Wall Street Seeing More Risk As Palo Alto Networks Evolves With The Times

Investors don’t really like change, and Palo Alto’s (PANW) decision to embrace more cloud-centric security offerings and alter its billing/sales approach seems to be causing some concern with at least some analysts and investors. On top of that, the company’s ongoing willingness to spend up on M&A has let some to ask questions along the lines of “well … if they’re so good, why do they need to do that?”

One of the things that I’ve always liked about Palo Alto is the company’s efforts to be proactive/active more than reactive (compared to, say, Check Point (CHKP) ) and I believe these latest moves are in keeping with that. What concerns me more at this point is the relatively high overall valuation levels in the software/tech space and the likelihood of slowing growth at Palo Alto (“trees don’t grow to the sky” and all that), given the central role growth plays in driving software company valuations. Even so, these shares look undervalued and still interesting today.

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Wall Street Seeing More Risk As Palo Alto Networks Evolves With The Times

Analog Devices Already Well-Valued For Its Quality

There are certainly some bargains out there in the chip sector today, but I’m not finding many in areas like analog. To that end, while I have no qualms about the quality of Analog Devices (ADI), nor its prospects for above-average growth in the years to come, I find that the market is already on top of the story. I don’t think the shares are notably overvalued (unless the economy is teetering on the brink of outright recession), but given the ongoing risks in the sector and my preference for buying in at discounts to fair value, I don’t see a need to jump in here today.

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Analog Devices Already Well-Valued For Its Quality

Huntington Bancshares Undervalued, But Not Looking Catalyst-Rich

Finding undervalued stocks is one thing, but finding catalysts and drivers that will close that valuation gap is often an overlooked part of the investment process (and a part of the whole “value trap” phenomenon). When I look at Huntington Bancshares (HBAN), I see a basically well-run bank trading more than 10% below fair value. I also see a bank that is forgoing some near-term growth to improve its full-cycle performance.

What I don’t see, though, is what will change investors’ minds about these shares in the near future. Worries about the health of shorter-cycle industrial markets are relevant to this Ohio/Michigan-centric back, as are the ongoing tariff issues with China and Mexico and the uncertain prospects for the USMCA. On top of that, while I think Huntington would/will do better in a banking downturn, the near-term outlook for pre-provision profit growth is pretty average-looking.

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Huntington Bancshares Undervalued, But Not Looking Catalyst-Rich

Apart From Valuation, It's Hard To Find Fault With CyberArk

I've written rather positively about the quality of CyberArk (CYBR) and its growth opportunity before, and that's not going to change here - I continue to believe that CyberArk is an early leader in an exciting growth sector within security (privileged access management) and that it has a large and growing addressable market in front of it. The hang-up I have today is that valuations in software overall, and security, in particular, are pretty high relative to long-term norms. I'd love to own CyberArk at the right price, and I admit that even I'm tempted to throw caution to the wind and just own it, but chasing elevated valuations carries more risk than I need in my portfolio.

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Apart From Valuation, It's Hard To Find Fault With CyberArk

Can Reduced Expectations And A New Product Rebuild Inogen's Premium?

Hyper-growth med-tech valuation exists in its own parallel dimension, and it’s a place where I rarely venture with my own money. To that end, I wasn’t excited about the premium the market was giving Inogen (INGN) a year ago and I haven’t seen much reason to write about it since then. In that time, though, the shares shot up more than 75% before starting a fall that has seen the shares lose more than 80% of their value.

I didn’t think the shares deserved to be trading at $160+ back in May of 2018, let alone nearly $290, but I also don’t think the mid-$60’s is fair now. While I’m not crazy about Inogen’s direct-to-consumer model, the reality is that working through home/direct medical equipment vendors isn’t any easier and there’s a definite market for portable oxygen concentrators given the limitations of air tanks. I do believe competitors like Philips (PHG) and ResMed (RMD) constitute a longer-term threat, but I also believe Inogen can lose some market share and still generate long-term revenue growth in the double-digits and high-teens FCF margins. It’s going to take time for Inogen to win back investor interest, but a new product launch and improved rep productivity should drive improved results from here.

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Can Reduced Expectations And A New Product Rebuild Inogen's Premium?

Tenneco Pounded Down On Weak Execution, High Leverage

I wasn’t all that fond of Tenneco (TEN) when I last wrote about it in the fall of 2018, but even though I had issues with the company’s unimpressive operating performance and weak leverage to vehicle electrification, I didn’t expect the 75% drop in the share price that followed. Management credibility is arguably at an all-time low now, and with weak trends in light vehicle builds and a weakening outlook for many commercial vehicles, Tenneco’s back-end-loaded second half guidance seems perhaps ambitious even with a meaningful revision after first quarter earnings.

It’s tough to reconcile the magnitude of the share price drop with the actual underlying performance (unimpressive as it has been), but net debt is now close to 3.5x expected EBITDA and the spin-out of DRiV has been postponed by at least six months. I can understand why deep-value/contrarian investors may want to give this a look (especially as I think auto/vehicle parts stocks are undervalued as a sector), but I’m concerned about the company’s long-term competitiveness and the fact that net debt now exceeds over a decade of estimated free cash flow in my model.

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Tenneco Pounded Down On Weak Execution, High Leverage

Infineon Scoops Up Cypress

Follow the markets long enough and you'll encounter a few moments that make you think the market is both sentient and messing with you - to that end, Cypress (CY) was on my to-do list today and then I woke up to the news that Infineon (OTCQX:IFNNY) and Cypress had agreed to a $10B buyout. While Cypress shares had done well since my last (bullish) article on the company in early January, this deal is certainly a nice capper on that share price move.

All in all, I think this is a reasonable deal for both parties. While Infineon is paying a rich-looking premium based on current margins, 2019 is likely to be an anomaly that doesn't reflect the real strength of the business. Moreover, I think the financial and operation synergy potentials are significant, and I believe Cypress's MCU and connectivity technologies will be valuable additions to Infineon's portfolio. For Cypress, while the company's growth plan could well have improved the business to a point where it would get this sort of valuation down the line, this deal takes execution risk off the table and gives shareholders a very fair multiple for the business.

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Infineon Scoops Up Cypress

Marvell Executing On A Once-Underappreciated Transformation Strategy

I liked Marvell (MRVL) back in September of 2018, as I thought the Street was too focused on the near-term challenges of integrating Cavium and not enough credit to the transformation underway in the business. While the shares dropped another 20% from that point in time with the SOX, the shares have since rebounded more strongly, and the shares now sit about 20% higher than they were at the time of the last article (while the SOX is down about 4%).

I continue to like the direction Marvell is going. Significant wins in 5G (primarily with Samsung) could translate into more than $700 million of incremental revenue, and the company has been building up its ASIC capabilities such that I believe the company has a chance of emerging as a viable second-source rival to Broadcom (AVGO) in time and shifting more of the business’s center of gravity towards growth markets and away from storage.

What I don’t like so much is the current valuation. Marvell has attractive end-market exposure for the next 12-18 months and looks better-positioned for the near-term growth that Wall Street loves so much, but I think the valuation is a tougher sell now.

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Marvell Executing On A Once-Underappreciated Transformation Strategy

voestalpine Almost Finished With A Fiscal Year To Forget

I was tentatively bullish on voestalpine (OTCPK:VLPNY) (VOES.VI) back in December, stating, “Although I’m reluctant to play chicken with a freight train and go against such strongly negative sentiment as is dominating steel today, the valuation on voestalpine has me sorely tempted to take a flyer on the assumption that 2019/2020 won’t be as bad as the price seems to be forecasting.”

Although the shares did pretty well for a while thereafter, rising about 20% through early April, the shares have since been pounded (down about 25% from the April highs) on weak carbon steel prices in the U.S. and EU, rising input costs, and growing questions about whether voestalpine’s “high-quality strategy” and focus on value-added products really produces a differentiated full-cycle earnings or cash flow stream.

Steel is very much out of favor, but I’m still tempted by the valuation … and that’s with a below-the-Street opinion on near-term global economic growth and steel prices. With voestalpine shares trading like they were any other steel company, and at least a few 2019 headwinds unlikely to reoccur, I’m once again considering these shares as a potential buy.

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Voestalpine Almost Finished With A Fiscal Year To Forget

Meaningful Progress At Columbus McKinnon Going Seemingly Unnoticed

Columbus McKinnon (CMCO) is a bit of a puzzler to me now. Despite racking up multiple quarterly EBITDA beats in a row and eight quarters of year-over-year gross margin improvement, the shares are about 15% lower than they were last time I wrote about this leading player in material handling, and that was closer to down 25% before a big post-earnings reaction. Granted, industrials haven't done so well over that same period, and there are valid concerns about slowing end-market demand, but I'm still surprised the improvements in the business aren't being better reflected in the share price.

More than a third of Columbus McKinnon's revenue comes from end-markets/sectors that I'm concerned about today, but the company is gaining share and management expects another four points or so of EBITDA margin improvement from fiscal Q4'19 levels. With increased R&D spending going towards automation-enabling product development and my expectation of low-to-mid single-digit long-term revenue growth, mid-single-digit FCF growth, and low-double-digit ROIC, I believe these shares offer meaningful upside even with the risk of a sharper near-term slowdown in the business.

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Meaningful Progress At Columbus McKinnon Going Seemingly Unnoticed

BRF SA Shifting Gears As It Contemplates A Merger With Marfrig

As I’ve written extensively in the past, BRF SA (BRFS) management has a lot on its plate trying to turn around this large Brazil-based poultry and processed food company. After years of ill-advised (or at least unfocused) M&A and scattershot business plans carried out by prior management teams, BRF found itself saddled with debt and an inefficient operating structure, leading to the entry of Pedro Parente and a completely new management team.

While there had been some signs of progress with the turnaround plan, and the outbreak of African Swine Fever in China has been a net positive for Brazilian protein companies, management is now considering a sharp change in strategy by entering into merger negotiations with Marfrig (OTCPK:MRRTY).

On balance, I’m not sure the advantages of a merger with Marfrig outweigh the challenges, but it does at least kick the can down the road in terms of showing results from the turnaround. Moreover, there aren’t going to be too many opportunities like this for BRF. While I continue to believe that BRF could be worth substantially more than its current share price down the road, I’m not sold on the idea that adding more complexity is the best way to build value.

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BRF SA Shifting Gears As It Contemplates A Merger With Marfrig

New Tariffs Create New Headaches For Rockwell Automation

At the time of Rockwell’s (ROK) fiscal second quarter earnings report in late April, I commented that I thought investors would have an opportunity to buy shares in this high-quality automation enabler at a lower price. Since then, the shares have dropped more than 15%, significantly underperforming industrials in general, on growing concerns about a slowdown in the industrial end-markets that make up a large part of the discrete automation market. Now with the prospect of significant tariffs on Mexico on the table, Rockwell is taking another body-blow.

I do believe that Rockwell management is underestimating the risk of a broader slowdown in industrial end-markets, even though I do basically agree with its more bullish medium-to-long-term outlook. With a real risk of a “lower-for-longer” end-market demand situation and now potential pressures from new tariffs, I’m inclined to keep waiting even though Rockwell shares now trade below my estimate of fair value.

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New Tariffs Create New Headaches For Rockwell Automation

Aptose Drifting Ahead Of Real Data From Its Intriguing Clinical Assets

I’ve tried to go to some lengths in the past to emphasize the risks that come with an investment in Aptose Biosciences (APTO) – a small biotech that has only recently seen its two lead compounds go into the clinic. Not only is there the ever-present risk of clinical trial failure (the large majority of Phase I cancer compounds fail) and the meaningful risk of further dilutive financing, but there’s a less-appreciated risk of investor sentiment (boredom, really), as biotechs can drift lower without positive data to keep investors engaged.

I continue to believe that, even with the risks involved, Aptose is a very interesting early-stage speculation. CG-806 could emerge as a hard-to-beat therapy option across a range of hematological cancers, while APTO-253 may prove to be the first effective drug targeting the “undruggable” MYC target, with potential applications outside of hematology.

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Aptose Drifting Ahead Of Real Data From Its Intriguing Clinical Assets

Universal Stainless & Alloy Products Badly Needs To Regain Momentum With Its Premium Alloy Offerings

Despite strong demand growth in end markets like aerospace and oil/gas, specialty alloy producers like Universal Stainless & Alloy Products (USAP) have underperformed the S&P 500 by a wide margin. USAP has been particularly weak, with the stock down more than 45% over the past year versus roughly 20% to 25% declines for Allegheny (ATI), Carpenter Technology (CRS), and Haynes (HAYN), as USAP's progress in boosting its premium mix has stalled out, tool steel demand has shrunk significantly, and margins have underwhelmed on disappointing volumes and price/cost mismatches.

I'm less bullish on USAP reaching/surpassing past gross and operating margin peaks than I was almost a year ago, but USAP's facilities (and particularly its more highly value-added North Jackson facility) are still significantly under-utilized, the backlog continues to grow, and there are still opportunities for USAP to leverage this strong commercial aerospace cycle. On the flip side, USAP has struggled to consistently boost its premium product mix, and the company's competitive positioning compared to Allegheny or Carpenter is less impressive.

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Universal Stainless & Alloy Products Badly Needs To Regain Momentum With Its Premium Alloy Offerings

Carpenter Technology Undervalued And Making Progress, But Where's The Spark?

I’ve had pretty mixed feelings about Carpenter Technology (CRS) for some time. In my last write-up on this specialty alloys company, I thought the shares looked undervalued, but I also thought the company really needed to show some improvement in execution before the Street would get behind it. While the shares did break out over $50 in the interim (up about 25% from the price of that last article), weak nickel prices and concerns about end-market demand have once again weighed on the shares and net-net, the shares are close to where they were at the time of that last article.

I like the progress that Carpenter has made with winning qualifications for its Athens facility, though it will take time for these qualifications to turn into revenue and profits. I also like the investments the company is making in areas like electrification-enabling alloys (including soft magnetics) and powered metals for additive manufacturing, but here again, it will take time for these efforts to really scale up. The good news? The company has a strong backlog but the shares are still undervalued on a historical median EBITDA multiple.

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Carpenter Technology Undervalued And Making Progress, But Where's The Spark?

Acerniox Not Really At 'Can't Miss' Levels

To whatever extent I’m grudgingly interested in steel stocks today, it’s because some of the valuations appear to be pricing in bleak near-to-medium-term scenarios that don’t seem to fit with what is actually going on in the world (and that’s from someone who is pretty bearish relative to consensus). Unfortunately, Acerinox (OTCPK:ANIOY) (ACX.MC) doesn’t seem to offer that same margin of safety today. I continue to believe this is a well-run leader in stainless steel, but steel price momentum looks weak, several end-markets are softening, and the valuation isn’t really pricing in doom, gloom, or boom.

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Acerniox Not Really At 'Can't Miss' Levels

Ternium Beaten Up, But The Quality Is Still There

The six months since my last article on Ternium (TX) have not been kind to the steel sector in general, nor this Mexican steelmaker in particular, with the shares down about 16% and roughly doubling the decline of the sector. While the sector has been pressured by weaker prices, rising costs, and concerns about demand growth in 2019 and beyond, Ternium too has been squeezed by pricing and costs, not to mention weaker-than-expected demand in its key operating regions.

Macro factors remain my biggest worry with Ternium, as construction activity has yet to turn in Mexico and Argentina’s “recovery” is at best looking like a drawn-out process. Improving demand in Brazil should help, but global weakness in the auto industry remains a point of pressure for the company. Given Ternium’s excellent margins (even in comparison to leaders like Nucor (NUE) and Steel Dynamics (STLD) ), longer-term prospects in both Mexico and Brazil, and the valuation, this is still a name I like within the steel sector.

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Ternium Beaten Up, But The Quality Is Still There

Gerdau's Share Price Weakness May Not Be Entirely Reasonable

I was skittish about the near-term performance prospects for Gerdau (GGB) back in early December, and the shares have fallen about 10% since then – modestly underperforming a weak steel sector over that time. Gerdau’s share price performance hasn’t been helped by weaker steel prices in the U.S., nor a slower-to-develop recovery in Brazil, and costs continue to rise in the meantime.

I’m not all that bullish on the U.S. steel sector, but I think Gerdau has significantly upgraded their U.S. operations, and I’m more bullish on the prospects for Brazil’s steel sector over the next few years as the country makes a tentative economic recovery. Like Ternium (TX), I think Gerdau could be positioned to post EBITDA and FCF growth at a time when U.S. steelmakers will have more lackluster results, and a stronger recovery in Brazil could maintain investor enthusiasm for that region. I’m less bullish on Gerdau relative to the sell-side, but below $4/share, I think these shares are worth a look.

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Gerdau's Share Price Weakness May Not Be Entirely Reasonable

Global Payments Scales Up Yet Again

The lucrative and growing payments market is one that increasingly rewards scale, and the leading players are acting accordingly. First Data (FDC) and Fiserv (FISV) are pairing up, as are Fidelity National (FIS) and Worldpay (WP). While not on the same scale, JPMorgan (JPM) is also scaling up, recently announcing the $500 million acquisition of InstaMed to target the fast-growing healthcare payments vertical. Not to be outdone (or left behind), Global Payments (GPN) has announced an acquisition of Total System Services (TSS) that should boost it to around 8% share of the U.S. acquiring market while filling in some gaps in its covered verticals.

Fintech is still hot, and although not every analyst or investor is sold on Global Payments’ strategy of using wholly-owned software offerings to drive customer acquisition and retention for its payments business, the shares seldom trade at much of a discount. Although I don’t think Global Payments is particularly cheap, I believe today’s share price is a relatively fair reflection of the value of the business at this point.

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Global Payments Scales Up Yet Again

Crane Going Hostile In An Effort To Acquire CIRCOR's Under-Managed Assets

Multi-industrial Crane (CR) had indicated before that they were interested in M&A, particularly synergistic deals in the fluid handling and/or aerospace businesses, and now, it’s clear that they’re serious about it. After trying unsuccessfully to engage the board in a friendly negotiated transaction, Crane has gone public with a hostile bid for chronic underperformer CIRCOR (CIR) that I believe offers shareholders more value than they’ll ever see from its current management team.

I don’t know how this story ends, but it’ll be interesting to watch. CIRCOR’s press release confirming the rejection of the deal makes for good comedy, but the reality is that closing hostile deals isn’t so simple. I believe the relatively concentrated ownership of CIRCOR could help apply pressure to the board (GAMCO, Vanguard, Royce, and T. Rowe Price collectively own 45% of the shares), and I believe Crane’s deal is quite fair, but there is no certainty that this deal can get done.

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Crane Going Hostile In An Effort To Acquire CIRCOR's Under-Managed Assets