Wells Fargo Offers Near-Term Rate Leverage And Long-Term Turnaround Potential

 

I’ve been bullish on Wells Fargo (NYSE:WFC) for a while – less on the basis of thinking it’s great and more on the basis of thinking “it’s not that bad” – and over the last six months this call has finally started to work. A shift toward “risk on” banks leveraged to the post-pandemic recovery has certainly helped, particularly with Wells Fargo’s well-above-average asset sensitivity, as has some increased confidence on management’s restructuring/turnaround plan and progress toward resolving the asset cap that has constrained the business for some time.

As one of the three banks in the U.S. with double-digit deposit share, Wells Fargo has a real chance of becoming one of the long-term winners as smaller “run of the mill” regional and community banks are squeezed out over time. Moreover, a streamlined bank more focused on higher-return opportunities in consumer and commercial banking has a better chance of recovering to mid-teens returns on tangible common equity over the next three to five years.

Given where things stand today, the investment argument for Wells Fargo is more complicated. I think investors who want an underappreciated story could do better with Citigroup (NYSE:C) or Truist (NYSE:TFC) among the larger banks now, and I think JPMorgan (NYSE:JPM) remains an appealing longer-term hold as well (with Bank of America (NYSE:BAC) moderately less attractive). Still, I do see annualized total return potential still in the high single-digits, which is still above the long-term norms of the sector, and there is still upside potential from the turnaround/restructuring efforts.

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Wells Fargo Offers Near-Term Rate Leverage And Long-Term Turnaround Potential

Lennox Leveraging Incredibly Strong Residential HVAC Demand

 

The HVAC space has stayed pretty hot in 2021 despite robust valuations, as the major players in the U.S. market, excluding Daikin (OTCPK:DKILY) have continued to outperform the broader industrial sector. Although the companies have been relatively careful with guidance and the sell-side continues to fret about a potential slowdown in the residential space, investors seem quite willing to pay rich multiples for growth rates that are admittedly, for now, well above what other sectors are offering.

Since my last update on the company in the fall of 2020, Lennox Intl (LII) shares have underperformed the broader industrial sector and most of its HVAC peers (except Daikin), though they’re still up about 15%. That could make some sense in the context of Lennox’s greater reliance on U.S. residential demand and less leverage to commercial HVAC in general and OUS HVAC in particular.

I still have trouble reconciling the multiples in the HVAC space today, and Lennox is no exception. Although I have pretty bullish growth expectations (relative, at least, to the sell-side), I can’t see a path to better than mid-single-digit long-term annualized returns from here, and that’s not attractive enough for me.

 

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Lennox Leveraging Incredibly Strong Residential HVAC Demand

PNC Financial Still Offers A Lot To Like As It Shifts To Recovery And Growth

 

PNC Financial (PNC) stands out as one of the very few banks I follow that doesn’t generate many complaints – the worst that’s usually ever said about PNC is that management takes a conservative approach and the business isn’t especially flashy. That’s fine with me, though, and few banks have generated better long-term returns than PNC.

With the purchase of BBVA’s (BBVA) U.S. banking assets complete, PNC has a coast-to-coast footprint and a presence in 29 of the 30 largest MSAs. Moreover, it’s a footprint skewed to some attractive growth markets, including the Southeast U.S., and a greater-than-average exposure to corporate lending.

I was bullish on PNC with my last update and the shares have continued to modestly outperform. While today’s price doesn’t offer an eye-popping total annualized return, I still believe PNC will continue to generate above-average returns, and I believe PNC will be a long-term winner in the ongoing consolidation of the U.S. banking sector. At a minimum, I think it’s a good candidate as a core long-term holding.

 

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PNC Financial Still Offers A Lot To Like As It Shifts To Recovery And Growth

Hexcel Has Bounced On Bullish Aerospace And Commodity Sentiment

 

When I last wrote about Hexcel (HXL) in January of this year, I underestimated the potential tailwind the shares could get from a further sentiment shift back toward later-cycle recovery stories (like aerospace) and material plays in an inflationary environment. With that, the shares have risen nearly another 40%, underperforming a few other aero plays like Spirit AeroSystems (SPR) and Universal Stainless (USAP), but outperforming names like Carpenter (CRS), HEICO (HEI), and Woodward (WWD).

At this point I don't think Hexcel shares offer a particularly attractive long-term return, but I fully acknowledge that cyclical stocks overcorrect on both ends of the cycle, and the outlook for the company's commercial aerospace business (especially the wide-body business) should only improve from here.

 

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Hexcel Has Bounced On Bullish Aerospace And Commodity Sentiment

MaxLinear Executing Well, But Growth Opportunities Like Data Center Are Becoming More Crucial To The Bull Case

 

MaxLinear (MXL) has had its operational challenges over the years, but with massive MIMO transceivers going into production, wireless backhaul picking up, and a long-awaited ramp with Amazon (AMZN) for its 400G PAM-4 on the way, better days could be on the way. It’s not as though the stock has been languishing either, with the shares up about 8% since my last update, outperforming the basically flat performance of the SOX since then.

I still don’t love the valuation here, but that’s a sector call/issue more than a MaxLinear-specific issue. I do still worry that Street and investor expectations for the PAM-4 business are too high (and that the company will struggle against Marvell (MRVL) and Broadcom (AVGO)), and the supply constraints that are limiting upside today could persist. I do like the connected home business, though, and ongoing momentum in 5G wireless would be a big help.

All told, I’m pretty lukewarm on MaxLinear. I think stocks like Broadcom (which I own), Renesas (OTCPK:RNECY) and STMicro (STM) offer better valuations, but MaxLinear could surprise on growth (in either direction), and the modeling upside for MaxLinear in a bull scenario is higher. If you feel like taking more risk in the pursuit of growth, this is a name to consider (as would Lattice (LSCC) and Silicon Labs (SLAB)), but it’s likely a tougher sale with the GARP/value crowd.

 

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MaxLinear Executing Well, But Growth Opportunities Like Data Center Are Becoming More Crucial To The Bull Case

Daikin's Reinvestment Plans Have Undermined Near-Term Growth And Sentiment

 

It may take money to make money, but that doesn’t mean that the Street is happy to hear it when company managements choose to reinvest in product R&D and sales channel development. That is precisely what Daikin Industries (OTCPK:DKILY) (6367.T) is doing, as the company aims to take more share in the U.S. market, but the end result is an earnings outlook around 7% to 10% lower than previously expected over the next few years.

Although I thought it was a little pricey (as were/are most HVAC companies), I liked Daikin back in October of 2020 and the shares did outperform peers like Carrier (CARR), Lennox (LII), and Trane (TT) until around mid-February, when the company began talking down numbers. All told, the shares are still up some from that last update, but well short of what its HVAC peers have done over that time.

The valuation looks interesting here on a long-term basis, but the prospect of iffy margin leverage over the next few years isn’t great for sentiment, nor is the likelihood that the company’s efforts to reinvest in the business, continue to pay a dividend, and pursue around $6B of M&A will lead to more leverage. Patient investors should take a look, but softer near-term results are a real risk.

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Daikin's Reinvestment Plans Have Undermined Near-Term Growth And Sentiment

Sika Riding On Its Leverage To Greener Construction

 

Quite likely one of the best-run companies I follow, Sika (OTCPK:SXYAY) (SIKA.SW) shares have “only” kept pace with the broader industrial sector since my last update on the company, as well as keeping pace with BASF (OTCQX:BASFY), while Saint-Gobain (OTCPK:CODYY) has done a fair bit better and RPM (RPM) a fair bit worse. Keep in mind, too, that “only” keeping pace still means that the shares are about 30% higher than they were at that last article.

Sika is already seeing a strong post-pandemic recovery, with particular strength in Asia (NASDAQ:CHINA) offsetting a more sluggish recovery in the U.S.. As the year rolls on, I expect good underlying demand improvement, and I love Sika’s long-term exposure to greener building trends in non-residential and infrastructure, leaving the company well-placed to take advantage of government programs aimed at promoting a greening of those end-markets.

Price/value remains a problematic issue if you’re a more value-oriented investor. I believe Sika could generate organic revenue growth double that of global GDP, with M&A adding in more on top of that, and I likewise see room for more operating leverage. Even with those assumptions in place, though, the valuation is very much in growth stock territory.

 

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Sika Riding On Its Leverage To Greener Construction

Recent Sluggishness In Schneider Electric's Share Price Worth Watching

 

First things first – I’m not an advocate of focusing on short-term stock performance. I am an advocate of opportunism, though, and sometimes short-term wobbles can create windows of opportunity. Such could be the case today with Schneider Electric (OTCPK:SBGSY) – the shares have been a little sluggish since my last update and on a year-to-date basis relative to the wider industrial space and peers like ABB (ABB), Eaton (ETN), and Siemens (OTCPK:SIEGY).

I remain a big believer in both the macro opportunities in front of Schneider (automation, digitalization, electrification, et al) and the company’s ability to leverage those opportunities into above-average revenue growth, margin improvement, and free cash flow. I can’t say that I find the shares a screaming bargain today, but the long-term prospective return is still reasonable and a reasonable return from a good company that I believe has more leverage to outperformance isn’t a bad thing.

 

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Recent Sluggishness In Schneider Electric's Share Price Worth Watching

Hurco Seeing Real Evidence Of The Turn

 

There have been some “fits and starts” to the post-pandemic recovery, including mixed trends on capital spending and manufacturing activity in some sectors, but with fiscal second quarter results in hand, Hurco’s (HURC) recovery seems to be solidly underway, and looking around the industry, I expect “recovery growth” over at least the next few quarters.

Hurco has lagged the broader industrial sector since my last update, but done a little better than my own “peer group” of metalworking-driven companies. The stronger evidence of recovery should be good for the stock from here, and I do believe the shares are undervalued below $40 in the near term (and priced for longer-term annualized returns in the double-digits), but this is an unfollowed, illiquid company, so investors need to understand the risk that this remains overlooked for an extended period of time.

 

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Hurco Seeing Real Evidence Of The Turn

More 'Hurry Up And Wait' For Accuray, But The China Opportunity Is Coming Through

 

It’s been a rough go for Accuray (NASDAQ:ARAY) since my last update on the shares. The combination of a weaker tape for small-cap med-tech and a lackluster fiscal third quarter hasn’t been a good one for the shares, which have lost close to 20% of their value since that last article – despite not much real change in the outlook. I get that Accuray is a frustrating stock to hold, and it has been for some time – investors have been waiting years for the supposed advantages of the CyberKnife system, the improvements to the Tomo platform, and the opportunities in China to deliver, and we’re still not quite there yet.

That said, I do believe the opportunity in China is real, and the technological improvements to Accuray’s systems, as well as a shift toward more hypofractionation in radiation oncology could finally be the right combination to unlock the potential here. I continue to believe that $6 to $7 is a fair price for now, but if the opportunity in China lives up to its potential, a double-digit share price is not hard to imagine.

 

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More 'Hurry Up And Wait' For Accuray, But The China Opportunity Is Coming Through

Citigroup Still Has A Lot Of Work And Potential Gains, Ahead Of It

 

It’s still early days for Jane Fraser’s tenure as the CEO of Citigroup (NYSE:C), but she’s off to a good start with the Street generally liking the news of the company’s plan to exit its non-core global consumer banking businesses. It remains to be seen what the company will do with respect to building up the U.S. operations, including potential M&A, but focusing on businesses with higher prospective returns is definitely the right move.

Citigroup shares have slightly outperformed the larger banking group since my last update, and I continue to think there’s a good argument for owning these shares as a play on a leaner, more profitable bank with strong global corporate finance capabilities and an improving core consumer bank. Low single-digit long-term core growth can still support a double-digit annualized return from here, and I believe this is an interesting risk/reward opportunity for investors willing and able to take more risk.

 

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Citigroup Still Has A Lot Of Work And Potential Gains, Ahead Of It

As COVID-19 Enthusiasm Fades, Abbott Labs Worth Closer Watching

 

I wasn’t all that bullish on Abbott Labs (ABT) back in the summer of 2020, as although I view this as a very high-quality med-tech company, the valuation seemed too rich. Add in my concerns about COVID-19 testing contraction in 2021 and beyond (something I’ve mentioned in reference to Agilent (A), Hologic (HOLX), and Thermo Fisher (TMO) among others more recently), and I didn’t like the set-up for the shares.

Since then, the shares have risen about 12% - less than half the gain of the S&P 500 and about 700bp shy of the larger med-tech group. That’s not quite enough to put Abbott in my “unfairly cheap” bucket just yet, but the prospective long-term return is now closer to the high single-digits and that’s enough to get my interest. Add in M&A optionality, and this is definitely a name to watch, if not consider outright.

 

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As COVID-19 Enthusiasm Fades, Abbott Labs Worth Closer Watching

Broadcom Executing Well, But Still Not Getting Its Due

 

Broadcom (AVGO) has remained a somewhat frustrating stock to own – I say “somewhat”, because while the shares aren’t far from their all-time high (about 5%) and have risen around 60% over the past year, they’ve still continued to lag the broader semiconductor space a little bit. I suspect this is due in part to the fact that management runs the business for long-term margins and growth (as opposed to shorter-term metrics), as well as the slower-growing software assets.

In any case, I continue to believe that Broadcom offers a good mix of quality and value. Broadcom has exceptionally strong businesses in multiple growing markets (including switching/routing, broadband access, custom ASICs, and front-end phone components), and I like the combination of mid-single-digit long-term revenue growth potential and exceptional (high 50%s) non-GAAP operating margins. With those drivers, I believe Broadcom shares should trade closer to the mid-$500s.

 

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Broadcom Executing Well, But Still Not Getting Its Due

JPMorgan Likely To Leverage The Recovery To Earn Even Higher Returns

 

Some companies are good defensive plays, others are good offensive plays. A rare few are both, and I believe that JPMorgan (JPM) qualifies. Strong operating scale and risk management practices mitigated the damage from the pandemic, and the company is now well-positioned to leverage its scale to drive even more share growth in the recovery, leading in turn to greater profit growth and share price appreciation.

I follow a lot of well-run banks, but I believe JPMorgan is still the best of the bunch, and I believe 17.5%-plus ROTCEs are possible on a long-term sustained basis, as well as GDP-plus growth, as the bank is one of the few capable of functioning as a truly national banking franchise in both commercial and retail banking.

As the Street has shifted from a preference for quality to a preference for growth, JPMorgan has lagged some this year, but as a long-term investor, I don’t need my holdings to beat the peer growth every month I hold them. I still see a high single-digit annualized return potential here, and though JPMorgan is not the cheapest bank, I think the combination of quality, value, and long-term opportunity should keep it in serious contention for most investors.

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JPMorgan Likely To Leverage The Recovery To Earn Even Higher Returns