Rexel Delivering On Its Turnaround, But Getting No Credit

In closing my last article on Rexel (OTCPK:RXEEY) (RXLSF), I commented that “turnarounds can test investor patience”, and that has certainly been true for this global electrical products distributor. The market hasn’t been too keen on many stocks in the distribution space since that last article, with stocks like Grainger (GWW) and Ferguson (OTCQX:FERGY) losing ground, but Rexel has done substantially worse, and likewise lagged the shares of electrical products companies like Eaton (ETN), Schneider (OTCPK:SBGSY), Legrand (OTCPK:LGRDY), Hubbell (HUBB).

I can understand investor concerns about slowing macro, as I too expect construction spending to slow in the EU and U.S. in 2019, and I can likewise understand concerns that Amazon’s (AMZN) efforts in the space will lead to lower margins over the long term. Still, those issues seem more than amply reflected in the share price, and I don’t think the valuation reflects the progress made in 2019, nor the benefits yet to be seen from exiting underperforming businesses and restructuring toward higher-value products.

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Rexel Delivering On Its Turnaround, But Getting No Credit

A Game-Changing Deal With Amazon Puts Balyo Into The Spotlight

Regular readers will probably already know about my interest in robotics and automation, and I do believe it is a major emerging trend that is going to significant reshape how companies approach manufacturing and logistics. On the logistics side, I’ve spent quite a bit of time looking at automation companies like Intelligrated (now owned by Honeywell (HON)), Daifuku (6383.T), and Cognex (CGNX), as well as maybe less obvious companies like Datalogic (OTC:DLGCF), as I believe companies like Amazon (AMZN), Walmart (WMT), and FedEx (FDX) are highly motivated to find solutions that reduce labor costs, improve accuracy, and accelerate fulfillment.

That brings me to Balyo (OTCPK:BYYLF) [BALYO.PA] – a very small French company that will probably be all but unknown to many readers. This company is tiny (a market cap of only around $125 million), and the ADRs are not at all liquid, but the company’s recent multiyear partnership deal with Amazon is likely to significantly increase the visibility of this robotic intelligence company and accelerate its market penetration. I want to again underline that this company is small and that the U.S. ADRs are illiquid, but there is meaningful growth potential here in a segment (logistics automation) that has an unfortunate lack of direct investment options.

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A Game-Changing Deal With Amazon Puts Balyo Into The Spotlight

Air Transport Group Shareholders Have A Lot To Consider

It’s been a tough stretch for Air Transport Group (ATSG) since the company’s early October announcement that it would be acquiring Omni Air, with the shares down about 20%. The “good news”, if you really want to call it that, is that the company’s closest comp, Atlas Air (AAWW), has been even weaker, as have FedEx (FDX) and UPS (UPS) (with Atlas and FedEx also underperforming Air Transport on a trailing twelve month basis), as concerns have grown regarding the impact of trade protectionism on cargo/shipping demand. Of course, Air Transport did itself no favors with a miss and guide-down for the third quarter.

Between uncertainties in the global economy, Amazon’s (AMZN) plans, and management’s ability to execute, there’s a lot for Air Transport shareholders to chew on. Underlying aircraft demand seems strong, and management has generally been reliable insofar as being careful about adding capacity ahead of real demand. With the Omni deal, Air Transport will also have a more stable block of revenue coming from the Department of Defense, as well as some longer-term fleet management options. Although these shares do seem undervalued, I’ve lowered my expectations and this is a tough stock to model given the substantial uncertainties in the business.

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Air Transport Group Shareholders Have A Lot To Consider

MSC Industrial Looking To A Restructured Sales Effort To Drive Better Results

As I've discussed (and lamented) on more than one occasion, MSC Industrial's (MSM) track record over the past couple of years has not been up to snuff, with the company underperforming other distributors like Fastenal (FAST) and Grainger (GWW) in both operational and stock performance terms. Although MSC's fiscal fourth-quarter results weren't all that great, expectations had ratcheted down going into the quarter, and it looks as though a long and surprisingly disruptive sales force restructuring/retraining process should start leading to better results in the coming quarters.

Valuation on these shares is mixed, and I don't think they're a screaming bargain, though I can support an argument that the company's profitability and return on capital (and assets) justify a price into the mid-to-high $90s. The biggest issue for the stock, though, is whether MSC can start delivering better organic sales growth and drive some of the long-awaited incremental operating leverage that investors have been waiting on for some time now.

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MSC Industrial Looking To A Restructured Sales Effort To Drive Better Results

Air Transport Group: Warning, Contents Have Shifted In Flight

Air Transport Group (ATSG) has chosen to alter its business in a pretty significant way with the $845 million acquisition of Omni Air. With this acquisition, Air Transport will be far more exposed to passenger-oriented ACMI and charter services, and the company will also add Boeing (BA) 777s to its owned and operated fleet.

I’m not unreservedly bullish about this deal, as I believe it adds operating complexity to a company that already had a track record of so-so execution in its core operations. It also likely takes an Amazon (AMZN) acquisition off the table (however likely that really was) and could lead Amazon to turn more toward Atlas (AAWW) as its provider of choice for future air cargo expansion needs. Adding government-funded charter services does help mitigate some of the ongoing cargo demand risks, though, and I do believe the shares remain undervalued below the mid-to-high $20’s.

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Air Transport Group: Warning, Contents Have Shifted In Flight

Like Other Old-Tech Names, Oracle's Value Is Tied To Its Ability To Reignite Growth

Reading the sell-side research on Oracle (ORCL), I’m struck by how frequently the analysts benchmark Oracle’s valuation multiples (whether it’s P/E, EV/FCF, EV/revenue, et al.) against the peer/industry group in an attempt to make the “Oracle is undervalued” case, but neglect to benchmark the company’s revenue growth rate. While margins and free cash flow certainly do matter, revenue growth is a significant near-term driver for valuation multiples, and Oracle’s growth rate is much more in the CA Inc. (CA)/IBM (IBM) neighborhood than the Microsoft (MSFT)/Adobe (ADBE) neighborhood of older tech stocks.

Given the weak growth rate, the recent trends in Oracle’s position in sell-side CIO surveys, and the company’s ongoing challenges with the on-premises-to-cloud transition, I can’t work up much enthusiasm for the stock. While many old-tech companies have faced challenges in their attempts to renew themselves and remain competitive (Microsoft had its issues, IBM is still in the middle of them…), I just don’t see enough of a discount here to take on the incremental execution risk.

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Like Other Old-Tech Names, Oracle's Value Is Tied To Its Ability To Reignite Growth

Air Transport Group Executing, But Headwinds Continue To Weigh

In terms "controlling what it can control", I believe Air Transport Services Group's (ATSG) management team is doing a good job. Even so, there are worries about Amazon's (AMZN) future plans for its Prime Air operations, possible competitive losses to Atlas Air (AAWW), higher rates, and access to planes continuing to weigh on the shares, which have underperformed Atlas Air quite significantly since March of this year.

I expect Air Transport to expand its business relationship with Amazon over time, but there are no guarantees. Likewise, I believe the company's efforts to expand its ground-based service and conversion businesses will pay off, but not for several years. Although the overall air cargo and leasing environment remains healthy, escalating trade disputes could threaten that and Air Transport doesn't have a great track record of free cash flow or ROIC generation. That said, there still appears to be worthwhile opportunity here for those investors who can get comfortable with the risks.

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Air Transport Group Executing, But Headwinds Continue To Weigh

Grainger's Strategy To Drive Better Volumes Showing Good Results

I haven’t been all that impressed with Grainger’s (GWW) strategy in recent years, and I think strategic issues are at least in part responsible for the stock’s underperformance relative to other distributors like MSC Industrial (MSM) and Fastenal (FAST) over the last three to five years. But credit where it is due – management’s most recent initiatives appear to be working out well, and the stock is quickly closing those performance gaps, having outperformed MSC, Fastenal, and HD Supply (HDS) over the last two years and especially in the last 12 months.

It remains to be seen whether Grainger can continue to leverage these improvements into ongoing sales and margin expansion. Amazon (AMZN) looms large as a threat and I think the entire industrial distribution space may find margin expansion to be more challenging than the Street expects.

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Grainger's Strategy To Drive Better Volumes Showing Good Results

MSC Industrial Still Looks A Little Underwhelming

Patience hasn't proved all that rewarding with MSC Industrial (MSM), as the shares have not only lagged peers like Grainger (GWW) and Fastenal (FAST) and suppliers like Kennametal (KMT) but are basically flat for the past year. The debate continues as to whether MSC Industrial's issues are predominantly driven by cyclical factors, or whether increased online competition and the expansion of Amazon (AMZN) into industrial distribution has permanently altered price transparency and the competitive balance.

I admit that I find it troubling that MSC reported only mid-single-digit organic growth despite Gardner's Metalworking Index hitting its highest level in seven years. A return to positive pricing was nice to see, as was the operating leverage, but this remains a "show me" story where valuation is not all that compelling.

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MSC Industrial Still Looks A Little Underwhelming

Zalando Building Up The Infrastructure To Be More Than Just Another Online Retailer

There’s a lot about Zalando (OTCPK:ZLNDY) that will look familiar to experienced investors – namely that tension between disruptive long-term growth and the fair price to pay today for that growth potential. Zalando has definitely made a mark in fashion e-commerce in Germany, and there is ample room to expand throughout Europe and into higher-margin services, but Amazon (NASDAQ:AMZN) looms large as a threat and more value-conscious investors may fret about how long it will take the company to earn attractive returns on the considerable sums it is putting into market and infrastructure development.

With the shares already seemingly discounting close to high teens long-term revenue growth and mid-single-digit FCF margins, I would say that expectations are already high and that this won’t appeal to many value-driven investors. On the other hand, the company continues to deliver strong growth metrics and the valuation isn’t absurd relative to what high-growth companies often get.

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Zalando Building Up The Infrastructure To Be More Than Just Another Online Retailer

Air Transport Not Just An Amazon Story

Air Transport Group (ATSG) shares have done well over the past year, but the shares have been stuck in a $6/share trading range since May, as inconsistent execution has blunted some of the benefits of the company’s transformative relationship with Amazon (AMZN). Despite those inconsistencies, management continues to build the business outside of Amazon, adding more 767 customers and launching a long-term effort to expand its potential operating fleet.

I believe Air Transport still has some upside from here, driven by my expectations for high single-digit revenue growth and improving free cash flow generation. I also believe that significant upside remains in the Amazon relationship, as Amazon seems to be serious about building out its independent logistics operations.

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Air Transport Not Just An Amazon Story

Buying Traffic Has Hammered Natural Grocers' Results

When I last wrote about Natural Grocers (NGVC) roughly 18 months ago, I said that I believed the shares would continue to head lower if the company couldn't reverse weak traffic trends. Management has in fact struggled to revive store traffic, and the shares are 50% lower now. Although the company is making decisions that make sense from a long-term perspective (getting more aggressive on price to drive traffic, reorienting marketing around what makes the stores different, and significantly reducing new store openings), it is still very much an open question as to whether Natural Grocers can find the right mix that will bring back traffic and allow for worthwhile margins.

I believe this latest disappointment (after fiscal first quarter earnings) has pushed the shares down to an interesting level, but there are outsized risks here. A multiple of 6.5x my 2018 EBITDA estimate will support a fair value around $8, and my DCF model suggests an even higher target, but models are not guarantees - there's a reason one of the most common words in conjunction with "earnings" is "surprise" - and this is a risky call at this point.

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Buying Traffic Has Hammered Natural Grocers' Results

Rexel Plugged Into Improving Trends

Distribution is a tough business, and Amazon's (AMZN) entry into industrial distribution has not made life any easier for companies like Grainger (GWW), Fastenal (FAST), Rexel (OTCPK:RXEEY), or WESCO (WCC). Even so, I think there's a worthwhile opportunity in Rexel today, as the market seems to be overestimating the threat from Amazon, and underestimating the benefits to be had from an improving construction market in Europe, self-directed internal improvements, and the benefits to be had from further consolidation.

I don't expect torrid revenue growth from Rexel, but I do expect some growth and improving margins to drive more compelling FCF growth, as new management responds to an activist investor's involvement with far-ranging self-improvement initiatives. With around 20% to 25% upside from here, Rexel looks well worth considering.

Rexel's ADRs are not liquid, and that is a shame. Investors can nevertheless look to the Paris-listed shares (RXL.PA) which have far more liquidity and which are available through many larger brokerages.

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Rexel Plugged Into Improving Trends

F5 Needs Some "Creative Destruction"

One of the hallmarks of the best-run companies is that they’re not the last to leave a party; well-run companies recognize that self-obsolescence and “creative destruction” are often essential parts of maintaining a healthy business over the long term. To that end, I would note that companies like Cisco (CSCO), Palo Alto (PANW), and VMware (VMW) often are building toward the next big thing while the current big thing is still generating meaningful cash flow.

That has not been the case, in my opinion, with F5 (FFIV). Although there’s nothing wrong with F5 getting everything they can out of the fading application delivery controller (or ADC) opportunity, I believe the company has not gone far enough, fast enough, to position the company for ongoing growth in the new cloud and hybrid cloud enterprise world.

These shares are up a little from when I last wrote about them, with a solid double-digit rally off the October lows, but I cannot muster much enthusiasm for the shares again. While I expect F5 to generate ample cash flow for some time, I really would like to see management use the company’s balance sheet to acquire more growth and relevance in the emerging networking world.

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F5 Needs Some "Creative Destruction"

Microsoft Looks Like An Elephant That Can Still Dance

Very large companies tend to struggle to innovate and grow, and large tech companies in particular historically have a very hard time remaking themselves over time. With that, yesterday’s leaders in tech are seldom today’s leaders and today’s leaders seldom become tomorrow’s leaders.

And then there’s Microsoft (MSFT). This company certainly has several missteps in its scrapbook, including multiple failures in mobile devices (phones especially), but with Azure, Office 365, and Dynamics 365, Microsoft looks to be in a good place with respect to cloud computing, and businesses like LinkedIn and Xbox offer additional avenues to growth.

It is admittedly hard to come up with a novel scoop or thesis on a huge, well-covered stock like Microsoft, but I have nevertheless large companies like this trade at attractive multiples and generate above-average returns. If my expectation of mid-single-digit growth is valid, a fair value of $90 or more seems appropriate and these shares are worth considering even late in this bull market.

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Microsoft Looks Like An Elephant That Can Still Dance

Better Late Than Never For MSC Industrial

One of the recent concerns about industrial maintenance, repair, and overhaul (or MRO) supply distributor MSC Industrial (NYSE:MSM) was why this leading distributor of metalworking tools (among other MRO supplies) was not seeing more benefit from the emerging industrial recovery in North America. Those concerns should ease a bit with the strong daily sales reported for the fiscal fourth quarter, but the company's long-term margin leverage remains a key question, and increased competition from Amazon (NASDAQ:AMZN) and now Berkshire Hathaway (NYSE:BRK.A) shouldn't be ignored.

I've owned MSC Industrial for some time, and I've written many times that when there's a conflict between "good company" and "good valuation", I go with the former. That said, there are legitimate arguments as to whether MSC is as good of a company as it used to be and whether today's valuation already captures a lot of what can go right for the business. Although I'm not rushing for the door, and there aren't a lot of clear bargains in the industrial space, it's hard for me to make a buy-case on the stock beyond a play on improving trends (momentum) in metalworking and related industries and at least a few more beat-and-raise quarters.

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Better Late Than Never For MSC Industrial

Air Transport Services Group Seems To Have Found A New Cruising Altitude

“It's different this time” is probably one of the most expensive phrases in the history of investing (although “what could possibly go wrong?” might be a close second), as it often represents a period of peak optimism that lures in investors right before the company/industry snaps back to reality. On the other hand, failing to notice and accept a new fundamental reality can also be pretty expensive, as it means you may stand forever on the sidelines watching a great story go by.

That brings me to Air Transport Services Group (ATSG) – a company and stock that I have liked for some time that may actually be seeing a fundamental transformation in its business. While I liked the shares a year ago, I didn't really expect another 50%-plus move in the shares. The company's bull case has materialized, though, as demand for its freight aircraft has picked up and the company continues to build out its fleet.

And now? Historically, this company has had a hard time earning attractive free cash flow and its EBITDA performance has been erratic. I'm nervous about assuming that the next 10 years will be a radical departure from this, but the company's relationship with Amazon (AMZN) is a major driver of change, and the company's e-commerce venture in China could prove very lucrative. I still consider this a high-risk investment (this type of business tends to have a lot of competition, a lot of debt, and relatively low returns), but a fair value in the low $20's does not seem crazy to me today.

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Air Transport Services Group Seems To Have Found A New Cruising Altitude

F5's Headwinds Aren't Letting Up

When I last wrote about F5 Networks (NASDAQ:FFIV) in the summer of 2016, I was skeptical that the company's new product launch/refresh cycle was going to deliver as much growth as the bulls hoped. So far, that call looks to be working out. Although the shares are up around 5% since that last article, that performance lags that of the NASDAQ and a broad peer group of companies like Cisco (NASDAQ:CSCO), Juniper (NYSE:JNPR), and A10 (NYSE:ATEN). What's more, numbers have been heading lower as the expected product growth has been slow to arrive.

I continue to believe that F5 is dealing with some troubling secular headwinds. Cloud service providers like Amazon (NASDAQ:AMZN) and Microsoft (NASDAQ:MSFT) are improving their ADC/load balancing services, and companies like Cisco are tough competitors in security. While I do still think there are opportunities out there for F5, I worry about how the shares will perform without stronger revenue growth. The implied return at this price isn't bad, but I think there could be further revisions to estimates before this cycle is over, and low-growth/high-margin tech stocks can be frustrating to own.

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F5's Headwinds Aren't Letting Up

Can Rakuten Maintain Leadership ... And Will It Matter?

Market leadership is all well and good, but if you can't make much real money from it, that leadership really doesn't get you very far over the long term. With Amazon (NASDAQ:AMZN) and Yahoo! Japan (OTCPK:YAHOY) putting pressure on Rakuten (OTCPK:RKUNY) in its core e-commerce business, Rakuten has had to respond with more aggressive marketing and promotions. At the same time, though, management is trying to be more disciplined and more demanding with its numerous ancillary operations, and the company has a credible shot of driving meaningful growth in its credit card business.

Modeling Rakuten offers a few more challenges than normal, as Amazon can be a brutally competitive player. While Rakuten would seem to offer about 10% upside from here on the basis of growth opportunities like Ebates, Viber, and its card business and improving profitability in its core Rakuten e-commerce business (Rakuten Ichiba), bulls need to at least consider the risk that Amazon and Yahoo! Japan compete so aggressively that meaningful profit growth in the core business proves elusive.

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Can Rakuten Maintain Leadership ... And Will It Matter?

Even After A Big Run, Atlas Air May Have More To Give

I didn't go into my latest round of due diligence on Atlas Air (NASDAQ:AAWW) expecting to find a bargain. While the shares couldn't sustain the spike brought about earlier in 2016 with a major agreement with Amazon (NASDAQ:AMZN), the shares did start a strong rally toward the end of summer, and the shares rose another 25% or so after the U.S. presidential election (despite the uncertain ramifications of the new administration's policies on international trade). And yet, while there are a lot of unknowns about future margins and the air cargo supply/demand balance still isn't great, these shares just might still be too cheap.

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Even After A Big Run, Atlas Air May Have More To Give