American Eagle: Good Management In A Worsening Macro Environment

It’s true that adverse macro conditions don’t impact all companies equally, but for a company of American Eagle Outfitters, Inc.’s (NYSE:AEO) size, there’s not much it can do to escape an increasingly difficult macro environment. I’ve been impressed with management’s efforts in merchandising in the past, as well as their efforts to optimize inventory and supply chain and store operating costs (including optimizing the footprint). That can still help in an environment of double-digit declines in teen retail spending and a potentially oncoming recession.

It's been a while since I’ve written on American Eagle, and at the time of my last article, I didn’t like the valuation or risk-reward balance. Down about 50% since then, I’m more positive on the shares from a valuation point of view, but I do still have concerns about the macro environment - even the best house on the block is at risk if the neighborhood is on fire. Mid-single-digit revenue growth and mid-single-digit free cash flow margins can support a long-term annualized return of around 10%, but investors need to be willing to wait out a few more quarters of pressured results.

 

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American Eagle: Good Management In A Worsening Macro Environment

Bank Of N.T. Butterfield & Son Underfollowed And Undervalued, Perhaps Capped On Growth

Despite rising rates, healthy results, uncertainty around the U.S. banking sector, Bank of N.T. Butterfield & Son (NYSE:NTB) (“Butterfield”) really hasn’t been able to catch investor attention. Down about 13% over the past year, underperforming U.S. regional banks, Butterfield’s underperformance seems unusual other than perhaps in the context of limited sell-side support and perceptions that the bank’s growth could be capped by its conservative management approach and very limited geographic footprint in the tax havens of Bermuda, Cayman Islands, and Channel Islands.

It's been quite a while since I last covered Butterfield, and since that last article the shares have more or less performed in line with the regional bank index. Low-to-mid single-digit core earnings growth should be enough to support a fair value above $40 today, but growth investors may regard this bank as too limited in its growth prospects to merit interest and more conservative value-oriented investors may be put off by the perception of elevated operating and regulatory risk, putting it in a sort-of investment twilight zone.

 

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Bank Of N.T. Butterfield & Son Underfollowed And Undervalued, Perhaps Capped On Growth

A Deere In The Spotlight

Investors are understandably nervous about 2023, as more and more companies are pointing to weakening trends and a more sober outlook for the next year. Heavy machinery is no exception, with investors concerned that strong backlogs will give way to weaker order trends and that a recent run of outperformance over other industrials will come to an end.

Deere & Company (NYSE:DE) has been stronger than most over the last two years, driven not only by strong demand for agricultural and construction machinery, but also self-help like growing precision ag and tech-driven ag businesses and margin improvement/efficiency efforts that have led to higher full-cycle margin projections. Valuation is not particularly cheap here, but if Deere can provide a strong beat-and-raise quarter with guidance to double-digit growth in FY’23, Deere could continue to outperform a while longer on the basis of its differentiated growth profile.

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A Deere In The Spotlight

JELD-WEN Struggling Now And Demand Could Erode Further Next Year

The manufactured building materials sector has admittedly seen some poor performers over the last two years despite strong residential and non-residential activity, but JELD-WEN (NYSE:JELD) (“Jeld-Wen”) nevertheless stands out with particularly poor performances on growth, margins, returns (ROIC, et al), and share price performance. Double-digit price increases haven’t been enough to offset steep cost inflation, and now the company is going into a period where underlying demand could well be noticeably weaker. On top of all that, whenever the company names its next permanent CEO, that will be the fourth such appointment in nine years – not a mark of stability.

When shares of a company like Jeld-Wen look cheap, it’s fair to ask yourself whether you’re underestimating just how tough things really or whether the market has overreacted and left the stock for dead. In many cases the answer can be “both”, and that could be the case here. I don’t feel like forward revenue growth of 3% to 4% and free cash flow margins in the 3% to 4% range are especially aggressive assumptions, but if pricing normalizes, they could well prove too aggressive and whatever undervaluation I see here could vanish quickly.

 

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 JELD-WEN Struggling Now And Demand Could Erode Further Next Year

Beacon Roofing Supply Making The Most Of Boom Times, But The Next Phase Could Be Tougher

Credit where due - Beacon Roofing Supply (NASDAQ:BECN) management has made the most of the fortunate situation they've found themselves in over the past couple of years. Healthy building activity has combined with incredibly strong pricing power to drive revenue, while steady margin improvement efforts have helped to offset the company's own cost inflation pressures. At a more bottom line level, not only has the company's debt situation improved significantly, but the company has also been able to return cash to shareholders through accelerated buybacks.

What comes next is the tricky bit - it's easy to climb onto the roof, but getting down can be more treacherous, and I do see some risk that expectations for 2023 are too high against a weakening macro backdrop. Likewise, management's own internal margin improvement targets may be too ambitious in the context of a less supportive end-market environment. The valuation already anticipates a lot of this, but I'd be cautious about buying in at this point in the cycle.

 

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Beacon Roofing Supply Making The Most Of Boom Times, But The Next Phase Could Be Tougher

Brady Has An Opportunity To Be More Than It Has Been, But Execution Is Uncertain

Can Brady (NYSE:BRC) be more than it has been?

This company hasn’t exactly covered itself in glory on a long-term basis. Despite rather strong margins and ROIC, the company hasn’t really been able to find growth – since 2000 revenue has grown at an annualized rate of 4%, while EBTIDA has grown about 4.6%. Adjusted free cash flow has done better (up around 7.5%), but the stock performance tells the tale – the shares have lagged the market and the industrial sector on an extended basis, with a 10-year annualized return around 6%.

That’s not an inspiring backdrop, but the company has been actively cutting costs and streamlining its portfolio, and management seems to appreciate the need to find growth opportunities and is targeting some logical areas that I think could hold some promise. I can’t say I love this company, but if it can deliver on what I think are pretty low expectations, I can definitely see upside from here.

 

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Brady Has An Opportunity To Be More Than It Has Been, But Execution Is Uncertain

Bank Of America Still Has The Credentials To Outperform

I’ve liked Bank of America (NYSE:BAC) (“B of A”) for over a year now, and while regional banks have lived up to my expectation of outperformance versus the money center banks, Bank of America has still done well on a relative basis – and “relative” is an important caveat here, as bank stocks have taken some hits this year despite the prospect of strong earnings growth in 2023. Since my last update, the shares have beaten large bank peers by about 10%, and have outperformed them by about 5% this year.

I continue to like this bank’s blended exposure to both money center banking and Main Street banking trends, including its improving performance in trading and its strong rate sensitivity. While I do think a weaker macro background for 2023 remains a threat, I believe B of A is capable of mid-single-digit long-term core earnings growth and that such growth (as well as near-term earnings and ROTCE) support a fair value in the low-to-mid-$40’s.

 

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Bank Of America Still Has The Credentials To Outperform

Litigation And Economic Cycles Dominate The 3M Discussion, But There Are Longer-Term Growth Issues To Consider

There's really not much positive to say about 3M (NYSE:MMM) since my last update on the company. Even against a backdrop of low expectations, the company has managed to come up short, with weaker-than-expected results in businesses tied to consumer electronics and healthcare. On top of that, the company has seen some adverse legal judgements, albeit these are early-stage rulings that aren't likely to fundamentally alter the picture.

My issues with 3M still run deeper than all of this. I praised the company in my last article for finally taking some value-building steps (spinning off Health Care and attempting to ring-fence some of its legal liabilities), but the fact remains that the company has been painfully reticent to reposition itself for the future and is increasingly looking like a short-cycle cyclical focused on squeezing margin and cash flow out of legacy businesses.

Down a bit since my last update, 3M has continued to underperform the industrial group, and while there are a few worse performers out there (Stanley Black & Decker (SWK) comes to mind), there aren't many. I do see some relative value here, and the dividend is good, but I'm still quite concerned that management seems to have little vision for the future beyond "that worked in the past … so let's do that again".

 

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Litigation And Economic Cycles Dominate The 3M Discussion, But There Are Longer-Term Growth Issues To Consider

Woodward Buffeted By Turbulence On Multiple Sides, But Results Should Improve

It seems at times that Woodward (NASDAQ:WWD) just can’t get a break. Long a leader in complex control systems and components that play essential roles in aviation propulsion and actuation, Woodward invested meaningful sums between 2013 and 2019 to add capacity in anticipation of a significant commercial aerospace ramp… only to get kicked in the head by the COVID-19 pandemic and the temporary collapse of the commercial aviation market. Then, more recently, as commercial aviation has started to recover, Woodward has found itself hamstrung by component and labor issues, as well as component/production difficulties at other suppliers that have led to some disappointments in commercial build-rates.

I look at Woodward’s leverage to the aviation recovery, and I think management has a fairly realistic (if not conservative) view on how build-rates will reaccelerate. I like the company’s industrial business in general, though the near-term outlook is shakier given ongoing issues in China. Trading at close to $100, I don’t see tremendous fundamental undervaluation, but I do acknowledge that this is a stock that could rerate more strongly as aviation builds accelerate and margins expand.

 

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Woodward Buffeted By Turbulence On Multiple Sides, But Results Should Improve

Free To Set Its Own Course, ESAB Is Running Into Some Cyclical Worries

Writing about the Enovis (ENOV) / ESAB (NYSE:ESAB) split back in April, I said that I was more interested in ESAB, as I thought this welding company had often gone underappreciated and under-supported within the dubious conglomerate operations of what used to be Colfax. The performance since then has done nothing to change my mind about that, as ESAB has done reasonably well for itself as an independent company, though it still carries some of the burdens of past issues created by Colfax.

ESAB shares have lost about 10% of their value over that time, trailing Lincoln Electric (LECO) and the broader industrial space, but outperforming many other short-cycle industrials like Kennametal (KMT) and Sandvik (OTCPK:SDVKY) as investors grow increasingly nervous about a short-cycle rollover in 2023. I don’t think this is the best set-up for ESAB, as short-cycle industrial and construction markets could weaken in 2023, but I do think there is underappreciated value and potential in this business.

 

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Free To Set Its Own Course, ESAB Is Running Into Some Cyclical Worries

Middleby Singed By Margin Weakness

Commercial kitchens and food processors are eager to increase capacity and contain (if not reduce) costs, and automation is a key part of that process. That’s very good news for Middleby (NASDAQ:MIDD), but strong demand from restaurants and foodservice customers is being offset by intense cost pressure, as well as emerging weakness in the residential business.

The valuation wasn’t great, but I thought Middleby was setting up as a “buy the dip” opportunity back in early March. That was absolutely the wrong call, as the shares have remained weak ever since, dropping around 17% and underperforming the market. There aren’t many good comps anymore, as most of Middleby’s competitors are part of larger conglomerates, but neither Marel (OTCPK:MRRLF) or Rational (OTCPK:RATIY) have been all that strong of late either.

 

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Middleby Singed By Margin Weakness

Donaldson Delivering, And Updated Guidance For FY'23 Could Be A Catalyst

I’ve liked filtration specialist Donaldson (NYSE:DCI) for a while now, and not only are the shares up about 15% since my last update (handily beating the broader market and the industrial sector), they’ve continued to beat the market (and the industrial group) since my initial write-up for Seeking Alpha. The thesis then and now was maximizing the value of the legacy heavy machinery and industrial filtration businesses while exploring opportunities to extend those core competencies into new markets like food/beverage, life sciences, and other process markets where filtration is important (and acquire new, complementary, competencies through M&A along the way).

I’ll be very curious to see what management says about guidance when it reports fiscal first quarter earnings later this month. The initial guide for FY’23 back in August surprised the Street with its conservatism, and the recent earnings/guidance calls from heavy machinery companies have been relatively good. Moreover, at a time when many short-cycle businesses are starting to roll over, many heavy machinery companies are carrying good backlogs into 2023 and underlying activity/utilization is still healthy.

With the shares performing well, I don’t see as much undervaluation here. I think the shares are still priced for long-term annualized returns in the high single-digits (around 8%), but near-term upside looks capped at around the mid-$60’s without a stronger outlook. There are worse things than owning a good company at a reasonable price, but there are more options now for investors and I’m not as inclined to chase Donaldson.

 

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Donaldson Delivering, And Updated Guidance For FY'23 Could Be A Catalyst

Globus Medical Showing Some Reacceleration And Innovation Can Continue To Drive Growth

Procedure volumes aren’t yet back to normal in spinal surgery, but the market continues to reward innovation and Globus Medical (NYSE:GMED) is reaping the benefits, as the company started to separate itself from the pack again in the third quarter. Further down the road, Excelsius still holds meaningful growth potential, as do the company’s efforts in trauma and robot-assisted joint reconstruction.

Globus has declined about 5% since my last update, but that’s still better than the market’s performance and the performance of the broader medical device sector (down about 15%), not to mention other ortho competitors like NuVasive (NUVA), Stryker (SYK), and Zimmer Biomet (ZBH). Valuation is more debatable without a more sustained recovery in procedure volumes, but I still see Globus as a long-term innovation-driven winner in the ortho space.

 

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Globus Medical Showing Some Reacceleration And Innovation Can Continue To Drive Growth

Haemonetics Leveraging Strong Recovery Trends And Repositioning For The Future

Companies facing markets in long-term decline have a few choices – pretend it’s not happening, consign themselves to riding it as long as they can, or harvest what they can and build toward a future based on new markets. It’s debatable as to whether plasma collection is a market truly in long-term decline, but with the growing investment in oligonucleotide therapies, gene therapies, and cell therapies targeting ailments treated with plasma-derived therapies, I believe Haemonetics (NYSE:HAE) is making the right strategic choice by reinvesting in growth opportunities like vascular closure within its Hospital business.

Haemonetics is likely looking at strong plasma center demand for many more years, and I find the margin improvement plans to be credible. At the same time, management will be directing free cash flow into supporting organic growth opportunities and pursuing diversification and new growth through M&A. Haemonetics shares have been strong over the past year, but if double-digit growth over the next five years and longer-term growth in the high single-digits is attainable, the shares aren’t yet overvalued.

 

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Haemonetics Leveraging Strong Recovery Trends And Repositioning For The Future

Ciena Needs More Chips To Pull Out Of The Dip

Bullishness on Ciena (NYSE:CIEN) has gotten me nowhere this year, as this large optical networking company has been hamstrung by its inability to secure the parts and components it needs to satisfy demand. While that demand has remained strong, and the company will head into 2023 with a strong backlog, the name seems to be a non-starter with the Street until the company can guide to meaningful sequential revenue growth and margin re-expansion.

Over the longer term, I still like Ciena’s leverage to service provider and webscale deployments, as well as opportunities to grow its routing and PON businesses, and I think the shares can deliver an annualized double-digit return. In the short term, though, it’s hard to see much upside beyond $50 unless and until the supply problems ease and management can guide to meaningful sequential revenue acceleration.

 

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Ciena Needs More Chips To Pull Out Of The Dip

United Community Banks Combines Solid Execution With An Ongoing M&A Growth Story

Banks are not very popular at the moment, and banks that lean heavily on M&A to drive growth are even less popular … and yet, United Community Banks (NASDAQ:UCBI) shares are up about 5% since my last update, outperforming the regional bank group by around 10%. UCBI management has continued its acquisitive ways, but has also been delivering on strong asset sensitivity and operating leverage, driving better-than-expected results for the year.

I continue to believe that UCBI operates in fundamentally attractive markets, and I like the company’s overall strategy with respect to lending and deposit-gathering, including meaningful operations in “second-tier” metro areas where there is still good population and income growth, but less competition from non-local banks. Valuation is challenged by the reliance on an M&A model, but I do believe the shares are still modestly undervalued.

 

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United Community Banks Combines Solid Execution With An Ongoing M&A Growth Story

Between Weakening Crypto And A Questionable Deal, Semtech Is On Its Heels

The last few months have not been easy ones for Semtech (NASDAQ:SMTC). A collapse in the value of Helium HNT cryptocurrency (down 95% over the past year) threatens one of the recent sources of momentum in the key LoRa business, while the acquisition of Sierra Wireless (SWIR) looks questionable at best. If that weren't enough, handset volumes are weak, and it looks like PON, data center, and 5G deployments are slowing.

Should the Sierra Wireless deal go forward, I think it will ultimately destroy value for shareholders. That's offset by good long-term trends and opportunities in home broadband and data center, not to mention the longer-term potential of LoRa in the IoT space. The valuation does look too low now, but it's hard for me to recommend a stock where I disagree with management's strategic priorities, and that's the case for me now with Semtech.

 

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Between Weakening Crypto And A Questionable Deal, Semtech Is On Its Heels

Innospec Continues To Hit Its Marks, And Performance Chemicals Is Showing Exciting New Potential

I'm accustomed to quiet excellence from Innospec (NASDAQ:IOSP), a small ($2.7B market cap) specialty chemical company with operations in fuel additives, personal/home care, and oilfield services. Typically not well-covered by the Street, Innospec has generated mid-teens long-term returns for investors and has continued to build the business through a combination of organic reinvestment and selective acquisition. It's been a while since I've written about the company, but it has continued to execute well. Up about 10% since my last update, Innospec has beaten the market over that time, as well as many of its specialty chemical peers.

With management reinvesting more aggressively in growth opportunities within specialty chemicals for personal care and looking to drive improved operating leverage in the oilfield services business, I'm still bullish on the company and I find the valuation more interesting here. If mid-single-digit revenue growth and mid-to-high single-digit FCF growth are credible, these shares could still offer double-digit annualized return potential from here.

 

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Innospec Continues To Hit Its Marks, And Performance Chemicals Is Showing Exciting New Potential

With Short-Cycle Markets Expected To Fade, Fortive's Next Big Testing Is Around The Corner

Writing about Fortive (NYSE:FTV) back in March of this year, I expressed some concerns about whether the company was really living up to its billing as a "compounder" that could consistently add value through M&A. While liking the company's efforts to build up strong recurring revenue and exposure to long-term secular trends like automation, electrification, ESG, productivity, and safety, as well as the company's prospects for above-average growth, I still had some concerns about the margins, M&A discipline, and valuation.

The shares did subsequently slip into the mid-$50's, a point where prospective returns would have been in the high single-digits, before rallying and outperforming the industrial group. Close to 10% higher now, Fortive has been delivering more of late, and it looks better-placed than many of its peers/comps to navigate this next phase of the economic cycle. Valuation is less exciting now, and unless you're willing to go back to the "good ole days" of 20x-plus EBITDA multiples, it's hard to make the case that Fortive is fundamentally undervalued.

 

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With Short-Cycle Markets Expected To Fade, Fortive's Next Big Testing Is Around The Corner

Allison Transmission Seeing Healthy Demand Today, But The Future Remains The Major Debate

Despite stronger near-term results, the “now versus then” debate on Allison Transmission (NYSE:ALSN) won’t go away, as analysts and investors continue to argue over the adoption curve of electrified trucks, what role Allison will play in electrified vehicles, and what the profitability of that role may be. In the meantime, Allison is looking forward to multiple potential growth drivers in its established business, but also faces the prospect of further cost ramps for electrification-related R&D.

I liked these shares back in August of 2021, and the stock has done alright since then – rising close to 10% and roughly doubling the return of the market, while also outperforming other commercial truck suppliers like American Axle (AXL), Cummins (CMI), and Dana (DAN). The valuation now is more “good” than “compelling”, and I’d lean more toward other names like Dana, but that’s largely splitting hairs.

 

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Allison Transmission Seeing Healthy Demand Today, But The Future Remains The Major Debate

Preferred Bank Executing On Rate Leverage, But The Street Isn't All That Interested

As far as managing what is within their control, I can’t find much fault with Preferred Bank (NASDAQ:PFBC) since my last update on this smallish ($5B in assets) California bank. Rate leverage has been very strong, operating leverage has been very strong, and credit quality has likewise been quite good. But, banks being out of favor, the shares have done only a little better than the average regional bank since my last update, falling about 5% - beating the market by around 10%, as well as peers like East West (EWBC), Hope Bancorp (HOPE), and Pacific Preferred (PPBI), while underperforming Cathay General (CATY) by a few points.

Macro headwinds remain real, and I don’t expect the Street to stop worrying about this issue for at least another quarter or two. Preferred still has some leverage to further rate hikes, but the bank is already seeing demand destruction for loans and I don’t see much sustainable operating leverage with loan growth. Long term, I still think this is a good bank and I think the valuation is attractive, but this could be stagnant money until the Street is ready to look past the coming slowdown.

 

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Preferred Bank Executing On Rate Leverage, But The Street Isn't All That Interested

Ternium Hit Too Hard On Near-Term Steel Price And Margin Weakness

Tougher times usually see investors run toward quality, but that hasn’t benefited Ternium (NYSE:TX) this year, as the shares of this Latin American steelmaker have fallen about 13% since my last update, underperforming Steel Dynamics (STLD) and Nucor (NUE) by a wide margin, as well as ArcelorMittal (MT) and Gerdau (GGB). Given Ternium’s leverage to a recovering North American auto industry and longer-term reshoring, I think this underperformance is short-sighted, but it is also true that Ternium is looking at weaker EBITDA margins through 2023/2024 and a competitive Mexican steel market.

I still believe Ternium is undervalued, and I further believe that the relative valuation has become meaningfully more attractive. This is likely not a name that will get much love over the next six months, as prices and spreads continue to weaken, but I see upside into the $40s as investors eventually come back to the strong margins, cash generation, and balance sheet and the positive growth outlook.

 

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Ternium Hit Too Hard On Near-Term Steel Price And Margin Weakness

Lennox Going Into 2023 With An Iffy Mix Of Headwinds And Tailwinds

Writing about Lennox International (NYSE:LII) over a year ago, I wrote that I was more bullish on the short-term opportunities for the company than the Street, but found the valuation unappealing, and particularly so given some longer-term challenges. Since then, the company has indeed executed well on its residential HVAC opportunities, as well as refrigeration, but the shares are down about 20%, lagging the broader industrial group and most of its HVAC peers (Carrier (CARR) has done a little worse, Daikin (OTCPK:DKILY), Johnson Controls (JCI), and Trane (TT) have done better).

I do agree that the company is going into 2023 with price/cost tailwinds at its back, not to mention healthy ongoing trends in refrigeration, but I also still believe that the company’s lack of leverage to commercial HVAC (particularly outside the U.S.) is a meaningful headwind. Valuation is more reasonable now than before, but not what I’d call compelling yet.

 

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Lennox Going Into 2023 With An Iffy Mix Of Headwinds And Tailwinds

Hologic Looks Reasonably Valued As Business Normalizes After The Pandemic

The pandemic is not completely finished, but the Street has nevertheless turned to the question of what the new normal will look like for Hologic (NASDAQ:HOLX) as high-margin COVID-19 testing fades. The pandemic left the company in an excellent position with respect to system placements, and I believe pandemic-driven placements will create a significant barrier to entry for newer systems. At the same time, normalizing procedure counts and improving component availability should help the surgical and imaging businesses.

Hologic shares are up about 10% since my last update, outperforming Abbott (ABT), Bio-Rad (BIO), bioMerieux (OTCPK:BMXXY), and Qiagen (QGEN) over that time. I expect long-term core revenue growth of around 5% to 6% from here for Hologic, but the company will have the liquidity to be more active in M&A if management can find suitable targets. I also see opportunity for higher margins from here, but the valuation anticipates a lot of this. Hologic is a good company and holding good companies at reasonable valuations can work long term, but I wouldn’t call this a screaming bargain.

 

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Hologic Looks Reasonably Valued As Business Normalizes After The Pandemic

Gorman-Rupp's Sell-Off Seems Overdone Relative To The Longer-Term Opportunities

Looking at Gorman-Rupp (NYSE:GRC) back in March of this year, I did like the company’s exposure to industrial markets like HVAC and longer-term opportunities in wastewater and stormwater/flood control, but I preferred names like Xylem (XYL) and Franklin Electric (FELE) on their combinations of end-market exposures and valuations. Since then, Xylem and Franklin Electric have both done better than the average industrial stock (up almost 25% and about 5%), while Gorman-Rupp has lost about a quarter of its value.

Gorman-Rupp’s has lagged many of its water/fluid control peers in terms of both organic growth and margins this year, and the acquisition of Fill-Rite brought considerable debt onto the balance sheet. Weaker margins and a higher discount rate (due to higher interest rates and a riskier balance sheet) do reduce my valuation some, but the market has more than corrected for this and I think the valuation is a little more interesting now.

 

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Gorman-Rupp's Sell-Off Seems Overdone Relative To The Longer-Term Opportunities

BankUnited: Valuation And Deposit Costs Offset Sound Growth Investments

There are certainly things to like about BankUnited (NYSE:BKU). This bank has significant operations in an attractive fast-growing market (Florida) and is using an organic growth strategy to expand into attractive markets like Atlanta and Dallas. The bank has also been focused on addressing past deficiencies in its core deposit base, while also returning meaningful capital to shareholders.

Despite those positives, the shares have lagged the larger regional bank group since my last article (up about 9% versus up 25%), as my concerns about the bank's deposit costs and valuation have played out. At this point, BankUnited shares do look undervalued, but so do many other bank stocks, and without more meaningful differentiation in loan growth, spread margin, and/or operating leverage, I don't see what really ought to drive a "buy this, not that" call for BankUnited.

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BankUnited: Valuation And Deposit Costs Offset Sound Growth Investments

Komatsu Beating Estimates And Raising Guidance, But Going Nowhere Fast

In my last article on Komatsu (OTCPK:KMTUY), I noted a growing rift between the performance of Komatsu as a company and the performance of its shares. Since then, the company has continued to execute well, handily beating expectations, but the shares have arguably still lagged what that performance should have earned. Komatsu’s local shares are up about 8%, while the ADRs are down about 8%, versus a 15% move in Caterpillar (CAT) shares, 3% moves at Deere (DE) and Terex (TEX), and a much weaker performance at Volvo (OTCPK:VLVLY) and Hitachi Construction Machinery (OTCPK:HTCMY).

I believe Komatsu is undervalued relative to what the market has typically paid for peak earnings, but I’m also concerned that demand for construction machinery in markets like North America isn’t likely to get much better, and that demand in Indonesia and across the mining sector could likewise soften from here. I see a trading opportunity here, but I’d be careful about not overstaying my welcome.

 

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Komatsu Beating Estimates And Raising Guidance, But Going Nowhere Fast

BRF Shares Look Almost Left For Dead, But Sustainable Momentum Is Still Lacking

Very little is going well for BRF S.A. (NYSE:BRFS) these days. High production costs are sapping margins, while high prices seem to be leading to some demand destruction in the Brazilian processed/branded food business. At the same time, new management has yet to give the Street a clear sense of what they will do differently or how they will achieve meaningfully better results than the frustrating run of inadequate profitability seen for many years now.

That gloom is amply reflected in the share price, which has fallen another 30% since my last update, noticeably worse than the weak results of other protein peers like JBS S.A. (OTCQX:JBSAY), Marfrig (OTCPK:MRRTY), Minerva (OTCPK:MRVSY), and Tyson (TSN). At this point, it’s not too much of a stretch to say that the market is valuing BRF as though it has almost no future and/or that Marfrig will make a lowball offer to sweep up the remainder of the company it doesn’t own.

I honestly don’t know what to tell investors at this point. The valuation seems harsh, but results aren’t going to get meaningfully better soon and I don’t see the company generating enough free cash flow to meaningfully reduce its debt for some time. At a minimum, while expectations may be washed out, investors should remember that it can always get worse from here and this is, at best, a high-risk deep value/turnaround story.

 

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BRF Shares Look Almost Left For Dead, But Sustainable Momentum Is Still Lacking

Carpenter Technology: Navigating Well Through A Turbulent Initial Aerospace Recovery Cycle

These early quarters of the commercial aerospace upswing have had their challenges, with OEMs forced to revise their production schedules in response to unpredictable component availability from their suppliers. This does set the stage for elevated performance risk in the short term, as quarter-to-quarter production may deviate from expectations, but I remain bullish on a multiyear trend of growing narrowbody and widebody aircraft construction.

Carpenter Technology (NYSE:CRS) shares have risen close to 15% since my last update on the company, making them an outperformer in a space where rivals like ATI (ATI), Hexcel (HXL), Howmet (HWM), and Universal Stainless & Alloy (USAP) have seen a little more turbulence in results and sentiment. I continue to believe that Carpenter is well-placed to leverage that growing aerospace demand into improved financials and valuation, and I believe the shares are still worth consideration here.

 

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Carpenter Technology: Navigating Well Through A Turbulent Initial Aerospace Recovery Cycle

Universal Stainless & Alloy Products Takes A Step Back As The Aerospace Recovery Cycle Lurches Forward In Fits And Starts

The recovery in commercial aerospace is real, but it has proven to be considerably less of a smooth upward ramp and more of a drunken lurch, as major OEMs like Airbus (OTCPK:EADSY) and Boeing (BA) struggle to balance uneven production rates and capabilities among suppliers, and those suppliers (and OEMs) continue to struggle with component/supply availability, input costs, labor availability, and just about anything else you care to name. Add in operational challenges (some self-inflicted, others not), and Universal Stainless & Alloy Products (NASDAQ:USAP) ("Universal Stainless") has struggled to maximize these still-early days of recovery.

Down about 10% since my last update, Universal Stainless has lagged other material and component suppliers to the aerospace industry, but only Carpenter (CRS) has really done well over that time, as ATI (ATI), Hexcel (HXL), and Howmet (HWM) have been more "meh" than magnificent.

I've never thought that Universal Stainless was the best operator of the bunch, but I've seen over many years across many cyclical industries that secular upswings tend to produce more dramatic improvements at the less-capable operators, and I believe that will still be the case here. By no means is this the cream of the crop, nor a long-term holding, but I do believe this unfollowed and thinly-traded supplier of specialty steels can still produce attractive returns for more aggressive investors.

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Universal Stainless & Alloy Products Takes A Step Back As The Aerospace Recovery Cycle Lurches Forward In Fits And Starts

Short-Term Noise Shouldn't Drown Out The Attractive Commercial Aerospace Story At ATI

Will the real commercial aerospace market please stand up?

Air travel continues to recover, and airlines continue to look to refresh and expand their fleets, but the progression of the commercial aerospace recovery in 2022 has been choppier than expected. Orders continue to come in and lead-times continue to stretch for key materials and components, but unreliable supply chains and component availability has led to a slower ramp than initially expected.

None of this is particularly good news for ATI (NYSE:ATI) (formerly known as Allegheny Technologies) in the short run, but there is good news in an expanding order book, improving margins, and a multiyear opportunity to leverage strong commercial aerospace demand into cash flows.

ATI shares have risen about 7% since my last update, good enough to beat the market, as well as most other material and component suppliers like Carpenter (CRS), Howmet (HWM), Hexcel (HXL), and Universal Stainless & Alloy (USAP) over that time. Valuation is still relatively appealing, and I think these shares still offer upside.

 

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Short-Term Noise Shouldn't Drown Out The Attractive Commercial Aerospace Story At ATI

PRA Group Languishing Ahead Of New Supplies Of Charged-Off Debt

The pandemic was weird.

A normal cycle would have seen a surge in bad debts that banks and other creditors would ultimately write off and sell to recovery companies like PRA Group (NASDAQ:PRAA) and Encore (ECPG). Unlike prior cycles, consumers got an unusual level of government assistance this time, propping up their solvency and the credit quality of lenders. With that, the expected surge in write-offs never really happened, and PRA Group and Encore have been watching their inventory of charged-off receivables dwindle, hitting cash collections, revenue, earnings and cash flow.

PRA Group shares are down about 25% since my last update, while Encore has done slightly worse. I have no expectations that a quick turnaround in reported financials is around the corner, but I do see rising consumer debt, declining credit quality, and a tougher economic environment in 2023. Should that all play out, charge-offs will start increasing more meaningfully (likely in late 2023 or in 2024), PRA Group will have more to collect, and earnings will rebound. Whether investors want to wait for that rebound is up to them to decide, but the shares do look undervalued below the $40’s.

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PRA Group Languishing Ahead Of New Supplies Of Charged-Off Debt

ITT Pressured By Delayed Cost Recoveries And Weakening Short-Cycle Markets

Above-average organic revenue growth and margin expansion haven't helped sentiment around ITT (NYSE:ITT) all that much, as this diversified industrial has continued to underperform relative to the broader industrial group. A cautious tone from management about 2023 hasn't really helped (even if I think it's a more realistic view than what other companies have offered), and investors are trying to figure out just what the macro outlook for 2023 is going to be.

Down more than 10% since my last update on the company, I have mixed feelings about the stock. I think the company has better cycle exposure than the valuation reflects, but delays in driving better price/cost mix and a heavy exposure to auto builds are not what the Street really wants now. High single-digit long-term annualized return potential isn't bad, but I think it may take a few quarters for these shares to work again, and it's hard to call this a must-own when investors have a wider selection of undervalued industrial stocks to choose from at the moment.

 

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ITT Pressured By Delayed Cost Recoveries And Weakening Short-Cycle Markets

Margin Challenges And End-Market Worries Overshadowing Good Growth At Materion

This has been a tougher-than-expected year for Materion (NYSE:MTRN). While the company has seen strong demand in key core markets like semiconductors, industrial, aerospace, and energy, multiple margin headwinds have worked against the company, depressing reported profits and cash flows and leading to negative estimate revisions. The third quarter in particular was rough for sentiment, with a sharp drop pushing the shares down almost 10% since my last update – underperforming Johnson Matthey (OTCPK:JMPLY), but outperforming the semiconductor market that drives a substantial part of the business.

The margin challenges are disappointing, but not unsurmountable, and I think the share price has already paid the price for the reset of expectations. I do have some concerns about weaker semiconductor volumes in 2023, but I believe heavy industry, oil/gas, and aerospace should remain healthy. I’ve decided to take a more conservative “show me” stance on longer-term margin improvement, but even with those revisions, high single-digit growth can support a higher price for the shares.

 

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Margin Challenges And End-Market Worries Overshadowing Good Growth At Materion

Trane Technologies Offers A Multipart Puzzle Between Industry Drivers, Macro Risk, And Valuation

I described Trane's (NYSE:TT) valuation as "interesting" earlier this year, as the HVAC sector had weakened on a slowing outlook and what I believed to be sector rotation. While I wasn't fully comfortable with the valuation, I thought growth prospects were stronger in the near term than the Street was appreciating, and that has been borne out this year by the company's results.

The shares have appreciated close to 10% since that last article, outperforming not only the broader industrial space, but other HVAC and refrigeration companies like Carrier (CARR), Johnson Controls (JCI), and Lennox (LII). On the positive side, I like Trane's leverage to what I believe can be a multiyear trend of efficiency-driven upgrades, but on the negative side, I have some concerns about 2023 expectations and the valuation.

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Trane Technologies Offers A Multipart Puzzle Between Industry Drivers, Macro Risk, And Valuation

Ingersoll Rand Executing Well And Better Days Are Still Ahead

A year ago I was neutral on Ingersoll Rand (NYSE:IR) shares, as I liked the multiyear growth story underpinned by the company’s exposure to capital spending and certain ESG touch points like energy and resource efficiency, not to mention the M&A optionality, but didn’t love the valuation. The shares have sold off about 5% or so since then, keeping pace with the broader industrial space and outperforming Atlas Copco (OTCPK:ATLKY).

I’m still not exactly thrilled about the valuation, and I don’t feel that my underlying expectations (high single-digit revenue growth and meaningful margin/FCF margin expansion) are conservative. Still, at a time when short-cycle names are rolling over, I think Ingersoll Rand is in better shape than most over the next five years (and beyond). While I’m tempted to hold out in the hope of a better price on a market sell-off, I don’t think there’s anything wrong with owning a good company (and one likely to outgrow its markets and peers) trading at a reasonable price.

 

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Ingersoll Rand Executing Well And Better Days Are Still Ahead

Textron Drifting, As Its Main Drivers Now Are Outside Of Its Control

Wall Street isn’t a sentimental place, but I can empathize if Textron (NYSE:TXT) management and investors are a little frustrated with the circumstances around this aviation company. Supply chain issues are preventing the company from producing Cessna bizjets at targeted rates, while the wait goes on for a major military award that will play a significant role in the future of the company’s helicopter business.

These shares have fallen almost 10% since my last update, underperforming the broader industrial space and other aerospace-leveraged names like General Dynamics (GD), Honeywell (HON), and Lockheed Martin (LMT), and only doing a little better than Boeing (BA). I do have some concerns that expectations for the bizjet cycle are getting too bullish, but I believe Textron can still generate long-term revenue growth in the neighborhood of 5% and the shares look more interesting on that basis, but there’s above-average risk here right now.

 

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Textron Drifting, As Its Main Drivers Now Are Outside Of Its Control

First Citizens BancShares Off To A Good Start With Its Transformative Acquisition

For several years now, investors owning the shares of banks undertaking large mergers have had to wait a while to see the benefits, as the market has taken a “wait and see” approach that has meant underperformance relative to benchmarks until the synergies start showing up. So far, First Citizens Bancshares’ (NASDAQ:FCNCA) (“First Citizens”) merger with CIT is working out well, and the stock has been outperforming on good core operating profits, with early evidence of cost synergies and above-average lending growth.

Up about 15% since my last update, First Citizens has outperformed the regional banking sector by close to 15%, as well as outperforming other commercial-driven growth banks like East West Bancorp (EWBC), Pinnacle Financial (PNFP), Signature (SBNY), or SVB Financial (SIVB). I have some concerns about a weaker macroeconomic environment in 2023 and higher deposit costs, but I’m still expecting high single-digit normalized core growth from this bank, and that continues to support an attractive return in a still-out-of-favor sector.

 

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First Citizens BancShares Off To A Good Start With Its Transformative Acquisition

Werner Enterprises Is More Defensive, But The Street Doesn't Care

Looking at Werner Enterprises (NASDAQ:WERN) back in March of this year, I thought that the company’s stronger skew to the more stable dedicated carrier business (contracted truckload trucking for customers like retailers) would serve the company in good stead as the freight cycle peaked and then rolled over, sending volume expectations and spot rates lower. Well, the cycle has rolled over, but Werner hasn’t been quite as defensive as I’d hoped – the shares have dropped about 10% since then, a little worse than Heartland Express (HTLD), which typically has some counter-cyclical appeal, and a little better than Knight-Swift (KNX).

At the risk of sounding a little flippant, it’s the rare trucking stock that doesn’t look cheap to me today, leading me to wonder whether my assumptions for the next three years (and beyond) are simply too bullish or whether the Street is doing what it often does with cyclical stocks – dumping them almost irrespective of longer-term value in favor of stocks more likely to show earnings growth and margin leverage over the next year or two.

I think it’s the latter, and Werner does still look undervalued to me. It’s a more defensive name, and this would seem like a better time to think of defense first, but investors should remember that cyclical plays are meant as trades (not long-term buy-and-holds) and there will come a time when a shift to more aggressive carriers will be in order.

 

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Werner Enterprises Is More Defensive, But The Street Doesn't Care

Even Considering A Worse-Than-Consensus Downturn, ArcBest Seems Too Cheap

Given the difficulties of predicting the timing and magnitude of the cycles, trucking stocks can create some attractive trading opportunities, but at the cost of elevated risk. I think that’s a relevant consideration when looking at ArcBest (NASDAQ:ARCB) – the shares do look undervalued now, but trucking stocks (including less-than-truckload carriers like ArcBest) don’t perform well when the PMI heads below 50 and there is growing evidence of a meaningful slowdown in industry drivers.

Since my last update, these shares have risen about 15% overall (and they ran up almost 80% toward the end of 2021), outperforming other LTL carriers like Old Dominion (ODFL), Saia (SAIA), and Yellow (YELL). I am concerned that I’m underestimating the degree to which ArcBest will see volumes and profits contract in the coming downcycle, but the shares look undervalued on what I consider to be reasonable modeling assumptions. While the space is a little crowded with ideas now, I think ArcBest is worth a look.

 

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Even Considering A Worse-Than-Consensus Downturn, ArcBest Seems Too Cheap