PacBio Shares Reflect Some Ongoing Worries About The Illumina Deal

Although Illumina (ILMN) reiterated during its first-quarter conference call that it expects its acquisition of Pacific Biosciences (PACB) (“PacBio”) to close around midyear, clearly the market is not wholly sold on that outcome, with the shares trading below $7 as of this writing. While we know that the FTC had a second round of questions for the company on the deal (disclosed by Illumina in conjunction with Q4’18 earnings) and the end of the U.K.’s Competition and Markets Authority Phase I review is coming up, neither PacBio nor Illumina has expressed any real concern that the deal won’t go through, and due diligence has continued to support the idea that the two companies really aren’t competitive in any meaningful sense.

I still believe the deal goes through, but it is arguably prudent to address what happens if the deal doesn’t happen. Assuming that PacBio would be entitled to a full breakup fee, I believe PacBio’s cash would be just barely sufficient, though the launch of the Sequel II and SMRT Cell 8M chip complicates discussions of cash burn. Given that I believe PacBio would be worth around $6.50 on a standalone basis, it’s hard for me to reconcile today’s price with the likely Illumina buyout and even the worst-case scenario of the deal collapsing.

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PacBio Shares Reflect Some Ongoing Worries About The Illumina Deal

JPMorgan Building On Strengths Outside Of Banking

JPMorgan (JPM) is one of the largest, and in my opinion also one of the best-run, banks in the U.S., but core deposit/lending banking operations are only part of the story. JPMorgan also has a significant payments business, and management has made it clear that they view growing this high-margin, high-returns business as a core priority. To that end, the company recently announced its largest deal since the financial crisis, and I expect further investments (both organic and M&A) to grow this business.

Although I continue to believe that core banking has more or less plateaued for this cycle, JPMorgan continues to stand out for the quality of its operations. Looking ahead a bit, I believe the company’s plan to drive organic growth (new branch openings) and leverage its substantial IT investments will drive better-than-average growth and cost leverage. There are bigger bargains in the banking sector today, but in terms of quality and value, I believe JPMorgan’s double-digit discount to fair value still makes it a name worth considering.

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JPMorgan Building On Strengths Outside Of Banking

Lattice's Investor Day Highlights The Separation From The Company's Past

To the extent that a bullish position on Lattice Semiconductor (LSCC) is controversial, at least beyond valuation arguments, it is controversial primarily because Lattice used to be a poorly-run, scattered, low-value-add chipmaker. I’ve written multiple articles on how Lattice has changed (new management, new plan, new priorities, et al), but the company made its own case recently with an Analyst Day that highlighted what’s new and different about Lattice today.

For those who’ve been following the story closely over the last year or so, this Analyst Day was more evolutionary than revolutionary, but management nevertheless provided some interesting detail, particularly with respect to content opportunities, a new design philosophy, and the near-to-medium-term financial model. It wasn’t a home run presentation (there was some disappointment on the operating margin target), but it was a positive in my view and this is still a stock that interests me at the right price.

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Lattice's Investor Day Highlights The Separation From The Company's Past

Steel Dynamics Has Near-Term Challenges, But The Valuation Is Getting Interesting

I was “cautious” on Steel Dynamics (STLD) back in January due to the challenges that come with descending from a cyclical peak, but it has still been among my favorite steel names for some time. To that end, I’m a little surprised that it has underperformed the sector since that last article, though another of my preferred names, Ternium (TX), has done even worse, while Nucor (NUE) has done a little better. On the other hand, a quick look at AK Steel (AKS), ArcelorMittal (MT), Gerdau (GGB), or U.S. Steel (X) and you realize it could still be worse.

I still believe this is a very well-run steel company, but I’m also still concerned about the underlying health of the U.S. short-cycle economy, the prospect of weaker demand and prices, and higher conversions costs. If that weren’t enough, there’s also the matter of meaningful U.S. capacity additions in sheet steel over the next few years. I do believe that Steel Dynamics is undervalued and might have some longer-term appeal now (particularly for investors with a more bullish outlook on the U.S. economy), but I do think Nucor has the better product mix for the next 6 to 18 months.

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Steel Dynamics Has Near-Term Challenges, But The Valuation Is Getting Interesting

Follow-Through Is The Next Big Challenge For ams AG

ams AG (OTCPK:AMSSY) (AMS.S) has given investors quite the ride over the last year or so, with the shares still down over 50% over the past year (far below the almost flat performance of the SOX), but up more than 60% since the time of my last article on a better first quarter, strong guidance for the second quarter, and several content wins in the Android smartphone market.

I don’t really expect trading in ams shares to really be any calmer any time soon. Not only are there risks to Apple (AAPL) volumes from the next phone cycle (which will begin later in 2019) and another possible inventory correction, but there’s still uncertainty about exactly which components ams is winning with these Android vendors, not to mention what those volumes will look like. On top of that, there’s still meaningful uncertainty about the pace of the recovery in demand for auto and industrial markets, and oh by the way, also ongoing competitive risks as companies like STMicro (STM), Sony (SNE), and Infineon (OTCQX:IFNNY) try to elbow their way into the 3D sensing market.

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Follow-Through Is The Next Big Challenge For ams AG

ArcelorMittal Lagging On Weaker Markets And Margins

Steel hasn’t been a particularly popular sector over the past three months, with the sector down about 7% or so. Unimpressive as that is, it’s downright aspirational for ArcelorMittal (MT), which has seen its share price drop about 20% over that time, with a significant drop in just the last two weeks. Between uninspiring prices in most of its markets, higher costs, and concerning macro signs, there are plenty of contributing factors to consider.

I’ve said it before and it merits repeating – stocks don’t go up just because they’re cheap. It usually takes some other catalyst, some reason to believe that the tide is going to turn in a more positive direction, to get share prices moving, and that could be problematic for ArcelorMittal in the near term. While I believe management is running the business along generally sound lines, weakness in Europe and emerging concerns about the U.S. market are likely to stick around a bit longer and ArcelorMittal really needs some beat-and-raise quarters coupled with a stronger steel market to change sentiment.

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ArcelorMittal Lagging On Weaker Markets And Margins

Nucor Has The Right Mix And A Better Valuation

I wasn’t a big fan of Nucor (NUE) back in February, and I don’t feel like I’ve missed out on anything with the 10% move down since then. While Nucor remains one of the best operators in the steel business, prices have weakened as I expected and volume hasn’t made up the difference. What’s worse, costs are rising and I think companies in the steel sector may be counting on more volume/demand recovery in the U.S. than the economy can support.

With the downward move the shares are more interesting now. I still prefer Steel Dynamics (STLD) and Ternium (TX) (though the shares of the latter have been quite weak since February), but Nucor does seem to offer some upside on my EV/EBITDA valuation approach, and Nucor should benefit from oncoming volume/capacity increases in a still-healthy market while others are now investing for capacity that won’t come into play for years.

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Nucor Has The Right Mix And A Better Valuation

Innospec Offers Steady Performance And Occasional Opportunities

Among specialty chemical companies, Innospec (IOSP) is a relatively low-drama player, with a solid management team that generally does a good job of managing its businesses to the realities of their respective end-markets – maximizing margins in slower-growing businesses, but exploiting growth opportunities where they are available. Innospec doesn’t often get all that cheap apart from broader market/sector pullbacks, but those are good times to reconsider these shares.

Innospec has come off a bit from a recent peak and the shares aren’t all that exciting from a DCF-driven value perspective, though an EV/EBITDA approach offers a little more upside. Capital deployment into growth M&A remains a definite possibility, but I’d prefer to try to pick up shares in the $70’s if possible.

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Innospec Offers Steady Performance And Occasional Opportunities

Qorvo Still Not Getting Its Due

When I last wrote about Qorvo (QRVO) in early January, I thought the shares of this chip company were undervalued, but I thought the near-term outlook was clouded by the possibility of another guidance cut (which happened with fiscal Q3 earnings in February) and a lingering perception of Qorvo as a “problem child” with respect to overreliance on mobile end-markets and problematic gross margins. To that latter point, the shares have continued to consistently lag the SOX since that last article, though they’re up about 20%.

Generating alpha by investing in laggards is a tough way to go, but it is not without its rewards. Once a company’s perception changes, the rerating can be quick and significant. While Qorvo seems to have lost content with Apple (AAPL) (back to Broadcom (AVGO), presumably), I think the IDP segment is under-appreciated, and I likewise think the gains with non-Apple vendors are underappreciated for their margin benefits. It doesn’t take heroic assumptions to get a high $80’s fair value, but this is a stock that has tested investor patience for some time and we may not be out of the woods yet with this sector correction.

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Qorvo Still Not Getting Its Due

Harsco Shifting From Turnaround To Transformation

Harsco (HSC) is a case-in-point as to why I say that successful turnarounds can exceed your expectations at the start of the turnaround, as management has done a great job of improving its core Metals & Minerals business and it seems as though some of the changes made to the Rail business are about to start paying off. On top of that, Harsco benefited from lucky timing (always a good thing in a turnaround) with the global recovery in steel production and in markets like oil/gas (for its heat exchangers).

Now management is underway with a transformation process that is seeing the company become less of a multi-industrial hodgepodge and more of a focused player in industrial-environmental markets like waste reclamation and treatment. Although the bigger move into waste treatment carries some operational risk, I believe management has earned the benefit of the doubt with respect to its ability to execute.

As for the shares, even with this recent sell-off, the shares are up about 10% from the time of my last article. I saw high $20’s to low $30’s value then, and I still see that now, and a return to the low $20’s in a broader market sell-off would be an opportunity to consider.

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Harsco Shifting From Turnaround To Transformation

Veeco Showing Signs Of A Longer-Term Transition To A Better Model

Although I thought Veeco (VECO) was undervalued in November of 2018, I didn’t expect the strong rebound in the share price, and I definitely underestimated the Street’s enthusiasm for the changes management was making to the business. To be fair, it’s not just a change in perception that I believe has driven the share price move; I believe Veeco has a better strategy and business plan in place now, and I underestimated the growth potential that such a shift could bring into the picture.

Veeco’s decision to move away from commoditized markets like blue LED and embrace more front-end equipment (not to mention equipment that enables leading-edge chip production) should bode well for growth and margins. Exactly how much it will margins is a big question when trying to figure out the valuation. If the changes management has made can put the company in a position to generate long-term EBITDA margins in the 20%’s and FCF margins in the mid-teens, there could still be further upside from here.

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Veeco Showing Signs Of A Longer-Term Transition To A Better Model

Slow Progress At BRF SA, But ASF Is Providing A Boost

BRF SA’s (BRFS) turnaround process is going to take years to complete, but management has made some progress already. Helping matters, a potentially severe outbreak of African Swine Fever (or ASF) in China has boosted protein stocks (BRF included) in anticipation of higher protein imports from that country and less demand for grain in Brazil.

The impact of the ASF outbreak is unlikely to provide a permanent boost to BRF, but it should boost revenue, profits, and cash flow at a time when the company could really use the boost. The shares look more fully-valued on a near-term basis, but I maintain my longer-term outlook that a successful turnaround could drive a meaningfully higher price for more patient investors.

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Slow Progress At BRF SA, But ASF Is Providing A Boost

With Apple No Longer An Overhang, Dialog Needs To Build Its Future Business

I thought Dialog (OTCPK:DLGNF) (DLGS.XE) was undervalued back in January on ongoing uncertainty over the company’s relationship with Apple (AAPL) in power management chips and what the future of Dialog would look like. Since then, the shares have shot up about 50% as investors have come to a more rational set of expectations regarding the ongoing contributions of sub-PMIC sales to Apple and emerging opportunities in connectivity and charger products.

I do like Dialog’s emerging portfolio in low-power connectivity, a key enabling technology for IoT, and I like the amount of capital management has on hand to deploy toward more business-building deals. Management has been disciplined here so far, and I hope that will continue. Now, though, the shares are valued much more like any other semiconductor company, and while I don’t think the valuation is inflated, I also don’t see a big discount to underlying fair value.

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With Apple No Longer An Overhang, Dialog Needs To Build Its Future Business

Louisiana-Pacific's Weaker First Quarter Looks Like A Bump Along The Bottom

When I last wrote about Louisiana-Pacific (LPX) in February, I thought that the shares were an iffy prospect given the run since last December and with weak near-term prospects for housing activity and OSB pricing. With the shares down about $1 since then (a little less than 5%), I really don’t feel like I missed out on much, as LP is going to have to spend a little time here bumping along the bottom of the OSB cycle.

Relative to a fair value in the high $20’s based on my estimate of “full-cycle EBITDA”, I think LP shares are a little undervalued, but not so dramatically so that I feel inspired to do much – this is an “apples to oranges” comparison, but Weyerhaeuser (WY) looks more substantially undervalued, offers a sizable payout, and has some similar underlying drivers (namely, housing).

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Louisiana-Pacific's Weaker First Quarter Looks Like A Bump Along The Bottom

PRA Group Doing Okay, But Needs To Find Another Gear

PRA Group (PRAA) has been a frustrating stock to follow and own lately, as management’s performance on margins has been underwhelming, while continuing to use leverage to buy more charged-off debt. A still-healthy economy is helping on the collections side, while rising charge-offs point to more supply in the relatively near future.

I’m still concerned about the possibility that there has been a permanent change in PRA Group’s core market and that collections margins will never be what they once were. Likewise, PRA’s sheer size is a limit to how much cherry-picking the company can do when buying new inventory. I can still argue for a price in the low $30’s, but I’m growing frustrated with the slow pace of margin improvement and management’s credibility could use some improvement.

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PRA Group Doing Okay, But Needs To Find Another Gear

Calyxt Continues To Make More Progress Than Is Shown In The Share Price

Make no mistake, Calyxt (CLXT) still has a long row to hoe. Although this bio-ag has now logged its first commercial sales in multiple product types, the company is likely somewhere around five years away from its first profitable quarters and six or so years away from being free cash flow positive. Moreover, a lot of the growth I model for Calyxt comes its high-oleic soybean product, a product category that has attracted plenty of competitive attention, and there is still a risk that a segment of consumers turn against gene-edited foods in the way they have against genetically-modified foods produced from seeds developed by the likes of DowDuPont’s (DWDP) Corteva or Bayer (OTCPK:BAYRY).

Although the shares have rebounded from the time of my last update, I don’t believe the shares fully reflect the progress and potential of the company. There have been some pushouts relating to commercial and development pipelines, but nothing out of the ordinary for a company at this stage, and there is meaningful upside from here as the company scales up its HO soy program and advances other projects to the market.

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Calyxt Continues To Make More Progress Than Is Shown In The Share Price

ITT Overlooked And Undervalued As A Late-Cycle Play

I'm not sure it's entirely appropriate to call a stock followed by over a dozen sell-side analysts and widely-owned by institutions "overlooked", but I don't get the sense that ITT (ITT) is as widely-known among investors as it should be. And, that's a shame. ITT isn't perfect, but I like this diversified industrial's philosophy of adopting best practices irrespective of their source, not to mention broad late-cycle exposure and a strong growth auto business.

Below the mid-$60s, I think ITT is undervalued. While there is some asbestos liability here, I believe it is well-covered, and the company has the dry powder available to make select acquisitions to build out its operations further. I believe the perception of the auto business has already corrected, and ITT's short-cycle industrial exposure is moderate, and so I believe this is a good time and place to consider this name.

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ITT Overlooked And Undervalued As A Late-Cycle Play

Colfax Logs A Stable Quarter Amid Significant Transformation

In multiple past articles on Colfax (CFX) I took management to task for the state of the business, including questionable long-term value in the Air & Gas Handling business, an unimpressive turnaround with Fab Tech, and a need to do something more transformative with the business mix. Since my last update, the company has made some significant announcements, led by the $3 billion-plus acquisition of DJO Global and the impending sale of the Air & Gas Handling business.

Although I think management’s growth expectations for DJO Global may be too high, this non-cyclical business should generate some solid cash flow and the AGH sale will reduce some of Colfax’s cyclicality. Top-line growth will still be a challenge, but better margins and a more stable business mix should be rewarded with a better multiple, and today’s multiple is not demanding.

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Colfax Logs A Stable Quarter Amid Significant Transformation

Copa Shares Snap Back As The Street Is Reminded Of The Strong Cost Story

Copa’s (CPA) low $70’s share price around Christmas of 2018 will probably go down in my annals of “shouda, couda, wouda”, and maybe ought to serve as a reminder to use a more compelling alert/reminder system. Anyway, while this Latin American airline’s shares had been drifting since February, the shares rebounded strongly after first quarter earnings, as management once again demonstrated its proven (but still occasionally overlooked) cost management ability and maintained a fairly benign outlook for the business, as well as reiterating some encouragement about the Brazilian market later this year.

I still believe Copa is undervalued and buyable here. There are risks that Brazil won’t recover as quickly or as strongly as hoped, and that’s likewise true for Argentina, but I believe the company has been operating well even with things as they are. With a very strong network and operating plan in place, I believe mid-single-digit revenue growth can drive high single-digit EBITDAR growth and support a fair value around $100.

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Copa Shares Snap Back As The Street Is Reminded Of The Strong Cost Story

Middleby Doing Better On A Core Basis, And Valuation Reflects That

With much-improved performance in the residential business and decent growth in commercial foodservice, Middleby (MIDD) has come back into investors’ good graces, with the shares up better than 25% over the past year. I liked Middleby better when the restructuring efforts were still in process and recovery in the business (and sentiment/perception) was still up for debate, and now I find the valuation more demanding for a company that I believe is too large to significantly outgrow its markets on an organic basis.

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Middleby Doing Better On A Core Basis, And Valuation Reflects That