Constellation is still under-leveraged on national distribution and under-leveraged to on-premises, but management continues to work at both, with evident progress over the last year (and beyond). While trade-down and tougher comps are an emerging risk, and I do see some margin vulnerability in the short term, Constellation still looks undervalued to me and worth a closer look.
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Constellation Brands: Executing Well And Gaining Share, With More To Come
Sensata Technologies (NYSE:ST) has seen its share price fall a little more than 20% since my last update. While I suppose that’s not terrible next to other broadly comparable suppliers to the auto and commercial vehicle markets, including Aptiv (APTV), Dana (DAN), and TE Connectivity (TEL), it’s not the year I expected for this sensing and controls company, and 2023 isn’t offering much in the way of macro certainty.
I do think that Sensata looks undervalued, but I also thought that in the high-$50’s. Now Sensata is looking at a potentially softer auto demand environment, as well as weaker trends for highway/off-road business and industrial markets. Provided that mid-single-digit growth is still viable, which I believe it is given the company’s higher EV content and its growth opportunities elsewhere in electrification, these shares offer a worthwhile return at today’s price.
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The investment case for Nidec used to be more of a battle about the right multiple to pay, as Nidec shares historically traded at rich multiples. While the sharp pullback has helped the longer-term valuation argument, the shares still remain pricey on more conventional short-term multiples-based approaches. While I do like Nidec’s leverage to vehicle electrification, a weaker market for consumer electronics could persist and Nidec has significant sentiment headwinds to overcome.
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Hammered By Input And Launch Costs, Nidec Is Worth Another Look
Down about a third since my last ill-fated update, Cognex has been a notable laggard in an otherwise flattish market for other automation names like Datalogic (OTC:DLGCF), Fanuc (OTCPK:FANUY), Keyence (OTCPK:KYCCF), Rockwell (ROK), and Yaskawa (OTCPK:YASKY), though KION (OTCPK:KIGRY), another logistics-driven name, has been even weaker. While I do see long-term value in the name here, it’ll be difficult for sentiment to turn with logistics revenue likely down 20%-plus again in 2023, particularly if other end-markets weaken more than seems to be baked into sell-side expectations.
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Cognex Languishing Through A Painful Reset Of A Major Growth Market
I’m increasingly concerned about what look like structural cost issues at Cemex that seem likely to lead to longer-term underperformance in profitability. That said, I do think infrastructure demand is likely to remain quite supportive and today’s price seems to reflect an overly bearish outlook for the company. Management has most definitely not earned the benefit of the doubt here, but if the company can manage something on the order of 4% long-term EBITDA growth, I do think there is some value here.
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The only real negative I can’t point to here, apart from a deteriorating macro environment, is the valuation. Hancock Whitney has been doing well, but not well enough to drive substantial upside revisions to my numbers, and so the outperformance is chewing into some of the undervaluation I saw before. I’d rather own a more expensive high-quality bank than a cheaper low-quality bank, but investors probably shouldn’t expect much beyond a high single-digit to low double-digit return over the next year.
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Hancock Whitney Outperforming On Solid Execution And A Great Balance Sheet
The challenge in approaching Franklin Electric today is balancing out the near-term end-market weakness with above-average long-term potential, as well as a valuation that’s not so exceptional compared to industrials in general, but looks rather good compared to how the market has traditionally valued water plays.
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Franklin Electric Offers Solutions To Long-Term Water Issues, But The Near Term Is More Challenging
Since my last update, this has been one of the strongest stocks among the industrials I follow, with the shares up almost 25% and beating flat performance for the larger multi-industrial group, as well as other high-value "compounder" industrials like Ametek (AME), Danaher (DHR), Fortive (FTV), Nordson (NDSN), Rockwell (ROK), and Roper (ROP). This outperformance has been well-founded, with strong double-digit revenue growth and healthy margins, as well as broad-based strength in the business.
Valuation is my biggest issue. I realize some investors believe in buying quality and holding on irrespective of valuation, but I think entry prices matter, and it's tough to see how IDEX is substantially undervalued even given above-average growth potential in the coming years.
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IDEX Rightly Appreciated For Its Excellent Credentials And Advantageous Market Exposures
Since my last update, Silicon Labs (NASDAQ:SLAB) has outperformed the broader semiconductor space by about 15%, as the company has continued to post strong growth from its IoT-focused business. While there is growing evidence of an impending slowdown (echoed by other players in IoT), this hasn’t been outside of my expectations. I do see elevated risk to sentiment and near-term estimates, but I also think Silicon Labs is trading at a pretty attractive valuation relative to how growth semiconductor stocks typically trade.
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Silicon Labs: A Growth Story That Is Dented, And Maybe Delayed, But Not Derailed
I like the strategy Valley National is following now, and I think the Bank Leumi deal may be a better long-term opportunity for the company than is reflected in the share price, as I think a larger private banking operation (somewhat similar to First Republic (FRC)) and a larger national specialty commercial lending franchise (somewhat similar to First Citizens (FCNCA)) can both create value. Still, I’m worried about the short-term profit outlook given the bank’s need to raise higher-cost deposits and the Street’s penchant for short-term thinking. Valuation is interesting at today’s level but there are a lot of banks trading at “interesting” valuations, and sentiment remains a concern for me.
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I still see Texas Capital as a short-term/long-term puzzle I do like the CEO’s vision for what the bank should be – focused on commercial lending, with stronger investment banking, trading, and treasury options to drive fee income and stickier relationships – but it will take time to get there. In the meantime, I see elevated operating risk on higher deposit costs and weaker operating leverage. Investors unsure of their ability to time a turn in sentiment for banks may want to consider buying or holding the shares now, but there could be better entry points over the next year.
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Texas Capital Bancshares: A Sound Long-Term Transformation Plan, But Vulnerable In The Near Term
While I thought the challenging macro environment in Turkey would mitigate potential gains in the share price, I’m happy to say I was wrong – Turkcell shares have risen more than a quarter since my last update, a strong performance against a backdrop of largely negative emerging market telco performances over that time. While the shares still look undervalued, the challenges of modeling in a high-inflation environment are considerable and ongoing erosion in the value of the Turkish lira remains a real risk.
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Turkcell Continues To Execute Well, But Macro Remains An Uncontrollable Risk
This has been a tougher-than-expected year for auto suppliers, as component availability (particularly semiconductors) has continued to impact production schedules, leading to lower-than-expected volumes and margin headwinds from inefficient production schedules, compounded by ongoing inflationary pressures on inputs. Despite those challenges, BorgWarner (NYSE:BWA) has done better than many peers relative to expectations, and management has kept the company on track with respect to building out its capabilities in electrification.
BorgWarner shares have lost about 5% of their value since my last update, a disappointing result, though still better than the S&P 500 and better than many peers/rivals like Faurecia (OTCPK:FURCF), Valeo (OTCPK:VLEEY), Aptiv (APTV), Lear (LEA), and Dana (DAN), though trailing American Axle (AXL) and Vitesco (OTCPK:VTSCY). While I do still believe that BorgWarner is meaningfully undervalued, a weaker consumer spending backdrop for 2023 isn't helping near-term sentiment, and significant ongoing questions remain about the long-term market share and profitability of BorgWarner's EV-based businesses.
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Broadcom shares have rebounded about 20% since my last update on the company (only about a month and a half ago), and while that is better than the performance of the SOX index (up about 16%) and certain select peers (like Marvell (MRVL)), a few like Microchip (MCHP) and NVIDIA (NVDA) have done even better. Pull the comparisons out a year, though, and Broadcom is handily outperforming all of those except Microchip (which it has outperformed, but not by a wide margin).
I still view Broadcom as a core holding. I love the company's leverage to high-end networking/data center demand for connectivity and AI acceleration, as well as leverage to home broadband, and I believe businesses like wireless, storage, and software are still more than worthwhile over the longer term. Roughly 20% below my fair value estimate and priced for a high single-digit long-term annualized return, this remains an attractive idea in my view.
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For Broadcom, Outperformance Is Just Another Day At The Office
Supply chain issues hamstrung Ciena (NYSE:CIEN) throughout its fiscal 2022 year, as the company couldn't get the chips and other components it needed to fulfill robust orders from telco, enterprise, and cable companies. The fiscal fourth quarter was a different story, though, as the company was finally able to fulfill more of its component needs, allowing for a double-digit sequential growth rate in its core networking equipment business.
Ciena shares spiked about 20% on the strong fourth quarter beat and management's guidance for FY'23, but the company isn't completely out of the woods yet where margin recovery is concerned. Even so, I believe the shares remain undervalued with more visibility on mid-to-high single-digit revenue growth (stronger over the next few years) and a sustained margin recovery, not to mention share growth in its core markets and expansion into meaningful new adjacent markets.
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Ciena Spikes On Improving Supply, And The Backlog Remains Robust
JPMorgan shares are up almost 20% since my last update, leading the way among the large banks that could reasonably be considered peers. With that outperformance, and the risk that net interest income could reach a peak in the next quarter or two, it’s harder to argue for JPMorgan’s near-term outperformance potential, but I do still see a worthwhile longer-term total return opportunity here. What’s more, if the economy weakens even more than I expect and sees a hard/harder landing scenario play out, I believe JPMorgan will fare better than most.
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The shares have fallen another 25% since my last update (and over 40% since I flipped from neutral to positive in mid-2021), dramatically underperforming its peer group. I've underestimated just how willing this bank would be to pay the short-term costs for long-term growth, but I do still believe in the longer-term story here. I think the shares remain undervalued, but I could see sentiment and near-term earnings pressure weighing on the stock at least through mid-2023, given where we are in the rate cycle.
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My feelings on Lexicon remain mixed since I wrote in July. I do see significant commercial potential for sotagliflozin based upon the size of the market and the clinical efficacy of the drug, but the challenges of building a go-it-alone marketing infrastructure capable of maximizing the opportunity are not at all trivial. Likewise, I'm encouraged by the potential of LX9211, but there's still a long road ahead to realizing that potential. I think a fair value estimate of $5.50/share is valid, but this remains a high-risk/high-reward sort of opportunity.
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Unexpectedly stronger headwinds from foreign exchange and input costs aren't exactly unusual today, but they are combining to make life more challenging for Brown-Forman (NYSE:BF.A)(NYSE:BF.B). On top of that, the underlying volumes in spirits aren't really that exceptional and the stock remains richly-valued by most approaches.
These shares are down around 10% since my last update, underperforming consumer staples (the Consumer Staples Select Sector SPDR Fund (XLP)) overall and names I preferred back in the day like Diageo (DEO) (that article is here) and Pernod Ricard (OTCPK:PRNDY) (that article is here). Still, while the long-term returns haven't been bad at all (a double-digit annualized total return over the last 10 and 15 years), the valuation today is no clear bargain to me, and I don't really find this a compelling idea even after the sharp post-earnings reaction.
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Brown-Forman: Not A Compelling Idea - Softening Volumes, Weaker Margins, And High Valuation
I can understand why at least some investors would prefer the certain accretion of buybacks over another M&A transaction that brings integration and execution risk. I believe further transformation is necessary, though, and I favor using cash flow to build up (or perhaps shore up) the company’s future prospects and cash flow generation capabilities, so I see this as a short-term versus long-term debate. I do think the selloff makes the shares more interesting, but I do also see ongoing execution risk here.
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NRG Energy And Vivint: Paying For Transformation, The Street Prefers Buybacks
This has had a massive negative impact on the share price, with the stock down more than 50% since my last update on the company. This is a huge setback, but I do note that the company is still leveraged to an ongoing trend among major retailers to shift to recycled polyesters and this inventory issue with retail and apparel customers will resolve over the next few quarters. Even with a sharp revision to near-term financials, I still believe there is a bullish case to be made for the shares, though it will take some time to recoup the losses seen in 2022.
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Unifi Hit By A Sharp Downturn In Orders, But It Doesn't Unravel The Long-Term Story
There’s no definitive rule about what works in med-tech, but companies that combine good-but-not-great revenue growth (below the double-digits) and good-but-not-great EBITDA margins (below the mid-20%’s) can often drift in a sort of valuation no man’s land where the shares can struggle to rerate meaningfully higher. That may be at least part of what’s hurting the share price performance of Enovis (NYSE:ENOV), as the company is an odd mix of business segments with varying growth prospects.
I wasn’t overly fond of Enovis at the time of the Enovis-ESAB (ESAB) separation, and the 20% or so drop in the share price since then hasn’t made me regret that position. I have been impressed with the performance of the Reconstructive business, but I continue to believe that management’s expectations and targets for the Prevention & Recovery business, and the business as a whole, could still be too high. What’s more, I think the lack of “pure-play” leverage to more attractive growth markets could make the stock a harder sell with institutional investors.
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I’m expecting high single-digit revenue growth from Sonova over the next three to five years, slowing toward a 5% to 6% growth rate over the longer term, and I’m expecting EBITDA margins to expand into the low-to-mid-30%s over the next few years. Between discounted cash flow and growth/margin-driven EV/revenue, I do think these shares offer enough upside to merit a closer look from investors.
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Sonova Seeing Strong Execution Collide With Macro Uncertainties
I didn’t find a particularly compelling risk/reward opportunity with the shares when I last wrote about the company in early February of 2021, and with the shares down almost 25% since then (underperforming peers like Stryker (SYK) and the broader med-tech space), I don’t feel like I’ve missed out on much. While there have been signs of progress here and there, the reality is that the company’s performance in the ortho space on a two-year stack shows share loss in major joints.
I don’t think the valuation is particularly demanding if Zimmer can generate around 3% long-term revenue growth, mid-30%’s EBITDA margins, and high single-digit FCF growth. The real question, though, is whether or not the company can generate the sort of differentiated growth that will get investors to take a closer look – low-growth med-tech is a tough set-up for making money and I do have concerns that this could be a value trap.
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Zimmer Biomet's Valuation Offset By Lackluster Growth And Limited Near-Term Margin Leverage
In terms of investor sentiment, it’s basically back to square one for AngioDynamics (NASDAQ:ANGO) after a fiscal first quarter where the reported numbers weren’t quite that awful, but where management commentary on several subjects cast a pall over the company’s near-term prospects.
The shares are down more than a third since my last update on the company, lagging Cardiovascular Systems (CSII) and Inari (NARI) by a wide margin, and lagging Penumbra (PEN) by an exceptionally large margin. It’s difficult to recommend the shares here, as value stories in small-cap med-tech don’t often work out well and many of the issues pressuring sentiment won’t resolve quickly. I do think today’s price undervalues the business as a going concern, but I don’t see a high likelihood of M&A interest and the company’s combination of sub-10% revenue growth and single-digit adjusted EBITDA margin is far from compelling.
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AngioDynamics Now Finds Itself Deep In The Street's Doghouse
This is an interesting time to evaluate PNC’s investment prospects. The valuation doesn’t stand out as exceptional relative to many other large banks (not to mention many smaller banks), but I like PNC’s skew to commercial lending and its strong credit quality history. If the economy does better than expected next year, PNC will likely be a laggard, but PNC is a good option for investors who may have a less robust outlook for 2023, but still want some bank exposure. I’d also note that in terms of P/TBV, P/E, and so on, PNC is trading below longer-term averages.
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PNC Financial Has A Better Mix Of Drivers In A Sector That's Still Off Its Highs
I can come up with at least a few reasons for some weakness in Pinnacle shares – the bank’s above-average deposit beta, aggressive opex spending growth, and dependence on loan growth among them – but even against a tougher backdrop for 2023/24, I think the shares still look attractive for growth-oriented investors willing to take on additional risk in pursuit of above-average returns.
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Pinnacle Financial Partners Undervalued, But Arguably Out Of Step With A Nervous Market
U.S. Bancorp has the “Main Street banking” exposure I still favor, but the bank’s leverage to corporate payments and merchant processing could be a near-term weakness if the economy slows more than expected, and I’m likewise still concerned about the bank’s deposit leverage through this next phase of the cycle. On the other hand, closing the Union Bank deal should relieve at least one sentiment overhang, and I think the shares are priced for a sub-2% core earnings growth rate that I believe the bank should be able to beat by a decent margin in the years to come.
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U.S. Bancorp: Valuation And A Vanishing Deal Overhang Should Help Address Underperformance
