Materion Rewarded For Exceeding Even Bullish Margin-Improvement Assumptions

I’ve commented many times over the years that successful turnarounds, particularly when the company has some meaningful moats, can significantly exceed expectations. That’s certainly been playing out at Materion (MTRN), as the company’s restructuring efforts – including a more lucrative product mix and a shift toward a more variable cost structure – have paid off better than the Street or I expected. With that, the shares are up more than 20% over the past year – significantly outperforming kinda/sorta comps like Allegheny (ATI), Carpenter (CRS), and Johnson Matthey (OTCPK:JMPLY).

I’m reluctant to just assume that Materion can’t find still more ways to improve itself, but I’m already valuing the company on the assumptions that 2019 EBITDA margin will reach a new peak (and continue to improve) and that FCF margin will reach a new peak in 2020 (and continue to improve). On the other hand, these improvements have come despite weak trends in consumer electronics and auto electronics, and improved revenue growth in a couple of years could unlock even more leverage.

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Materion Rewarded For Exceeding Even Bullish Margin-Improvement Assumptions

Better Execution Leading To Better Valuation For GenMark

I thought GenMark Diagnostics (GNMK) was a high-risk/high-reward opportunity in mid-December, amidst a sharp downturn in the market overall and small-cap med-tech especially, and the shares have rebounded strongly (up almost 50%) since then. While a general sector and market recovery certainly helps, I think GenMark is also helping itself with more consistent management execution and a more credible path to key revenue breakpoints like $100 million, $200 million, and $400 million.

GenMark shares still look undervalued, but this is a competitive space and the company is somewhat late to the game. Although I think the qualities of the ePlex system will help GenMark win slots and drive usage, and I believe the shares are still undervalued below $8, this is still a stock with above-average risks.

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Better Execution Leading To Better Valuation For GenMark

Alaska Air Focusing On Execution, But The Shares Are Lagging

Alaska Air (ALK) enjoys a good reputation for the quality of its operations and management execution, but the "what have you done for me lately?" world of Wall Street doesn't reward that on a consistent basis. To that end, while I had some concerns in my last article about weaker sentiment across the airline sector, Alaska Air has underperformed, largely on what I believe to be concerns about near-term weakness in fares in its West Coast and Hawaiian operations.

Alaska Air's concentration on the West Coast remains a risk factor, but I believe the quality of the operation is still undervalued, and with a significant upturn in free cash flow on the way (barring a major deterioration in the sector), I believe management will be in a good place to return more capital to shareholders. Below $80, I think the shares are worth a look.

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Alaska Air Focusing On Execution, But The Shares Are Lagging

Geely Trying To Stay Between The Lines In A Turbulent Chinese Market

It has been something of a wild ride for Geely (OTCPK:GELYY) [0175.HK] shareholders since my last update. While the shares are up close to 20% since that last article (which was around the time of its 52-week low), the shares were up more than 60% before this recent 30% sell-off on ongoing concerns about the company’s volumes and margins.

I do still believe that Geely shares are undervalued, and I still believe that Geely is going to emerge from the Chinese auto mosh pit as one of the survivors and leaders of the local industry. I also believe, though, that 2019 is going to be a rocky year with considerable uncertainty over U.S.-China trade relations and their impact on Chinese consumer spending and sentiment. I’d really like to see better sales momentum in Geely’s newer offerings before getting more bullish, though timing entry points for this name has always been challenging, given its relatively controversial status (very wide spreads between high/low price targets and estimates for revenue, EBITDA, and free cash flow).

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Geely Trying To Stay Between The Lines In A Turbulent Chinese Market

FLSmidth's Underperformance Seems Overdone

I didn’t really like the prospects of FLSmidth (OTCPK:FLIDY) (FLS.KO) as a long-term hold back in September, but I didn’t expect a nearly one-third drop in the share price, nor the significant underperformance relative to other mining-exposed names like Epiroc (OTCPK:EPOKY), Metso (OTCQX:MXCYY), and Weir (OTCPK:WEIGY). In addition to concerns about an early end to the mining capex cycle, I believe the market has sold off FLSmidth on lingering angst over the company’s weak, low-margin cement business.

While the cement business looks like an “is what it is” situation for the foreseeable future, I think the market is too sour on the mining business and the company overall. FLSmidth is well-aligned with the mining industry’s push towards automation and productivity and I believe copper, gold, and coal prices remain supportive for the business. With the shares more than 20% below fair value, this is a name to consider, but the U.S. ADRs have lousy liquidity and if macro weakness spreads, it’ll likely pressure commodity prices and mining names in the near term.

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FLSmidth's Underperformance Seems Overdone

HollySys Undervalued (Maybe Significantly), But Confounding

HollySys (HOLI) is a case-in-point to what I’m talking about when I say that some otherwise undervalued opportunities just aren’t worth the hassle. Although HollySys has significant growth potential serving China’s automation and rail markets, consistent growth has always been elusive and management’s communication with investors is tragically bad. Considering all of that, and ongoing risks to China’s near-term economic health, I’m not all that surprised that the shares are down more than 10% from my last update on the company.

So is HollySys worth the hassle now? The shares are looking more than 30% undervalued to me, and I do believe the company has strong core capabilities in areas like control technology. I believe there are opportunities for HollySys to take share from the likes of Honeywell (HON), Emerson (EMR), and Yokogawa (OTCPK:YOKEY), while also expanding its portfolio and addressable markets. All of that said, the risks here are high, as management has earned the “doubt of benefit” and really needs to establish credibility with analysts and investors to prosper.

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HollySys Undervalued (Maybe Significantly), But Confounding

Broadcom Looks Undervalued After Resetting Expectations

I’ve been cautious on chip stocks in recent months, primarily because I thought the Street was carrying inflated expectations for a strong second half rebound. Although I can’t say Broadcom (AVGO) has totally de-risked its fiscal second half, nor can I say that there’s no further downside for the global economy and/or chip stock revenue expectations, I think expectations are at a much saner level than they were before, with chip stocks having modestly underperformed the overall market.

I believe Broadcom shares should trade above $300. Moreover, I think management has proven itself over the years as one of the most realistic teams in the space with respect to what drives value in semiconductors. With a strong presence in the data center, as well as a host of other opportunities, I continue to believe this is one of the best-run semiconductor companies, and now it’s trading below fair value.

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Broadcom Looks Undervalued After Resetting Expectations

OMA Delivering Some 'Oh My' On Margins

I thought Grupo Aeroportuario del Centro Norte (OMAB) (or “OMA”) shares looked too cheap back in mid-December as investors rushed to panic about the potential risk to airport concessions/tariffs and air travel volumes in Mexico from the new populist government. Since then, not only has OMA’s traffic held up better than expected (true for Mexico as a whole as well), but OMA has outperformed with respect to growing non-aero revenue and controlling/reducing expenses.

With the 50%+ move in the ADRs, I look at OMA as more of a hold now than an appealing buy. Air traffic is holding up well and there could be more upside in EBITDA and FCF on even better operating leverage, but I’m not inclined to press my luck too far here. A pullback to the mid-$40’s would be a different story, though, and this is a name worth keeping on a watchlist.

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OMA Delivering Some 'Oh My' On Margins

Air Transport Services Group Leveraging Its E-Commerce-Driven Growth Opportunities

With the rapid growth in e-commerce and Amazon's (AMZN) ever-growing logistics needs, Air Transport Services Group (ATSG) continues to look like a relatively below-the-radar name worth considering. Customer concentration is a notable risk, but Amazon appears deeply committed to growing its logistical/delivery capabilities, and Air Transport Services Group's services are invaluable to the DoD as well. Free cash flow will remain difficult to predict on a year-to-year basis, but the underlying profitability of the business appears to be improving and adding A321 conversion capabilities down the road should only help.

Free cash flow modeling is challenging as the year-to-year commitments to growth capex can swing wildly with new contract wins (like the expanded business ATSG secured from Amazon late in 2018), but EV/EBITDA is a little more consistent and suggests worthwhile upside from here.

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Air Transport Services Group Leveraging Its E-Commerce-Driven Growth Opportunities

Wabtec Has To Re-Earn Its Premium, But Valuation Seems Low Relative To Near-Term Expectations

Wabtec (WAB) has certainly lost the benefit of the doubt it enjoyed for so many years, at least in terms of how the market viewed its growth potential and the multiples that growth potential was worth. Between worries about the quality of the business it acquired from GE (GE), management’s ability to integrate the deal, and underlying market/business trends in both freight and transit, expectations are certainly quite a bit lower now than a year or so ago, and the shares have lost about a third of their value since my last article on the company in early October.

Although I think there are still valid arguments for a fair value above $90, there’s a lot that Wabtec has to prove before that will resonate with the Street, and Wabtec needs to deliver some clean quarters before the market will pay 12x or more for forward EBITDA.

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Wabtec Has To Re-Earn Its Premium, But Valuation Seems Low Relative To Near-Term Expectations

Cummins Well-Positioned For The Correction

Cummins (CMI) is enjoying the last few quarters of this heavy-duty truck-driven cyclical peak, but management is already preparing for a downturn in 2020 that will almost certainly lead to one year (maybe two) of negative comps in revenue, EBITDA, and free cash flow. Ex-North America demand and other businesses like Power could help soften the blow, but cyclicality is just part of the story and something that long-term investors need to accept.

I think valuation on Cummins is pretty reasonable today, and I don’t see it as particularly over-valued or under-valued. Certainly there is a risk that end-market demand will correct to a “weaker for longer” cycle than currently expected, but my bigger concern is just how markets tend to treat cyclical stocks; Wall Street is obsessed with growth and Cummins shares may well lag when the reality of the cycle starts showing up in the numbers, even though everybody knows it’s a cyclical company that goes through its ups and downs and still manages to generate strong cash flows and ROICs across the cycle.

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Cummins Well-Positioned For The Correction

Expectations Are Low, But voestalpine Is Getting Squeezed On Costs And The Outlook Is Tricky

If you want more evidence of the challenges facing the steel industry, look no further than voestalpine’s (OTCPK:VLPNY) (VOES.VI) fiscal fourth-quarter results and new guidance from a few days ago. While voestalpine is more leveraged to specialized products and downstream operations than steel producers like ArcelorMittal (MT), the fact remains that steel companies are feeling the squeeze from weaker prices, iffy demand, and rising costs, and it doesn’t sound like those challenges are getting any easier.

With management calling for flat EBITDA in fiscal 2020 and pointing to growing signs of weakness in several key end-markets, it’ll take some time before investors start considering the possibility of better earnings in FY'21 and beyond. Likewise, while the valuation looks low now on both a relative and absolute basis, weakening end-user demand and ongoing cost pressures aren’t going to have investors too excited about buying in ahead of that recovery. I do believe that voestalpine has some long-term appeal here, but investors are going to have to have patience with this one.

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Expectations Are Low, But voestalpine Is Getting Squeezed On Costs And The Outlook Is Tricky

Kirby's Marine Business Recovers, But Energy And Valuation Are Challenges

I thought Kirby's (KEX) marine business was likely to improve when I last wrote about the company in August of 2018, but I also thought the valuation anticipated that. To that end, the shares are about 7% lower than the time of that last article, but there were some pretty significant swings in the meantime, as shares fell almost 30% to their December lows before a meaningful rally. During that period, Kirby's marine business has indeed showed ongoing signs of improvement and recovery, with improved utilization, pricing, and margins in the inland business, and a slower recovery in coastal, but a recovery all the same.

With shares having basically round-tripped in the interim, my feelings on valuation haven't changed that much. In the $70s (or below), this is a good name to consider for its strong position in inland petrochemical barging and the prospects for an improving mix in its diesel engine service business. At today's prices, though, I'm not quite so interested.

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Kirby's Marine Business Recovers, But Energy And Valuation Are Challenges

Hurco Now Definitely In The Down Cycle

There's really no more "if" or "I wonder" about Hurco (HURC) and what's going on in the machine tool cycle - Hurco's April quarter marked the third straight quarter of year-over-year declines in orders, and revenue comps should soon turn negative. Although I think Hurco is faring better than average so far, it's too soon to really tell, and I think investors should expect year-over-year declines in revenue for both this year and next, though I still expect a return to growth in 2021.

Buying into a downturn is tricky. I was pretty underwhelmed by the near-term potential of these shares back in March, and the shares have dropped about 10% since then - lagging not only industrials in general, but also other machine tool companies like DMG Mori (OTCPK:MRSKY) and Fanuc (OTCPK:FANUY). Although I do believe the shares are undervalued, I don't believe the market has really accepted the probability of a weaker-than-expected second half in the U.S. economy, and I see more downside risk for the shares and the market. With at least a couple more quarters of order correction likely, I think there's still risk here, even though longer-term investors may want to keep an eye out for good entry points.

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Hurco Now Definitely In The Down Cycle

Ciena Doing Great In North America; Europe Remains An Opportunity

Between strong deployments from Tier 1 and Tier 2 service providers in North America and healthier trends among enterprise customers than seen by chip companies like Xilinx (XLNX) and Intel (INTC), Ciena (CIEN) had a great fiscal second quarter. Better yet, between a strong competitive position at 800G, ongoing growth in segments like submarine deployments, and opportunities to gain share in Europe, I don’t believe Ciena has exhausted its growth potential.

I’ve been generally bullish on Ciena for a while now, and there are at least some metrics by which the shares are still undervalued. I like to buy stocks like Ciena when they slip below my long-term DCF-based fair value (which is now near $40), and Ciena has been volatile enough that I don’t think it’s entirely unreasonable to think there will be more “buy on a pullback” opportunities. Still, management is executing well on its opportunities, leading to share gains and improving margins.

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Ciena Doing Great In North America; Europe Remains An Opportunity

Stryker Priced Accurately For What It Is - 'The' Best Large Med-Tech

I've made no secret of my abiding respect for Stryker (SYK) and its ability to leverage M&A and disruptive internal R&D to target and deliver on above-average growth opportunities in med-tech. In the roughly seven years Kevin Lobo has been the CEO, the company has spent $14 billion on M&A but has stayed away from "scale for scale's sake" deals in favor of purchasing potentially disruptive assets like Mako, SBI, and K2M, and has managed to deliver organic growth rates (over 7% in Q1) comfortably ahead of its peer group.

Trees don't grow to the sky, but Stryker has growing room. The company is under-leveraged to Europe and emerging markets relative to its peers and Mako continues to drive share gains in knees, while trauma and neuro still offer room for growth. Valuation is still my main hang-up, as I'm not all that excited about the mid-single-digit prospective returns that the stock would seem to offer at today's prices.

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Stryker Priced Accurately For What It Is - 'The' Best Large Med-Tech

AllianceBernstein Seeing Short-Term Pain, But The Long-Term Plan Intact

The first quarter of 2019 wasn’t a particularly easy one for asset managers, AllianceBernstein Holding L.P. (AB) included, and this asset manager’s roughly 3% decline since my last update puts on the slightly below-average end of the scale over that period, though it remains one of the leaders in its peer group over the past year (a period in which many rivals are down 10% or more).

First quarter results weren’t great in absolute terms, nor relative to expectations, but long-term trends remain positive, as AB continues to see strong retail inflows, healthy fees, and good performance. While weaker markets are pushing back the 30% operating margin goal, I believe the underlying fundamentals are still healthy, and I believe these shares are attractively-priced below $30 for investors who want a more income-skewed total return.

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AllianceBernstein Seeing Short-Term Pain, But The Long-Term Plan Intact

XPO Logistics Taking A One-Two Punch Of Slowing Macro And Persistent Business Quality Questions

When I last wrote on XPO Logistics (XPO) roughly a year ago, I wasn't all that interested in the shares due to what I thought was an overheated valuation. Little did I expect the chaos that would ensue, including a large M&A transaction that never happened, the loss of a significant chunk of business from Amazon (AMZN), significant high-level executive turnover, multiple EBITDA misses, and persistent questions regarding the company's working capital management and intrinsic growth capacity.

Although I still like XPO's less-than-truckload (LTL) trucking operations and I believe the contract logistics business may be underappreciated on its long-term leverage to e-commerce fulfillment, I don't like the debt-funded share buybacks, and I think the macro picture is getting more challenging. On the other hand, there's a sizable short position here and the market could reward performance that simply meets expectations in 2019. On top of that, today's valuation seems to only be anticipating low single-digit long-term FCF growth.

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XPO Logistics Taking A One-Two Punch Of Slowing Macro And Persistent Business Quality Questions

Ship Finance May Be Looking To Grow The Business Again

A high-yield play on shipping, Ship Finance (SFL) has never been the easiest stock for investors to follow. Between eccentric non-GAAP accounting, little sell-side coverage, and share price volatility tied to the volatile and cyclical shipping industry, the shares have moved around a fair bit over the last five years. While the dividend has been more stable for about two years, it is still more than 20% below the peak ($0.45/share, last paid in Q1’17), and an uncommonly high yield has long been one of the key attractions of this stock.

Appreciating that the dividend is relatively safe (but far from guaranteed), this continues to look like a good option for investors willing to take on some higher risk in the pursuit of higher yields. The company has a significant portion of revenue locked up until multiyear time charters with high-quality counterparties and an empty order book should mean substantial cash flow coming in over the coming years. While I’d like to see management prioritize debt reduction and an increased payout, investors should be prepared for capital deployment into M&A, as it still sounds as though that’s where management’s attention is now.

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Ship Finance May Be Looking To Grow The Business Again

Criteo Trying To Rebuild A Stalled Growth Engine In Mid-Flight

As an ad tech company built around a machine learning-based ad retargeting engine, Criteo (CRTO) has had a rough go of it in recent years. Between concerns about privacy and the growing use of ad blocking software, Criteo has found it harder and harder to generate growth from what was once a very successful differentiating technology. While the company has been building up other businesses, they’re simply not big enough yet (nor will be in the near future) to offset the fundamental underlying pressures in the core business.

Expectations are low for Criteo now; low-to-mid single-digit revenue growth and mid-single-digit FCF adjusted free cash flow growth can support a fair value above $20, but 2019 is going to be a year of next-to-no growth (and possible contraction), there are still risks with changes to Google’s (GOOGL) Chrome browser, and management frankly doesn’t have much credibility with the Street. Newer offerings like sponsored products and in-app advertising could help spark a turnaround, and expectations are low, but investors will need a lot of patience.

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Criteo Trying To Rebuild A Stalled Growth Engine In Mid-Flight