Synovus Delivering On Growth And Leverage

 There have long been vocal doubters on Synovus (NYSE:SNV), and the company’s share price performance over the last couple of years has lagged its peer group, but with above-average fourth quarter results and guidance for 2023, Synovus is getting a little more positive attention lately. While I do think some of management’s growth targets for 2023 could prove challenging (if not ambitious), 3% to 4% core growth can drive a respective target price and anticipated return from here.

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Synovus Delivering On Growth And Leverage

Consistency Carrying Commerce Bancshares

I believe that at least part of the reason that investors are willing to bid up Commerce Bancshares (NASDAQ:CBSH) to above-average multiples is that this bank is built to weather the ups and downs of normal banking cycles without much drama. And so it would seem to be the case in the fourth quarter as well, as the bank continues to see solid, but not spectacular, results.

Commerce shares are up a bit from my last update, outperforming peers in a market where there is still a lot of angst as to what banking earnings will look like in 2023 due to rising deposit costs and more limited operating leverage prospects. As much as it surprises me to say this, I don't find the valuation all that bad, at least relative to what passes for normal with Commerce, and while I can't really recommend it wholeheartedly as a bank stock likely to generate substantial outperformance, I think it is a name for investors who want less drama and volatility.

 

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Consistency Carrying Commerce Bancshares

Truist Looks Better Placed Than Many Banks For Better Growth In 2023

Banking is all about leverage, and Truist (NYSE:TFC) looks to be better-placed than most peer banks to drive rate and operating leverage in 2023, setting the bank up for relatively better operating performance. In the context of what I think is a still-too-low valuation, that's a positive set-up for investors looking for names in the still out-of-favor banking sector.

Truist had been outperforming its peer group since my last update, and a well-received earnings report certainly didn't hurt. While I would be careful not to project too much onto a company that has struggled to meet expectations since the transformative combination of BB&T and SunTrust, it does seem as though this bank may finally be getting its legs under it, and I still see opportunities to drive growth and value creation from here. Below the mid-$50's, I think this is a name to consider.

 

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Truist Looks Better Placed Than Many Banks For Better Growth In 2023

UnitedHealth Seems Curiously Undervalued Given Multiple Growth Drivers

In a business where scale is king UnitedHealth (NYSE:UNH) has all the scale that an investor could ask for and more. What’s more, the company has actively built and pursued attractive growth opportunities outside of its traditional (and more heavily regulated) medical insurance/benefits business, including its OptumHealth provider business, OptumRx PBM, and OptumInsight analytics/information systems businesses.

I like where UnitedHealth sits going into 2023. Normalization of healthcare utilization will be a modest headwind, but the company’s vulnerability to inflation and a potential recession are quite modest, and higher rates benefit the business. On top of that, the company still has opportunities to drive growth from its OptumHealth and Medicare Advantage businesses. While there are some challenges on a straight P/E-based valuation, I do think these shares are undervalued on a longer-term core earnings basis.

 

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UnitedHealth Seems Curiously Undervalued Given Multiple Growth Drivers

Fulton Financial Could Use More Core Growth Leverage

It’s still early in the fourth quarter reporting cycle, but so far the bank sector is not having the easiest time. The main drivers aren’t all that surprising to me – I’ve been writing about the threats presented by rising deposit betas, weaker operating leverage, and slowing loan demand for some time, but it seems as though the Street is taking it more seriously now.

Fulton Financial (NASDAQ:FULT) came up short on fourth quarter results and 2023 guidance, although the bank is actually performing well with respect to its deposit beta. Leveraging the Prudential Bancorp deal will be an important driver in 2023, as will the health of the economy in the Philadelphia region, but this remains a bank that has something to prove to the Street where operating leverage and organic growth are concerned.

These shares have fallen about 10% since my last update, more or less matching regional bank peers. I do think the shares are likely undervalued here, but with a challenging 2023 ahead and not a lot of clear positives to tie a bullish thesis to, I can’t really muster that much enthusiasm today.

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Fulton Financial Could Use More Core Growth Leverage

First Republic Planting The Seeds For A Later Harvest

It may be an exaggeration to say that 2023 is a lost year for First Republic (NYSE:FRC), particularly in mid January, but I don’t think it’s an exaggeration to say that the results this bank will post this year will not be representative of the real long-term earnings power of the business. First Republic is going to take a hit from much higher funding costs, but the bank is willing to pay that short-term cost to reap the long-term benefits of continuing to build a base of high net-worth customers that can continue to support above-average loan growth and profitability over the longer term.

First Republic shares have done pretty well in the brief time since my last update, climbing more than 12% in the last six weeks and outperforming peers (particularly smaller regional banks). The call on this stock is a fair bit more challenging today – while I think the shares are undervalued for investors looking for a long-term buy-and-hold name, I do think there's a better-than-average chance of another chance to buy at more attractive levels this year, particularly if the Fed maintains a harder line on rates through the end of the year.

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First Republic Planting The Seeds For A Later Harvest

JPMorgan Executing Well In Challenging Times And Still Undervalued

This year is likely to be one where management and business quality, as well as past strategic decisions, really show up in the results of bank companies. Most banks will likely see net interest margins peak between Q4’22 and Q2’23, operating leverage will be harder to come by, deposit costs will rise and so too will credit costs. With above-average funding, loan growth and market share growth prospects, and fee-generating businesses, I think JPMorgan (NYSE:JPM) is better placed than most, though I do acknowledge that operating leverage could still prove to be a headwind for this large bank.

My last update on JPMorgan was fairly recent, but the shares have continued to outperform since then, as well as outperforming over the past six and 12 months. My core assumptions haven’t changed that much, though my 2023 numbers are a bit higher now. I’m expecting long-term core growth in the 4% to 5% range, driven not only by fee-generating businesses like its payment operations, but share gains in commercial lending as well. Below the high-$140s to low-$150s I believe these shares are worth consideration.

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JPMorgan Executing Well In Challenging Times And Still Undervalued

Keysight Technologies Offers Enough Quality Growth To Support A Robust Valuation

There are plenty of sayings (and cliches) regarding valuation and quality in the investment world, but it is nevertheless true that quality, value, and price are all distinct characteristics. I mention this because I think it’s an important backdrop for looking at Keysight Technologies (NYSE:KEYS). This leader in electronic design and test and measurement tools isn’t conventionally cheap, but I do think the less-cyclical nature of the business, the quality of the business, and the longer-term growth and margin potential combine to make a stronger value call than the multiples might otherwise suggest.

I’m not saying that Keysight is cheap, but I do think investors can expect to get solid value for the money here. I do see some risk that macro headwinds could prove stronger than the Street expects in calendar 2023, but I like the company’s long-term leverage to macro trends like data traffic growth, connectivity, and electrification. At $165 or below this would feel like an easier (or safer) call, but even at today’s price I think long-term investors can reasonably expect to be happy with the long-term returns.

 

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Keysight Technologies Offers Enough Quality Growth To Support A Robust Valuation

Cirrus Logic's Current Valuation Seems Less Than Completely Logical

A carefully cultivated skepticism can be an investor’s best friend, and when a stock looks too cheap, it’s absolutely a good idea to wonder why. In the case of Cirrus Logic (NASDAQ:CRUS), I understand concerns about the company’s heavy reliance on Apple (AAPL) and a soft outlook for smartphone units in CY’23, but even with those concerns accounted for, the share price here looks surprisingly attractive.

I like the efforts the company has taken to diversify beyond its long-held strength in audio, and I think there is still plenty of room for the High-Performance Mixed Signal (or HPMS) business to grow from here. I likewise think additional M&A deals are more likely than not. All things considered, then, I think this is a name where readers might want to consider some due diligence and investigation of their own.

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Cirrus Logic's Current Valuation Seems Less Than Completely Logical

Penumbra Riding Higher On Upcoming Launches And Rerating

When I last wrote about Penumbra (NYSE:PEN) in August of 2022 I was bullish on the company based on the prospects for meaningful upcoming product launches and a material rerating for the shares. This has largely panned out since then, with the company recently launching the Lightning Flash in the U.S. and seeing valuation multiples expand again on more bullishness around the company’s ability to hit 20% revenue growth in 2023.

The shares are up more than 35% since that last article, handily beating the Dow Jones Select Medical Equipment Index over that time, as well as rival Inari (NARI). Valuation is never completely straightforward with growth med-tech like Penumbra, but at this point I see the valuation as much less of a bargain, but I don’t discount the possibility of even further positive rerating if Penumbra can log some beat-and-raise quarters on the back of Lightning Flash and other new products heading to the market this year.

 

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Penumbra Riding Higher On Upcoming Launches And Rerating

Power Integrations Seeing A Temporary Brownout

Even differentiated growth stories are often bounded by the performance of the underlying markets they serve, and so it seems with Power Integrations (NASDAQ:POWI). After a soft third quarter that saw 13% sequential revenue contraction, management guided to even weaker fourth quarter results and the company is likely to see a year-over-year decline in 2023 as the company sees inventory corrections across much of its business.

Even so, the shares have held up pretty well, only declining about 7% over the past year and outperforming the semiconductor industry index (the SOX) by more than 20%. Performance compared to other power-heavy semiconductor stocks has been more mixed, with onsemi (ON) and Analog Devices (ADI) outperforming and Infineon (OTCQX:IFNNY) underperforming. Pull the comparison out to three years and Power Integrations has done a little better than the SOX, a little worse than Analog and Infineon, and nowhere near as well as onsemi, which I attribute at least in part to POWI’s robust valuation in years past.

Looking at the investment case, I see some similarities with names like Lattice (LSCC) and Silicon Labs (SLAB) where valuations have gotten a little less demanding but where it’s still hard to call them conventional bargains. I’m not a big believer in “ignore valuation and just buy”, but if you want a solid multiyear growth semiconductor story this is a name to look at today.

 

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Power Integrations Seeing A Temporary Brownout

Cosan: Volatility In SEE Markets Only Adds To The Complexity

Brazilian conglomerate Cosan (NYSE:CSAN) is a complicated story in the best of times, as this company pursues a holding company structure to invest in a wide range of businesses, including its Raizen joint venture with Shell (SHEL) in sugar, ethanol, and retail fueling, its Rumo rail operations, and other businesses like natural gas distribution, lubricants, and land development. On top of this “chosen” complexity, the company is now also dealing with a more volatile environment for its core sugar, ethanol, and energy (or SEE) operations, with weaker ethanol prices in Brazil and more risk in the sugar market.

Cosan is a difficult stock to recommend in some respects, as there are a lot of moving parts to track and this isn’t the easiest investment for investors to assess. I do believe management has built a track record of value creation, but it looks as though the business will only get more complex and diversified over time. I do believe this pullback in the shares is an opportunity for investors who can look past increased near-term volatility, but this isn’t really a “sleep well at night” sort of stock.

 

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Cosan: Volatility In SEE Markets Only Adds To The Complexity

S&W Seed: Trying To Thread The Needle With A Refreshed Product Lineup And Growth Strategy

It's been a while since I've written about S&W Seed Company (NASDAQ:SANW) and the intervening period has not been particularly kind to this small ag-tech company. The company has continued to struggle to get farmers to use its higher-value improved alfalfa varieties and a distribution agreement with Corteva's (CTVA) never really produced the hoped-for benefits; likewise with a venture into sunflower seed development. Management hasn't given up, though, and the company is hoping that new efforts in sorghum and stevia, in addition to better execution in the alfalfa and forage/cover crop businesses, can finally drive some momentum in the business.

This is an exceedingly risky proposition, and the company now has the dreaded "going concern" warning in its financial filings. It does seem that the new Double Team herbicide-resistant sorghum product is gaining some traction, but the company is pressed on liquidity and has only a narrow path forward, particularly as growing the sorghum business will require reinvestment. I can see meaningful upside from here if management can thread that needle, but readers should realize that this is an exceptionally speculative stock.

 

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S&W Seed: Trying To Thread The Needle With A Refreshed Product Lineup And Growth Strategy

SKF's Rally Into 2023 Seems Overdone

Industrials have certainly recovered of late. With investors feeling more confident that the impending downturn will be mild and that rate hikes are close to an end, the industrials have climbed about 20% over the last three months, and Sweden’s SKF (OTCPK:SKFRY) has gone along for the ride, though the shares are still down about 20% over the last year.

I think this rally may prove to be too much too soon. With global PMIs falling and the company likely to see weaker end-market demand coupled with price/cost pressures, 2023 isn’t going to be an easy year and if the market is wrong about a mild slowdown, there could still be meaningful downside to estimates. I don’t think SKF is particularly expensive now (and my near-term expectations are below sell-side averages), but I see a relatively unfavorable risk/reward balance going into the fourth quarter reporting season.

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SKF's Rally Into 2023 Seems Overdone

EnPro Becoming A Slimmer, More Profitable, And Less Cyclical Multi-Industrial

EnPro (NYSE:NPO) management has been transparent about its intentions to continue to remake the company into a more niche-oriented multi-industrial focused on less-cyclical, faster-growing markets, and with a product portfolio more skewed to high barriers to entry driven by engineering and sticky customer relationships. With the sale of GGB done, EnPro goes into 2023 focused on its specialty Sealing Technologies and Advanced Surface Technologies businesses, both of which offer better growth and margins than the company's historical trends.

These shares have done well since my last update, appreciating more than 15% and beating both the S&P 500 and the wider industrial group.

I do see some near-term sentiment risk for EnPro, as the company is heavily dependent upon the semiconductor industry and still has meaningful exposure to cycle markets like heavy-duty trucks and short-cycle "general industrial". While 2023 likely won't be a banner year, I do think the company is well-placed for organic growth in the mid-single-digits and strong EBITDA and free cash flow margins. The shares aren't particularly cheap now, and I'd rather wait in the hopes of a pullback, but I like the strategy management is following, and I think EnPro can be a long-term outperformer in the multi-industrial segment.

 

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EnPro Becoming A Slimmer, More Profitable, And Less Cyclical Multi-Industrial

Teleflex Already Getting A Pretty Good Benefit Of The Doubt

Teleflex (NYSE:TFX) goes into 2023 needing to prove that the company can get the business growing back to a level more in line with investor expectations, and that includes the key UroLift product. The company has faced challenges including disrupted office visit trends and supply shortages, but the market is not going to be particularly forgiving if the business doesn’t start showing real acceleration over the next few quarters.

I can’t say that I’m all that bullish on the shares today. I think reaccelerating the UroLift business may be more challenging than management believes, and I’m concerned that the company is going to find itself challenged to meet Street growth expectations. M&A remains a wild card, and management has a good track record here, but I just don’t see the combination of growth and margins that would lead me to get all that excited about today’s valuation.

 

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Teleflex Already Getting A Pretty Good Benefit Of The Doubt

Adecoagro Hit Hard By A Weakening Outlook For Ethanol And Sugar Production

Brazil’s Adecoagro (NYSE:AGRO) is a good case-in-point that a commodity company can do everything right (or at least do many things right) and still see larger commodity and economic trends, and investor worries about those trends, undo that hard work. Adecoagro, for its part, as long been a low-cost producer of sugar and ethanol (or SEE) in Brazil, as well as a low-cost producer of grain and other agricultural products in Argentina, but it has meant basically nothing for long-term investors, as annualized returns over the last three, five, and 10 years is basically flat to negative.

I was bullish on the prospects for Adecoagro to leverage attractive energy, sugar, and crop prices into solid cash flow that would be returned to shareholders in the wake of completing a major multiyear investment program. While the company has indeed instituted a dividend and buyback, the shares are still down about 15% since that last update – outperforming Cosan (CSAN) and Sao Martinho, but still down (and worse than the performance of other ag names like Cresud (CRESY) and SLC Agricola (OTCPK:SLCJY)).

The trouble with assessing Adecoagro today is that whenever you find yourself asking “how could it get worse?” with a commodity company, the market has an uncanny way of showing you just exactly how it could get worse. I do think that Adecoagro’s valuation is low, but with real concerns about ethanol and sugar prices over the next 12-18 months, as well as crop yields and profitability, this is a tough place to go bargain-hunting.

 

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Adecoagro Hit Hard By A Weakening Outlook For Ethanol And Sugar Production

Housing Turbulence Could Open A Window Of Opportunity With Rayonier

While it’s true that timberlands can be a good investment category over time (if bought and managed properly), it doesn’t automatically follow that timber REITs are a can’t-miss investment opportunity, as the market has frequently assigned robust multiples to these businesses. In the case of Rayonier (NYSE:RYN), for instance, an investor who bought the shares on the day after the spinoff of Rayonier Advanced Materials (RYAM) and reinvested the distributions would have an annualized return of around 3.5%, while an investment in Weyerhaeuser (WY) would have returned around 3.4%, and PotlatchDeltic (PCH) would have returned around 6.7%.

Still, for almost any going concern, there’s a price where it makes sense to consider (or reconsider) the investment case. I don’t think Rayonier is quite there today, but were the shares of this timber REIT to sell off on weaker near-term results due to the temporary downturn in U.S. housing, it’s a name I’d certainly consider, particularly for investors who want some resource/commodity exposure.

 

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Housing Turbulence Could Open A Window Of Opportunity With Rayonier

Acuity Continues To Execute, But Weaker Non-Resi Trends Seem To Be Weighing On Shares

One of the more frustrating investment situations to be in is to see a company executing a little better than expected, but see the shares drift lower anyway. Such is the case with Acuity Brands (NYSE:AYI), where two decent quarters (relative to sell-side expectations) and inline guidance for FY’23 hasn’t been enough to maintain investor enthusiasm. Down about 5% since my last update on the company, Acuity has modestly outperformed the S&P 500 but underperformed the broader industrial space, including other non-resi-skewed comps like Allegion (ALLE), Hubbell (HUBB), Johnson Controls (JCI), and Otis (OTIS).

I’ve written in the past about the risk of “boredom” with this stock; it’s not well-covered and the long-term growth potential in the core business (lighting) isn’t very exciting. Still, while recognizing risks like increased competition from overseas lighting manufacturers and overpaying for growth-oriented M&A (for the Intelligent Spaces Group, or ISG), not to mention my weaker-than-the-Street outlook for non-resi activity in 2023/24, the share price does look too low to me and this may be a name for value-driven investors to consider.

 

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Acuity Continues To Execute, But Weaker Non-Resi Trends Seem To Be Weighing On Shares

Alnylam Pharmaceuticals Starts 2023 With In-Line Revenue And A Full Slate Of Clinical Read-Outs

This will be another busy year for Alnylam Pharmaceuticals (NASDAQ:ALNY), as this leading RNAi biotech expects to release clinical updates on five different clinical programs, in addition to anticipated updates from partnered programs and multiple potential IND filings. Though the company has a relatively thin late-stage pipeline, positive early-stage updates from programs with large addressable markets could be enough to maintain a positive level of investor enthusiasm.

Alnylam shares have continued to outperform since my last update, besting the SPDR S&P Biotech ETF (XBI) by about 10%. Some minor adjustments to my model take my fair value above $240, and while that isn’t especially robust return potential given the risks with biotech investing, I would note that clinical and regulatory milestones during the year could meaningfully add to that fair value. Still, I would characterize today’s price more as “good, not great”, even though I am a big believer in the company and its core technologies. 

 

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 Alnylam Pharmaceuticals Starts 2023 With In-Line Revenue And A Full Slate Of Clinical Read-Outs

Cycle Worries Weighing On Renesas Electronics And Creating A Bargain Valuation

Semiconductor stocks are off their lows, but I certainly wouldn’t say that sentiment is particularly healthy – lead-times have started to shrink and companies have started openly acknowledging customers inquiring about pushouts (if not outright cancelations). With declining ASPs likely to push total industry revenue into contraction next year, valuations have retreated to the low end of historical ranges.

Japan’s Renesas Electronics (OTCPK:RNECF) (OTCPK:RNECY) (6723.T) has been holding up relatively well with respect to reported results since my last update, and the shares haven’t done too badly – more or less keeping pace with peers like NXP Semiconductors (NXPI) and ON Semi (ON), though modestly lagging Microchip (MCHP) and Texas Instruments (TXN), and lagging SiC-driven rivals like Infineon (OTCQX:IFNNY) and STMicro (STM) more significantly.

At this point I continue to believe that Renesas shares are meaningfully undervalued. Auto chip demand is holding up better and inventories are not particularly robust heading into a year where many OEMs are looking to catch up on deferred production schedules. I don’t ignore the risk of a steeper decline in the non-auto business, but I like Renesas’s leverage to auto MCUs and ADAS, as well as longer-term opportunities in industrial MCUs and integrated solutions, and I think today’s valuation is too low.

 

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Cycle Worries Weighing On Renesas Electronics And Creating A Bargain Valuation

A Turn In Short-Cycle Industrial Demand Only Adds To IPG Photonics' Challenges

IPG Photonics (NASDAQ:IPGP) has continued to have a difficult time of it. Russia’s invasion of Ukraine, and the sanctions that followed, were always going to make 2022 more challenging for the company, but IPG Photonics has also had to deal with interruptions in China’s economy from its COVID-19 policies, as well as emerging weakness in many short-cycle industrial markets.

I thought IPG Photonics had some high-risk contrarian attributes roughly a year ago, but the shares have lost another quarter of their value, lagging the broader industrial space, but performing more in line with nLIGHT (LASR) and Chinese laser rivals Han’s Laser (002008.SZ) and Raycus (300747.SZ). At this point, I do see elevated risks to short-cycle demand, but I also think the share price discounts a lot of that. I’m reluctant to double-down on a “buy” call that has failed, but mid-single-digit growth can support a double-digit return from here, and I don’t think that’s an overly demanding outlook.

 

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A Turn In Short-Cycle Industrial Demand Only Adds To IPG Photonics' Challenges

Beaten-Down MaxLinear Starting To Look More Interesting

The last year has been a rough one for MaxLinear (NASDAQ:MXL), with the shares down about 46% (underperforming the broader semiconductor market by almost 20%) despite strong growth in the company’s WiFi connectivity business. Not only have investors become more cautious on chip stocks in general, but there are greater concerns now about potentially slowing cable net-adds in 2023 hurting the Broadband business as well as ongoing concerns about the proposed Silicon Motion (SIMO) deal.

Down more than 40% since my last update on the company, the shares are quite a bit more interesting now even with those fears around cable subscriber growth. I’m not particularly positive on the Silicon Motion deal, and I think the company continues to overstate the opportunity in PAM-4, but I think a lot of bullishness has been beaten out of these shares and I think the longer-term potential in home connectivity and 5G is enough to support the shares from here, with any progress in optical interconnect and the Silicon Motion deal constituting upside beyond that.

 

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Beaten-Down MaxLinear Starting To Look More Interesting

Cycle Worries Have Opened A Window Of Opportunity At Shin-Etsu Chemical

Even the best companies aren’t immune to macro challenges, and that’s certainly the case these days at Shin-Etsu Chemical (OTCPK:SHECY) (4063.T) (“Shin-Etsu”). One of the best-run companies I know in the broader chemical space (and perhaps irrespective of industry grouping), Shin-Etsu shares have come under pressure on worries about the impact of weaker housing on polyvinyl chloride (or PVC) prices/margins, as well as concerns about weakness in the semiconductor and electronics markets.

Concern is appropriate, and Shin-Etsu is very likely to see weaker profits over the next 12-18 months, but I think the downturn needs to be kept in context. Namely, this remains the world leader in PVC cost structure and North American capacity, and the U.S. housing market should resume growing after this upcoming correction. Likewise, while I do see some risk to semiconductor demand, demand for leading-edge chips is unlikely to weaken substantially for long. Even with some risk to earnings expectations over the next 12 months, I believe the shares are priced for attractive long-term returns.

 

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Cycle Worries Have Opened A Window Of Opportunity At Shin-Etsu Chemical

A Mostly Clean Quarter Drives A Better Valuation For AngioDynamics

At least some of the sharp decline in AngioDynamics (NASDAQ:ANGO) after its disappointing fiscal first quarter report in October of 2022 could be tied to fears that there was another shoe to drop, and likewise, the solid rebound in the shares on basically in-line fiscal second quarter results likely has at least something to do with relief that there were no similar surprises this time around. With that, the shares are up a strong 20% since my last update.

It doesn't take particularly demanding assumptions to get to a $20-plus fair value for AngioDynamics (35%-plus upside from here), and there are legitimate growth opportunities here. There are still risks, though, including a single-digit revenue growth rate that falls short of what the Street often demands of smaller med-tech names and a history of inconsistent execution on once-promising opportunities in a range of markets. In my last article, I acknowledged that it was likely futile to downgrade when the damage had already been done; while I do still see upside here (potentially meaningful upside), another quarter of in-line or better results would be welcome.

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A Mostly Clean Quarter Drives A Better Valuation For AngioDynamics

Hurco Closes The Fiscal Year Strong, But Not Quite In The Clear Yet

The industrial sector has been a more interesting place of late. While there are still troubling signs for 2023, including higher rates, contracting manufacturing PMI, and weakening business confidence, the market has been more willing to look for "buy the dip" opportunities and the sector has done well over the last three months. That said, there has still been a gap between the broader industrial space and sub-sectors like metalworking where there are still risks about short-cycle weakness and where Hurco (NASDAQ:HURC) has modestly underperformed the sector since my last update (up around 4% versus 11% for industrials) while beating the S&P 500 and other machine tool companies like DMG Mori (OTCPK:MRSKF) and Okuma (OTC:OKUMF) and metal tools company Kennametal (KMT).

Hurco's better-than-expected fourth quarter results are encouraging, but I'm not willing to sound the "all clear" at this point given increasing pressures on smaller manufacturers. That said, I do think the reshoring trend still has legs and I believe management has the company in good shape to weather whatever remains of this downturn. I do still see double-digit annualized return potential from here, but I would again remind investors of the risk of a worse-than-expected short-cycle slowdown in 2023, particularly with numerous quarterly reports and 2023 guidance calls on the way in this sector over the next six weeks.

 

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Hurco Closes The Fiscal Year Strong, But Not Quite In The Clear Yet

MSC Industrial Lagging Despite On-Target Performance

Industrial stocks have held up rather well over the last three months, with investors apparently more confident that the risks to 2023 are priced in now and that the Fed’s efforts to stomp out inflation won’t lead to significant demand destruction. Despite that generally healthy backdrop, MSC Industrial (NYSE:MSM) and other industrial distributors have lagged the industrial sector since my last update, with MSM shares selling off more noticeably in response to fiscal first quarter earnings that weren’t really all that bad.

I do still see risk in the short-cycle industrial outlook, but metalworking-heavy sectors like aerospace, autos, and energy should be healthy, and heavy machinery is likely to hold up at least through the first half of the year. What’s more, the company continues to execute on growth strategies like in-plant sales, vendor-managed inventory, and diversification beyond metalworking. Weaker price and margin leverage remain risks, but MSC Industrial’s valuation is not demanding at this point.

 

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MSC Industrial Lagging Despite On-Target Performance

Constellation Brands: Demand And Margin Concerns Drive A Selloff

There has long been above-average volatility at Constellation Brands (NYSE:STZ) around quarterly earnings reports, and going into this fiscal third quarter report there were some elevated concerns about slowing volume growth. With weaker-than-expected depletions and worse cost guidance from management, Constellation's earnings/guidance report was disappointing, leading to sharp underperformance (around 800-900bp) relative to the S&P 500 and the consumer staples group.

While I had written about some risks going into this quarter a month ago, Constellation's performance was weaker than I'd expected. Still, I believe these are short-term issues that while not trivial, don't impair the long-term thesis for the company or stock. I still see Constellation as a share grower (with long-term revenue growth in mid-to-high single-digits) with meaningful untapped opportunities in improved retail and on-premise distribution. I do still have some concerns about FY'24 guidance (which I'll discuss), but I think this is a name well worth considering.

 

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Constellation Brands: Demand And Margin Concerns Drive A Selloff

Texas Instruments Well Placed For The Long Haul, But Not Especially Cheap Today

Texas Instruments’ (NASDAQ:TXN) (“TI”) track records of exceptional margins and market share are no accident, and management has not been afraid to break from the pack to chart its own course (including decisions to build inventory when others cut production, using price to gain share, and eschewing distributors for more direct relationships). Over the long term, this has served investors well, with above-sector performance and a reputation as more of a safe haven in the semiconductor space.

I liked Texas Instruments back in October near the end of a slide that took the shares from the $180s to the $150s, and the shares have done reasonably well since then as the broader semiconductor space also has picked up off its lows. I do see elevated ongoing risk to the sector for at least another three to six months, though, and I don’t expect TI to be as much of an outperformer when the markets go back to a “risk-on” positioning with chip stocks.

An OK hold at these levels, I’m more neutral on the stock as a near-term buy, but I would keep an eye out for the upcoming fourth quarter earnings/guidance cycle as a potential opportunity to pick up shares on a pullback.

 

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Texas Instruments Well Placed For The Long Haul, But Not Especially Cheap Today

Performance Food Group Has Ample Scale, But Margins Need To Get Better

Distribution is a tough business, but one that rewards scale and particularly scale combined with efficiency. This is something that giant food distributor Sysco (SYY) understands well, but that other rivals like Performance Food Group (NYSE:PFGC) and US Foods (USFD) have struggled to match. While there are still opportunities to benefit from share gain and share-of-wallet gain across the large food service and convenience store markets, I need to see more evidence from Performance that it can really drive attractive leverage from the business.

Performance Food has been doing well with respect to reported versus expected earnings, with a multi-quarter run of better-than-expected EBITDA results, including a sizable beat-and-raise in the fiscal first quarter (the calendar third quarter). Still, this looks like a situation where meaningful long-term margin improvement is already in the stock and management will have to continue beat-and-raise performances to drive further outperformance.

 

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Performance Food Group Has Ample Scale, But Margins Need To Get Better

FB Financial: It's Going To Get Worse Before It Gets Better

With the Fed hiking interest rates another 50bp as of this writing and signaling a willingness to go even further, it's going to be even harder to be in the banking business over the next several quarters. Tennessee's FB Financial (NYSE:FBK) is a case in a point, as management has already said they're going to pull back on lending in the face of rising deposit betas, and with little help coming from mortgage banking or credit, pre-provision profit growth is going to get harder to come by.

I believe FB Financial's operations in Tennessee do have some value, given the above-average growth in the region, but I believe today's price pretty fairly reflects that value. Mid-to-high single-digit core earnings growth can support a fair value in the mid-to-high $30s, but the stock is less attractive on multiples-based valuation and I frankly see more things that could go worse over the next 12 months relative to expectations than go better.

 

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FB Financial: It's Going To Get Worse Before It Gets Better

The Rebound At Terex Should Have Legs

While the 2023 outlook for many industries is getting more frightful, the recent trading in Terex (NYSE:TEX) and other heavy machinery names has been pretty delightful, with Terex up more than 65% from its summer lows and leading in trailing 6-month performance over other machinery names like Caterpillar (CAT) (up 15%), Deere (DE) (up 36%), Metso (OTCPK:OUKPY) (up 18%), and Oshkosh (OSK) (up 2%).

Relative to many other industrials, demand for equipment used in markets like aggregates, agricultural, environmental (recycling, et al.), forestry, mining, and so on should hold up better, particularly given strong backlogs to start the year. While I do see some risks around private non-residential construction, overall, I think Terex is well-placed, and I don't think the stock is necessarily played out yet.

 

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The Rebound At Terex Should Have Legs

Smith & Nephew: Potential Only Has Value If You Can Execute

Long a laggard in the ortho space, I was more bullish on Smith & Nephew (NYSE:SNN) last September on what I thought were cogent plans from a relatively new management to address and reverse this long-term pattern of underperformance. While a year and change may not be giving them enough time, particularly given the disruptions created by the pandemic, the reality is that the company hasn’t made the expected progress and isn’t getting the job done in either revenue growth or margin improvement.

With that ongoing disappointing run of performance, the share price has suffered, falling another 25% or so since my last update and underperforming peers/rivals including Stryker (SYK) and Zimmer Biomet (ZBH), but managing to outperform Enovis (ENOV). While the shares do look undervalued even without significant near-term improvement, I think it’s hard to make an argument for owning them without more evidence of real traction with the self-improvement initiatives.

 

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Smith & Nephew: Potential Only Has Value If You Can Execute

Cadence Bank: Better Growth And Betas, But It Will Get Harder From Here

The early returns from the merger that created the new Cadence Bank (NYSE:CADE) have been mixed - while the bank is performing well operationally, the stock has been lagging the regional banking group and has seen a sharper sell-off over the last week or two. With that, the stock is down more than 20% since my last update, basically doubling the declines of the regional bank group.

While I can understand investor nervousness on the sector to a point, particularly as funding costs start to accelerate and the macro outlook for 2023 starts to deteriorate, but I think the reaction is overdone in this case. With a strong Net Promoter Score (a reflection of customer satisfaction), an attractive geographic footprint leveraged to many growing metro areas, and better-than-average funding and fee-generating bases, I do believe Cadence should be valued more highly than it is today.

 

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Cadence Bank: Better Growth And Betas, But It Will Get Harder From Here

Atlas Copco: Still Excellent, Still Expensive, And Maybe A Bit Vulnerable

There may be better industrial companies out there than Atlas Copco (OTCPK:ATLKY), but the number of entries above them on that list is going to be relatively few. Few companies have matched Atlas when it comes to a margin-rich, asset-light model predicated on driving share growth through both strong engineering and distribution and expansion into adjacent markets, and the valuation typically reflects tat.

Since my last update, Atlas shares have modestly outperformed the broader industrial space (by a couple of percentage points), but have outperformed the S&P 500 by a wider margin. By comparison, other industrials I hold in similar regard like Eaton (ETN) and Honeywell (HON) have done a little better, while Parker-Hannifin (PH) has done a little worse, and Ingersoll Rand (IR), a direct competitor in compressors, has outperformed Atlas more meaningfully (by around 400bp).

I have no issues with Atlas Copco from a long-term perspective, but I do see some challenges in the coming quarters as short-cycle industrial markets slow down and the entire industrial group deals with an uncommon combination of elevated backlogs, high inventories, high costs, and weakening demand. Likewise, the nature of Atlas’s business could lead to relative financial outperformance in FY’23, but underperformance in FY’24. Should the shares sell off during this turbulence, strongly consider adding them.

 

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Atlas Copco: Still Excellent, Still Expensive, And Maybe A Bit Vulnerable