Thursday, March 31, 2022

onsemi Riding High, But The Ride Doesn't Have To End Soon

onsemi (NASDAQ:ON) (formerly "ON Semiconductor") is rising quickly up my list of go-to examples when I say that successful turnarounds can go much further than the market initially thinks. CEO Hassane El-Khoury has quickly established credibility for the company's margin-improvement efforts, including exiting less-efficient fabs and walking away from low-margin business, and it lends more credibility to a long-term growth story built on rapidly-growing demand for advanced power and sensing/imaging chips across a range of auto, industrial, and compute markets.

I've liked onsemi for a while, and I still do even after a 40% run since my last update. Along with Infineon (OTCQX:IFNNY) and STMicro (STM), I expect onsemi to ride strong demand in power and sensing to high single-digit long-term revenue growth, while company-specific drivers lead to substantially higher margins and free cash flow generation. With updated expectations, I think these shares have near-term upside well into the $70's, though I do see more short-term cyclical risk here.

 

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onsemi Riding High, But The Ride Doesn't Have To End Soon

With The First Midwest Merger Done, Old National Bancorp Needs Execute On The Opportunity

Banks undergoing significant mergers are typically put in the penalty box now due to concerns about regulatory delays and real post-deal synergies, but the close of Old National Bancorp’s (NASDAQ:ONB) merger of equals with First Midwest hasn’t really helped much. These shares have continued to lag peers since my last update, with the shares up about 4% against closer to a 10% positive move in the peer group and a similar 4% move in the S&P 500.

I have decidedly mixed feelings on Old National shares at this point. On one hand, the valuation doesn’t seem ambitious or aggressive to me, even in the context of long-term term earnings growth in the neighborhood of 4%. On the other hand, neither of these two banks stand out on customer service or long-term core growth, and the Chicago-era lending market is getting increasingly competitive.

 

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With The First Midwest Merger Done, Old National Bancorp Needs Execute On The Opportunity

Hammered By Supply Issues, Inogen Could Be A 2023 Comeback Story

I was concerned about Inogen's (NASDAQ:INGN) supply chain risk back in August of 2021, but that situation went from bad to worse since, culminating in a roughly one-month suspension of manufacturing. While there have been encouraging developments (including growth in the rental business), supply chain and margin challenges are likely to loom over the company and the stock for the remainder of 2022.

These shares have fallen another 45% since my last update, and they look pretty washed out at this point, with little sell-side support and a pretty undemanding valuation. With ongoing growth opportunities in the rental and international channels, I think this is a name that could come back to life when the supply situation improves (likely 2023), allowing for revenue reacceleration and margin leverage.

 

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Hammered By Supply Issues, Inogen Could Be A 2023 Comeback Story

Employers Holdings Leveraging The Reopening And Expansion Of The Economy

Employment and job growth are looking pretty good for the time being, and while the workers’ compensation insurance market is quite competitive, operating conditions look basically favorable for Employers Holdings (NYSE:EIG) right now. Premiums have been growing nicely, and while I do have some concerns that loss frequency will increase, I think management is generally conservative with underwriting.

The shares haven’t done all that much since my last write-up, and comparisons to other large underwriters like Hartford (HIG) and W. R. Berkley (WRB) are of limited value given very different business mixes, and likewise with Amerisafe (AMSF), which is also a pure workers’ comp underwriter, but focuses on higher-risk groups. I do still see fair value in the mid-$40’s on the basis of both near-term ROE (P/BV) and long-term core earnings growth, but that makes this a relatively middling prospect today.

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Employers Holdings Leveraging The Reopening And Expansion Of The Economy

Lattice Semiconductor Continues To Tear It Up With Strong Execution

Given that the SOX is still down about 10% on a year-to-date basis, maybe it’s time to check in with Lattice Semiconductor (NASDAQ:LSCC) and see if investor nervousness about the semi cycle and peaking lead-times has led to a sustained sell-off in this great growth stock.

Yeah … no.

Although the shares are down about 25% from their November peak, Lattice shares are up another 30% or so since my last update. Fueled by incredibly strong momentum in its core lower-range FPGA business and very good ongoing execution, there’s really nothing to fault here other than the valuation, and even I’m willing to acknowledge that special growth stories fall into their own bucket where “fair value” is concerned.

 

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Lattice Semiconductor Continues To Tear It Up With Strong Execution

Atlas Copco - Always Excellent, Almost Always Expensive

Maybe no other company illustrates the challenges with the idea of "you have to pay for quality" better than Atlas Copco (OTCPK:ATLKY). While the Swedish industrial conglomerate doesn't get quite the same "compounder" fanfare as companies like Fortive (FTV) or Roper (ROP), the company nevertheless has an established track record of above-average margins, ROIC, free cash flow growth, and so on … as well as a 10-year total return (annualized) below that of the S&P 500. I believe a long history of an elevated valuation has contributed to keeping a lid on the share price, though a 10%-plus annualized return over a long period is not exactly "bad".

These shares are down about 7% since my last update, and now there are a lot more concerns in the market about industrials - particularly whether these companies (and stocks) are going to get squeezed between slowing demand (as indicators like the PMI slow) and persistent supply chain pressures. I think Atlas will navigate these challenges well, but the valuation is certainly not in straightforward bargain territory. While this is about as attractive as I've seen the valuation in a while, investors should be alert to the risk of further derating.

 

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Atlas Copco - Always Excellent, Almost Always Expensive

Columbus McKinnon's Transformation Still Not Fully Reflected In The Shares

Change takes time, but Columbus McKinnon (NASDAQ:CMCO) has made it clear that they’re serious about transforming into a higher-value-added provider of automation-enabling machinery and generating stronger margins in the process. Multiple M&A transactions have augmented the company’s product lineup, while the newest iteration of the company’s Blueprint for Growth strategy continues to offer avenues to margin improvement.

When I wrote about Columbus last summer, I said I saw a window of opportunity in the shares. That window has stayed propped open longer than I expected, though the shares have kept pace with the wider industrial sector while slightly underperforming the S&P over that time. With mid-single-digit long-term revenue growth potential, improving margins, and the possibility of double-digit ROIC in FY’23, I still see meaningful potential in these shares today.

 

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Columbus McKinnon's Transformation Still Not Fully Reflected In The Shares

Reliable Execution Has Done A Lot Of Good For MTN Group

Another year has gone by and sentiment around MTN Group (OTCPK:MTNOY) is as good as it has been in quite a while. CEO Ralph Mupita has proven that he and his management team can deliver on a number of value-creating moves without dropping any balls across this pan-African telco provider’s vast business footprint (272M subs). Better still, the company’s relationships with regulators seem to be on better footing, while economies across Africa are benefiting (to varying degrees) from higher export commodity prices and waning burdens from the pandemic.

The good and bad of MTN Group as a stock is that valuation is driven so much more by sentiment around emerging markets (Africa in particular, naturally) than underlying financials. I thought the shares were exceptionally cheap a year ago, but they had been that way for some time. In the last year, though, sentiment has shifted significantly, driving the ADRs up more than 100%.

I continue to view these shares as undervalued and capable of delivering double-digit annualized returns for some time, largely on the back of strong growth in higher-value data and fintech services. This is a harder stock to recommend to casual investors, though, as there are a lot of moving pieces to track and sentiment on emerging markets can swing so wildly.

 

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Reliable Execution Has Done A Lot Of Good For MTN Group

Lundbeck Languishing Without Clear Drivers

Danish drug company H. Lundbeck A/S (OTCPK:HLUYY) ("Lundbeck") hasn't underperformed in terms of core operating earnings since my last update, but the company has seen unsatisfying results for its main growth drivers and the pipeline remains skewed to high-risk late-stage programs and unproven (and high-risk) early-stage compounds. On top of all that, the company is proposing "a heads we win, tails we still win" split share structure that favors its primary shareholder.

I'll discuss the share split later, as it really irritates me. Operationally, I don't see the story as having changed so much from my last update, and a lot is still riding on a normalization of marketing behaviors where the company can get its reps in front of doctors. While I can make the argument that these shares are undervalued, potentially significantly so, a lot is riding on the upcoming read-out of Rexulti in Alzheimer's-associated agitation, as there is little to drive the stock higher in the short term beyond that.

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Lundbeck Languishing Without Clear Drivers

Valeo Hammered On Sector-Wide Operational Challenges And Future EV Fears

The last seven or eight months have been brutal for tier one European auto suppliers. It's bad enough that component shortages have led OEMs to produce less than they'd like, but erratic start/stop schedules have wreaked havoc on supplier operations, and supply and labor challenges have done them no favors either.

The best thing I can probably say about Valeo's (OTCPK:VLEEY) performance since my last update is that a quick glance at Faurecia (OTC:FAURY) and Vitesco (VTSCY) shows that it could have been even worse, though all of these have underperformed American suppliers like Aptiv (APTV) and BorgWarner (BWA).

It's not smooth sailing ahead for Valeo just yet. While the company should be past the worst of the production disruptions, I expect the Street is still going to fret about losses tied to the EV development programs and the risk that EV component insourcing limits the long-term opportunity. These aren't new concerns, but there aren't many positives to offset them now. I believe that Valeo is materially undervalued here, but the company needs beat-and-raise reports (particularly on margins) to shift sentiment.

 

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Valeo Hammered On Sector-Wide Operational Challenges And Future EV Fears

Sunday, March 27, 2022

For 3M, Inertia May Be The Bigger Long-Term Threat

3M (NYSE:MMM) has been hit hard by growing concerns over the company’s potentially large financial liabilities tied to PFAS (per- and polyfluoroalkyl substances) contamination and allegedly defective military earplugs. It certainly also hasn’t helped that the company’s revenue and margin leverage performances have been lackluster at best, all contributing to a nearly 25% decline in the stock price since my last update on the company – far worse than the basically flat performance of the broader multi-industrial sector.

I do still see some value in these shares, but for reasons I’ll discuss in greater detail, I don’t have as much confidence in management as I'd like, and it’s harder to argue for owning these shares given the sentiment headwinds from the legal liability issues.


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For 3M, Inertia May Be The Bigger Long-Term Threat

Friday, March 25, 2022

Insteel Generating Historically Strong Margins With Robust Underlying Demand

These are interesting times to be in the steel business, particularly with the market uncertainty unleashed by Russia’s invasion of Ukraine. Insteel Industries, Inc. (NYSE:IIIN) has different exposure than companies like Commercial Metals (CMC) or Nucor (NUE), as it is a steel products producer, taking wire rod and producing prestressed concrete strand and welded wire reinforcing products for the non-residential and infrastructure markets. Nevertheless, navigating the challenges of inadequate domestic supply, strong end-user demand, and rising input costs makes things pretty “interesting” for Insteel as well.

I was more cautious on Insteel at the time of my last article, as I was concerned how the market would react to what looked like some turbulence in the outlook for non-residential construction. The shares have held up better than I expected since, rising almost 10% as the company has done a good job securing better spreads and managing a challenging supply environment.

Given my expectation that non-residential construction will accelerate later this year and into 2023, and that infrastructure and institutional spending will start accelerating in 2023, I like the near-term outlook, but I am still concerned about the risk of peaking financial performance.

 

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Insteel Generating Historically Strong Margins With Robust Underlying Demand

Allegheny Technologies Setting Up For Higher Highs As Aerospace Recovers

The shares of specialty alloy producer Allegheny Technologies (NYSE:ATI) have already doubled lows in the late fall of 2021, as the market has started pricing in both the recovery in the commercial aerospace market and management's progress on self-help initiatives. Still, these are the early days of the recovery, and it doesn't look as though the market is fully pricing in what this newly more efficient company can earn as the cycle ramps further.

To be clear, I do not think that Allegheny is a good buy-and-hold stock for long-term investors. The commercial aerospace cycle should take several years to play out, but even with the improvements made to the business, I think full-cycle returns are unlikely to be all that attractive. In other words, this is a stock to try to own on the way up, but you really don't want to ride along for the down-cycle. Given low double-digit EBITDA margin in 2022, accelerating into the mid-teens and beyond over the next five years, I think there's at least 10% to 15% more near-term upside today.

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Allegheny Technologies Setting Up For Higher Highs As Aerospace Recovers

ICU Medical: There Is Still Upside Here As Management Goes Big To Drive Value

Operating in a sub-sector of med-tech that has long rewarded scale, ICU Medical (NASDAQ:ICUI) has gone for scale in a big way. The acquisition of Smiths Medical from Smiths Group (OTCPK:SMGZY) was very nearly a “merger of equals”, at least in terms of revenue and so forth, and while the logic of the deal is sound, management is taking on some meaningful integration challenges and risks, including leveraging up the company.

There are a lot of things I like about this deal. Not only does Smiths Medical give ICU Medical more scale in its core infusion business, it adds complementary assets elsewhere in the business. Smiths will increase ICU’s international presence, and I see a lot of “blocking and tackling” opportunities to improve operational metrics.

Although these shares aren’t as cheap as I might like on cash flow, that’s not uncommon in med-tech, and I see fair value above $265 today.

 

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ICU Medical: There Is Still Upside Here As Management Goes Big To Drive Value

New York Community Bancorp Idling Until Regulators Wave Green Flag On Flagstar Merger

At this point New York Community Bancorp (NYSE:NYCB) shares remind me of an F1 driver that has to start the race from pit lane; they’re sitting there watching the pack fly by while the company waits for regulators to wave the green flag and clear the transformational merger with Flagstar (FBC). Since my last update, these shares have fallen more than 10%, underperforming regional peers by more than 15%.

I don’t see any evidence that NYCB and Flagstar won’t get that clearance, and that’s key to the bull argument here. While there are several good things going on at NYCB beyond that deal, a liability-sensitive effectively single-market lender is not going to fare well in this market. I still expect the deal to close in 2022, though, and I still believe that the combined bank will generate mid-single-digit core earnings growth that supports a fair value in the $15-16 range today.

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New York Community Bancorp Idling Until Regulators Wave Green Flag On Flagstar Merger

Gorman-Rupp A More Off-The-Radar Play On Water

Pump manufacturer Gorman-Rupp (NYSE:GRC) didn't see quite the same level of excitement when institutional investors piled into water-related stocks, and the shares have held up comparatively better as that sector has cooled. Basically flat now from my last update (but up as much as a third in the interim), the valuation is still in that "okay but not great" gray zone where it's harder to make a definitive call either way.

There's plenty to like about Gorman-Rupp, and not just its exposure to water infrastructure spending. The company is also leveraged to a coming recovery in new commercial construction, as well as infrastructure, and further growing in process-oriented industry. That said, the margins aren't really exceptional and I do think that limits some of the upside.

 

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Gorman-Rupp A More Off-The-Radar Play On Water

Vontier - Faster EMV Erosion Is A Near-Term Challenge, And The Street Needs To See A Better Path For Growth

I've written in the past that oddly undervalued stocks make me nervous, and Vontier (NYSE:VNT) is at least partly a case in point. Writing about the stock a year ago, I wondered why the shares seemed so cheap, and the shares have fallen another 20% since then despite posting better-than-expected financial results.

While management's guidance for a quicker decline in EMV-related revenue certainly drove recent weakness, the reality is that Vontier shares have been weak since September of 2021 (the time of the company's first significant M&A transaction) despite generally good results and a decent outlook. While I can understand some degree of frustration over capital deployment and concerns about near-term growth leverage, expectations are so low now that low single-digit growth can drive a double-digit forward return.

 

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Vontier - Faster EMV Erosion Is A Near-Term Challenge, And The Street Needs To See A Better Path For Growth

Xylem Worth Another Look After A Big Valuation Reset

Xylem's (NYSE:XYL) valuation has clearly benefited in the past from its strong leverage to ESG themes, with the company's leverage to water infrastructure leading it to score well on the environmental part (the "E") of ESG fund mandates. With that tailwind of investor enthusiasm for water stocks, Xylem has enjoyed a multiple typically reserved for companies with stronger "compounder" credentials like Danaher (DHR) or IDEX (IEX).

That valuation, not the company's qualities, has long been my prime issue with the stock, but after a one-third decline in the share price since my last update (far worse than declines in other compounds like IDEX or other water infrastructure names like Franklin Electric (FELE) or Mueller (MWA)), a revisit is warranted.

There are certainly things that I find less than ideal about Xylem, but I'm also a believer that almost every asset has its right price. What's more, for all of my skepticism and cynicism about what the Street was recently paying for water-related names, I do think that the water market has attractive long-term structural characteristics. Xylem isn't a slam-dunk just on valuation now, but it's a great deal more interesting than before.

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Xylem Worth Another Look After A Big Valuation Reset

Cullen/Frost: Stretched Valuation, Can't See Fundamental Value

I never expect the market to be completely rational, but occasionally you do find some head-scratching valuations in the banking sector. In the case of names like First Republic (FRC) or SVB Financial (SIVB), high multiples can be explained by an established track record of well-above average organic growth. In the case of Commerce (CBSH), you can argue for a “sleep well at night premium”.

And then there’s Cullen/Frost (CFR). This is one of those situations where I can say I love everything but the valuation, and while that was true a year ago, that didn’t stop the shares from going up another 30% and handily beating regional bank peers. Cullen/Frost doesn’t offer extraordinary growth, but it may well have an M&A “backstop” and I can’t argue with the quality of the bank franchise. Still, with the shares trading at 18x my above-Street ’23 EPS estimate and the valuation implying long-term core earnings growth in the mid-teens, I just can’t see the fundamental value here.

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Cullen/Frost: Stretched Valuation, Can't See Fundamental Value

Armstrong World Leveraged To Non-Residential Recovery And Pricing, But Self-Help Could Go Even Further

Writing about Armstrong World Industries (NYSE:AWI) in August, I was ambivalent on this leading manufacturer of commercial ceiling tiles and specialty ceiling materials, as I thought the company's strong leadership in its core market was offset by the share valuation and the prospect of weaker renovation activity in 2022 ahead of recovery in non-residential construction.

Since then, the shares have fallen more than 10%, and management's guidance for margins in 2022 was softer than the Street had expected. At the same time, though, the company is showing exceptional pricing power and the company is still leveraged to what I expect will be a meaningful renovation cycle targeting "healthy building" initiatives. If Armstrong can generate long-term revenue growth in the mid-single-digits, free cash flow growth in the high single-digits, and mid-20%'s adjusted operating margins, I see upside of around 20% from here.

 

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Armstrong World Leveraged To Non-Residential Recovery And Pricing, But Self-Help Could Go Even Further

Merit Medical's Underperformance Seems Overdone As Elective Procedures Normalize

The medical device space has taken a few more body-blows in recent months, with elective procedure counts once again impacted by the pandemic and cost inflation pressuring margins. While the cost inflation is going to be a lingering issue, elective procedure counts should improve and normalize as the year goes on, driving some decent revenue prospects as hospitals work through their backlogs.

Specific to Merit Medical Systems Inc. (NASDAQ:MMSI), the share price underperformance since my last update looks a little excessive. Although I didn't find the valuation compelling then, a 10%-plus decline on top of good results in the second half of 2021 and guidance for 2022 changes the math some. Although smaller med-techs with single-digit revenue growth prospects can sometimes linger in valuation purgatories, mid-single-digit revenue growth and ongoing margin improvement should be able to support a return to the $70's for these shares.

 

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Merit Medical's Underperformance Seems Overdone As Elective Procedures Normalize

With Underwhelming Growth And Expensive M&A, Fortive's Compounder Credentials Are In Question

It took a little longer than I expected, but at least some of the derating process that I'd expected for the industrial sector is taking place and it's been unpleasant so far, with many higher-multiple industrials down 10% or more since the start of the year, including "compounder" stocks like Danaher (DHR), IDEX (IEX), and Rockwell (ROK) (Ametek (AME) and Roper (ROP) are in this group too, but have declined less than 10% since the start of the year).

Fortive (NYSE:FTV) is included in that group, with a roughly 20% year-to-date decline and a similar move since my last update on the stock. I wasn't that fond of the shares then due in large part to valuation, but now there seems to be more grumbling about the multiples that Fortive is paying and whether shareholders are getting good value for that money.

I do share many of these concerns, though I think Fortive is also building a less-cyclical "all-weather" company that can generate some pretty solid free cash flow over the long term. While not my favorite company in terms of drivers or business strategy, and the valuation argument is not at all straightforward, I do think the share price is getting more interesting.

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With Underwhelming Growth And Expensive M&A, Fortive's Compounder Credentials Are In Question

Unifi Looking To Translate Solid ESG Credentials Into Better Financials

ESG investment mandates are becoming more and more common, but not all ESG-compliant companies are created equal - a fair few of these businesses are still more "vaporware" than real, with an investment case that rests on significant fundamental shifts in how consumers, companies, and economies operate. Not so with Unifi (NYSE:UFI), as this yarn producer has a long operating track record behind it, including a strong track record with its REPREVE line of polyester and nylon yarns made from recycled plastics.

Unifi's management has some bold goals, including a nearly mid-teens revenue growth rate over the next three and a half years, as well as significant margin improvement. While I do think the wind is at Unifi's back where the increased use of recycled materials is concerned, I do have some concerns that the goals a bit too ambitious. Even still, a more modest set of targets can still drive a double-digit annualized return from today's level.

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Unifi Looking To Translate Solid ESG Credentials Into Better Financials

Bio-Techne - Exceptional Leverage To Biopharma Growth, And Priced Accordingly

You don't go to the leading edge of life sciences/bioproduction looking for bargains, as the strong growth and margins available to companies facilitating the rapid growth of new biologic treatment options like gene and cell therapies have fueled strong share price performance (and multiples) for larger, better-known companies like Danaher (DHR) and Thermo Fisher (TMO), as well as smaller players like Bio-Techne (NASDAQ:TECH).

I find a lot to like in Bio-Techne's leverage to cell and gene therapy-enabling products like GMP protein production and non-viral gene editing, as well as its leverage to life sciences/bioproduction research tools, spatial biology, and molecular diagnostics. I don't find nearly as much to like in the valuation, but stocks like these are a "you either get it, or you don't" sort of proposition where you're basically betting that the underlying growth of the market and the company's strategic decisions will eventually lead to enough revenue and profit growth down the line to redeem an eye-watering valuation today.

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Bio-Techne - Exceptional Leverage To Biopharma Growth, And Priced Accordingly

W.W. Grainger Continues To Ride High As Company-Specific Strategic Initiatives Produce Results

Seven months later, and not all that much has changed for me in regards to W.W. Grainger (NYSE:GWW). The company continues to have important, differentiating growth drivers in the short term, but long-term concerns about margins and valuation. Still, that debate continues now from a higher valuation, as the shares have climbed almost 20% since my last update, beating the S&P 500, industrials in general, and specific distributors like Fastenal (FAST) and MSC Industrial (MSM).

In that last update, I thought Grainger at least had the virtue of a differentiated growth story to separate it from what I thought was an expensive overall industrial sector. With a lot of quality industrials taking a beating since then, I see that as a less compelling argument and I don’t find as much to like at this price.

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W.W. Grainger Continues To Ride High As Company-Specific Strategic Initiatives Produce Results

Cycle Risks Remain, But Analog Devices Has Solid Long-Term Credentials

There is certainly a faction of analysts and investors that perpetually view semiconductors as either in a downturn or heading toward the next downturn, and I suppose while that may be technically true, you will miss a lot of winners that way. That being said, it's equally foolish to ignore the cyclicality of the semiconductor space, as buying at the top can lead to a lot of years of lackluster performance.

I was neutral on Analog Devices (NASDAQ:ADI) back in April of 2021 mostly due to my concerns about a sentiment shift against semiconductors as investors would eventually come to the conclusion that unsustainable lead-times are, in fact, unsustainable and will eventually lead to an order correction cycle that would likely compress growth and margins for a time.

Since then, the shares have returned about 5%, underperforming the S&P 500 and the SOX, as well as some of the chip names I've preferred, including Broadcom (AVGO) and STMicro (STM). I'm still concerned about sentiment and the prospect of negative revisions when lead-times shrink, but this is definitely a name I'd at least follow now and seriously consider if there's another re-test of those lows in the $140's.

 

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Cycle Risks Remain, But Analog Devices Has Solid Long-Term Credentials

Franklin Electric Offers Leverage To Real Pain Points In Water

One of my criticisms about the typically richly-valued industrial water sub-sector is that many of these companies aren't especially well-leveraged to real pain points in global water - namely, ensuring adequate supplies of clean drinking water. Leak detection, condition monitoring, advanced metering, and basic infrastructure (pumps, valves, et al) certainly have their place, but I think Franklin Electric's (NASDAQ:FELE) focus on groundwater pumps and growing focus on water treatment/quality sets it apart.

These shares have outperformed other water stocks like Mueller (MWA), Watts (WTS), and Xylem (XYL) by pretty meaningful amounts since my last update (around 20%, 15%, and 35%, respectively), though the shares are only up slightly in absolute terms (and Evoqua (AQUA) has done even better). Given the company's performance since that last update, including strong pricing power, I'm more bullish on the shares and the valuation today.

 

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Franklin Electric Offers Leverage To Real Pain Points In Water

ams-OSRAM Undergoing A Painful Reset, But Better Days Should Lie Ahead

 Neither operating conditions nor sentiment have gotten much better for ams-OSRAM AG (OTCPK:AMSSY) (AMS.S) since my last update, with investors basically heading to the sidelines as the company absorbs the hit from reduced business at Apple (AAPL) and exiting low-margin legacy OSRAM businesses. While the OSRAM moves will improve long-term margins and ams is gaining business with Android OEMs (not to mention non-smartphone business), the reality is that the market isn't eager to buy in ahead of real evidence of those improvements.

That reality is why I was still lukewarm on the shares back in August, and the shares have fallen another 25% or so since then, underperforming the SOX index and individuals names like STMicro (STM) that I've liked better. I'm getting more intrigued by the "post-reset" potential of ams, though, and I think the upcoming capital markets day in early April could be an opportunity for management to set clear benchmarks and start shifting the tone on the shares. It's still early, and the risk of disappointment is high, but this is getting more and more interesting as a contrarian/overlooked turnaround play.

 

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ams-OSRAM Undergoing A Painful Reset, But Better Days Should Lie Ahead

Crane Is Just Starting To Lift

With process industries, aerospace, and retail/leisure activity picking up, it shouldn’t be altogether surprising that Crane (NYSE:CR) shares are doing better, particularly when management execution seems to be improving as well. Relative to my last update on the shares, Crane is up about 8%, beating the S&P 500 as well as the broader industrial sector (by close to 10%).

I don’t think Crane’s run is over yet. Process industries are just starting to recover, and even if the market is anticipating that, there are opportunities to grow the business and boost margins. Aerospace is just starting on what should be a nearly decade-long growth cycle, and recovering retail activity and acute labor pressures should drive more growth in the Payment & Merchandising Technologies (or PMT) business. On top of that, there’s margin leverage and capital redeployment potential here, and I can see a path to double-digit annualized returns from here.

 

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Crane Is Just Starting To Lift

Heartland Express Continues To Muddle Through As Trucking Rates Approach A Cyclical Top

The going hasn’t gotten any easier for Heartland Express (NASDAQ:HTLD) in the last couple of quarters, as the company has continued to miss revenue expectations and has run its streak to five straight quarters of weaker than expected top-line results. While earnings performance has been a little better relative to expectations on a reported basis, gains on equipment sales have been an important part of that performance and seem unlikely to continue at the same rate. On top of all that, truckload rates are likely to peak in the first half of 2022 and then start declining.

I wasn’t that positive on Heartland back in August of 2021, and I thought investors would do better with Knight-Swift (KNX). Since then, Heartland shares have fallen about 10% versus the 15% rise in Knight-Swift, while Werner (WERN) and Schneider (SNDR) have likewise outperformed.

Given the underperformance at Heartland and the opportunity to take advantage of better driver availability, I think Heartland is likely less vulnerable to this next phase of the cycle and may well show better counter-cyclical performance. That said, I still think Knight-Swift offers a better long-term opportunity.

 

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Heartland Express Continues To Muddle Through As Trucking Rates Approach A Cyclical Top

Werner Enterprises Looking To Accelerate Growth As Rates Approach A Cyclical Peak

 

I've been getting more interested in transports lately, including truckload carriers like Heartland (HTLD), Knight-Swift (KNX), and Werner Enterprises, Inc. (NASDAQ:WERN), as the market seems to be pricing in a fairly steep decline off of an approaching peak in rates (likely late Q1/early Q2) despite a fair bit of evidence that the market will see a shallower correction. While buying into cyclical declines is always risky, the prospect of interesting long-term values makes the sector worth another look.

Specific to Werner, I do have some concerns about the cost of the company's growth plans (namely, capex spending weighing on DCF-based valuation) and whether the company can hit some bold growth targets, but I like the more defensive trucking mix here and the opportunity to grow value-added businesses like last-mile service. With an apparent fair value above $50, this is another name in this sector to consider.

 

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Werner Enterprises Looking To Accelerate Growth As Rates Approach A Cyclical Peak

Parker Hannifin Makes Its Case For Fundamental Change

 

One of the topics I’ve mentioned relatively frequently in talking about Parker-Hannifin Corp. (NYSE:PH) is the growing dichotomy between the market’s ongoing perception of this company as a classic short-cycle industrial and the reality of the company’s transformation toward an a-cyclical (or at least less cyclical) compounder that creates value across cycle. Management went to some lengths to reiterate that case at its recent Investor Day, and it’s an argument I think is worth listening to.

I was very tempted to buy into Parker Hannifin shares last August, and while I have missed the recent rebound from the low $270’s, I think there’s still credible long-term value here. I’m not completely with the bulls who think this is a brand new Parker Hannifin, and I think the company still lacks “flashy” exposure to attractive secular growth markets, but I think there is a lot more to this story than just short-cycle industrial exposure.

 

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Parker Hannifin Makes Its Case For Fundamental Change

First Citizens BancShares Entering Into A New Era With An Interesting Valuation

 

Whenever the words “transformative M&A” are used, it’s usually an apt description no matter how the deal goes - whether it goes well or not, it’s almost certain to meaningfully transform the future of the company doing the deal. First Citizens BancShares (NASDAQ:FCNCA) is no stranger to deals, but acquiring CIT Group brings an entirely new set of opportunities and risks to the table; the opportunity to leverage a national lending franchise with a low-cost deposit base, but also the risks inherent to integrating a very different sort of business.

Paying less than tangible book value certainly reduces some of the risk to the CIT deal, but management will still have tough choices to make down the line regarding whether or not to maintain certain lines of business and whether to change CIT’s underwriting practices. I expect the deal to allow First Citizens to generate mid-single-digit long-term core earnings growth off of a much larger asset base, and given the current valuation, these shares are worth closer consideration.

 

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First Citizens BancShares Entering Into A New Era With An Interesting Valuation

Saturday, March 19, 2022

Truckload Rates Are Peaking, But But Knight-Swift May Not Be Unsaddled This Time

 

Cyclical industries are tricky. Not only do you often hear various iterations on the theme of “it’s different this time” during the peaks (spoiler alert – it’s almost never different), but you have the bull trap lure of attractive-looking valuations ahead of weaker revenues and margins, and often cuts to expectations as the cyclical highs and lows tend to exceed initial expectations.

So, with that backdrop, maybe it is different this time for Knight-Swift Transportation (NYSE:KNX). Given a still-tight market for trucks and drivers, not to mention ongoing growth in e-commerce and intermodal, I think there’s an argument for a shallower cyclical correction this cycle. What’s more, Knight is actively building up its non-truckload operations and truckload earnings may only be around half the mix when the cycle peaks.

I liked Knight back in August, and the shares have beaten the S&P 500 since then, rising about 13%. That performance only matches that of the Dow Jones Transportation Index, though, and while the shares have outperformed some truckload carriers (Heartland (HTLD), U.S. Xpress (USX), Werner (WERN), Schneider (SNDR) has outperformed, as have more logistics-driven names like J.B. Hunt (JBHT). I still believe these shares are undervalued, but I do advise readers to beware of cyclical correction risk.

 

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Truckload Rates Are Peaking, But But Knight-Swift May Not Be Unsaddled This Time

Mueller Water Lagging As Investors Turn Away From A Once-Hot Sector

 

Residential construction remains healthy, and municipals are already coming up with cash for water and wastewater infrastructure projects ahead of stimulus-driven spending, but that's not helping the water infrastructure space outperform recently. Between supply chain pressures and derating off of what were generally too-high multiples (at least in my opinion…), this has been a weaker sub-segment of industrials since the late fall of 2021.

I thought Mueller Water (NYSE:MWA) had better prospects on its leverage to residential construction and self-help, but that didn't work out quite like I'd expected. Although Mueller shares have outperformed Xylem (XYL), they've still lagged the broader industrial space and the S&P 500. There's still a relative value call to be made here, but margin pressure is going to last a while longer and I think investors can and should consider names like Zurn (ZWS) and Franklin Electric (FELE) alongside Mueller today.

 

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Mueller Water Lagging As Investors Turn Away From A Once-Hot Sector

Capital One's Curious Valuation Seems To Be Predicting Tougher Times

 

Enlightened paranoia is a valuable asset when it comes to investing - if something looks too good to be true, it often pays to thoroughly reexamine your assumptions rather than just assume the market has it all wrong. That brings me to the curious case of Capital One (NYSE:COF). I understand concerns that charge-offs and delinquencies will get worse from here, but relative to a healthy labor market and conservative reserving, the valuation here seems to be pricing in some really tough times ahead.

Capital One came through the pandemic-driven downturn in better shape than I'd expected, and in better shape than management had expected given initial reserving decisions. The shares have risen around 90% since my last update - okay relative to large banks, about on par with American Express (AXP) and Discover (DFS), and better than Alliance Data (ADS) and Synchrony (SYF), but the shares have significantly underperformed large banks (by more than 20%) since August of 2021.

I find the valuation curious. Maybe I'm missing something, but even in the context of inflation and credit normalization, the valuation here is pretty appealing if Capital One can generate normalized core earnings growth in the neighborhood of 5%.

 

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Capital One's Curious Valuation Seems To Be Predicting Tougher Times

Textron's Bizjet Business Shouldering More And More Of The Growth Load

 

One of the advantages of a conglomerate strategy is that cyclically strong businesses can offset cyclically weak businesses, leading to at least a little less volatility over the full cycle. The catch, though, is that sooner or later all of the businesses have to pull their own weight. That’s my main issue with Textron (NYSE:TXT) right now – while the bizjet business (Aviation) is performing well and set up for multiple years of good performance, the Bell helicopter business is in a transition period and the Industrial segment has been a chronic underachiever.

There are potential sources of upside, including the possibility of a significant military project win for Bell, but my main concerns are that the bizjet recovery is already priced in and that a meaningful turnaround in Industrial is a lower-probability event. I can see, maybe, upside into the low $80’s today, but that’s not enough to get me really interested in the stock.

 

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Textron's Bizjet Business Shouldering More And More Of The Growth Load

Successfully Differentiating Itself On Growth Is A Key Opportunity For F.N.B.

 

I haven't generally been all that bullish on F.N.B. Corp (NYSE:FNB), and over the last couple of years, that has been the right call, as the shares of this Pittsburgh-based bank have underperformed peers and the S&P 500. Looking at recent results, though, and the opportunity in markets like North Carolina and Baltimore, I see more potential for worthwhile acceleration and some outperformance over its regional peers.

Given F.N.B.'s appealing mix of "big bank" product offerings and "small bank' service quality, I do think F.N.B. can be a share gainer in its legacy markets while also leveraging above-average growth potential in newer markets. If F.N.B. can generate around 5% to 6% long-term core earnings growth, these shares look around 10% to 20% undervalued today after basically matching its peer group since my last update.

 

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Successfully Differentiating Itself On Growth Is A Key Opportunity For F.N.B.

Fifth Third Shifting Into Higher Gear As Rates And The Economy Ramp Up

 

The Fed is tightening again, and the economy is growing - this is the opportunity that growth-oriented banks like Fifth Third (NASDAQ:FITB) have been waiting for, and management seems ready to produce. Not only is Fifth Third looking to further leverage its "land and expand" strategy and take more share in faster-growing Southeast markets (including a focus on consumer business that I think many banks are overlooking), but the bank is also focused on opportunities like commercial lending growth in California and Texas, as well as in the emerging point of sale lending market.

I was bullish on Fifth Third when I last wrote about the stock, and thought there was a lot of growth potential once rates started heading higher. The shares have since outperformed the peer group by a healthy margin (around 20%), while also outperforming the S&P by a wide margin. The shares don't look particularly cheap now (as was the case back in August), but if Fifth Third can deliver on its growth targets, there could be beat-and-raise upside here.

 

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Fifth Third Shifting Into Higher Gear As Rates And The Economy Ramp Up

Fulton Financial Getting More Active, But Value Creation Still Not Certain

 

The trailing multiyear track record at Fulton Financial (NASDAQ:FULT) has left a lot of investors wanting more, with the shares lagging regional bank peer groups by quite a bit over the last few years. Although earnings growth hasn’t been too bad, (10% on a trailing 5-year basis, 6% on a trailing 10-year basis), the predominant sentiment has long been “yeah, it’s fine … but there isn’t much going on”, particularly with the company sitting on excess capital that management wanted to deploy into M&A.

After a long wait, longer than I imagine management intended or wanted, Fulton Financial has finally gotten back to M&A, though I don’t think the target was to everyone’s liking. While integrating Prudential Bancorp (PBIP) should unlock worthwhile synergies, loan growth and rate leverage prospects seem more average than exceptional and at best I think the shares are modestly undervalued relative to other smaller bank peers with stronger organic growth stories.

 

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Fulton Financial Getting More Active, But Value Creation Still Not Certain

Hartford's Consistent Performance Not Quite In Step With The Hard Commercial P&C Market

 

The commercial P&C market continues to enjoy a rare period of profitable underwriting, but shares of The Hartford Financial Services Group (NYSE:HIG) ("Hartford") aren't really reflecting that. Up about 5% since my last update, Hartford has outpaced the S&P 500 but come in well short of peers/comps like Allianz (OTCPK:ALIZY), Chubb (CB), Travelers (TRV), W. R. Berkley (WRB), and Zurich (OTCQX:ZURVY).

I believe at least some of the underperformance can be tied to Hartford's business mix - while the company's strong exposure to small commercial is a positive over a full cycle, it hasn't benefited as much from this hard market. I also think Hartford's large exposure to workers' comp is an issue; pricing is weak here and Hartford doesn't have the same strength in specialty lines that Berkley has to offset that pressure.

I still like Hartford shares, but this is more of a "slow and steady wins the race" sort of call. I believe there will be slow improvement in the personal lines business from here, and I would expect to see management try to drive more specialty growth in the years to come. Hartford Next, a cost-saving program, still has more to contribute, and I continue to expect solid core earnings growth for years to come.

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Hartford's Consistent Performance Not Quite In Step With The Hard Commercial P&C Market

Thursday, March 17, 2022

Air Transport Group Delivering On At Least Some Of Its Potential

 

The arrival was a little delayed, but it looks like Air Transport Group (NASDAQ:ATSG) is finally getting some of the credit I think it deserves for the quality freighter leasing business it has been building for several years. While a lack of exposure to the spot market may explain why the shares had lagged a bit before, they have risen about 15% since my last update, more or less matching Atlas Air (AAWW) over that period.

Valuation is challenging (as in “difficult to model/calculate” not “expensive”). While management is right to note the significant structural free cash flow base that the company has built, the reality is that growth is still tied to ongoing growth CapEx. The shares trade at a low multiple to forward EBITDA and still look priced for a high single-digit total annualized return at this level; perhaps not compelling enough for some investors today, but still with upside to margin improvement.

 

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Air Transport Group Delivering On At Least Some Of Its Potential

Aviva Undervalued As It Nears Completion Of Its Corporate Makeover

 

Aviva (OTCPK:AIVAF) management has continued to execute well on its plan to transform the company into a more predictable insurance company focused on retirement, protection, and P&C insurance, and one more likely to spin off meaningful capital returns to investors in the years to come. Despite that steady execution, the shares haven’t done all that much, with a total return of around 6% since my last update – close to the S&P 500 and better than peers like Legal & General (OTCPK:LGGNY) and Phoenix (OTC:PNXGF), but still a little less than the 8%-10% I had hoped to see.

Reconsidering the company today, I think the shares are around 15% to 20% undervalued, but with the business likely to grow around 4% henceforth, value realization will likely take some time. I do see good opportunities in the P&C operations and in the bulk annuity/pension insurance operations, but this is very much a “slow and steady” type of proposition for investors.

 

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Aviva Undervalued As It Nears Completion Of Its Corporate Makeover

Geely Auto Has Hit Some Big Potholes, But The Fundamental Story Is Intact

 

China's auto industry has taken a beating over the last four months, and Geely Automobile Holdings (OTCPK:GELYF) has been hit hard, with the shares down about 50% since my last update on the company. While more EV-leveraged names like BYD (OTCPK:BYDDY) and XPeng (XPEV) have held up better, closer comps like Great Wall (OTCPK:GWLLY) have also been hit hard.

The short-term outlook for Geely is challenging, as input costs are going to weigh on margins and the company is still navigating the impact of COVID-19 lockdowns and component shortages, particularly for higher-end NEV models. Longer term, though, I continue to like the company's move to mid- and high-range models, as well as its aggressive plans to build out its NEV offerings and grow its export business.

As the leading domestic player in China, I still expect high-single-digit to low-double-digit long-term revenue growth and even stronger FCF growth as the company scales up. Geely's growth can support a substantially higher fair value now, but sentiment is a major headwind now and more pronounced acceleration in unit volumes is likely a prerequisite to better share price performance.

 

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Geely Auto Has Hit Some Big Potholes, But The Fundamental Story Is Intact

Comerica Offers Focused Exposure To Rates And Business Growth

 

The last six months have seen a definite uptick in expectations for a new rate-tightening cycle, as one of the perennially most rate-sensitive banks out there, Comerica (NYSE:CMA) has shot higher, rising about 30% since my last update and outperforming larger bank peers by a similar amount. Given Comerica’s significant leverage to variable-rate loans, considerable excess cash, and heavily commercial-weighted loan book, this is definitely a good way to play higher rates and improving business activity.

Because Comerica is so sensitive to rates, it’s a tougher bank to model on a longer-time basis – in just the last 90 days, the sell-side average EPS estimate for 2023 has risen $1.35, or about 20%. I have my concerns about Comerica as a long-term buy-and-hold name, but the shares do seem to still offer some near-term upside.

 

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Comerica Offers Focused Exposure To Rates And Business Growth

Serious Margin Challenges At Dana Prove Too Spicy For The Street

 

I pushed my luck.

Writing about Dana (NYSE:DAN) in March of last year, I was encouraged by the strong performance of this light truck and commercial vehicle supplier during the pandemic, as well as its underrated leverage to electrification. Unfortunately, input costs and issues tied to OEM production schedules hammered the business, especially in the second half of 2021, and sent the shares down about 30%, worse than the 20% to 25% declines for most commercial vehicle suppliers like American Axle (AXL), Cummins (CMI), CVG (CVGI), Meritor (MTOR) (pre-deal), and so on.

The margin weakness is disappointing to be sure, but I don’t believe it necessarily reveals any fundamental weakness in the business or its management, as I believe the circumstances of the last six to 12 months are far from typical. Moreover, I still see a meaningful electrification opportunity here and a pretty compelling valuation that can drive double-digit future annualized returns.

 

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Serious Margin Challenges At Dana Prove Too Spicy For The Street