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
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
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
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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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
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
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
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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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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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
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
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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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 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 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