Energy Efficiency, Automation, And Service Should Drive Growth At Johnson Controls

One of my preferred names in the hot HVAC space, Johnson Controls (JCI) has done pretty well since my last update, rising about 45% against roughly 30% moves at Carrier (CARR) and Trane (TT) and a weak performance at Lennox (LII) (my other preferred name, Daikin (OTCPK:DKILY) has not done as well). I believe some of this outperformance may be tied to rotation to less richly-valued names, as well as some appreciation for the upside Johnson Controls has in areas like building control, automation, and management, as well as indoor air quality and electrification.

The valuation call today is tougher. I still like the opportunity in those aforementioned market segments, as well as the opportunity to drive better revenue growth and margin leverage from improved service attachment (getting more of the ongoing maintenance revenue from its installed equipment). On the other hand, the shares are pretty richly-valued for what is actually a lackluster margin/ROIC/ROA profile, and discounted cash flow suggests mid-single-digit total annual return potential from here.

 

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Energy Efficiency, Automation, And Service Should Drive Growth At Johnson Controls

Otis Shares Have Lagged, But The Service Opportunity Could Still Be Underappreciated

I wasn’t all that excited about the opportunity in Otis Worldwide (OTIS) shares in late September, and the shares have lagged since then – rising less than 5% against a 20% move for the wider industrial sector and 20%-plus moves in other building equipment stocks like Johnson Controls (JCI), but doing about 10% better than Kone (OTCPK:KNYJY), which I also thought was expensive, and Schindler (OTCPK:SHLAF) in the elevator niche.

Looking at 2021, while Otis does have a decent backlog supporting new equipment revenue, I’m concerned about weakness across the construction space, including multifamily, office, and hospitality. I’m also concerned the assumptions across the industrial sector from management teams that they’ll just be able to pass on any material cost headwinds in the year. I’m more bullish on the opportunities to leverage IoT to drive more lifecycle revenue and gain maintenance share from independents, but that’s going to be a multiyear story.

Otis did beat and raise, and the underperformance has improved the relative valuation argument. I still don’t really like the stock here, but I could see non-resi equipment names getting a little more love later in the year, and this is a borderline name today.

 

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Otis Shares Have Lagged, But The Service Opportunity Could Still Be Underappreciated

Parker-Hannifin Offering Short-Cycle Leverage, But A Whole Lot More Too

Writing about Parker-Hannifin (NYSE:PH) in August I highlighted the efforts that management has been making to transform a business historically driven by short-cycle industrial markets into a more diversified, higher-margin, better overall industrial company. Since then, the shares have added another 40%, more than doubling the return of the broader industrial sector.

“It’s different this time” are words that should always worry investors, and I do have concerns about valuations across the broad industrial group. That said, I do believe that Parker-Hannifin is a different company today than five, 10, or 20 years ago, and I’m not going to just assume that the shares are doomed the underperform now that the PMI is closing in on 60. I am not all that excited about the prospective returns I see here today, but I would still very much agree with a “best among its peers” argument in favor of choosing Parker-Hannifin if you had to buy an industrial.

 

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Parker-Hannifin Offering Short-Cycle Leverage, But A Whole Lot More Too

Strong Work-From-Home Offsetting Weaker Enterprise Trends For Dell

For tech hardware companies like Dell (DELL), HP (HPQ), and Lenovo (OTCPK:LNVGY), what the pandemic has taken away with one hand has, at least to some extent, given back with the other. While the pandemic has hit demand for categories like storage, PCs volumes have been notably strong, helping these leading players in an increasingly consolidated market.

As with Lenovo, I expect Dell to see a shrinking benefit from PC demand, but demand for servers and storage should pick up, and longer-term initiatives like IT-as-a-Service (Project Apex) do offer upside. With the spin of VMware (VMW) now widely regarded as a done deal, Dell will also get a significant boost to its deleveraging efforts, even if at the cost of high-margin, above-average revenue growth and software exposure.

I thought Dell looked undervalued back in September, though I preferred Lenovo, and the 20% move since then has managed to beat the S&P 500 and NASDAQ, while lagging HP and Lenovo. I like the valuation better now relative to Lenovo, but I’m increasingly nervous about overstaying my welcome with this PC-driven upturn. I think improving storage performance and the eventual announcement of a VMware spin can maintain the momentum in 2021, but I’d guard against getting too greedy here.

 

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Strong Work-From-Home Offsetting Weaker Enterprise Trends For Dell

The Market Already Anticipates PACCAR's Recovery

Heavy machinery stocks have enjoyed a strong rebound on the improving outlook for 2021, with names like Caterpillar (CAT), Deere (DE), and Terex (TEX) performing well over the last year (up 60% to 90%). PACCAR (PCAR), though, has been a different story, with the shares outperforming the broader industrial space but underperforming cyclical heavy machinery peers.

Some of the problem may be PACCAR’s quality. Paradoxical as it sound, cyclical rallies often don’t benefit superior operators quite as much, and PACCAR has an excellent track record relative to the broader heavy machinery space where metrics like long-term margins, cash flow, and returns on assets are concerned.

Given that Cummins (CMI), another exceptional company, has managed to outperform (though not as much as non-truck heavy machinery companies), though, it may well be something more PACCAR-specific, including worries about margin pressures and a shorter run to the next peak in the truck cycle.

I could see PACCAR retesting and surpassing its recent 52-week high, but I don’t see that much upside left in this upcycle and peak-to-trough moves in these shares have often seen the price decline by roughly a third. This would definitely be a name I’d revisit on a sell-off, but I don’t like the risk/reward trade-off right now.

 

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The Market Already Anticipates PACCAR's Recovery

With The Business Stabilizing, Cadence Bancorporation May Be Looking For An Exit

Houston-based Cadence Bancorporation (CADE) hasn't had the easiest time over the last few years, as the bank has been struggling with higher credit losses and dents to its reputation as a quality growth name. While credit has started to stabilize, overall metrics still aren't great relative to peers and management has acknowledged that the days of double-digit loan growth are probably over.

Cadence isn't the first bank to see once-bold growth plans interrupted by the realities of underwriting issues, and I don't believe Cadence is a "broken" bank, particularly given still-strong credit and the capability of absorbing meaningful losses. That said, if a recent Bloomberg report is true and Cadence has chosen to explore a sale of the business, I don't think the company will struggle to find takers.

I do see the stock as close to fair value today, with a high single-digit total annualized long-term return potential, but I also do see a buyout price likely starting at around $25. I would never suggest that a reader buy a stock purely as a takeout play, but there is still some upside here.

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With The Business Stabilizing, Cadence Bancorporation May Be Looking For An Exit

Geely Back At Cruising Speed And Gaining Share In China's Recovering Auto Market

The downside to following a lot of stocks is that inevitably you have items on your to-do list that just keep sliding down, and such has been the case with Geely Auto (OTCPK:GELYY) (175.HK). Last year was an awful year for auto sales in China (which probably encouraged me to keep pushing it off), but these shares are nevertheless almost 80% higher now from my last write-up, with the company gaining share and putting together a good recent run of above-market volume growth (gaining more share).

Geely has always had its doubters, but the company has successfully transitioned away from being just a maker of lower-end vehicles and has created a viable mass-market platform, with some early successes targeting the lower end of the high-end market with its Lynk & Co ("Lynk") brand. Likewise, Geely has always had bold plans to be a major player in electrification, and the market has taken a lot more notice since the unveiling of the Sustainable Experience Architecture (or SEA) in September of 2020.

There are still plenty of issues and challenges here. The parent company (ParentCo)/listed company (ListCo) structure is confusing at best and creates the potential for self-dealing at worse. To that end, while merging the Volvo (OTCPK:VOLAF) auto business (owned by ParentCo) into Geely ListCo would likely be good for shareholders, there really hasn't been a meaningful discussion of terms. Moreover, the Chinese EV market is exceptionally competitive, with established foreign automakers like Toyota (TM) and Volkswagen (OTCPK:VWAGY), established local players like BYD (OTCPK:BYDDY), and new entrants like Tesla (TSLA) and XPeng (XPEV) all competing for future share.

Today I see Geely as a fairly-priced play on Chinese auto market growth and Geely's own prospects to gain more share and margin leverage. That may sound like damning by faint praise, but with some EV players trading at over 10x '22 revenue "fairly-priced" has some appeal.

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Geely Back At Cruising Speed And Gaining Share In China's Recovering Auto Market

East West Bancorp Still A Great Mid-Cap Bank, But Priced More Like It

Back in late September I thought that East West Bancorp (EWBC) was a great mid-cap bank not getting its due from the market. While even average bank stocks have run since then, East West’s better than 110% jump since that last article does make it a standout alongside what I believe are other differentiated growth stories among smaller banks like First Republic (FRC), Bank OZK (OZK), Pinnacle Financial (PNFP), and SVB Financial (SIVB).

I have significantly upgraded my earnings growth assumptions since then; in large part due to an improved credit and spread outlook, as well as improving economy, but also in part to a more aggressive approach on capital allocation (holding on to more capital to grow the business). That significantly boosts my long-term core earnings growth estimate (to the mid-to-high single-digits), but it’s hard to argue to that East West’s differentiated growth opportunities are going unappreciated today.

 

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East West Bancorp Still A Great Mid-Cap Bank, But Priced More Like It

Illinois Tool Works Offers Sharp Short-Cycle Recovery Exposure, But A Robust Valuation

The problem with saying that “valuation always matters” is that there’s a “when?” part that often goes unsaid. Illinois Tool Works (ITW) has finally started looking a little “mortal” recently with the shares underperforming the broader industrial space since my last update, a bit curious perhaps given the company’s exceptional near-term growth leverage and demonstrated margin excellence.

The long-term track record is still firmly in ITW’s favor, and this isn’t a name I’d bet against. Still, this is a company with less long-term historical organic growth than you might assume, and I’m modestly concerned that the company’s relatively less-attractive end-market exposures may create some modest headwinds. My bigger issue remains valuation – priced for a mid-single-digit total annualized long-term return, I just don’t see enough opportunity here to favor it over other industrials, even with the superior margins and quality ITW offers.

 

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Illinois Tool Works Offers Sharp Short-Cycle Recovery Exposure, But A Robust Valuation

M&T Bank Acquires People's United In An Attractive Win-Win Deal

In several articles over the years I have mentioned M&T Bank (MTB) and People’s United Financial (PBCT) together, as although M&T is a much larger bank, they are geographic neighbors, they share a similar credit and operational culture, and they have both served their shareholders relatively well over the years with what I’d call an “opportunistically conservative” model.

On Monday those ties became much closer, as M&T Bank and People’s United announced a merger wherein M&T will acquire People’s United in an all-stock deal. While I’d run the numbers on a possible merger here before, I had thought that People’s United would likely prefer to remain independent and pursue its own value-added M&A strategy over time. But in a difficult environment for organic bank earnings growth, I think the M&T opportunity was too much to pass up.

On a pro forma basis, I like this deal. People’s United shareholders are getting more than I think the bank was currently worth on a standalone basis, and they get to participate in the upside of the merged entity if they wish. M&T finds a good use of capital, eases some of the growth worries I had, and improves its franchise by essentially replicating it in New England with an excellent cultural fit.

 

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M&T Bank Acquires People's United In An Attractive Win-Win Deal

ING Signals The Worst Is Over, And The Shares Remain Undervalued

Around the time of the U.S. Presidential election, bank stocks both here and abroad finally started moving, with investors more optimistic about the outlook for a global economic recovery that would not only limit credit losses but eventually help reinflate interest rates (and spreads). As a spread-driven bank, that’s obviously good news for ING Groep (ING), and while management remains cautious on rates, the worst does seem to be over from a provisioning standpoint.

ING shares (the ADRs) are up about a third from the time of my last update, underperforming U.S. bank stocks, but with the local shares doing a little better than the Europe 600 Banks index. Pull the comparisons out to a year and ING ADRs and local shares have underperformed U.S. banks by a little less and outperformed European bank stocks by a little more.

I continue to believe that ING shares are undervalued, and this remains one of my favored picks in Europe. ING’s capital is rock-solid, and capital returns are likely to be significant over the next few years, and I like the bank’s disciplined multimarket lending approach, as well as the prospects for long-awaited opex savings from years of back-office investment in IT.

 

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ING Signals The Worst Is Over, And The Shares Remain Undervalued

The Market Is More Than Willing To Give Cullen/Frost The Benefit Of The Doubt Today

You don’t have to look very hard to find things to like about Cullen/Frost Bankers (CFR) (“Cullen Frost”), the holding company that owns Texas’s Frost Bank. Cullen Frost has grown deposits by almost 9% a year over the past decade, outgrowing the 8% growth in Texas, has a loan book that is more skewed to business operations (C&I instead of CRE), has exceptionally low deposit costs, and above-average historical credit quality.

You also don’t have to look hard to see a forward P/E multiple more than 50% above its peer group average and a P/TBV ratio likewise about 50% above where it should be on the basis of near-term return on tangible common equity (ROTCE).

I like a lot about Cullen Frost, and I believe the company could be more active on synergistic M&A if management wanted to go that route, but this isn’t a very acquisitive bank and I’m concerned about the impact of weak spread growth prospects over the next couple of years relative to that valuation. Cullen Frost has done better for its shareholders than most banks over the long term, but at today’s price I just don’t see a lot of value.

 

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The Market Is More Than Willing To Give Cullen/Frost The Benefit Of The Doubt Today

Inphi's Data Center Game Remains Strong As The Clock Ticks Down

I think there’s a good argument to be made that Inphi (IPHI) has been one of the best plays on the growth of data center spending over the past three years (NVIDIA (NVDA) certainly belongs in that discussion too), with the company enjoying especially strong share in physical layer Ethernet components and subsystems (analog chips, DSPs, and optical components), particularly its PAM4 platform. While telecom has been more up-and-down, this market too should enjoy a rebound in 2021 as major service providers resume deployments and the company moves beyond the loss of Huawei as a customer.

Inphi’s upside is now limited by the pending acquisition of the company by Marvell (MRVL). I continue to believe that this is a good (albeit expensive) deal for Marvell, and I expect the deal to close in the second half of the year. With Inphi trading at a greater than 8% discount to the implied deal value, this might be a name to consider for investors who like to trade those deal spreads.

 

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Inphi's Data Center Game Remains Strong As The Clock Ticks Down

Badger Meter - A Quality Water Name That Is Priced Accordingly

Badger Meter (BMI) is a great example of why I say that valuation in and of itself isn’t really a driver of future performance – these shares have been “expensive” for a long time, and yet they’ve beaten the S&P for five years in a row (by double digits in three of those years) and generated an annualized average return of over 18% over the last decade, outperforming both the S&P 500 and its water sector peers.

Badger Meter is still expensive, but it also still has leading share in the almost-oligopolistic U.S. water meter market, a market where there is still meaningful growth potential in remote metering, and a growing technology suite that addresses water quality issues. I can’t make the numbers work on the basis of the growth and margins I expect, but Badger has good margins, good ROIC, healthy markets, growth opportunities, and strong ESG credentials, so I wouldn’t call it a promising short candidate either.

 

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Badger Meter - A Quality Water Name That Is Priced Accordingly

Oshkosh Still Early In Its Cyclical Upswing And Offers Upside

Diversification can be a funny thing – while exposure to multiple markets with relatively low correlation can help over the long term, it also means that purer plays will tend to outperform at various points in the cycle. Oshkosh (OSK) hasn’t done badly since my last update relative to the larger industrial group (nor over the last year), but it has been left in the dust by stocks more leveraged to construction and mining equipment like Caterpillar (CAT), Deere (DE), Komatsu (OTCPK:KMTUY), and Terex (TEX).

I think Oshkosh is still in a relatively good place from a cyclical perspective. Although I have some concerns that expectations for non-residential construction are too high, I think Oshkosh is nevertheless going to see improving demand from here and improving margins. Relative to other industrials, I still like the above-average long-term total appreciation potential, but I would remind readers that it’s a cyclical stock and holding over the long-term may not be the easiest choice.

 

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Oshkosh Still Early In Its Cyclical Upswing And Offers Upside

Sensata Technologies Still Has More To Offer

Leveraged to recovering auto demand, and having addressed Street content growth worries at least twice in the last few years, Sensata Technologies (ST) has done well both since my last update and over the past year. Margin leverage and capital allocation priorities now seem to be the newest concerns on the stock, but I believe management will answer the doubters again, though it may take a couple of years.

Sensata doesn't get noticeably cheap on a DCF basis all that often, and I see the shares as more or less fairly-valued by that metric. Still, the shares do again look undervalued on a margin/return-based multiple approach, and I believe investors can reasonably expect a high single-digit total annualized long-term return from today's price.

 

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Sensata Technologies Still Has More To Offer

Nucor: A Mini-Mill Enjoying A Mini-Boom

The recent parabolic rise in steel prices caught pretty much everyone by surprise … and if you disagree with that, I’d point to the fact that roughly a quarter of U.S. steel capacity is still offline despite hot-rolled coil prices exceeding $1,000/st for several weeks. Still, fortune favors the prepared, and Nucor (NUE) is going to reap the benefits of this unexpected mini-boom in the first half of 2021 before what I expect will be a sharp correction as the restocking cycle ends and new capacity comes online.

When I last wrote about Nucor in August of 2020, I wrote that while I did still think the stock was undervalued and offered some upside, I preferred names like Steel Dynamics (STLD) and Ternium (TX) and that a more robust steel price environment would favor inferior names. Since then, Nucor has gone up about 35%, lagging Steel Dynamics’s 40% rise, Ternium’s 81% rise, and U.S. Steel’s (X) (one of the aforementioned “inferior operators”) 145% rise.

Nucor is currently trading at what I estimate to be around 3x on a spot-EV/EBITDA basis, and that’s a pretty fair peak-of-cycle multiple. I do still see a little upside from here (to around $60) and these higher prices could stick around a little longer (especially if I’m wrong/too bearish on non-resi activity), but I think buying a steel company at/near record steel prices is not generally going to work out.

 

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Nucor: A Mini-Mill Enjoying A Mini-Boom

Power Integrations Reaping The Benefits Of Sound Management Decisions

Even in the somewhat rarefied air of semiconductor sector valuations, Power Integrations (POWI) stands out trading at close to 48x 2021 EPS estimates - not as high as NVIDIA (NVDA), but still on the upper end of the sector. Of course, not many semiconductor companies have a line of sight to possibly multiple years of double-digit revenue growth and meaningful margin expansion, as well as a tough-to-beat moat in vital semiconductor sub-sector (power conversion).

I'm bullish on Power Integrations' near-term opportunities in rapid charging, mid-term opportunities in areas like industrial automation, brushless motors, and electrification, and mid-to-long-term opportunities like auto electrification, not to mention specialty areas like gallium nitride (GaN chips). Still, it's tough to make the numbers work, as today's valuation already appears to anticipate mid-teens long-term revenue growth and meaningful margin expansion.

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Power Integrations Reaping The Benefits Of Sound Management Decisions

Hub Group Undervalued With An Improving Growth Outlook

Logistics infrastructure is under strain across the U.S. right now, but with challenges come opportunities, including the opportunity for Hub Group (HUBG) to lock in better prices, continue its productivity/efficiency initiatives, and reinvest in the growth of what is already the second-largest intermodal services provider.

Balancing growth and margins will always be a challenge for providers like Hub Group and J.B. Hunt (JBHT), but I like how the business has evolved over the last four years and I like management's moves to expand the business's footprint (including the recent addition of a well-regard asset-light last-mile logistics provider). With the shares looking undervalued below the mid-$60's, I think near-term worries about gross margin pressure have created a window of opportunity here.

 

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Hub Group Undervalued With An Improving Growth Outlook

Amidst Ongoing Turmoil, Credicorp Still Offers Attractive Upside

Between the pandemic and government turmoil, there's still quite a bit of upheaval in Peru, and that's seldom good for business. Nevertheless, things are slowly getting better and Credicorp's (BAP) conservative operating philosophy (including conservative economic projections and reserving decisions over a year ago) seems to be serving the bank well during this challenging period.

I can't say that the risks to Credicorp's credit quality or Peru's economy have peaked and that it will be smooth sailing from here. Frankly, given Peru's political environment today, "smooth sailing" is probably a pipe dream. Even so, I expect a strong recovery over the next couple of years, with Credicorp regaining 2019 levels of profitability in 2022 (on the earlier edge of my prior outlook) and long-term core earnings growth in the neighborhood of 7%-8%.

These shares have risen about 30% since my last update, lagging the recovery in the U.S. bank sector, but outperforming the S&P 500 and modestly outperforming the iShares MSCI Peru ETF (EPU). With low-to-mid-teens annualized total return potential and a fair value closer to $200/share, I think this is a name for investors to consider as one of the better economies in South America gets back on track.

 

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Amidst Ongoing Turmoil, Credicorp Still Offers Attractive Upside

Consumer Broadband Shining For MaxLinear, But Other Businesses Need To Step Up

Work-from-home has continued to be a boon for MaxLinear (MXL), has record growth in 2020 for broadband subscribers has driven strong demand for MaxLinear’s front-end and connectivity solutions, and the acquisition of Intel’s (INTC) Home Gateway business has gone exceptionally well. Less impressive has been the performance in infrastructure, and MaxLinear is going to need that business to step up in 2021.

I thought MaxLinear was priced for in-line performance back in December, and that’s largely what has happened, with the shares modestly outperforming the SOX over the last couple of months. I have raised my revenue and margin expectations, driven in large part by Broadband and Connectivity (the former Connected Home segment), but MaxLinear’s outperformance now seems much more tied to a ramp in the Infrastructure segment, where I see more competitive threats.

 

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Consumer Broadband Shining For MaxLinear, But Other Businesses Need To Step Up

ON Semiconductor Highlights The Importance Of Management And Margins

In only about two months, ON Semiconductor (ON) shares have appreciated another 30%, roughly doubling the return of the SOX index. A strong beat-and-raise quarter doesn’t explain the outperformance, as peers/rivals like Infineon (OTCQX:IFNNY), STMicro (STM), and Texas Instruments (TXN) had those too.

I believe the performance of ON shares is testament to just how important management and margins are to investors. While new CEO Hassane El-Khoury hasn’t had the opportunity to conduct a full review (there will be an August analyst day), his initial takes on his plans for ON are pretty much exactly what investors wanted to hear – prioritize higher-margin value-added products, get out of some lower margin businesses, rationalize the manufacturing base, and reinvest in growth.

I said before that I thought a better-run ON could see around nine points of long-term margin improvement. I’m currently modeling a bit less than that, but there’s still room for outperformance and I think ON has a credible line of sight to adjusted FCF margins of 20% or more over time. A lot of this is now in the share price, though, and while I do still believe that the combination of growth ramps (in auto and industrial, especially) and margin expansion is a powerful one, I don’t see the upside I did before.

 

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ON Semiconductor Highlights The Importance Of Management And Margins

Mueller Looks Undervalued And Has A Few Positive Drivers

I last wrote about Mueller Water (MWA) in late September, and despite liking Mueller's leverage to residential housing construction and potentially greater federal support for water infrastructure projects, I wasn't that sold on the shares. Since then, the stock has very slightly outperformed the S&P 500 and the industrial sector as a whole, more or less keeping pace with comps like Watts (WTS) and Xylem (XYL).

I'm still not all that bullish that federal infrastructure stimulus will mean much for Mueller, but I guess any help is help. I am more bullish on residential construction, though, as I do see ongoing strength and an under-supplied market. I'm also more bullish on the prospects for a manufacturing footprint upgrade to generate better long-term margins, with capex spending normalizing in a few years and adding a further boost to FCF margins. I still don't love the DCF-based valuation here, but the shares do seem undervalued on margins, and in an expensive industrial sector, this name does have some catch-up appeal.

 

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Mueller Looks Undervalued And Has A Few Positive Drivers

Growth Opportunities Making W.W. Grainger's Story More And More Interesting

When I last reviewed W.W. Grainger (GWW) ("Grainger"), at a point only a month removed from peak COVID-19 panic, I called the stock a "borderline buy", as I was intrigued by the growth potential of new ventures like Zoro and MonotaRO, but still concerned about pricing/margin pressures and the details of the post-pandemic recovery. Since then, the shares have lagged the broader industrial space by about 10%, as well as rival MSC Industrial (MSM), lagged the S&P by a bit less, and kept pace with Fastenal (FAST).

I still am concerned about the long-term outlook for margins, particularly as the lower-margin "Endless Assortment" businesses ramp, but I believe the growth outlook is getting better, and Grainger may well give Fastenal a run for its money on long-term growth. Grainger is still not a clear-cut buy on the fundamentals, but it's becoming more and more appealing and better execution on margins could unlock a lot of upside.

 

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Growth Opportunities Making W.W. Grainger's Story More And More Interesting

With Weaker Non-Resi Markets, Hubbell's Self-Help Story Is More Important Than Ever

There are good things about the Hubbell (HUBB) story, including the company's leverage to still-healthy utility markets and recovering industrial markets. The company generates decent cash flows, and while I don't like the lighting business nor the Aclara metering business all that much, I believe expectations have largely reset there.

What hasn't been so good is the margin story, with no real leverage there in several years. Management continues to talk a good game on cost-cutting/efficiency opportunities, but with non-resi markets looking weaker in 2021, executing on those opportunities is even more important.

I wasn't all that excited about these shares back in August of 2020, and since then they've largely tracked the larger industrial space, also underperforming more direct comps like ABB (ABB), Eaton (ETN), nVent (NVT) and Schneider (OTCPK:SBGSY). While Hubbell has been more cyclical in the past than these comps, and should have decent leverage to industrial end-market recoveries, the shares continue to look quite average in terms of return potential.

 

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With Weaker Non-Resi Markets, Hubbell's Self-Help Story Is More Important Than Ever

As The Switch Peaks, Nintendo Needs To Build The Next Growth Engine

Deciding who has the best software platform in gaming is no easy feat, but there’s no denying that Nintendo (OTCPK:NTDOY) (7974.T) has generated some long-lived favorites that continue to generate substantial interest and revenue for the company. What makes Nintendo’s business more challenging, though, is the inescapable cyclicality of the business as new platforms rise, peak, and fall, and with this business having so much operating leverage, profits and free cash flows can swing wildly.

The Switch platform is nearing its peak, but management has thrown cold water on the idea that a new hardware platform is just around the corner. I appreciate the desire to maximize the value of the platform, but the reality is that Nintendo is setting up for earnings and cash flow erosion starting next year, and without a new platform to drive investor sentiment, I believe the stock may struggle to make much headway.

 

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As The Switch Peaks, Nintendo Needs To Build The Next Growth Engine

Aptiv Has Morphed Into A New-Tech Growth Story

Investors often like themes, and with Aptiv's (APTV) leverage to auto electrification, active safety, and infotainment, the company and stock check a lot of boxes for investors. On top of that, Aptiv is also a well-run company that is quite likely to lead the auto supplier sector in growth over the next three to five years, with minimal legacy concerns tied to the deprioritization of legacy gasoline powertrains.

I grossly underestimated the extent to which Aptiv's appeal beyond the numbers would drive a fundamental shift in how investors approach valuation. Aptiv has now morphed into a full-on "new tech" growth stock, and is priced accordingly.

This makes valuation quite difficult for me - Aptiv trades well beyond the bounds of discounted cash flow or margin-driven EV/revenue multiples (a common relationship in the sector) and is clearly a growth stock now. So do you treat it like a stock like NVIDIA (NVDA) or even Tesla (TSLA)? If so, the target price can get extremely high very quickly. If it doesn't deserve quite those sorts of valuation, how much less?

I believe Aptiv could generate mid-teens annualized EBITDA and FCF growth over the next decade, so is that worth 30x forward earnings? 40x? 50x? Trading at over 40x '21 EPS and over 30x '22 EPS, I think these are questions prospective buyers might want to consider.

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Aptiv Has Morphed Into A New-Tech Growth Story

Synaptics Executing Well On A Higher-Growth, Higher-Margin Model And Not Getting Full Credit

Synaptics (SYNA) is doing what many semiconductor companies struggle to do – meaningfully remaking itself into a higher-margin player in more defensible, faster-growing market segments. Many companies have struggled to successfully disengage from a heavy revenue reliance on Apple (AAPL), and likewise many chip companies have found it hard to transition away from consumer markets where “fast follower” Asian rivals quickly compete away margins. Synaptics, though, has executed on this transition quite well over the last couple of years.

Cheap stocks are all but impossible to find in the semiconductor space today, and there are still significant questions about the growth opportunities in areas like Mobile and PC for Synaptics over the next couple of years. Nevertheless, I do believe the company’s IoT business is set to generate strong growth, and I believe mid-to-high single-digit long-term revenue growth is possible here, and with higher margins.

There’s more modeling risk with businesses in transition/transformation, but I see near-term upside into the $140’s here and longer-term total annualized return potential in the high single-digits.

 

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Synaptics Executing Well On A Higher-Growth, Higher-Margin Model And Not Getting Full Credit

Zimmer Biomet Sees Some Pandemic-Related Turbulence, But Continues Its Self-Improvement Drive

I was honestly pretty conflicted about Zimmer Biomet (ZBH) (“Zimmer”) when I last wrote about the company. The main source of my conflict was that I thought sell-side expectations of Zimmer emerging as a share-gainer in the orthopedic space (knees and hips, specifically) could be a little inflated, or at least premature, but the valuation wasn’t bad.

Since then, the shares have more or less matched the broader medical device space, underperforming Stryker (SYK), which I still think is a better company, and outperforming Johnson & Johnson (JNJ), which I think suffers from a split focus at the highest management levels. At this point, I’m still pretty ambivalent about the share price potential – the total return potential isn’t what I typically like to see, but it’s not bad on a relative basis, and I still see possibilities for Zimmer to outperform. All in all, I think it’s a story that will be driven by management execution, and so far that has been a favorable driver.

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Zimmer Biomet Sees Some Pandemic-Related Turbulence, But Continues Its Self-Improvement Drive

Weyerhaeuser Harvesting Record High Prices, But The Good Times Never Last

For Weyerhaeuser (WY) investors, current conditions may feel a bit Dickensian – it’s among the best of times with respect to lumber and oriented strand board (or OSB) prices, and the housing market looks healthy, but a relatively soft dividend yield and limited guidance leave investors wanting more. On top of that, for all of the words written over the decades about the value in owning timber assets, Weyerhaeuser has been a sustained underperformer, even when the dividends are included.

It’s going to take time for the industry to catch up on capacity, and the OSB market has been shockingly restrained, though I’m sure the pandemic has “helped” in that regard. In any case, while I do believe that 2021 EBITDA could be 20% or more above Weyerhaeuser’s long-term full-cycle average, it’s looking likely that 2022 will be at least 20% below. I do see some undervaluation here, but given the volatility in the business and the long-term track record, it’s not a compelling must-buy for me.

 

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Weyerhaeuser Harvesting Record High Prices, But The Good Times Never Last

DBS Group Has Quieted Credit Concerns And Can Pivot To Growth Again

There's still a long way to go in terms of addressing the global pandemic and getting back to business as usual, but the global economy is picking up. Between government assistance programs in many countries and its own underwriting discipline, Singapore's DBS Group (OTCPK:DBSDF) (OTCPK:DBSDY) has come through this trial in better-than-expected shape, answering critics who tried to claim that earnings were being boosted by less disciplined underwriting standards that would be exposed during the next big economic downturn.

Since my last update on DBS Group, these shares have done okay - rising about 25% and doing a little better than other regional peers like Standard Chartered (OTCPK:SCBFY), United Overseas Bank (OTCPK:UOVEY), and OCBC (OTCPK:OVCHF), but not really standing out from global peers as much as you might hope relative to what I see as superior underlying quality.

I still see double-digit potential from DBS Group on what I believe are relatively conservative long-term growth assumptions that drive a core earnings growth rate around 5%. Meaningful upside could come from greater progress in emerging markets, particularly using digital banking strategies and select physical acquisitions to grow in attractive markets like India, Indonesia, and Vietnam over the coming decade, though increased competition remains a risk.

 

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DBS Group Has Quieted Credit Concerns And Can Pivot To Growth Again

Emerson Benefiting From A Quicker Recovery In Longer-Cycle Markets

Things still aren’t great for Emerson Electric (EMR), but better days are definitely in sight, and management’s efforts to diversify and reposition the automation business are already starting to pay off. A change in the top, bringing in only Emerson’s fourth-ever CEO, may sound like a risk, but the new CEO is a company veteran with a good track record at the Automation Solutions business.

These shares have done pretty well since my last update, helped by a very healthy sentiment around the economic recovery and the impact that will have on Emerson’s longer-cycle automation markets. While the shares don’t look particularly cheap in what I believe is a relatively expensive industrial sector (relative to the S&P 500 at similar points in the cycle), they could still have some appeal if you feel you have to own something in the space and/or aren’t as worried about overall valuation levels.

 

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Emerson Benefiting From A Quicker Recovery In Longer-Cycle Markets

Independent Bank Group's Upside Tied To A Resumption Of M&A

Banks have recovered well from multi-decade valuation lows in 2020, though the next couple of years will likely still see many banks struggling to generate pre-provision profit growth. For Independent Bank Group (IBTX) of Texas (and Colorado), though, I see normalization of the growth story as less about loan growth and spread expansion, and more about a resumption of M&A activity as management looks to build on a valuable toehold in the Texas banking market.

I was lukewarm on Independent Bank back around third quarter earnings, and while these shares have continued to enjoy the market-beating tailwind that has lifted bank stocks in general, the 20% or so move since that last article has lagged the bank’s comp group.

As before, so much of the valuation now depends on the bank’s return to growth-by-M&A. I do see double-digit annualized return potential here, but there are some banks out there with more undervaluation and cleaner growth stories. All in all, I like Independent Bank as a company, but I can’t say it’s a top idea right now.

 

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Independent Bank Group's Upside Tied To A Resumption Of M&A

II-VI Dives Into The Battle For Coherent And More Diversification

Coherent (COHR) has suddenly become hot property, with three companies bidding on this photonics, laser, and optical components company. The latest entrant, II-VI (IIVI), would appear to be seeking to not only round out some of its assets in photonics, but also further vertically integrate its laser and optics capabilities, as well as expand its addressable market opportunities outside of communications.

The $6.5B price that II-VI is offering is indeed steep (or closer to $6.8B including a break-up fee), but II-VI’s $200M synergy target may well prove conservative and II-VI has a good history where deal integration is concerned. What’s more, there’s legitimate scarcity value here, and II-VI won’t really have another opportunity at an asset like this.

The Coherent deal isn’t a “must have” for II-VI, and the added debt will be an issue for some investors, but I believe it makes long-term strategic sense. My bigger issue with II-VI is the valuation, as II-VI has definitely transited to “growth stock” valuation over the past six months or so. Granted, with II-VI’s leverage to telecom and datacom infrastructure spending, 3D sensing growth, silicon carbide growth, and other drivers, it deserves to be treated like a growth stock, but the valuation isn’t as straightforward as before.

 

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II-VI Dives Into The Battle For Coherent And More Diversification

Hancock Whitney Has Above-Average Upside, But It Requires Self-Improvement

With many banks on the prowl for M&A, I believe that to some extent banks will need to “earn” their right to stay independent; if a bank cannot generate sufficient returns on capital on their own, sooner or later another bank is going to make the shareholders an offer they won’t refuse. In the case of Hancock Whitney (HWC), a legacy of underperformance with respect to margins and returns (ROE, ROTCE, et al) but a good core deposit base makes this a prime candidate for a “get better or get bought” story.

Management at Hancock is still in the relatively early stages of a meaningful cost-cutting program that I believe, coupled with eventual improvements in interest rates, can drive returns on equity back to 10% or better and drive long-term core earnings growth in the mid-single-digits. That, and a low double-digit ROTCE in 2021 and 2022 should support a fair value in the low $40s and a double-digit annualized total return opportunity.

 

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Hancock Whitney Has Above-Average Upside, But It Requires Self-Improvement

This Recovery Cycle Is Showing Why Texas Instruments Is Among The Best In The Business

To quote George Peppard's Hannibal Smith from the original A-Team, "I love it when a plan comes together." Texas Instruments' (TXN) relatively bold decision to maintain production capacity during the downturn risked some adverse numbers for gross margins and balance sheet metrics in a slower (or delayed) recovery, but left the company in perfect position to benefit from the sharp rebound in demand for auto and industrial semiconductors. While this period of elevated demand won't last forever, it will do great things for the numbers for a while.

It wasn't as if TI's excellent management was really in doubt, but this is just another confirmation that this really is one of the best-run chip companies in the business. Not everything at TI is perfect (share loss in MCUs merits watching), but there's little question that this is a core holding in the chip space. Still, I thought the shares were expensive back in October, and while they've done well since, they still have lagged the SOX index and chip names I preferred like ON Semiconductor (ON) and STMicroelectronics (STM).

What can be debated is whether today's valuation is still reasonable. TI management would seem to have some doubts, as they've made no buybacks in the last two quarters, despite no liquidity worries. If I dial everything up to "11", I can get to the mid-$170's, but then again I can't rule out at least a couple more strong quarters on this demand rebound. I understand the fear of selling in the $170's only to see the shares hit $200 or more on a blow-off, but while I think TI is a great long-term holding, I won't be buying it for my own portfolio here.

 

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This Recovery Cycle Is Showing Why Texas Instruments Is Among The Best In The Business

STMicroelectronics Reaping A Booming Recovery Market

Up about 37% from my last update, STMicroelectronics (STM) (“STMicro”) has gotten a little more credit for its growth and margin improvement potential, but the shares have still lagged the sector, as investors were put off by a more cautious tone at management’s December capital markets day and the shares lost some pace relative to the sector.

I can’t really fault how business is going at STMicro, even if the current pace is unlikely to be sustainable. With strong growth opportunities across an array of businesses, including microcontrollers (or MCUs) and RF in areas like autos, industrial, and IoT, as well as more efficient operations, I like this company’s outlook.

What I don’t like anymore is the price. The market has bid up the sector, and while there are some relative value arguments for STMicro, and an implied mid-to-high single-digit annualized total return isn’t bad, it’s hard for me to recommend this one with quite the same enthusiasm as before.

 

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STMicroelectronics Reaping A Booming Recovery Market

Steel Dynamics Ideally Positioned To Leverage Soaring Steel Prices

The last four months have shown that I was too hasty in shifting my outlook on Steel Dynamics (STLD) from "buy" to "hold", as steel prices have rocketed higher on industrial restocking (especially auto companies) and steel companies have been surprisingly slow to restart shuttered mills, with capacity utilization still at only 75% despite spot prices of close to $1,200 per ton. With some buyers still reluctant to place orders ahead of expected capacity additions (which should lower prices), and Steel Dynamics benefitting from a lag in realizations, the first half of 2021 should look quite good.

Then again, I do still believe that prices will weaken in the second half as restocking fades and more capacity comes online. Likewise, I'm still not as bullish on the outlook for non-resi construction in 2021 or 2022.

While I was premature downgrading Steel Dynamics in October, I would note that the share price appreciation of roughly 25% since then has been outshone by Acerinox (OTCPK:ANIOY) (up about 35%), Alcoa (AA) (up 57%), and Ternium (TX) (up 35%) - all of which I recommended in lieu of Steel Dynamics. As things sit today, I like Steel Dynamics more, and I do think infrastructure stimulus could provide a kicker. I don't know that I can say Steel Dynamics is my favorite name now, but I do see some upside here.

 

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Steel Dynamics Ideally Positioned To Leverage Soaring Steel Prices

Alaska Air Can Continue To Outperform As Travel Recovers

The pandemic has crushed air travel demand, and there's very little that airlines can do about other than to reduce costs and run as efficiently as possible ahead of the eventual recovery - a situation that plays relatively well to Alaska Air's (ALK) strengths where cost control is concerned, though much of Alaska Air's efficiency is still tied to actually flying jets with passengers.

I liked Alaska Air back in August, arguing that this well-run carrier would make it through the downturn in better shape than most and would go into the recovery with a better, more profitable fleet. I still believe that. These shares have outperformed since my last article, rising more than 50% and beating peers (the U.S. Global Jets ETF (JETS)) by about 20% and specific rivals like Delta (DAL) and Southwest (LUV) by about 10% to 15%, while Spirit (SAVE) has done about 15% better.

I continue to like Alaska Air here and think it's worth buying/holding, but investors should note the likelihood of above-average volatility.

 

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Alaska Air Can Continue To Outperform As Travel Recovers

Bank OZK Proving Out Its Credit Quality, But Loan Growth Concerns Loom

Wall Street is an “it’s always something” kind of place, and I wouldn’t expect sell-side analysts who were bearish on Bank OZK (OZK) to simply abandon that position just because the credit story is shaping up far better than the bear-case scenarios bandied about in mid-2020. Given where we’re at in terms of the pandemic and the impact it has had (is having, and will have) on real estate categories like hospitality and offices, it is fair to wonder whether loan growth will be the next focus of more bearish theses.

With these shares up more than 60% from when I last wrote about them, making Bank OZK a relative stand-out, I certainly don’t see the upside I once did. Credit is holding up better than I expected (I wasn’t bearish, but I was cautious), and that helps future earnings growth, but I think a near-term fair value around $40 with longer-term annualized total return potential close to 10% is a reasonable assessment of the opportunity here. I would note, though, that Bank OZK has meaningful under-used capital, and effectively deploying that could meaningfully improve the outlook.

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Bank OZK Proving Out Its Credit Quality, But Loan Growth Concerns Loom

South State Bank: Not Cheap On The Multiples, But The GARP Case Is Interesting

Last year, two of my preferred smaller banks, South State Bank (SSB) and CenterState, got together in a merger of equals that combined two active acquirers with attractive footprints in growing Southeast U.S. markets into a much larger bank with an excellent growth footprint, a strong core deposit base, good fee-generating businesses, and a lot of options to deploy capital. While credit was a risk going into this down-cycle, the combined entity has acquitted itself well so far.

Valuation for South State isn't as straightforward as you might like. It's not cheap on conventional multiple-based approaches, and the growth expectations are not conservative. Still, given the opportunity to leverage a low-cost deposit base, outmaneuver larger rivals, squeeze out smaller sub-scale players, and deploy more capital toward M&A, I think South State could generate high single-digit to low double-digit core growth and drive double-digit annualized long-term total returns from here.

 

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South State Bank: Not Cheap On The Multiples, But The GARP Case Is Interesting

Renesas' Acquisition Of Dialog Is A Win-Win

It’s an odd thing when two companies you really like get together. I’ve thought for some time that both Japan’s Renesas (OTCPK:RNECY) and the U.K.’s Dialog Semiconductor (OTCPK:DLGNF) were underrated and undervalued by the Street, though both have done well since my last write-ups on the companies (Renesas here and Dialog here).

Apparently, Renesas agrees that there’s more to Dialog than the Street thinks and that the company’s technology can do a lot more. On February 8, Renesas and Dialog announced that Renesas will acquire Dialog for EUR 67.50 per share, and add Dialog’s capabilities in power management, connectivity, and other mixed-signal chips to its own capabilities in MCUs, SoCs, and mixed-signal.

I believe Dialog shareholders are getting a fair price, but given the sentiment in the sector, you could perhaps argue that “fair” is undervalued. In any case, I expect little risk of the deal not going through. While I believe Renesas shares remain attractive, whether the modest spread between the deal price and Dialog's share price (EUR 2/share as of this writing) is sufficient reward for a trade is harder to say.

 

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Renesas' Acquisition Of Dialog Is A Win-Win

Fastenal Seeing The Start Of A Rebound, And Bullish On Margins

While the recovery isn’t robust, and it’s not happening evenly across end-markets, there is ample evidence from recent reports, including Fastenal’s (NASDAQ:FAST) fourth quarter results and ongoing monthly sales numbers, that manufacturing end-markets are turning around. Guidance across the sector has been cautious, and I’m not looking for Fastenal’s growth to accelerate into the high single-digits in 2021, but fastener demand should improve throughout the year and help offset the headwinds that will come whenever the pandemic fades and drives lower demand for janitorial/safety equipment.

Of course, Fastenal’s valuation remains an issue. The shares typically trade above what would otherwise seem fair or normal, even allowing for Fastenal’s superior margin and ROIC profile. About the best that I can say is that the valuation isn’t so stretched on a relative basis (Fastenal’s forward PE and/or EV/EBITDA relative to the manufacturing/industrial sector), but I find relative valuation more useful for trading as opposed to longer-term investing.

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Fastenal Seeing The Start Of A Rebound, And Bullish On Margins