more challenging in the short term. If the company stays on track such that double-digit revenue growth in FY’22 and high single-digit or low double-digit growth for a few years thereafter looks more probable than possible, I could easily see at least a doubling if not close to a tripling of the share price based on what the market has historically paid for that kind of growth from small med-techs.

 

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Accuray Is Seeing Green Shoots For Its Large China Opportunity

Texas Capital Bancshares Showing Progress On Credit

Now the real work begins.

Texas Capital Bancshares (TCBI) shares have done well over the past three months as investors have shifted toward a "risk on" position with the banking sector, and I also believe the hiring of former JPMorgan (JPM) executive Rob Holmes as the new CEO has brought a renewed optimism around the potential for the company to chart a new, more profitable course over the next decade.

When I last reviewed Texas Capital , I thought the stock offered upside on the potential of what the bank could/can become until better leadership, but that upside was tempered by above-average near-term volatility and operating risks. That's still basically my position, and while I do still see worthwhile long-term upside on its transformation potential, I'd like a better entry price to take on the risk that the path to that potential could be longer or rockier than the bulls think.

 

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Texas Capital Bancshares Showing Progress On Credit

KeyCorp Is Focused On The Right Details And Undervalued Going Into 2021

The last three to six months have been good ones for banks, as investors have grown more comfortable with the credit risk outlook, not to mention the prospect of an economic recovery and modest rate improvements in 2021. Spread revenue growth is still going to be challenging, loan growth is likely to remain weak (apart from another round of PPP loans), and charge-offs will still be rising, but the storm has largely passed.

KeyCorp (KEY) was one of my recommended ideas back in August of 2020, as I thought the Street was overestimating the credit risk and underestimating both the fee-based income and operating leverage potential. Since then, the shares have outperformed other regional banks by a bit, though not as much as I would have hoped. While there is a real debate to be had over whether Key can achieve its targeted positive operating leverage in 2021, and results are likely to be messy for a couple of years, I do believe Key stands out on a valuation basis, and this is a name still worth considering.

 

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KeyCorp Is Focused On The Right Details And Undervalued Going Into 2021

(Exclusive) Ciena About To Pivot From Recovery To Growth

In terms of reported reports, Ciena (CIEN) isn’t out of the woods yet with respect to the carrier sending slowdown that management announced back in early September 2020, hammering the stock. Still, Wall Street is a forward-looking place, and with the downturn likely ending in FQ2’21 and grow resuming thereafter, I still there are solid reasons for owning Ciena shares.

When I last wrote on Ciena, my conclusion was that the share price weakness following a very negative revision to short-term guidance was a buying opportunity given the meaningful long-term opportunities for Ciena to leverage data traffic growth into higher revenues, margins, and profits.

Since then, the shares have risen about 25%, modestly outperforming the NASDAQ index and its peer group, and regaining much of the ground lost after the September warning. Even with those gains, I believe Ciena shares can continue to outperform on the basis of rebounding spending among Tier 1 North American customers and significant international opportunities.

 

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(Exclusive) Ciena About To Pivot From Recovery To Growth

Travelers Outperforming On Firmer Markets And Benign Losses

Although Travelers (TRV) is widely respected as a well-run P&C company, that hasn’t really benefited shareholders all that much, as this insurer’s market returns have lagged the broader sector (and the S&P 500) for many years now, though the last 12 months have been a period of outperformance.

While I don’t believe that Travelers has the same level of risk in its 2015-2018 book, I am concerned about increased competition in the small/medium-sized commercial market where Travelers specializes, as well as the company’s relative lack of specialty lines exposure. On the other hand, this is an insurer that has generated sustained (although not continuous) double-digit ROEs and demonstrated a great deal of discipline with respect to both underwriting and capital returns. With what looks like a prospective long-term annualized return of around 8%, Travelers strikes me as an “okay, but not great” idea today.

 

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Travelers Outperforming On Firmer Markets And Benign Losses

Credit Risk Fading For BankUnited, But The Valuation Already Assumes Above-Average Growth

Investors have returned to bank stocks in a significant way, and riskier names (or at least those perceived as riskier) have done pretty well over the past few months. Included in that list is BankUnited (BKU), which has now reported three straight quarters of better-than-expected provisioning results. At the same time, BankUnited has been making what looks like prudent decisions with respect to its loan activity, and the influx of low-cost deposits since the start of the pandemic raises the prospect of a much-improved funding situation into the recovery.

The "but" is that a lot of the positives seem to be in the share price. I do expect above-average long-term growth from BankUnited, and the shares aren't overvalued, but near-term upside to around $40 and a long-term high single-digit expected annual total rate of return seems a little less exciting to me than other banks that still appear to offer the possibility of double-digit returns.

 

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Credit Risk Fading For BankUnited, But The Valuation Already Assumes Above-Average Growth

ASML Riding High On Exceptional Demand For Its Leading-Edge Semiconductor Tools

With strong demand for leading-edge logic chips and improving demand for memory chips, pretty much everything is going ASML's (ASML) way these days.

When I last wrote on the company, I said, "give me a 10% pullback" and I'd be tempted to buy in. The shares pulled back about 7% and then shot up nearly 60%, handily beating the NASDAQ and SOX indices, though trailing other semi cap equipment names like Applied Materials (AMAT), Advanced Energy Industries (AEIS), Lam Research (NASDAQ:LRCX), and Tokyo Electron (OTCPK:TOELY) to varying degrees. Pull the comparisons out to a year and ASML looks more competitive, but still not a sector leader - a reminder, perhaps, that valuation can still matter at the margin.

As things stand today, I continue to love this business, but the valuation is even harder to handle. Yes, top companies deserve premium valuations, and ASML's moat and growth prospects absolutely merit designation as a top company. Still, I believe interest rates are more likely to head higher than lower from here, and I just can't find an argument for valuation beyond a sort of musical chairs relative value approach.

 

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ASML Riding High On Exceptional Demand For Its Leading-Edge Semiconductor Tools

Zions Still Has Attractive Long-Term Drivers After This Rally

The last three months have been good to banks, as investors have grown increasingly confident in a more benign credit loss outlook and an improving macro environment in 2021. As one of the more notably undervalued banks in its "weight class", in no small part due to weaker credit and pre-provision profit growth expectations, Zions Bancorporation (ZION) has certainly benefited from this shift in sentiment.

Zions has risen more than 45% since my last update, handily outperforming many of its peers, and while I no longer see the same scale of undervaluation as I did before, I do still see Zions as priced for double-digit total returns from here. The bank sector no longer offers the sort of risk-adjusted rewards (valuations were at decade-plus lows back in the fall of 2020), but if Zions can leverage its aggressive PPP loan participation and multiyear tech upgrade cycle, these shares could have better long-term upside than many peers.

 

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Zions Still Has Attractive Long-Term Drivers After This Rally

Progress On Self-Improvement Efforts Can Make Citi A Winner In 2021

It's taken far longer than shareholders wanted, but Citigroup (C) shares have finally started outperforming. I believe this recent improvement has more to do with the overall rally in bank stocks than any particular surge in confidence regarding Citi's turnaround plan, but I do believe that a healthier economic environment in 2021 will help that process. I'm likewise bullish on the prospects for new CEO Jane Fraser to effect real changes in the business given her history with operational turnarounds.

I've been bullish on Citi for a while, but the bank has only matched its peer group over the last three years as management has struggled to make meaningful changes to the business. I do believe Fraser will improve and accelerate that process, and I expect that investors will see incremental changes (announcements) in strategy as opposed to a big one-time announcement, and those announcements could help build some momentum through 2021. I do believe there is a lot of work ahead for Citi to close the ROTCE gap with its peers, and I'm not expecting Citi to become the best of the group, but I do still see more upside here as these changes start to take hold.

 

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Progress On Self-Improvement Efforts Can Make Citi A Winner In 2021

Higher Expectations Make First Republic's Loan Growth Even More Important

Although First Republic (FRC) has reminded a standout performer in the banking sector over the last year, the share price appreciation slowed a bit relative to the broader regional bank space over the last three months as investors became more bullish on the sector's recovery prospects in 2021 and First Republic's growth was less of a standout opportunity.

First Republic's valuation has rarely ever stood out as a bargain, but that hasn't held back the share price appreciation as the bank has continued to post exceptional growth (double-digit CAGR for both loans and pre-provision profits over the past decade). I'm not in the "ignore the valuation and just buy" camp, but I do believe the odds favor First Republic once again beating its initial guidance for the year, and with this bank still poised to be a growth outperformer, I don't think the valuation premium is at immediate risk.

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Higher Expectations Make First Republic's Loan Growth Even More Important

Wells Fargo Continues To Languish Under Its Consent Order

As Wells Fargo (WFC) closes the books on another year to forget, and the fifth year in a row where the shares underperformed its comp group, it’s fair to wonder just how long it’s going to take for this bank to turn around. The consent decree (and the related asset cap) has clearly damaged the business, leading to noticeable share loss in the corporate lending business, and the expense structure is out of whack in comparison to its peer group, but it may well prove challenging to meaningfully cut expenses without undermining revenue generation even more in the short term.

While I said that Wells Fargo wasn’t “my favorite name” back in May of 2020, I nevertheless underestimated some of the challenges that the bank would still be facing heading into 2021 and overestimated the extent to which sentiment would shift more towards the recovery prospects (which it has for many of Wells Fargo’s peers). Trading below tangible book, there’s more upside here than with most other large banks now, but there are valid reasons for that discount and I still can’t call this a favored name, even though I do believe the appreciation potential is better than average.

 

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Wells Fargo Continues To Languish Under Its Consent Order

PNC Financial's Valuation Is More Demanding, But Management Has A Good Execution History

With the rebound in bank stocks, largely on improving outlooks for the economic situation and rates in 2021, expectations are now higher going into 2021. For PNC Financial (PNC), that means that executing on the synergy opportunities from the acquisition of BBVA's (BBVA) U.S. operations (Compass) is a must-have. Luckily, management has a good track record where M&A synergies and post-deal growth are concerned, and I have few real concerns there.

As has been the case with many other banks, including JPMorgan (JPM), PNC's valuation and stock outlook have evolved from what I considered nearly can't-miss to "still alright for long-term investors". I no longer see the obvious bargains in this sector that I once did, but I do believe the long-term prospective returns from PNC are good enough to earn it a spot in (or at least consideration for) quality growth-at-a-reasonable-price portfolios.

 

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PNC Financial's Valuation Is More Demanding, But Management Has A Good Execution History

With A Sequential Bounce In Orders, Hurco Shifts To A Cyclical Recovery Story

When I last wrote on Hurco (HURC), I said that, "trying to call a bottom in the machine tool space is a good way to look foolish", and so it proved to be, as the rebound I expected in the fiscal fourth quarter (ended October 31) didn't really materialize - orders did improve meaningfully on a sequential basis, but the sequential revenue recovery did not materialize. That said, trends across the machine tool space do seem to be improving, with auto demand stabilizing and some growth in areas like medical, semiconductor, and mold/die.

I'm expecting a couple of years of double-digit sales growth from Hurco as manufacturers in the U.S., Germany, Italy, and other countries see a rebound in demand, but I still only expect the company to outgrow developed country GDP by a very modest amount over the long term. Even so, single-digit FCF margins and a return to low double-digit EBITDA margins should argue for a stock price closer to $40, with a double-digit long-term annualized return opportunity at today's prices.

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With A Sequential Bounce In Orders, Hurco Shifts To A Cyclical Recovery Story

JPMorgan Still A Best-In-Class Pick, But Bank Valuations Have Improved Significantly

I've been bullish on JPMorgan (JPM) for some time, and the bank has outperformed its peer group not only over the last three months and the last 12 months, but over longer periods as well. Simply put, I believe JPMorgan has established a strong case that it is one of the best-run banks in the world, and ongoing investments in areas like technology, marketing, and organic expansion (new branches/loan offices) should continue to generate strong long-term returns for the bank.

While banks didn't have a great 2020 overall, they ended strong, with better than 33% appreciation in the last three months. JPMorgan has participated in this rising tide, and I no longer believe that banks (on the whole) offer outsized returns relative to the risk. I continue to believe that JPMorgan is a good stock to own in the space, and I believe the long-term returns are still attractive (in the very high single-digits), but I no longer view this stock or this sector as materially overlooked or beaten down.

 

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JPMorgan Still A Best-In-Class Pick, But Bank Valuations Have Improved Significantly

Alnylam Pharmaceuticals Logs Another Clinical Win For Its Amyloidosis Program

Despite a few hiccups recently in partnered/out-licensed programs, Alnylam (ALNY) recently announced another clinical win for its ATTR amyloidosis program, and the company moves into 2021 with three approved products, a fourth soon to come, and a deep pipeline that the company discussed in more detail during a two-day R&D event back in December.

Alnylam had a respectable 2020 from a market performance standpoint, but couldn’t keep pace with the broader biotech sector. With 2021 looking a little light in terms of thesis-changing events, it could be a little harder to maintain the momentum, but I do believe the pipeline and commercial opportunities support a fair value in the mid-$160’s.

 

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Alnylam Pharmaceuticals Logs Another Clinical Win For Its Amyloidosis Program

Business Activity Is Slowly Improving, But MSC Industrial Has Yet To See The Big Turn In Demand

Industrials certainly haven’t been suffering going into the new year, with the sector up about 20% in the last two months of 2020 alone as investors reposition for a cyclical recovery buoyed in part by COVID-19 vaccinations. MSC Industrial (MSM) has gone along for the ride, slightly outperforming the sector since my last update, as stocks sensitive to industrial production (including names like Kennametal (KMT), Parker-Hannifin (PH), and Sandvik (OTCPK:SDVKY)) have also been performing quite well. 

While skeptical about management’s ability to deliver on its latest self-improvement program (largely a collection of reheats and repackaged goals from past unsuccessful efforts), I did see some relative value in the stock in that last write-up. With the outperformance since then, I’m not as excited about the relative value opportunity, and while I do think there could be more room for cyclicals to run on recovery hopes, management execution will become an increasingly significant part of the story as 2021 develops.

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Business Activity Is Slowly Improving, But MSC Industrial Has Yet To See The Big Turn In Demand

Broadcom's Preferreds Are Worth A Look As The Common Shares Continue To Lag

Semiconductors remain a hot space, helped in no small part by strong enterprise networking demand, improving wireless demand, prospects for an auto/industrial recovery in 2021, and increasing confidence on both the likelihood of vaccines knocking back the COVID-19 pandemic and the new U.S. administration making peace with the Chinese.

I continue to believe that Broadcom’s (AVGO) common shares offer some compelling value for money at today’s level, but I believe investors with more interest in income may want to consider the Broadcom preferreds (AVGOP) – a mandatory convertible preferred stock that gives investors participation in upside to the common shares as well as a decent (if not good) yield in the meantime. Broadcom shares have remained a frustrating laggard relative to the broader semiconductor space, but relative to both the growth and margin potential, I believe the market’s skepticism is misplaced.

 

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Broadcom's Preferreds Are Worth A Look As The Common Shares Continue To Lag