McPhy Offers A Still Largely Unknown Play On Green Hydrogen

Green hydrogen has been getting more and more attention lately as a viable means of decarbonizing high-pollution industries like steel and cement, as well as at least some elements of transportation. Produced with clean renewable power like solar, wind, or hydroelectric, green hydrogen could not only displace some of the 70Mtpa of “grey hydrogen” produced today, but also become viable in a range of applications where hydrogen isn’t used currently.

France’s McPhy (OTC:MPHYF) (MCPHY.PA) wants to play a major role in that process. McPhy is focused on electrolyzers (or electrolysers), a key component in the hydrogen production process that takes water and electricity as inputs and produces hydrogen. Producing 5Mt of green hydrogen in 2030 would translate into around 25GW of installed electrolyzer capacity, a total market opportunity of over $16B, and even a single-digit share of that would represent a major opportunity for this small company.

To be clear, McPhy is an exceptionally speculative play. Green hydrogen demand may never develop into anything meaningful, and even if it does, other players like Cummins (CMI), Siemens Energy (OTCPK:SMNEY), or ITM Power (OTCPK:ITMPF), not to mention later entrants or startups could outmaneuver and outcompete McPhy. Still, for investors who can take the risks, it’s an interesting early-stage picks-and-shovels play to explore further.

 

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McPhy Offers A Still Largely Unknown Play On Green Hydrogen

Agilent Leveraged To Post-Pandemic Recovery And Advanced Drug Discovery And Production

 

You don’t go to the life sciences space looking for conventional bargains – it’s a high-growth, a high-margin sector that has attracted a lot of investor attention and the valuations reflect that. For investors who can get comfortable with the higher multiples, though, I do think there are some interesting stories, and Agilent (A) is one of them.

With research labs still operating well below normal and other end-markets like Chemicals and Energy likewise below historical norms, I see worthwhile upside for Agilent on post-pandemic normalization. I also like the company’s leverage to increased service penetration with its laboratory customer base, as well as the growth opportunities in biological drug discovery and production.

 

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Agilent Leveraged To Post-Pandemic Recovery And Advanced Drug Discovery And Production

BorgWarner's Recent Analyst Day Laid Out Clear Targets, But Settled Nothing

 

BorgWarner (NYSE:BWA) has been a battleground stock recently, and the company’s investor day last week changed basically nothing. BorgWarner bulls still believe (broadly speaking, of course) that the OEM insourcing is a manageable threat and that the company has assembled a compelling xEV portfolio. Bears still believe that insourcing will be a huge negative influence and that BorgWarner is doomed to a future with little revenue growth and weaker margins.

As an owner of BorgWarner shares, it’s pretty obvious which camp I’m in, though I wouldn’t consider myself a raging bull – there are very real threats that BorgWarner is facing, not to mention major modeling unknowns, and the company’s R&D and M&A plans run the risk of setting fire to significant amounts of shareholder capital.

I’ve chosen to take a more conservative outlook for the next five years, largely on elevated R&D spending and the risk of M&A swap-outs of higher-margin legacy ICE components for lower-margin (initially) xEV components, but my 2030 assumptions change by only a couple of percentage points, and I still believe these shares offer double-digit near-term upside and above-average long-term upside as well.

 

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BorgWarner's Recent Analyst Day Laid Out Clear Targets, But Settled Nothing

Rexnord Finds A Good Deal For Shareholders And Shifts To A Water-Driven Future

 

Win-win transactions aren’t necessarily commonplace, but I think Rexnord (RXN) and Regal Beloit (RBC) found one, with the two companies intending to combine Rexnord’s Process and Motion Control (or PMC) business into Regal Beloit in a Reverse Morris Trust transaction that will see Rexnord shareholders own something around 38% to 39% of the combined company, while also owning shares in a new water infrastructure pure play.

Having recently written on Regal Beloit, I encourage readers to check out my thoughts on that company and how it stands to benefit from the PMC deal. For Rexnord shareholders, the benefits come not only with the value of the stake in an improved Regal Beloit, a short-cycle industrial with exposure to the post-pandemic recovery, HVAC, and industrial automation, but also the higher multiples that the Street typically awards water infrastructure companies.

Rexnord shares have done well since my last update, rising more than 50% on improving post-pandemic sentiment. No longer a laggard to the industrial sector, I do still see upside potential. There are still plenty of uncertainties that complicate the modeling process, but I believe Rexnord’s near-term fair value rises to over $50 with the Regal Beloit transaction and the probable post-deal re-rating.

 

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Rexnord Finds A Good Deal For Shareholders And Shifts To A Water-Driven Future

Regal Beloit Offering Cyclical Leverage And Deal Synergy

With short-cycle industrial markets firmly in recovery mode and longer-term opportunities in HVAC and industrial automation, end-market conditions are looking pretty supportive these days for Regal Beloit (RBC). Strong execution in tougher markets in 2019 and 2020 likewise lends more credibility to management’s cost reduction targets, as the company definitely outperformed expectations for decremental margins during the pandemic downturn.

On top of that, the acquisition/merger with Rexnord’s (RXN) Process and Motion Control business (or PMC) creates new synergy opportunities on both the cost and revenue lines, with the deal also significantly enhancing Regal Beloit’s Power Transmission business.

I can see near-term upside in Regal Beloit to around $160, and above-average longer-term total annualized return potential beyond that. It is a cyclical, largely short-cycle, industrial business, but one where I believe there are both revenue and margin tailwinds to drive the business.

 

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Regal Beloit Offering Cyclical Leverage And Deal Synergy

AerCap Scores The Mother Of 'Buy Low, Sell High' Deals

Investors can’t fault the management of AerCap (AER) for thinking too small. Yet again management has shown its willingness to make bold moves at tough points in the cycle, agreeing to a huge $31B-plus deal with General Electric (GE) to acquire GEACS and create far and away the largest aircraft leasing company in the world.

I believe time will show this to be a savvy deal done a bit past the bottom of the cycle, with AerCap paying around 0.6x book (on a levered basis) for a quality leasing company and paying around 0.75x to 0.80x for a fleet similar to its own, all while maintaining its invaluable investment-grade debt rating. I expect meaningful aircraft sales in the years to come (into a strengthening market), with share repurchases restarting a little further down the line.

 

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AerCap Scores The Mother Of 'Buy Low, Sell High' Deals

 

Time horizon is always an important detail in investments – you can be right about the short-term outlook for a company (or stock) and wrong about the long-term, or vice versa, and lose money on what was otherwise a sound idea.

In the short term, it seems like the market has serious misgivings and doubts about the benefits that International Flavors and Fragrances (IFF) can reap from its large merger with DuPont’s (DD) Nutrition and Bioscience business. Indeed, there is a lot to prove here, including whether the revenue and R&D synergies will be real, whether the company can hit its margin targets, and whether the deal will fundamentally upgrade IFF’s long-term growth outlook versus its prior standalone potential.

I have my own doubts about the deal, but it seems as though the pessimism is excessive. Long-term revenue growth in the 3% to 4% and mid-teens FCF margins can support a fair value comfortably above today’s price (and a long-term annualized total return in the double-digits), and those inputs assume that the company comes in short of its own post-merger targets.

 

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For Now, The Market Seems Skeptical That International Flavors And Fragrances' Big Deal Will Pay Off

Evoqua Water Technologies Leveraged To Both Sides Of The Water Quality Equation

As a general rule of thumb, you don’t look to water/water technology companies to find bargains. With less-cyclical business models, leverage to water quality concerns, and the potential for increased federal support through regulation and infrastructure spending, they tend to trade at premiums to the wider multi-industrial space.

With that in mind, I’m not surprised that Evoqua Water Technologies (AQUA) shares look pricey by my typical investment standards. I do like the basic story here, though, including leverage to a “water as a service” business model and the potential for meaningful PFAS water clean-up mandates. If you’re less valuation-sensitive, or have some context for a 32x multiple to ’22 EPS as “cheap”, then there may be something here for you.

 

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Evoqua Water Technologies Leveraged To Both Sides Of The Water Quality Equation

Vontier Looks Oddly Cheap Ahead Of Major M&A Deployment

 

Years of investing will make you paranoid, or at least highly suspicious, when you find what appear to be bargains hiding in plain sight. There are some issues with Vontier (VNT), including a business that could be more vulnerable to the shift toward electrified passenger vehicle powertrains, but given the company's pedigree (part of the Danaher (DHR)/Fortive (FTV) family tree), a good CEO, and the explicit intention of deploying capital toward growth M&A, I find the discount to fair value today to be odd.

With what looks like fair value in the low-to-mid-$40s, I do wonder what I'm missing about Vontier today. Yes, there are EMV headwinds that will weigh on growth, and the business isn't as "future-proof" as you may like. M&A also carries risk, as the company could overpay or go down roads that lead nowhere. Still, with the base business undervalued on what I think are reasonable, if not conservative, assumptions, I think this is a name to check out.

 

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Vontier Looks Oddly Cheap Ahead Of Major M&A Deployment

Eaton Still Looks Like The Pick Of The Litter

It’s been a little while since I’ve thought Eaton (ETN) was truly cheap, but like Parker-Hannifin (PH), I’ve stayed positive on Eaton as a “best of breed” among increasingly richly-valued industrials. In particular, I’ve favored Eaton for its strong leverage to electrification, as well as longer-term leverage to vehicle electrification and an aerospace recovery.

Up more than 20% since my last update, and still beating both the S&P 500 and its peer group, the valuation argument isn’t getting any easier. Management’s recent investor day did make me feel a little better about my growth expectations, though, and I still lean positive on Eaton for its leverage to long-term secular growth themes, though I do see the long-term annualized expected return as pretty pedestrian now.

 

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Eaton Still Looks Like The Pick Of The Litter

Operational Leverage And Improved Clarity Have Catapulted ArcelorMittal Shares

Among commodity companies, weaker players typically outperform in up-cycles as they see even greater operating leverage benefits from higher prices and volumes. That would be enough to explain at least some of ArcelorMittal’s (MT) impressive performance since September, but added clarity on capital allocation priorities and operational strategies has analysts feeling quite a bit more confident about a sustained improvement in full-cycle profitability at this giant steelmaker.

I’m cautiously optimistic on the prospects for improved full-cycle profits, as management is both saying and doing the right things, and has taken some meaningful steps to improve returns and walk away from lower-return assets. Still, improvements to commodity company operating models aren’t really proven until the next down-cycle, and that’s clearly not the environment today.

I don’t find Arcelor shares to be particularly cheap today, but that’s in part due to my belief that steel prices are going to start declining in the second half of the year, shrinking the operating leverage for the sector in 2022. I can see upside to the low-to-mid-$30’s on a “stronger for longer” steel market (a more bullish scenario, in other words), but as is I think Arcelor is more or less priced in line with other quality names today.

 

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Operational Leverage And Improved Clarity Have Catapulted ArcelorMittal Shares

Compass Diversified Holdings Chugs Along

It has been a little while since I've updated my thoughts on Compass Diversified Holdings (CODI), but, in the meantime, not all that much has changed. Distributable cash continues to grow at a mid-single-digit rate, the actual distribution has been steady, and management continues to prioritize consumer businesses.

On the negative side, the company continues to hang on to some lackluster, lagging enterprises that aren't really living up to their potential, but senior management has at least shown a willingness to shake up company-level management at some of the laggards.

CODI has generated an annualized total return of around 18% over the last three years, and that's not bad. Moreover, the corporate structure (a partnership) can provide some tax advantages for investors, though creating challenges and complications for others. I would call the valuation "okay" today, but I do have some near-term concerns about deal multiples limiting management's ability to effectively deploy and recycle capital.

 

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Compass Diversified Holdings Chugs Along

Ternium Seeing End-Market Recoveries And Reaping The Benefits Of Higher Steel Prices

The boom goes on in steel prices.

Mexico’s Ternium (NYSE:TX) is not going to see quite the same price leverage as U.S. steelmakers like Nucor (NYSE:NUE) or Steel Dynamics (NASDAQ:STLD), but global prices have also been quite a bit stronger in 2021 so far than initially expected. That’s going to drive robust revenue for most of the year, as well as even better operating leverage and cash flow generation than previously expected.

The biggest risk I see with Ternium today is that high steel prices start destroying demand, just as industrial markets in Mexico, Argentina, and other South American markets start to recover. There is also some uncertainty on capex/capital allocation beyond this year, with management clearly interested in growing the business to capture expanded opportunities. Even with that factored in, though, the shares continue to look undervalued.

 

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Ternium Seeing End-Market Recoveries And Reaping The Benefits Of Higher Steel Prices

The Market's Love Affair With Atlas Copco Risks Lower Long-Term Returns

I’m often asked what I think is the best company or stock in a given industry or sector – Atlas Copco (OTCPK:ATLKY) is definitely one of the best companies I follow, irrespective of sector or industry. Double-digit trailing FCF growth, mid-teens FCF margins, strong share in multiple markets, and a disciplined management team all play into that, and the double-digit long-term total return has likewise been quite good.

Still, for all of the positives I see at Atlas, including good leverage to the global industrial recovery and ongoing investment in semiconductor capex, the valuation is just too high. I see Atlas as among the lowest long-term return prospects among the industrials I cover, and lest you think I’m overly conservative on modeling, I’d note that my 2023 revenue number is more than 10% above the sell-side average (likewise for FCF).

I’ve learned to not underestimate how far the market can run with a name it likes, but it’s tough for me to envision the combination of growth and further re-rating it will take for Atlas to keep generating double-digit returns for investors.

 

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The Market's Love Affair With Atlas Copco Risks Lower Long-Term Returns

Manitex Past The Worst And Now Leveraged To Equipment Recovery

Heavy equipment stocks have been doing pretty well since the election, and Manitex (MNTX) has gone along for the ride. Up about 75% since my last article, Manitex’s performance slots in pretty well between a handful of better-performing names like CNH (CNHI) and Deere (DE) and worse-performing names like Caterpillar (CAT), Oshkosh (OSK), and Palfinger (OTCPK:PLFRY), while more or less matching Manitou.

I do expect a healthy recovery in 2021 despite a lackluster non-resi construction environment, as fleet operators (including rental companies) emerge from their own capex lockdowns to refresh their fleets. Beyond that, a meaningful infrastructure bill could provide a bigger boost to demand later in 2021 and into 2022, and Manitex still has the company-specific driver of leveraging its knuckle-boom crane business (PM Group) and driving more sales of this under-penetrated (in the U.S.) equipment category.

After the big move in the shares, I would say the stock is more fairly-valued now than definitively cheap, and outsized upside is now tied more to an even stronger/longer recovery cycle and better success driving growth in knuckle-boom cranes – both of which are plausible.

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Manitex Past The Worst And Now Leveraged To Equipment Recovery

IPG Photonics Getting A Little Too Much Love Now

Fiber laser leader IPG Photonics (NASDAQ:IPGP) has quite a track record - not many companies manage a decade-plus of double-digit revenue growth, nor consistent mid-teens-or-better FCF margins, to say nothing of strong returns on capital and assets during more normal business conditions. On top of that, internal diode development and sourcing capability has long been a key competitive advantage for the company, allowing it to set the pace for innovation while maintaining very good margins.

In the near term, it gets better. IPG's revenue has long been driven by industrial capex cycles, and I believe we're in the early stages of a strong capex upswing - one that could be extended further if there is meaningful reshoring (or even just near-shoring) of manufacturing capacity. Opportunities in EVs, solar, and additive manufacturing only add to the longer-term potential.

The "but" is valuation. I don't believe IPG Photonics should trade like an industrial growth stock (where valuation is barely a concern). I'm likewise concerned that the Street is a little too blasé about the risk of meaningful price/margin pressure from its largest rival in China. While I do think that IPG merits a premium and offers good leverage to industrial capex growth, I think the current share price reflects that and doesn't leave an especially exciting, long-term expected return for investors.

 

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IPG Photonics Getting A Little Too Much Love Now

Columbus McKinnon Doing The Heavy Lifting To Build Long-Term Shareholder Value

Moving things around a factory, plant, or mill may not be the sexiest business out there, but it’s pretty essential and as companies continue to turn to automation, material handling is going to become increasingly important. On top of that, Columbus McKinnon (CMCO) has shown that it can execute on margin-improvement initiatives, portfolio restructuring, and product R&D, as well as value-added R&D.

That’s the elevator pitch for Columbus McKinnon, and these shares have done well since I last identified them as an underrated industrial back in August of 2020. While the 50% or so move in the stock since then (almost 20% better than the broader industrial sector) as soaked up a lot of the undervaluation I saw, I do still see better long-term return potential here than for the average industrial, and I think Columbus McKinnon is on a credible path to above-average underlying performance.

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Columbus McKinnon Doing The Heavy Lifting To Build Long-Term Shareholder Value

Komatsu Emerging From The Downturn With Upside If Mining Companies Start Spending Again

With some improvement in its core construction and mining markets, Komatsu (OTCPK:KMTUY) has done pretty well since my last update – outperforming underground mining equipment specialist Epiroc (OTCPK:EPOKY) and mining capex provider Weir (OTCPK:WEGRY), but not keeping pace with Caterpillar (CAT), CNH (CNHI), or Deere (DE) over that time.

I do like Komatsu’s commitment to areas like automation and electrification, but I also believe the company has been too slow dealing with challenges to its Indonesian coal mining and Chinese excavator businesses. An infrastructure stimulus bill in the U.S. and strong global commodity prices could extend this recovery, particularly given over-aged mining equipment fleets around the world, but I look at this as more of a trade now than a fundamental recovery story.

 

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Komatsu Emerging From The Downturn With Upside If Mining Companies Start Spending Again

E-Commerce, Software, And A General Spending Rebound Can Drive Global Payments

It’s an interesting coincidence to me that two of the largest players in U.S. merchant acquiring, Fidelity National Information (NYSE:FIS) and Global Payments (NYSE:GPN), seem pretty close today in terms of valuation relative to my estimated fair values. While I talked about the prospects for FIS about two weeks ago, today I focus on Global Payments.

In addition to ongoing synergies from the TSYS deal, Global Payments has good leverage to the ongoing growth of e-commerce, particularly in the smaller-business vertical, as well as opportunities to leverage its growing suite of proprietary cloud-based software offerings to drive share growth and share-of-wallet. Moreover, with more and more banks trying to drive card revenue, the Issuer Solutions business is looking at a good addressable market opportunity as well.

Global Payments is not all that cheap on a discounted cash flow basis, and that has been true for most merchant acquirers for most of the last decade. I wasn’t overly excited about the valuation when I last wrote about the stock, and while the shares are up more than a third since then, they’ve basically tracked the S&P 500 over that time. Still, I do see the potential of a mid-to-high single-digit long-term total return there, and a margin/return-based EV/EBITDA model suggests near-term potential in the double-digits.

 

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E-Commerce, Software, And A General Spending Rebound Can Drive Global Payments

Middleby Has Rocketed Higher On A Much-Improved Foodservice Outlook

Never underestimate the upside potential for a proven growth story with strong fundamentals.

I’ve had my issues with Middleby’s (MIDD) valuation over the years, as well as the company’s reliance on M&A to fuel growth, but the reality is that we’re talking about a company that has generated almost 13% revenue growth over the past decade (from the not-so-tiny starting point of over $850 million) and consistently generates double-digit FCF margins – something not all that many industrials manage to do. On top of that, not only has the foodservice industry held up better than expected during the pandemic, the government has really stepped up in terms of financial support.

All of that has fueled a remarkable 270% trough-to-peak run in the shares. I can’t say that I see Middleby as undervalued now, but that hasn’t held back the shares in years past.

 

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Middleby Has Rocketed Higher On A Much-Improved Foodservice Outlook

Aptose Provides An Encouraging Update, But The Road Ahead Is Still Long

Now that’s more like it – after a clinical update at December’s American Society of Hematology (or ASH) meeting that offered more worries than encouragement (at least for the market), Aptose Biosciences (APTO) provided a clinical update with fourth quarter earnings that offered more encouragement on the safety and efficacy of the lead drug luxeptinib (formerly known as CG-806).

This remains a challenging and frustrating time to own Aptose shares, but also a time with significant potential ahead. While I do believe there is strong preclinical evidence of the potential of luxeptinib, proving out that potential in the clinic takes time and investors are left to sift through the dribs and drabs of information presented along the way. I do believe that the European Hematology Association meeting (or EHA) in June is probably too soon to see more definitive evidence of efficacy (or lack thereof), but investors should have a good idea of where luxeptinib stands before year-end with the 2021 ASH meeting.

I’m sticking with a $7/share fair value for now, but I want to emphasize again that this is based on pretty harsh odds of clinical success. Most Phase I drugs fail, and particularly in oncology, but if future updates provide better grounds for higher odds of success, there is still significant value to come.

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Aptose Provides An Encouraging Update, But The Road Ahead Is Still Long

Share Growth, Demand Growth, And Technology Opportunities Driving XPO Logistics

Between strong growth in e-commerce and outsourced logistics, share growth in multiple parts of the business, and ongoing efficiency improvements from tech investments, things are pretty much going XPO Logistics’ (XPO) way this day. Moreover, with ongoing share growth and efficiency gains still possible, I don’t think the operational improvement story is necessarily over.

It’s been a little while since I updated my thoughts on XPO, and since my last update, the shares have moved to the high end of the $100 to $120/share value range I saw then, modestly outperforming the S&P, while underperforming Old Dominion (ODFL) and J.B. Hunt (JBHT). Given the trends driving improved operating results (both internal and external), I think there could still be double-digit upside from here, and the spin-off of the logistics business could perhaps unlock more upside, as XPO shares do continue to trade below most sell-side sum-of-the-parts estimates.

 

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Share Growth, Demand Growth, And Technology Opportunities Driving XPO Logistics

POSCO Seeing A Broad Demand Recovery With Strong Price And Margin Leverage

The U.S. is in a class by itself where steel price momentum is concerned, but that doesn’t mean that operating conditions haven’t improved materially for South Korea’s POSCO (PKX) as well. With improving demand from a range of end-markets, including autos, appliances, construction, and machinery, prices have quite strong in Korea, putting POSCO in a stronger position to leverage the ongoing global recovery.

POSCO shares have done okay relative to global peers like Nucor (NUE) and Steel Dynamics (STLD) since my last update, keeping pace with a nearly 65% share price move, though ArcelorMittal (MT), Cleveland-Cliffs (CLF), U.S. Steel (X), and Ternium (TX) have done even better.

POSCO isn’t exactly cheap now on a long-term basis, but I wouldn’t expect that in a period of strong price recovery. Still, I see double-digit appreciation potential on the basis of near-term EBITDA and ROE prospects. I’d also note that while POSCO’s non-steel operations have often historically been a drag on the company, the prospects for businesses like POSCO Chemical are quite good.

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POSCO Seeing A Broad Demand Recovery With Strong Price And Margin Leverage

Improving Stainless Demand And Bottoming Markets Encouraging For Universal Stainless & Alloy Products

This pandemic-driven downturn has been a brutal one for Universal Stainless & Alloy Products (USAP), and while commodity stainless steel markets have turned up on improving demand from end-markets like autos and appliances, it’s going to take a little longer for markets like aerospace and oil/gas to sort themselves out and drive USAP’s recovery.

When I last wrote about USAP, I thought the shares were undervalued below $8 to $9. Since then, the shares have risen about 25% to a little over $9, as 2020 revenue and EBITDA came in a little lower than I’d expected, FCF outperformed on a greater net working capital release, and commodity markets have rebounded sharply.

I do expect meaningful recovery growth from USAP starting late in 2021 and continuing on through 2024 on recovering aerospace and oil/gas, as well as increased premium offerings in a range of smaller markets including “general industry” categories like medical and semiconductor. With that recovery, I think the near-term fair value improves to $10-12/share, and I do see a possibility of the stock overshooting as the recovery becomes evident.

Still, I would remind investors that this is a stock that should be bought to be sold – holding over a full cycle is painful, and despite three major runs over the last 20 years (2007, 2011-12, and 2018), the annualized return over those 20 years is just 1%.

 

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Improving Stainless Demand And Bottoming Markets Encouraging For Universal Stainless & Alloy Products

Calyxt Using A More Conventional Model To Pursue Significant New Agri-Bio Market Opportunities

What do you do when a publicly-traded company continues to pursue a business strategy you don't agree with? If you're me (and I am…), you step aside. There are just too many options out there to just settle for a model you don't like and hope it works out.

That brings me to Calyxt (CLXT). While I did see some potential in the company's former commercial model - one that involved using TALEN gene-editing technology to develop crop seeds with desirable traits, but then attempt to directly commercialize consumer-oriented products - I fundamentally disagreed with it. Since then, the company has shifted to a seed/trait licensing model more in line with what Bayer (OTCPK:BAYRY) and Corteva (CTVA) and other agri-biotechs use, and this is a model I'm comfortable with.

Calyxt is still a risky, speculative play. While TALEN gene-editing technology does have some advantages in the lab (faster development, etc.), there is still both developmental risk and commercial acceptance risk. Still, I like the market opportunities that Calyxt is targeting and I think this is a speculative play well worth considering.

 

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Calyxt Using A More Conventional Model To Pursue Significant New Agri-Bio Market Opportunities

Fly Leasing Still Offers Upside On Air Travel Demand Recovery

Not all undervalued stocks are the same, and determining how much of a stock’s apparent undervaluation is due to sentiment, temporary headwinds, and longer-term structural/competitive issues are a big part of generating above-average long-term investment returns.

That brings me to Fly Leasing (NYSE:FLY), an aircraft leasing company that combines all of the above issues into one somewhat challenging situation to evaluate.

I do absolutely believe there is a “cheap for a reason” aspect to Fly Leasing, including a lower-quality customer base (reflected in weaker rent collection), less capital flexibility, a less advantageous corporate structure, and more limited growth options. On the other hand, I do also see a great deal of skepticism built into the share price ahead of what should be an emerging recovery in domestic/short-haul flights.

I don’t exactly like Fly Leasing, and I remain content to own AerCap (NYSE:AER) in my own portfolio, but I do believe that FLY should trade closer to the mid-teens than the low teens, and as vaccinations progress around the world and air travel recovers (starting later in 2021 and into 2022), I do believe the numbers and sentiment will improve.

 

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Fly Leasing Still Offers Upside On Air Travel Demand Recovery

Microchip Technology Trying To Manage Unprecedented Near-Term Demand Ahead Of Attractive Long-Term Growth Opportunities

These are crazy days in the chip space, with semiconductor companies struggling to secure the wafer, assembly, and test capacity they need and strong demand pushing lead times to new peaks. Supply constraints are likely to lead to a longer period of sustained high lead times than past cycles, but achieving a graceful dismount will be an industry-wide challenge.

Luckily, in the case of Microchip (MCHP) at least, there are strong underlying end-market drivers that can help patch over some of the likely oncoming volatility.

Microchip wasn't a favored name of mine when I last wrote about the stock in August, though "only" matching the SOX was still good for a nearly 40% move in the stock. As for the stocks I liked better, Lattice (LSCC), ON Semiconductor (ON), and Renesas (OTCPK:RNECY) have outperformed, Broadcom (NASDAQ:AVGO) has basically matched Microchip, and STMicroelectronics (STM) has underperformed.

Looking out at the sector now, valuations are stretched and it's hard for me to see how multiples rerate higher, particularly with revenue outperformance like constrained by supply/capacity issues. At best, I can see the order/lead-time situation leading to an extended peak, but the multiples across the space today are tough to embrace.

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Microchip Technology Trying To Manage Unprecedented Near-Term Demand Ahead Of Attractive Long-Term Growth Opportunities

Cummins: New Engine Opportunities And Clean Energy Can Patch Over Cyclical Risk

When I last wrote on Cummins (CMI) I said that I saw decent long-term appreciation potential, but that I was concerned that the truck cycle and industrials in general had overshot some. In the intervening months the industrial space had another “here, hold my beer” run and these shares are up another 20% or so – in line with industrials in general, and better than PACCAR (PCAR), but well short of agriculture and construction-leveraged names like Caterpillar (CAT), CNH (CNHI), and Deere (DE).

A potentially peaking North American truck market is definitely a concern, but I believe recent outsourcing wins give investors some positive drivers to look forward to in a few years. I likewise believe Cummins’s strong leverage to green hydrogen is a powerful sentiment offset to any cyclical risk, though what momentum investors giveth, they will eventually taketh away.

As is, I still like Cummins about as much as I like other high-quality industrials like Dover (DOV), Parker-Hannifin (PH), or Rockwell (ROK), though I am sympathetic to the argument that Cummins’s greater cyclicality should come with some “bonus” in terms of expected return.

 

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Cummins: New Engine Opportunities And Clean Energy Can Patch Over Cyclical Risk

 

It may seem like a bizarre observation in the context of 14% year-over-year revenue growth and 63% booking growth in the last quarter, but Broadcom (AVGO) really isn’t that well-suited to this bullish growth cycle in chip stocks. Broadcom management certainly cares about and nurtures growth opportunities, but this name was among the first chip companies to really appreciate that margins drive long-term value, and that margin focus usually serves Broadcom better in periods of weaker sentiment.

Be that as it may, Broadcom is looking at major growth opportunities in 2021, including the next generation of Apple (AAPL) 5G iPhones, 400G networking with data center customers (including hyperscale customers), custom ASIC with AI and wireless infrastructure opportunities, and a Wi-Fi 6 upgrade cycle. With those drivers in place, Broadcom could generate a mid-teens near-term return and high single-digit long-term annualized returns.

 

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Broadcom: Abundant Growth And Margin Opportunities Could Push Shares Higher

 

Roche Continues To See Mixed Results, At Best, From The Clinic

 

Roche (OTCQX:RHHBY) (OTCQX:RHHBF) doesn’t have to deal with network TV executives, but investors can nevertheless be forgiven if recent clinical failures collectively feel more than a little like being nibbled to death by ducks.

As I’ve said many many times in the past, failure is part and parcel of drug development, and Roche isn’t exempt just because it’s big. Likewise, Roche has taken some pretty big swings at notoriously difficult diseases, and I frankly commend them for doing so when we’ve seen many other drug company CEOs go the route of lackluster and instead try to grow through cost-focused M&A and/or outsized price increases.

Still, the situation is what it is and Roche could use some wins. Biosimilars are still biting hard into the business and the pharmaceutical business is one where patent expiry is always a threat – whether that’s today or down the road a few years. Low-to-mid single-digit growth can still support a worthwhile fair value and expected return from here, but sentiment could really use a boost.

 

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Roche Continues To See Mixed Results, At Best, From The Clinic

nVent Prioritizing Better Opportunities As Electrification Demand Is About To Accelerate

 

As recovery plays go, I can't complain too much about the performance of nVent (NVT) since my last update. I liked the company for its leverage to a short-cycle industrial recovery in 2021, and that thesis is still very much in play. On top of that, though nVent isn't the best way to play widespread electrification, it does still have leverage there and I see additional self-improvement potential.

These shares are up more than 40% since my last update, handily outperforming not only the S&P 500 and the broader industrial space, but other electrification names like ABB (ABB), Eaton (ETN), and Schneider (OTCPK:SBGSY) as well, and almost performing industrial growth story Itron (ITRI) as well.

Although I do worry that nVent's less impressive growth and margin profile will factor more into future performance, I do still the shares as undervalued enough to be worth consideration.

 

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nVent Prioritizing Better Opportunities As Electrification Demand Is About To Accelerate

Rinse-And-Repeat Is Fine For Brookfield Infrastructure Partners

 

Not messing with a good thing is a surprisingly hard thing for many corporate managers to do, but Brookfield Infrastructure Partners L.P. (NYSE:BIP) has continued to execute on a disciplined program of buying assets in target end-markets (particularly regulated utilities, rail, midstream, and datacomm), operating them well, and then selling the assets and recycling the capital when the right opportunities present themselves.

With that, these units have generated an annualized return over 23% (with reinvested distributions) since my last update, beating the S&P 500, and a 10-year annualized return (again with reinvested distributions) of over 20%. Strip out the reinvestment part of the calculation and you’re still talking about a 17% annualized total return over the past decade, not to mention the potential benefits to some investors from the partnership structure.

Given how low rates have pumped up most assets and asset classes, I’m honestly surprised that BIP trades at a yield close to 4% and below my fair value estimate (with an underlying assumption of around 7% to 8% long-term free cash flow growth). While these units are not appropriate for everyone, and some investors should consider Brookfield Infrastructure Corporation (NYSE:BIPC) instead, I do still like BIP as a long-term holding.

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Rinse-And-Repeat Is Fine For Brookfield Infrastructure Partners

Hollysys Offering Automation Potential And A Boardroom Soap Opera

 

In a relatively short period of time, Hollysys (HOLI) has transitioned from an erratic and enigmatic play on Chinese industrial and rail automation to a rancorous soap opera worthy of a telenovela. Whether any of this benefits shareholders remains to be seen, as the proposed buyout is still short of what this company could be worth with more consistent execution.

Hollysys has been gaining share in the Chinese process automation market and has at least a credible chance of organically growing/expanding into the discrete automation market as well. The rail business is a harder call, but is at least still in the game. Whether there will be steady management and improved transparency, such that institutional interest improves remains to be seen. There is significant potential undervaluation here, but whether or not the stock can ever fulfill that potential is still very much in doubt.

I also want to note that while I have spelled Hollysys as “HollySys” in the past, I have changed to confirm to the format used in recent company communications.

 

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Hollysys Offering Automation Potential And A Boardroom Soap Opera

Harsco's Recovery Is Delayed, Not Canceled

My bullish thesis on Harsco (HSC) in August of 2020 was basically a macro-econ call – as the global economy got back underway, steel utilization would pick up (driving demand in Environmental), hazardous waste streams would recover (driving Clean Earth), and deferred transit rail maintenance would eventually get done.

That all worked pretty well up until the fourth quarter earnings report, as the shares were actually outperforming Parker-Hannifin (PH) and Kennametal (KMT) since my last update. Now, these are very different companies, but they tend to do well as early-cycle recovery plays, so that’s why I mention them. After earnings, though, and management’s weak guide for ’21, the stock got beaten down and the return since my last article has more or less tracked the broader industrial space – not bad (up 28%), and definitely better than the S&P 500 (up 13%), but not quite what I hoped to see.

I believe this story can still provide some delayed gratification, and I think the long-term potential of the Environmental and Clean Earth businesses is attractive. I think Rail would be better in somebody else’s hands, but I would expect management to hold on until better performance can support a better sale multiple.

 

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Harsco's Recovery Is Delayed, Not Canceled

Marvell's Growth Transformation Well-Reflected In The Valuation

 

I like a lot of what Marvell (MRVL) management has been doing, including the acquisition of Inphi (IPHI) and the company’s push into custom silicon for data center/hyperscale customers. Supply constraints and uncertain timing on 5G base station deployments are headwinds, but at least relatively well-understood ones at this point.

What I haven’t liked so much has been the valuation, as the semiconductor sector has been hot on strong demand growth across multiple end-markets. Marvell provided a blink-and-you-missed-it dip around earnings, but has since filled that gap. Still, while the shares are up a strong 30% since my last update, that’s actually lagging performance relative to the SOX, as well as Broadcom (AVGO), one of Marvell’s largest competitors.

I know growth investors are fully in the driver’s seat now, and I do like the growth opportunities across Marvell’s business, including base station silicon, data center silicon, and auto Ethernet. I just don’t like the extent to which all of the good news is already in the share price. Moreover, I’d note that buying into peaking lead times for chip stocks doesn’t usually end well – it doesn’t preview a crash, but it does suggest there will be another chance to buy in at better valuations.

 

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Marvell's Growth Transformation Well-Reflected In The Valuation

Chart Industries: From Cleaner Energy Upside To A Cleaner Energy Story In 6 Months

For quite a while my thesis on Chart Industries (GTLS) has been that it's a really good industrial gas infrastructure company with meaningful operational upside from cleaner energy opportunities like LNG and green hydrogen.

That perception has definitely shifted in the last six months, with the company aggressively pursuing opportunities in green hydrogen and carbon capture, as well as emerging industrial growth opportunities and ongoing LNG opportunities. With Chart Industries now seen as a clean energy play (or "cleaner" at least), the shares have more than doubled since my last update and now trade like an industrial growth stock.

Valuation here is challenging, just as it is in other industrial growth areas like automation - the operational upside is certainly there, but a lot of growth is already baked into the share price. I do still see okay long-term upside potential, but I would caution investors that volatility is likely to remain high given energy tech's growth darling status at the moment.

 

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Chart Industries: From Cleaner Energy Upside To A Cleaner Energy Story In 6 Months

Innospec - Recovery Leverage And M&A Capacity

 

With highway traffic still down meaningfully in the first quarter and oil/gas production activity likewise well off prior norms, it's not exactly business as usual for Innospec (IOSP), but the arrow is definitely pointing up.

As lockdown restrictions ease across the world and economic activity gets back to normal, I expect to see meaningful rebounds in the Fuel Specialties and Oilfield Chemicals businesses of Innospec. Meanwhile, the Performance Chemicals business never saw the same volume pressure, which makes sense given its leverage to personal care products like shampoos and laundry detergent.

Given Innospec's strong balance sheet, I fully expect management's attention to turn toward M&A in 2021, and I believe agriculture and mining may be areas of particular focus. The possibility of such M&A does create some modeling challenges, but with the rebound in the shares since my last update, I believe these shares are priced more as an attractive hold than a materially undervalued opportunity.

 

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Innospec - Recovery Leverage And M&A Capacity

PAX Global Remains Well-Leveraged To Double-Digit Growth In Cashless Transactions

Credit where it’s due – PAX Global Technology (OTCPK:PXGYF) (327.HK) management has done a very good job over the past couple of years in pivoting the business toward better growth opportunities in merchant point-of-sale (or POS) terminals, particularly its Android terminals, and deemphasizing markets like China where competition is just too fierce to make attractive returns. Moreover, some of the company’s fiercest competitors, including Verifone and Ingenico have chosen to deemphasize hardware in many of the markets PAX targets.

With that, these shares have appreciated more than 100% since the time of my last article, handily beating its comp group, though not keeping pace with Square (SQ) or PayPal (PYPL) over that time period.

There are plenty of issues for investors to consider before investing in PAX Global. Management’s disclosures have gotten better, but investors expecting transparency on par with U.S.-listed companies are likely to be disappointed. What’s more, while these shares have decent liquidity, investors may find the Hong Kong-listed shares more attractive.

I do continue to see an elevated risk profile here, but with mid-single-digit revenue growth and a double-digit discount rate still supporting a double-digit long-term total annualized expected return, it’s hard not to still lean favorably toward these shares.

 

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PAX Global Remains Well-Leveraged To Double-Digit Growth In Cashless Transactions

TipRanks: Ciena: An Undervalued Play On Near-Term Recovery And Long-Term Growth Potential

It has been a rough period for optical suppliers, as reduced spending from telco service providers like AT&T (T) and Verizon (VZ) has led to weaker demand for Ciena (CIEN), as well as peers and rivals like Cisco (CSCO), Infinera (INFN), and Juniper (JNPR).

That said, Ciena has likely seen the worst of this cyclical slowdown, as book-to-bill has climbed back above 1.0 and orders should translate to stronger revenue in the second half of the year. Beyond the near-term recovery, there are also opportunities for Ciena to displace Huawei with European and Asian customers and gain market share in new metro/edge applications.

Bearing this in mind, Ciena should trade closer to $62 today, with longer-term annual return potential in the high single-digits to low double-digits as the company executes on market expansion opportunities.

 

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Ciena: An Undervalued Play On Near-Term Recovery And Long-Term Growth Potential

 

Copa Still Has More Upside To Offer Even On A Slower Recovery Path

Nothing has really gone easy for the airline industry in this pandemic, including a recent resurgence in COVID-19 cases that has led many governments to reinstitute strict (or at least stricter) travel restrictions. That's not going to make life any easier for Copa Holdings (CPA), as it tries to balance capacity, costs, and cash burn across its Latin American footprint, but it doesn't also change my long-term view all that much.

Copa shares have appreciated almost 80% since my last update, but I still think there's more left in these shares as travel demand recovers, Copa simplifies its fleet, and continues to leverage long-term growth through its very valuable Panama-centered hub-and-spoke system. With long-term adjusted revenue growth (adjusted to a pre-pandemic starting point) of 4% and low-double-digit FCF margins (actually a contraction from the trailing decade), I still see double-digit annualized total return potential today.

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Copa Still Has More Upside To Offer Even On A Slower Recovery Path

Kirby's Business Needs A Little More Time, But The Stock Has Recovered

Conditions in the refining and chemical industries aren't fully back to normal, but they're trending back in that direction, with the ongoing economic recovery driving higher prices and improving capacity utilization. It's not "business as usual" again yet for Kirby (KEX), but the worst of the downturn is well behind the company and the second half of 2021 should see a more meaningful recovery.

As is usually the case, the share price has moved ahead of the reported numbers, with the shares up about 65% since my last article despite a couple more soft quarters. At this point, Kirby valuation hasn't fully gone back to pre-pandemic norms, but I expect that as soon as the company returns to beat-and-raise quarters, the sell-side will find reasons to stretch out the multiples to support higher price targets.

 

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Kirby's Business Needs A Little More Time, But The Stock Has Recovered

Grupo Aeroportuario Del Centro Norte Has Performed Well On Recovery Prospects

While the pandemic continues to seriously and severely impact air travel, Grupo Aeroportuario del Centro Norte (NASDAQ:OMAB) ("OMA") has done quite well, rising another 50% since my last article. While traffic has remained quite weak, the company's Master Development Plan with the Mexican government came out much better than I'd expected, and management has done a very good job managing costs during the downturn.

The strong performance has tempered my enthusiasm for the shares. I still see a high-single-digit long-term annualized potential return from here, but I typically target double-digit returns from my emerging market investments. It's a quibble, I'll grant, and I wouldn't be in a rush to sell, but I think the obvious undervaluation has been soaked up.

 

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Grupo Aeroportuario Del Centro Norte Has Performed Well On Recovery Prospects

SFL Still Generating Free Cash Flow, But Management Needs To Rebuild Investor Confidence

SFL Corporation (SFL) has long been one of those “yeah, it’s okay … I guess” stocks for me. I have never been all that impressed with management, and ship leasing is a tough business, but the dividend yield had been pretty solid and investing in ship leasing is a viable alternative to trying to pick winners in the even more challenging shipping sector.

Still, the results are what they are. With these shares recent having hit a decade-plus bottom in January (from which they’ve bounced 40% already), the 10-year annualized return with reinvested dividends is just 1.8%, while the five-year annualized return is 0.3%. I would also note that 2020 makes for the fourth straight year where dividends were flat or down (down in 2017, 2018, and 2020), and the current $0.60/share payout is one-third of the 2016 payout on a broadly similar revenue base.

I get that successful investing requires an investor to be fearful when others are confident and bold when others are fearful. To that end, the shares do look undervalued on cash flow even with minimal revenue growth, though the unpredictable pattern of capex to build the fleet is a key issue, and I believe there is room to both improve the payout and reduce debt further (and/or make fleet additions). Still, even with potentially outsized upside potential, I struggle to buy/own shares in companies where I just don’t have that much confidence in management’s ability to generate attractive long-term economic returns.

 

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SFL Still Generating Free Cash Flow, But Management Needs To Rebuild Investor Confidence

Chubb Throws A Stag Party For Hartford Financial Services

Writing about Chubb (NYSE:CB) earlier this week, I said that I thought it was pretty likely that Chubb was going to turn to M&A to build the business further, with exposure to small-/medium-sized commercial clients being a prime target. Three days later, Chubb announced an unsolicited bid for Hartford Financial Services (HIG) ("Hartford").

Although initial reaction to the bid hasn't been universally positive for Chubb, I don't think it's a bad deal. In fact, I see it as a highly accretive deal, and I think Hartford will try to negotiate a higher price and see that a bit more of that accretion is "shared" with Hartford shareholders. The market would seem to think so too, as Hartford shares already trade above the proposed deal price.

I do think that Hartford is a good target for Chubb and I do think that Chubb can afford to pay more and still achieve worthwhile synergies. How far investors want to push their luck, and whether investing today in pursuit of a higher price makes sense, is up to them, but I would note that I would have previously said that $65 was a good fair value for Hartford on a standalone basis.

 

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Chubb Throws A Stag Party For Hartford Financial Services

If Everest Re Can Ease Investor Doubts About Reserves, These Shares Should Do Well

The performance of Everest Re (RE) over the last few years has been interesting to follow. While this generally well-regarded insurer has generated double-digit compound book value growth since the mid-90s and through-cycle ROEs of 10%, the shares have lagged peers like Arch Capital (ACGL), Chubb (CB), RenRe (RNR), and W.R. Berkley (WRB) over that time.

I think some of this underperformance is due simply to Everest's greater exposure to reinsurance - a business that has seen significant capital inflows push down returns, even as Everest has shifted away from property reinsurance and toward casualty/specialty. I also think, though, that there are lingering concerns about the reserves, as Everest was an aggressive underwriter of primary insurance during a soft market, and many other insurers have had to take action to shore up those reserves.

Management adjusted its reinsurance reserves in the fourth quarter, but didn't meaningfully touch the insurance reserves, and I think at least some investors are going to hold off a bit longer waiting for the other shoe to drop. I do think that Everest Re is undervalued on a long-term core earnings growth rate around 5%, but investor sentiment/confidence is a big deal with insurers, so it may take a more concerted effort from management to convince the Street that the back book is solid.

 

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If Everest Re Can Ease Investor Doubts About Reserves, These Shares Should Do Well

With Outsized Business Uncertainty, The Market Still Basically Hates ams AG Right Now

Given the messy and dilutive deal for Osram (OTCPK:OSAGF), a deal with questionable long-term synergies, and ongoing concerns that it will lose its high-profile front-facing 3D sensing slot with Apple (AAPL), I wasn’t fond of ams AG (OTCPK:AMSSY) back in September. That was in spite of a valuation that I thought was quite low in many respects. About six months later, while the shares have risen since that last article (about 10%), they’ve continued to underperform – lagging the S&P 500 (up about 18%), the SOX index (up more than 40%), and other notable Apple supplies like Cirrus (CRUS) and Qorvo (QRVO) (up around 37% and 46%, respectively). Making matters worse, not only have semiconductor stocks been hot, so too have auto suppliers (with Osram generating significant revenue from the auto-end market).

These shares continue to look undervalued, even factoring in what I believe are relatively conservative assumptions. Still, with the Apple worries hanging over the shares, I don’t see outperformance as particularly likely until later in the year when there should be clarity on the issue.

 

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With Outsized Business Uncertainty, The Market Still Basically Hates ams AG Right Now