McPhy Offers A Still Largely Unknown Play On Green Hydrogen

Green hydrogen has been getting more and more attention lately as a viable means of decarbonizing high-pollution industries like steel and cement, as well as at least some elements of transportation. Produced with clean renewable power like solar, wind, or hydroelectric, green hydrogen could not only displace some of the 70Mtpa of “grey hydrogen” produced today, but also become viable in a range of applications where hydrogen isn’t used currently.

France’s McPhy (OTC:MPHYF) (MCPHY.PA) wants to play a major role in that process. McPhy is focused on electrolyzers (or electrolysers), a key component in the hydrogen production process that takes water and electricity as inputs and produces hydrogen. Producing 5Mt of green hydrogen in 2030 would translate into around 25GW of installed electrolyzer capacity, a total market opportunity of over $16B, and even a single-digit share of that would represent a major opportunity for this small company.

To be clear, McPhy is an exceptionally speculative play. Green hydrogen demand may never develop into anything meaningful, and even if it does, other players like Cummins (CMI), Siemens Energy (OTCPK:SMNEY), or ITM Power (OTCPK:ITMPF), not to mention later entrants or startups could outmaneuver and outcompete McPhy. Still, for investors who can take the risks, it’s an interesting early-stage picks-and-shovels play to explore further.

 

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McPhy Offers A Still Largely Unknown Play On Green Hydrogen

Agilent Leveraged To Post-Pandemic Recovery And Advanced Drug Discovery And Production

 

You don’t go to the life sciences space looking for conventional bargains – it’s a high-growth, a high-margin sector that has attracted a lot of investor attention and the valuations reflect that. For investors who can get comfortable with the higher multiples, though, I do think there are some interesting stories, and Agilent (A) is one of them.

With research labs still operating well below normal and other end-markets like Chemicals and Energy likewise below historical norms, I see worthwhile upside for Agilent on post-pandemic normalization. I also like the company’s leverage to increased service penetration with its laboratory customer base, as well as the growth opportunities in biological drug discovery and production.

 

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Agilent Leveraged To Post-Pandemic Recovery And Advanced Drug Discovery And Production

BorgWarner's Recent Analyst Day Laid Out Clear Targets, But Settled Nothing

 

BorgWarner (NYSE:BWA) has been a battleground stock recently, and the company’s investor day last week changed basically nothing. BorgWarner bulls still believe (broadly speaking, of course) that the OEM insourcing is a manageable threat and that the company has assembled a compelling xEV portfolio. Bears still believe that insourcing will be a huge negative influence and that BorgWarner is doomed to a future with little revenue growth and weaker margins.

As an owner of BorgWarner shares, it’s pretty obvious which camp I’m in, though I wouldn’t consider myself a raging bull – there are very real threats that BorgWarner is facing, not to mention major modeling unknowns, and the company’s R&D and M&A plans run the risk of setting fire to significant amounts of shareholder capital.

I’ve chosen to take a more conservative outlook for the next five years, largely on elevated R&D spending and the risk of M&A swap-outs of higher-margin legacy ICE components for lower-margin (initially) xEV components, but my 2030 assumptions change by only a couple of percentage points, and I still believe these shares offer double-digit near-term upside and above-average long-term upside as well.

 

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BorgWarner's Recent Analyst Day Laid Out Clear Targets, But Settled Nothing

Rexnord Finds A Good Deal For Shareholders And Shifts To A Water-Driven Future

 

Win-win transactions aren’t necessarily commonplace, but I think Rexnord (RXN) and Regal Beloit (RBC) found one, with the two companies intending to combine Rexnord’s Process and Motion Control (or PMC) business into Regal Beloit in a Reverse Morris Trust transaction that will see Rexnord shareholders own something around 38% to 39% of the combined company, while also owning shares in a new water infrastructure pure play.

Having recently written on Regal Beloit, I encourage readers to check out my thoughts on that company and how it stands to benefit from the PMC deal. For Rexnord shareholders, the benefits come not only with the value of the stake in an improved Regal Beloit, a short-cycle industrial with exposure to the post-pandemic recovery, HVAC, and industrial automation, but also the higher multiples that the Street typically awards water infrastructure companies.

Rexnord shares have done well since my last update, rising more than 50% on improving post-pandemic sentiment. No longer a laggard to the industrial sector, I do still see upside potential. There are still plenty of uncertainties that complicate the modeling process, but I believe Rexnord’s near-term fair value rises to over $50 with the Regal Beloit transaction and the probable post-deal re-rating.

 

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Rexnord Finds A Good Deal For Shareholders And Shifts To A Water-Driven Future

Regal Beloit Offering Cyclical Leverage And Deal Synergy

With short-cycle industrial markets firmly in recovery mode and longer-term opportunities in HVAC and industrial automation, end-market conditions are looking pretty supportive these days for Regal Beloit (RBC). Strong execution in tougher markets in 2019 and 2020 likewise lends more credibility to management’s cost reduction targets, as the company definitely outperformed expectations for decremental margins during the pandemic downturn.

On top of that, the acquisition/merger with Rexnord’s (RXN) Process and Motion Control business (or PMC) creates new synergy opportunities on both the cost and revenue lines, with the deal also significantly enhancing Regal Beloit’s Power Transmission business.

I can see near-term upside in Regal Beloit to around $160, and above-average longer-term total annualized return potential beyond that. It is a cyclical, largely short-cycle, industrial business, but one where I believe there are both revenue and margin tailwinds to drive the business.

 

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Regal Beloit Offering Cyclical Leverage And Deal Synergy

AerCap Scores The Mother Of 'Buy Low, Sell High' Deals

Investors can’t fault the management of AerCap (AER) for thinking too small. Yet again management has shown its willingness to make bold moves at tough points in the cycle, agreeing to a huge $31B-plus deal with General Electric (GE) to acquire GEACS and create far and away the largest aircraft leasing company in the world.

I believe time will show this to be a savvy deal done a bit past the bottom of the cycle, with AerCap paying around 0.6x book (on a levered basis) for a quality leasing company and paying around 0.75x to 0.80x for a fleet similar to its own, all while maintaining its invaluable investment-grade debt rating. I expect meaningful aircraft sales in the years to come (into a strengthening market), with share repurchases restarting a little further down the line.

 

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AerCap Scores The Mother Of 'Buy Low, Sell High' Deals

 

Time horizon is always an important detail in investments – you can be right about the short-term outlook for a company (or stock) and wrong about the long-term, or vice versa, and lose money on what was otherwise a sound idea.

In the short term, it seems like the market has serious misgivings and doubts about the benefits that International Flavors and Fragrances (IFF) can reap from its large merger with DuPont’s (DD) Nutrition and Bioscience business. Indeed, there is a lot to prove here, including whether the revenue and R&D synergies will be real, whether the company can hit its margin targets, and whether the deal will fundamentally upgrade IFF’s long-term growth outlook versus its prior standalone potential.

I have my own doubts about the deal, but it seems as though the pessimism is excessive. Long-term revenue growth in the 3% to 4% and mid-teens FCF margins can support a fair value comfortably above today’s price (and a long-term annualized total return in the double-digits), and those inputs assume that the company comes in short of its own post-merger targets.

 

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For Now, The Market Seems Skeptical That International Flavors And Fragrances' Big Deal Will Pay Off

Evoqua Water Technologies Leveraged To Both Sides Of The Water Quality Equation

As a general rule of thumb, you don’t look to water/water technology companies to find bargains. With less-cyclical business models, leverage to water quality concerns, and the potential for increased federal support through regulation and infrastructure spending, they tend to trade at premiums to the wider multi-industrial space.

With that in mind, I’m not surprised that Evoqua Water Technologies (AQUA) shares look pricey by my typical investment standards. I do like the basic story here, though, including leverage to a “water as a service” business model and the potential for meaningful PFAS water clean-up mandates. If you’re less valuation-sensitive, or have some context for a 32x multiple to ’22 EPS as “cheap”, then there may be something here for you.

 

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Evoqua Water Technologies Leveraged To Both Sides Of The Water Quality Equation

Vontier Looks Oddly Cheap Ahead Of Major M&A Deployment

 

Years of investing will make you paranoid, or at least highly suspicious, when you find what appear to be bargains hiding in plain sight. There are some issues with Vontier (VNT), including a business that could be more vulnerable to the shift toward electrified passenger vehicle powertrains, but given the company's pedigree (part of the Danaher (DHR)/Fortive (FTV) family tree), a good CEO, and the explicit intention of deploying capital toward growth M&A, I find the discount to fair value today to be odd.

With what looks like fair value in the low-to-mid-$40s, I do wonder what I'm missing about Vontier today. Yes, there are EMV headwinds that will weigh on growth, and the business isn't as "future-proof" as you may like. M&A also carries risk, as the company could overpay or go down roads that lead nowhere. Still, with the base business undervalued on what I think are reasonable, if not conservative, assumptions, I think this is a name to check out.

 

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Vontier Looks Oddly Cheap Ahead Of Major M&A Deployment

Eaton Still Looks Like The Pick Of The Litter

It’s been a little while since I’ve thought Eaton (ETN) was truly cheap, but like Parker-Hannifin (PH), I’ve stayed positive on Eaton as a “best of breed” among increasingly richly-valued industrials. In particular, I’ve favored Eaton for its strong leverage to electrification, as well as longer-term leverage to vehicle electrification and an aerospace recovery.

Up more than 20% since my last update, and still beating both the S&P 500 and its peer group, the valuation argument isn’t getting any easier. Management’s recent investor day did make me feel a little better about my growth expectations, though, and I still lean positive on Eaton for its leverage to long-term secular growth themes, though I do see the long-term annualized expected return as pretty pedestrian now.

 

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Eaton Still Looks Like The Pick Of The Litter

Operational Leverage And Improved Clarity Have Catapulted ArcelorMittal Shares

Among commodity companies, weaker players typically outperform in up-cycles as they see even greater operating leverage benefits from higher prices and volumes. That would be enough to explain at least some of ArcelorMittal’s (MT) impressive performance since September, but added clarity on capital allocation priorities and operational strategies has analysts feeling quite a bit more confident about a sustained improvement in full-cycle profitability at this giant steelmaker.

I’m cautiously optimistic on the prospects for improved full-cycle profits, as management is both saying and doing the right things, and has taken some meaningful steps to improve returns and walk away from lower-return assets. Still, improvements to commodity company operating models aren’t really proven until the next down-cycle, and that’s clearly not the environment today.

I don’t find Arcelor shares to be particularly cheap today, but that’s in part due to my belief that steel prices are going to start declining in the second half of the year, shrinking the operating leverage for the sector in 2022. I can see upside to the low-to-mid-$30’s on a “stronger for longer” steel market (a more bullish scenario, in other words), but as is I think Arcelor is more or less priced in line with other quality names today.

 

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Operational Leverage And Improved Clarity Have Catapulted ArcelorMittal Shares

Compass Diversified Holdings Chugs Along

It has been a little while since I've updated my thoughts on Compass Diversified Holdings (CODI), but, in the meantime, not all that much has changed. Distributable cash continues to grow at a mid-single-digit rate, the actual distribution has been steady, and management continues to prioritize consumer businesses.

On the negative side, the company continues to hang on to some lackluster, lagging enterprises that aren't really living up to their potential, but senior management has at least shown a willingness to shake up company-level management at some of the laggards.

CODI has generated an annualized total return of around 18% over the last three years, and that's not bad. Moreover, the corporate structure (a partnership) can provide some tax advantages for investors, though creating challenges and complications for others. I would call the valuation "okay" today, but I do have some near-term concerns about deal multiples limiting management's ability to effectively deploy and recycle capital.

 

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Compass Diversified Holdings Chugs Along

Ternium Seeing End-Market Recoveries And Reaping The Benefits Of Higher Steel Prices

The boom goes on in steel prices.

Mexico’s Ternium (NYSE:TX) is not going to see quite the same price leverage as U.S. steelmakers like Nucor (NYSE:NUE) or Steel Dynamics (NASDAQ:STLD), but global prices have also been quite a bit stronger in 2021 so far than initially expected. That’s going to drive robust revenue for most of the year, as well as even better operating leverage and cash flow generation than previously expected.

The biggest risk I see with Ternium today is that high steel prices start destroying demand, just as industrial markets in Mexico, Argentina, and other South American markets start to recover. There is also some uncertainty on capex/capital allocation beyond this year, with management clearly interested in growing the business to capture expanded opportunities. Even with that factored in, though, the shares continue to look undervalued.

 

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Ternium Seeing End-Market Recoveries And Reaping The Benefits Of Higher Steel Prices

The Market's Love Affair With Atlas Copco Risks Lower Long-Term Returns

I’m often asked what I think is the best company or stock in a given industry or sector – Atlas Copco (OTCPK:ATLKY) is definitely one of the best companies I follow, irrespective of sector or industry. Double-digit trailing FCF growth, mid-teens FCF margins, strong share in multiple markets, and a disciplined management team all play into that, and the double-digit long-term total return has likewise been quite good.

Still, for all of the positives I see at Atlas, including good leverage to the global industrial recovery and ongoing investment in semiconductor capex, the valuation is just too high. I see Atlas as among the lowest long-term return prospects among the industrials I cover, and lest you think I’m overly conservative on modeling, I’d note that my 2023 revenue number is more than 10% above the sell-side average (likewise for FCF).

I’ve learned to not underestimate how far the market can run with a name it likes, but it’s tough for me to envision the combination of growth and further re-rating it will take for Atlas to keep generating double-digit returns for investors.

 

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The Market's Love Affair With Atlas Copco Risks Lower Long-Term Returns

Manitex Past The Worst And Now Leveraged To Equipment Recovery

Heavy equipment stocks have been doing pretty well since the election, and Manitex (MNTX) has gone along for the ride. Up about 75% since my last article, Manitex’s performance slots in pretty well between a handful of better-performing names like CNH (CNHI) and Deere (DE) and worse-performing names like Caterpillar (CAT), Oshkosh (OSK), and Palfinger (OTCPK:PLFRY), while more or less matching Manitou.

I do expect a healthy recovery in 2021 despite a lackluster non-resi construction environment, as fleet operators (including rental companies) emerge from their own capex lockdowns to refresh their fleets. Beyond that, a meaningful infrastructure bill could provide a bigger boost to demand later in 2021 and into 2022, and Manitex still has the company-specific driver of leveraging its knuckle-boom crane business (PM Group) and driving more sales of this under-penetrated (in the U.S.) equipment category.

After the big move in the shares, I would say the stock is more fairly-valued now than definitively cheap, and outsized upside is now tied more to an even stronger/longer recovery cycle and better success driving growth in knuckle-boom cranes – both of which are plausible.

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Manitex Past The Worst And Now Leveraged To Equipment Recovery

IPG Photonics Getting A Little Too Much Love Now

Fiber laser leader IPG Photonics (NASDAQ:IPGP) has quite a track record - not many companies manage a decade-plus of double-digit revenue growth, nor consistent mid-teens-or-better FCF margins, to say nothing of strong returns on capital and assets during more normal business conditions. On top of that, internal diode development and sourcing capability has long been a key competitive advantage for the company, allowing it to set the pace for innovation while maintaining very good margins.

In the near term, it gets better. IPG's revenue has long been driven by industrial capex cycles, and I believe we're in the early stages of a strong capex upswing - one that could be extended further if there is meaningful reshoring (or even just near-shoring) of manufacturing capacity. Opportunities in EVs, solar, and additive manufacturing only add to the longer-term potential.

The "but" is valuation. I don't believe IPG Photonics should trade like an industrial growth stock (where valuation is barely a concern). I'm likewise concerned that the Street is a little too blasé about the risk of meaningful price/margin pressure from its largest rival in China. While I do think that IPG merits a premium and offers good leverage to industrial capex growth, I think the current share price reflects that and doesn't leave an especially exciting, long-term expected return for investors.

 

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IPG Photonics Getting A Little Too Much Love Now

Columbus McKinnon Doing The Heavy Lifting To Build Long-Term Shareholder Value

Moving things around a factory, plant, or mill may not be the sexiest business out there, but it’s pretty essential and as companies continue to turn to automation, material handling is going to become increasingly important. On top of that, Columbus McKinnon (CMCO) has shown that it can execute on margin-improvement initiatives, portfolio restructuring, and product R&D, as well as value-added R&D.

That’s the elevator pitch for Columbus McKinnon, and these shares have done well since I last identified them as an underrated industrial back in August of 2020. While the 50% or so move in the stock since then (almost 20% better than the broader industrial sector) as soaked up a lot of the undervaluation I saw, I do still see better long-term return potential here than for the average industrial, and I think Columbus McKinnon is on a credible path to above-average underlying performance.

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Columbus McKinnon Doing The Heavy Lifting To Build Long-Term Shareholder Value

Komatsu Emerging From The Downturn With Upside If Mining Companies Start Spending Again

With some improvement in its core construction and mining markets, Komatsu (OTCPK:KMTUY) has done pretty well since my last update – outperforming underground mining equipment specialist Epiroc (OTCPK:EPOKY) and mining capex provider Weir (OTCPK:WEGRY), but not keeping pace with Caterpillar (CAT), CNH (CNHI), or Deere (DE) over that time.

I do like Komatsu’s commitment to areas like automation and electrification, but I also believe the company has been too slow dealing with challenges to its Indonesian coal mining and Chinese excavator businesses. An infrastructure stimulus bill in the U.S. and strong global commodity prices could extend this recovery, particularly given over-aged mining equipment fleets around the world, but I look at this as more of a trade now than a fundamental recovery story.

 

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Komatsu Emerging From The Downturn With Upside If Mining Companies Start Spending Again

E-Commerce, Software, And A General Spending Rebound Can Drive Global Payments

It’s an interesting coincidence to me that two of the largest players in U.S. merchant acquiring, Fidelity National Information (NYSE:FIS) and Global Payments (NYSE:GPN), seem pretty close today in terms of valuation relative to my estimated fair values. While I talked about the prospects for FIS about two weeks ago, today I focus on Global Payments.

In addition to ongoing synergies from the TSYS deal, Global Payments has good leverage to the ongoing growth of e-commerce, particularly in the smaller-business vertical, as well as opportunities to leverage its growing suite of proprietary cloud-based software offerings to drive share growth and share-of-wallet. Moreover, with more and more banks trying to drive card revenue, the Issuer Solutions business is looking at a good addressable market opportunity as well.

Global Payments is not all that cheap on a discounted cash flow basis, and that has been true for most merchant acquirers for most of the last decade. I wasn’t overly excited about the valuation when I last wrote about the stock, and while the shares are up more than a third since then, they’ve basically tracked the S&P 500 over that time. Still, I do see the potential of a mid-to-high single-digit long-term total return there, and a margin/return-based EV/EBITDA model suggests near-term potential in the double-digits.

 

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E-Commerce, Software, And A General Spending Rebound Can Drive Global Payments

Middleby Has Rocketed Higher On A Much-Improved Foodservice Outlook

Never underestimate the upside potential for a proven growth story with strong fundamentals.

I’ve had my issues with Middleby’s (MIDD) valuation over the years, as well as the company’s reliance on M&A to fuel growth, but the reality is that we’re talking about a company that has generated almost 13% revenue growth over the past decade (from the not-so-tiny starting point of over $850 million) and consistently generates double-digit FCF margins – something not all that many industrials manage to do. On top of that, not only has the foodservice industry held up better than expected during the pandemic, the government has really stepped up in terms of financial support.

All of that has fueled a remarkable 270% trough-to-peak run in the shares. I can’t say that I see Middleby as undervalued now, but that hasn’t held back the shares in years past.

 

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Middleby Has Rocketed Higher On A Much-Improved Foodservice Outlook