Tuesday, April 13, 2021

Industrias Bachoco Looks Undervalued On Demand Recovery And Pricing Power

 

It's not easy to earn strong long-term returns from commodity food products. A few companies manage it, Tyson (TSN) being one of them, but it's not the norm and those outlier stories are often driven by some combination of scale leverage and growing premiumization (a shift to higher value-added processed/packaged foods).

That's a risk factor to keep in mind when looking at Mexico's Industrias Bachoco (IBA), but I think there are also positive drivers at play here. Not only does Bachoco run a pretty tight ship where operating efficiency is concerned, but the company also has leverage to positive long-term drivers like organic and inorganic portfolio expansion and increased protein consumption in its primary market as household incomes increase.

I do believe that higher grains prices are a risk, but I also believe they are a well-understood risk and management's efforts on hedging and pricing should reduce the downside risk. If Bachoco can generate long-term revenue and FCF growth on the low end of the mid-single-digits, I believe investors can reasonably expect long-term annualized returns in low-to-mid teens.


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Industrias Bachoco Looks Undervalued On Demand Recovery And Pricing Power

Grupo Aeroportuario Del Pacifico Still Offers Reasonable Potential As Domestic Travel Recovers

 

All of the Mexican airport operators have done well over the last six months or so, boosted by optimism on COVID-19 vaccines, a path back towards traffic normalization, and a surprisingly accommodating Mexican government. Of the three, Grupo Aeroportuario del Pacifico (PAC) (or “GAP”), has been the relative laggard since my last update on the company but has still done alright, rising about 36% versus 40% for Grupo Aeroportuario del Centro Norte (OMAB) and over 55% for Grupo Aeroportuario del Sureste (ASR) and around 28% for the S&P 500.

Surprisingly strong traffic in March doesn’t hurt the GAP bull case, nor does the surprisingly accommodating new Master Development Plan (or MDP). With healthy leverage to Volaris (VLRS) and domestic leisure travel, GAP could well exceed some of its own targets for traffic renormalization, though international travel remains a weak spot and is likely to remain so for a while longer.

While the healthy move in the share price does take some of the easy money off the table, I don’t think GAP is overpriced yet, nor priced beyond a point where investors can expect a reasonable return. Long-term annualized returns in the high single-digits may not seem so exciting at this point, but relative to a lot of other options, I think this airport operator still has some appeal.

 

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Grupo Aeroportuario Del Pacifico Still Offers Reasonable Potential As Domestic Travel Recovers

Cadence Bancorp Finds Its Buyer

 

It looks as though there was something to the rumors after all.

A couple of months after Bloomberg reported that Houston-based Cadence Bancorp (CADE) had sent bankers out to gauge interest in a sale of the company, the company found its suitor – agreeing to what is basically a merger of equals with Mississippi-based BancorpSouth (BXS).

This is a curious deal, and I can imagine that at least some Cadence shareholders won’t be too thrilled about it. I do see potential long-term synergies from this combination, and the stock-for-stock structure gives Cadence shareholders exposure to that upside, but I expect at least some shareholders would haven’t preferred the certainty of a larger upfront buyout valuation.

For BancorpSouth shareholders, I think this is a sound long-term move. Not only will the combination with Cadence give the company a chance to make better use of its lower-cost deposit base, the combination will diversify the lending base and add more exposure to more attractive markets, albeit with a higher initial level of credit and execution risk.


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Cadence Bancorp Finds Its Buyer

MSC Industrial's Markets Are Returning To Growth, But Follow-Through Is Essential

 

As some early recovery stories have flattened out, MSC Industrial (MSM) shares haven’t done much in the last three months – they’ve outperformed other industrial distributors like Fastenal (FAST) and Grainger (GWW), and mostly kept pace with the S&P 500, but they have lagged the broader industrial space.

In the “buy the rumor, sell the news” world of Wall Street, it’s worth asking whether there will be enough momentum in the industrial recovery to keep driving positive sentiment here. While some analysts do seem to believe the U.S. is on the cusp of some sort of “super-cycle” recovery, that strikes me as a new version on the old “it’s different this time” theme.

Instead, I think the real key for MSC Industrial now is executing on what management has positioned as a transformative management restructuring (Mission Critical) meant to resolidify the company’s position in metalworking, expand into complementary adjacent markets, and drive better margins from a restructured expense base.

It sounds great in theory, but I’ve almost lost count of the number of management plans that were supposed to drive these benefits and didn’t, whether that was due to the plan being wrong or the execution being poor. Maybe we really are on the cusp of an unusually strong recovery cycle, and maybe MSC will get it right this time, but I’m not inclined to press my luck.


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MSC Industrial's Markets Are Returning To Growth, But Follow-Through Is Essential

Roper Has Underperformed Recently, But The Valuation Argument Isn't Clear-Cut

 

One of the tricky things about investing in companies where the valuation has decoupled from the underlying financial reality is that sentiment can shift without much reason, and you really don’t know when it will come back.

There are definitely some issues with Roper (ROP) and some valid bear arguments, but the underperformance since my last article (about 36% relative to the broader industrial sector) has surprised me, even though I did think the shares were overvalued.

Whether this is a “buy the dip” opportunity really depends on your confidence in the business model. If Roper can maintain double-digit growth, the shares do seem to offer a FCF-based prospective return on par with other high-quality industrials. If growth is more likely to be in the mid-to-high single-digits, though, the valuation isn’t nearly so appealing. On top of that, Roper isn’t particularly well-leveraged to where we are in the cycle, nor to some of the more favored industrial themes right now.

 

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Roper Has Underperformed Recently, But The Valuation Argument Isn't Clear-Cut

Eventual Post-Pandemic Normalization And Better Margins Can Support A Higher Price For Axalta

 

Axalta’s (AXTA) recovery is probably going to look a little different than most other industrial companies, and certainly other coatings companies. With a large piece of the business leveraged to the auto refinish market, the post-pandemic recovery is likely to be a later in the cycle, driven by a more gradual return to pre-pandemic behaviors. Axalta also lacks meaningful exposure to architectural coatings, a significant driver for many paint companies given the strength in the residential new-build and remodel markets.

I don’t believe a modestly delayed recovery in revenue is a particularly good reason to avoid Axalta. I do also see the possibility for more M&A activity here – with both sides of the story (Axalta as a buyer or seller) in play.

Low single-digit revenue growth and mid-single-digit FCF growth, as well as mid-teens operating margin and low 22%’s EBITDA margin, can support a fair value in the low-to-mid $30’s today, and a long-term annualized return in the mid-to-high single-digits. I would argue that’s good enough to make Axalta worthy of further consideration.

 

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Eventual Post-Pandemic Normalization And Better Margins Can Support A Higher Price For Axalta

Inogen's Strategic Shift Seems Prudent, But It Will Take Time To Deliver

 

When I last wrote about Inogen (INGN), I had several concerns about the company – including the risk that the company had saturated its direct-to-consumer upfront purchase market and that its sales force quality had declined. Both of these issues have become more apparent in the time since, and the COVID-19 pandemic only added to the company’s challenges, leading to weak share price performance since that last article.

There’s new management at Inogen and a new strategy in place. I like the new plan, and I think it can drive more sustainable long-term performance, but it’s going to take time to gain traction, and there’s still a lot of work for the company to do. Fortunately, the business still rests on some good foundational drivers – a strong product offering and a strong argument for portable oxygen concentrators (or POCs) to be used more than they are.

I do see worthwhile return potential here, and I do believe that Inogen is undervalued relative to its growth prospects in the coming years. That said, it’s in a growth “twilight zone” now, and the Street is definitely not sold on the new model and/or management’s ability to execute. This is a high-risk call, but one where more aggressive investors could see an outsized return if management can execute.

 

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Inogen's Strategic Shift Seems Prudent, But It Will Take Time To Deliver

Masonite Looking Undervalued As Improvement Initiatives Take Hold

 

If Masonite (DOOR) can’t succeed today, when can it?

Despite a virtual duopoly in interior doors and a strong position in exterior doors, Masonite has struggled in recent years on a host of operating issues, leading to a five-year performance that trails both the S&P 500 and the building materials sector.

Since 2019, though, the company has had new management, and between increased pricing power and more activity on restructuring and growth initiatives, the results have been improving. A stronger residential market has likewise given the company a healthy tailwind for at least the next year.

I do worry that management’s targets are too bold, but the Street doesn’t seem to believe them anyway, so I’m not sure how much risk of underperformance there really is. Relative to my model, these shares do seem to hold value if the company can deliver on mid-single-digit revenue and FCF growth, though I am expecting a level of margin performance the company has not managed before.

 

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Masonite Looking Undervalued As Improvement Initiatives Take Hold

Tokyo Electron Leveraging Semiconductor Math, And Looking For Share Gain Opportunities

 

I had a finance professor as an undergrad who liked to say “math works”, and when it comes to the math on semiconductor capex, the math still works for Tokyo Electron (OTCPK:TOELY) (8035.T) (“TEL”). New demand from end-markets like autos, consumer, data center, industrial, medical, and wireless is likely to drive at least mid-single-digit chip volume growth over the next decade, and increasing production complexity means ever-higher capital intensity.

TEL also has credible opportunities to continue gaining share in its core semiconductor production equipment (or SPE) markets, while also driving further progress in margins, with management targeting 30%-plus operating margins when it reaches JPY 2T in revenue.

Where the math stops working for me is valuation. I realize we’re in a bullish cycle for SPE capex spending and that drives higher multiples, but the stock really doesn’t work on a GARP basis. That’ll be fine for some investors, and I do certainly understand using Tokyo Electron as a play on ongoing capex spending growth, but I’ve too many cycles in this sector to want to play the game of musical chairs.

 

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Tokyo Electron Leveraging  Semiconductor Math, And Looking For Share Gain Opportunities

Saturday, April 10, 2021

Integra LifeSciences Shifts Toward A Better Growth/Margin Mix And Looks To Procedure Normalization

 

Integra LifeSciences (IART) has enjoyed a good run since the fall of 2020, rising more than 40% and handily beating the broader med-tech space. It seems as though investors have really liked the company’s decision to exit orthopedics and reallocate capital toward regenerative medicine, and that makes sense as it should drive better top-line growth, margins, and FCF generation.

While I saw some value in the shares back in September, the run since then has moved them to overvalued territory relative to the likely growth and margins. I don’t discount the possibility of outperformance, as Integra has shown good internal product development capabilities, but today’s valuation requires a level of growth (low double-digits) that I think is unlikely to develop.

 

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Integra LifeSciences Shifts Toward A Better Growth/Margin Mix And Looks To Procedure Normalization

Analog Devices Ready To Leverage A Long-Term Inflection In Chip Demand

 

Only by the bubbly standards of the semiconductor sector could Analog Devices’ (ADI) performance since my late August piece be thought of as disappointing, as the shares have risen almost 40% - lagging the SOX index by around 10 points and likewise lagging other high-quality analog peers like Microchip (MCHP) and NXP Semiconductors (NXPI), with the latter almost certainly getting a boost from its greater leverage to an auto sector recovery.

Pretty much everything is going Analog’s way right now. There are supply constraints, but Analog seems better-placed than average to handle them, and while the communications end-market has remained volatile, 5G deployments are a “when, not if” driver. Meanwhile, auto and industrial demand is recovering, with a host of factors in place to drive content growth for several years.

There will likely be a rollover in the cycle at some point as lead times shrink (though maybe not until late in 2021 or early 2022), but that will be a pause in what I see as a strong “mega-cycle” of chip growth across multiple end-markets. On top of that, the Maxim (MXIM) deal should close this summer, giving the company some cost and revenue synergy opportunities.

Of course, valuation remains problematic. It’s not unusual for multiples to stretch in upcycles, and that’s what’s happening now. I won’t dismiss the possibility of a stronger-for-longer cycle, but I don’t think my 6% organic long-term core revenue growth rate, 45%+ adjusted operating margin, or 40% long-term adjusted FCF margin assumptions are particularly conservative, and the long-term returns just don’t look that exciting now.

 

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Analog Devices Ready To Leverage A Long-Term Inflection In Chip Demand

Still Waiting For A Better Entry Point On IDEX

 

I don’t expect the shares of quality companies to go on sale that often, and I do regard IDEX (IEX) as a “best of breed” player in fluid management, with an asset-light model focused on multiple smaller businesses that are leaders in their markets by virtue of differentiated product design and capabilities. Likewise, the company’s 20%-plus operating margins and long track record of healthy ROICs speak for themselves.

I have no issues with the quality or growth potential of IDEX, but I am a firm believer that overpaying for even the best companies is a ticket to long-term underperformance. Since my last update, these shares have continued to rise (up another 18%), but lagged the broader industrial group by around 10%, as well peers like IMI plc (OTCPK:IMIAY) (OTCPK:IMIAF), and the valuation is still no bargain.

High single-digit FCF growth isn’t enough to support a particularly attractive return, and I’d likewise note that the P/E has crept up to a 50% premium over the S&P 500 (the high end of the historical range), while the P/E of the S&P 500 itself is close to 50% above its long-term average. None of that precludes further gains for IDEX, but I do worry about the inevitable normalization of valuations across the industrial sector (and the market as a whole).

 

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Still Waiting For A Better Entry Point On IDEX

Watts Water Technologies Looks Like An Expensive Way To Play Water Themes

 

Water technology remains an area of the market where you really don’t go looking for bargains, and this has been true for quite some time. What I find interesting, though, is that these stocks haven’t necessarily lived up to the hype – the growth has been fine, and there’s been margin improvement, but the sector hasn’t been that breakaway success you might have expected, and the returns haven’t been that exceptional over the last three or five years.

Turning to Watts Water Technologies (WTS), there are a lot of things I like about this company, including its credible and growing leverage to smart/connected devices. What I don’t like, not surprisingly, is the valuation. I do expect non-residential demand to improve in 2022, and I do see a window of opportunity for connected devices to drive margin improvement, but that seems well-reflected in the share price.

 

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Watts Water Technologies Looks Like An Expensive Way To Play Water Themes

Fears Of A Post-Pandemic Hangover Have Weighed On Thermo Fisher's Shares

 

When I last reviewed Thermo Fisher (NYSE:TMO) (“Thermo”) my view on the stock was that, while the price wasn’t out of line for other life sciences companies, the longer-term prospective return still wasn’t that great. Since then, sell-side analysts have dutifully kept hiking their price targets, but the shares have flattened out some on worries about the impact of a sharp falloff in COVID-19 testing in 2021.

COVID-19 testing is going to meaningfully decline (or at least I sincerely hope so), but Thermo Fisher has gained significant ground in areas like molecular diagnostics (PCR-based testing in particular) that I don’t believe it is likely to surrender. Moreover, bioproduction remains a very attractive market over the long term. On top of all of that, the company is likely to keep generating $7 billion or more a year in free cash flow, creating huge opportunities for capital deployment.

I have increased my long-term revenue assumptions on the basis of that larger long-term footprint, and I expect mid-single-digit long-term growth even from the elevated starting point of the COVID-19-boosted 2020 numbers. While I can’t call Thermo a “bargain” per se, I do see a more interesting potential return from these levels, and it’s hard not to like the long-term opportunities/markets Thermo serves.

 

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Fears Of A Post-Pandemic Hangover Have Weighed On Thermo Fisher's Shares

WESCO Still Offers Electrification-Driven Upside

 

It's a little hard to claim that a stock that has doubled since late October 2020 may not be getting its full due, but such is the case with WESCO (WCC).

Given the company's leverage to electrical distribution and growth in electrification, data centers, and utility spending, I think there's a solid case for WESCO outgrowing GDP by around 100bp-125bp over the next decade. Add in the greater scale from the Anixter deal, in what is often a scale-driven business, and I think there's an argument for double-digit FCF growth and meaningful share upside from here.

 

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WESCO Still Offers Electrification-Driven Upside

For Colfax, Breaking Up Looks Like A Value-Creation Opportunity

 

I’ve been lukewarm on Colfax (CFX) for a while now, and I don’t really feel like I’ve missed out on much. The shares have basically kept pace with the broader industrial space since my last write-up, while names I preferred like Eaton (ETN), ITT (ITT), and Parker-Hannifin (PH) have done better, and the longer-term results (annualized returns over the last five and 10 years) are likewise substandard.

Now there’s another twist in the Colfax story, with management deciding to split the company apart. Given the different needs and demands of the two businesses (MedTech will need more R&D and M&A investments, as well as more working capital), it makes sense and there’s definitely positive attributes to both businesses – including a welding business that has been outperforming Lincoln Electric (LECO) recently.

As far as valuation goes, though, my feelings are mixed. My 2023-2025 revenue and FCF estimates are higher than the Street now, but that’s not really enough to drive a stand-out valuation. Valued on a sum-of-the-parts basis, though, I can see an argument for a fair value above $50, with a lot riding on what MedTech can achieve in terms of top-line growth.

 

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For Colfax, Breaking Up Looks Like A Value-Creation Opportunity

Enpro In The Early Stages Of A Transformation Toward Better Growth And Margins

 

It is not unreasonable for investors to be skeptical about corporate transformation stories, but I think Enpro (NPO) (the company recently rebranded itself as “Enpro” instead of “EnPro”) is making a solid case that they are serious about improving the business and reversing over a decade of underwhelming performance. Management has sold $500M of “stagnant” legacy assets, acquired $600M of more dynamic assets, and continues to implement lean initiatives, not unlike those used at Danaher (DHR) and other high-performing multi-industrials.

There’s definitely more work to do, and M&A is going to feature prominently in that, with the company espousing an approach similar to that Ametek (AME), Danaher, Graco (GGG), or IDEX (IEX) – a focus on defensible leading niches in attractive growth markets (7% or better growth) and healthy margins.

With improving end-market demand, more opportunities to drive margin improvement through lean initiatives, and a willingness to continue selling under-performing assets (while acquiring more promising assets), I think this is a name worth watching. If management can drive revenue growth of around 4% and get FCF margins into the low double-digits on a sustained basis, the shares can support a triple-digit valuation.

 

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Enpro In The Early Stages Of A Transformation Toward Better Growth And Margins

Attractive Long-Term Growth Opportunities Support NXP Semiconductors Beyond This Near-Term Demand Surge

The entire semiconductor space may be running hot today, but with volume and content growth in autos, recovery and new market opportunities in industrial and communication markets, and lean channel inventories, it may take some time for record-high lead-times to shrink. And even when they do (they always do…), NXP Semiconductors (NXPI) has strong multiyear secular growth drivers that can cushion the blow relative to other chip companies.

I’ve definitely underestimated the Street’s enthusiasm for chip names, but I at least got it right in preferring NXP within the space, as the shares have risen more than 75% since my last update – handily outperforming the sector and more direct peers like Texas Instruments (TXN) and Microchip (MCHP), though Renesas (OTCPK:RNECY) and ON (ON) have done even better (though ON with a restructuring/self-improvement theme).

I don’t know when the music is going to stop for the chip sector; in the past, high lead-times have led to weaker results down the road, but maybe this cycle will be different. I don’t really like the long-term prospective returns in the space now, but I do like NXP’s relatively better growth outlook. If management can really deliver on margin leverage (a challenge for the company in the past), so much the better. I can see the appeal in NXP from better growth prospects and a “have to own something” standpoint, though I don’t plan to chase the shares up here.

 

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Attractive Long-Term Growth Opportunities Support NXP Semiconductors Beyond This Near-Term Demand Surge

Siemens Healthineers Offers More Than Just Acquired Growth And Synergy Opportunities

 

The market’s mood has certainly improved where Siemens Healthineers (OTCPK:SMMNY) (OTC:SEMHF) is concerned. Whether that’s due to a strong fiscal first quarter result that showed a good recovery in imaging, the fact that the Varian (VAR) financing is complete and on better-than-expected terms, or just improving sentiment, I don’t think shareholders are going to look that particular gift horse in the mouth.

Healthineers has done better than I’d expected in the relatively short time since my last update. Up about 25%, Healthineers has been outperformed very slightly by Philips (PHG) (on which I’ve been bullish), but has outperformed other med-techs like Abbott (ABT) and Intuitive Surgical (ISRG). Keep in mind, though, that the shares underperformed after the Varian announcement, so on a one-year comparison, Healthineers is still the laggard of that group (though still up more than 35%).

I still like Siemens Healthineers as a business, and I think the acquisition of Varian will ultimately be looked at as a good move. I’m also bullish on some of the company’s own organic growth initiatives, including new offerings in imaging and diagnostics. Valuation isn’t great right now, but it’s not much worse than other quality med-techs, and I can see a sound argument for holding, particularly with an improving capital equipment environment and possible upside from COVID-19 antigen testing.

 

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Siemens Healthineers Offers More Than Just Acquired Growth And Synergy Opportunities

Tuesday, April 6, 2021

Heineken N.V. Offers Above-Average Growth And Margin Self-Help, But A Lot Of That Is In The Share Price Now

 

Operating conditions have remained challenging for brewers, particularly brewers like Heineken N.V. (OTCQX:HEINY) with above-average exposure to on-premises channels (basically, beer consumed outside the home), as pandemic lockdowns have seriously hurt business in Western Europe and some Latin American countries. The good news, such as it is, is that the first quarter will likely be the last really poor one ahead of recovery for the rest of 2021.

Navigating the pandemic isn’t Heineken’s only challenge. The company is really the last of the major brewers (depending upon your definition of “major”) to launch a large-scale restructuring program, and management is targeting significant expense reductions, but only expecting to get back to around pre-pandemic margins in 2023. While bulls see this as a conservative guide, that may not be the case given Heineken’s model.

These shares have done okay since my last write-up, mostly tracking with the S&P 500 and other brewers like Anheuser-Busch InBev (BUD), Carlsberg (OTCPK:CABGY), Diageo (DEO), while Constellation (STZ) has outperformed and Molson Coors (TAP) has significantly outperformed (much to my own surprise). At this point, I would say Heineken is an okay hold, with some positive leverage to premiumization, volume growth, and self-improvement, but with some fundamental challenges as well.

 

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Heineken N.V. Offers Above-Average Growth And Margin Self-Help, But A Lot Of That Is In The Share Price Now

Merit Medical - Recovering Procedure Counts, New Products, And Margin Expansion Support The Stock

 

Merit Medical Systems (NASDAQ:MMSI) (“Merit” or “Merit Medical”) shares trade near their 52-week high and within sight of an all-time high, and not without good reason. Business held up pretty well in 2020 considering the sharp declines in elective procedures across the world, and the company is leveraged not only to recovering procedure counts in 2021 but new product introductions that were delayed by the pandemic.

Beyond that, the company is also in the early stages of a meaningful margin improvement initiative that includes deprioritizing low-margin products and relocating more production to lower-cost factories. Add in a significant new product (in trials) and the possibility of more R&D allocated to more sophisticated new products, and the growth-plus-margin-enhancement story looks pretty appealing.

Investors need to keep some sense of perspective here – this isn’t Intuitive Surgical (NASDAQ:ISRG) or Stryker (NYSE:SYK) and it never will be – but valued for what it is, I think it’s still a solid med-tech with a self-improvement story. If management can stay on target with its 5% to 7% annual top-line growth, a fair value in the mid-to-high $60s is reasonable today.

 

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Merit Medical - Recovering Procedure Counts, New Products, And Margin Expansion Support The Stock

 

Wabtec Makes Its Third-Largest Deal, And Rail Continues To Recover

 

Writing about Wabtec (NYSE:WAB) a month ago, I did see some near-term risks to the business from the freight business, but more so from sell-side expectations that I thought were a little too high. I also saw an opportunity to buy into a large player in freight and passenger train equipment and services at a time when pessimism was still running high.

A month isn’t much of a window for evaluating performance, but the shares have modestly outperformed the S&P 500 since then (while almost matching the Dow Jones Transports). More interesting to me are the revisions in sell-side expectations, the announcement of the Nordco deal, and some opportunities tied to federal infrastructure stimulus. Between them, I believe Wabtec has upgraded the business and expectations are a little more reasonable for the near term.

I still believe that Wabtec could be a $100-plus stock in 2023 and in normal markets, that’s not a bad prospective return. I’m expecting long-term adjusted revenue in the low single-digits, reflecting challenges and changes in the freight market, as well as mid-single-digit FCF growth and margin improvements over the next three to five years.

 

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Wabtec Makes Its Third-Largest Deal, And Rail Continues To Recover

Digi International Digging Into The Emerging IoT Service Opportunity

 

Company transformations are interesting opportunities for investors, but not without some risks. I’ve seen plenty of companies announce new initiatives, products/services, and corporate priorities that were little more than attempts to prolong and extend a failed management’s tenure at the helm. But I’ve also seen company transformations that were, well, transformational, leading to major shifts in revenue and margins.

I like what Digi International (NASDAQ:DGII) is shooting for in its IoT Solutions business – offering customers a simplified approach to leveraging IoT for functions like asset tracking and condition monitoring. I also like the exposure to out-of-band network management solutions, and I’m not all that troubled about Digi’s prior history as a lackluster communications hardware company.

My biggest concern at this point is competition/barriers to entry – I would think that Digi’s monitoring services should be relatively sticky once they’re in place, but I have some concerns that are there’s really no “secret sauce” here that would block out other potential rivals.

Even with that concern, these shares look interesting below $20, as I believe high single-digit revenue growth and scaled-up margins can drive a double-digit long-term return from here.


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Digi International Digging Into The Emerging IoT Service Opportunity

Trane Technologies Needs Some Beat-And-Raise Quarters To Restoke Investor Enthusiasm

 

As I’ve written before, I think the global HVAC market (particularly the commercial/institutional market) is one of the more attractive markets today, as global ESG concerns are likely to put a premium on energy-efficient HVAC systems and controls, not to mention the recent pandemic driving more interest in indoor air quality systems. On top of that, the transportation refrigeration market looks poised for a strong rebound after some rough quarters.

Those positives aside, I’ve also written that I thought most HVAC stocks were ahead of where they should be on valuation, making them relatively less attractive. Since my last update on Trane Technologies (TT), the shares have continued to chug along well relative to the S&P 500 (basically tracking the S&P at 13% growth), but they’ve lagged the broader industrial space by a few percentage points. Trane has outperformed Carrier (CARR), Lennox (LII), and Daikin (OTCPK:DKILF) (OTCPK:DKILY). Meanwhile, Johnson Controls (JCI), which I did see as undervalued until relatively recently, is up more than a third over that time.

My view now is pretty much what it has been. I’m still pretty bullish on the near-term prospects for residential and transportation, but resi HVAC comps are going to get a lot more challenging in the second half. I’m not so bullish on the near-term commercial HVAC opportunity, but opportunities in indoor air quality are still relevant. Longer-term, I’m intrigued by management’s R&D and M&A focus on emerging technology. I’m still not excited about the share price/valuation today, though I could see some sources of upside across the business.

 

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Trane Technologies Needs Some Beat-And-Raise Quarters To Restoke Investor Enthusiasm

With Attractive Exposure To Multiple Secular Growth Markets, Siemens' Undervaluation Is Unusual

 

Follow stocks long enough and your initial reaction to seeing an undervalued mega-cap will probably be less "what a bargain!" and more "what am I missing?" That seems particularly relevant in the case of Siemens (OTCPK:SIEGY), as this slimmed-down and refocused industrial conglomerate is well-positioned in attractive end-markets like industrial automation, industrial software, electrification, building modernization/control, healthcare, smart infrastructure, and mobility… and yet the shares still trade at what appears to be a long-term discount to other quality industrials.

Siemens shares (the ADRs) have risen a little more than 25% since my last write-up, doing a little better than the S&P 500, but lagging the broader industrial space. While automation companies haven't really been posting outstanding performances in that time, Siemens' performance is still toward the lower end of the range, with Emerson (EMR), Fanuc (OTCPK:FANUY), and Yaskawa (OTCPK:YASKY) outperforming, and ABB (ABB), Rockwell (ROK), and Schneider (OTCPK:SBGSY) posting similar performances (likewise for more software-driven names like Dassault (OTCPK:DASTY) and Hexagon (OTCPK:HXGBY).

At this point I still think Siemens is attractive on a relative basis. Further portfolio refinement seems highly likely, and while I think M&A may still be on the docket, the company doesn't need to do large-scale M&A to participate in numerous attractive end-markets with above-GDP multiyear growth potential.

 

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With Attractive Exposure To Multiple Secular Growth Markets, Siemens' Undervaluation Is Unusual

Ametek Looking To Get Back To Meaningful M&A As Pandemic Challenges Ease

If you want to find things to complain about with Ametek (NYSE:AME), be ready to put in a little extra work. It's possible to fault the relatively low returns of capital to shareholders and the generally high multiples the shares trade at, but neither are particularly damning in my book.

Ametek has shown over and over again that it can identify value-adding M&A targets and then build upon those deals with strong margin improvement (a la Danaher (DHR) and Fortive (FTV)), while reinvesting in the businesses to maintain their competitiveness and pricing power. That, in turn, has driven strong revenue (6% annualized growth for over a decade), good margins, strong (and improving) FCF margins, and above-average returns to shareholders.

Ametek presents two challenges for more fundamentally-inclined GARP-style investors. First, M&A is core to the business plan, but challenging to model on a year-to-year basis. Second, the company is a cash-generating machine and rarely trades at what look like conventionally cheap valuations.

I am concerned about the potential future impact on the share price from today's low rates and somewhat stretched industrial valuations, but I believe Ametek is in that upper echelon of high-quality industrials, and I believe the prospective returns today (mid-to-high single-digits) are in line to slightly better than the peer group average, and Ametek still offers some relative value.

 

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Ametek Looking To Get Back To Meaningful M&A As Pandemic Challenges Ease

Kennametal May Return To Growth This Quarter, But The Longer-Term Opportunity Isn't So Exciting

 

Short-cycle industrial markets are definitely in recovery mode now, and that has driven a much improved outlook for companies leveraged primarily to shorter-cycle markets, including Kennametal (KMT). Kennametal also has the advantage of an ongoing restructuring initiative that actually seems to be bearing fruit after numerous less successful restructuring attempts in years past, and between cyclical recoveries and self-improvement, double-digit operating margins don't seem too far away.

My feelings on Kennametal were decidedly mixed when I wrote about the company in May. While I did believe the shares were undervalued on near-term recovery potential, the weaker long-term outlook tempered my enthusiasm and I preferred other short-cycle names like Parker-Hannifin (PH) and Columbus McKinnon (CMCO). Since then, Kennametal has outperformed the S&P 500 and the broader industrial space, rising almost 70%, but Parker and Columbus McKinnon have done better still.

I'm still not looking to add Kennametal as a long-term holding. I'm a little more bullish on the likelihood of management hitting its restructuring-driven margin goals, and I'm looking for a 30% trough-to-peak revenue improvement that could still leave upside (a 50% move is possible), but I have longer-term structural and competitive concerns here, and I think getting to double-digit FCF margins, let alone beyond that, is going to be challenging.

 

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Kennametal May Return To Growth This Quarter, But The Longer-Term Opportunity Isn't So Exciting

Gates Industrial Can Be More Than A Short-Cycle Recovery Story

With close to half of its revenue coming from auto end-markets and the remainder from largely short-cycle markets, Gates Industrial Corporation (GTES) should be well-placed for a strong recovery in 2021. To that end, management has already guided for revenue growth of 9% to 14%, with healthy EBITDA margins, as those markets come back to life.

What the company can do above and beyond cyclical recovery leverage will be a key factor in the longer-term returns for shareholders. Management has already produced some tangible benefits from its investments and reinvestments into materials research, and the opportunities to drive improved new product development and gain share in existing markets is real, but the company will also need to couple that with improved margins and reduced leverage.

I can’t call Gates a compelling idea on a long-term basis, but the stock does look more undervalued on a shorter-term margin/return-driven approach. The biggest risk I see there is that the market moves on from short-cycle names – something that has happened around this point in prior cycles, but those prior cycles didn’t involve a recovery from a global pandemic coupled with significant stimulus efforts.

 

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Gates Industrial Can Be More Than A Short-Cycle Recovery Story

Sunday, April 4, 2021

MTN Group Still Offers Huge Potential - But That's Never Been The Issue

 

MTN Group (OTCPK:MTNOY) is the sort of stock that will make you seriously question whether stockpicking is worth the time and energy. This company should have so much going for it, including a leading mobile service footprint across much of Africa and a fast-growing mobile money business, but results over the years have never lived up to the potential.

Some of the challenges are outside of the company’s control, including government ineptitude and corruption, macroeconomic challenges, and shocks like the COVID-19 pandemic. Other issues, like a weak competitive position in South Africa, should be more within management’s power to control but nevertheless linger on.

I remain bullish on MTN Group’s leverage to data traffic growth and mobile money growth, as well as its leverage to overall population and economic growth in Africa. That bullishness has to be tempered, though, by certain realities – there’s work to do in South Africa, the company has had contentious relationships with several governments, and Africa as a whole is a continent that investors have been waiting to see blossom for close to 50 years now.

MTN shares look undervalued even with exceptionally high discount rates and what should be reasonable, if not conservative, growth assumptions. Management is also pursuing some very sound operational strategies. Whether the macro and political environments will cooperate is a separate issue, though, as is the question of whether sentiment will meaningfully improve.

 

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MTN Group Still Offers Huge Potential - But That's Never Been The Issue

Alfa Laval Trading On Par With Other Quality Industrials, And Offering A Clean-Tech Kicker

 

There are several secular growth stories out there for investors, including electrification, automation, and data growth, but clean energy technology (including decarbonization) has been getting its time in the spotlight more recently. With strong technologies in heat transfer, separation, and fluid handling, the Street has started to appreciate Alfa Laval’s (OTCPK:ALFVF) (OTCPK:ALFVY) leverage to this opportunity, as well as the leverage in the Food/Water business to alternative proteins.

When I last wrote about Alfa Laval in August of 2020, I suggest investors hold off in the hope of a lower price. They got that chance with a roughly 20% decline from early August to late October, since which the shares have risen almost 50%.

At today’s price I think Alfa Laval offers a return potential on par with other high-quality industrials, many of which also have leverage to attractive long-term secular themes (Eaton (ETN), Emerson (EMR), Honeywell (HON), Schneider (OTCPK:SBGSF) (OTCPK:SBGSY), et al). I think it’s a decent enough hold at this level, but near-term expectations may yet be a little high and if there’s a sell-off after Q1 earnings/guidance, it’s a name I’d revisit.

 

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Alfa Laval Trading On Par With Other Quality Industrials, And Offering A Clean-Tech Kicker

SLC Agricola Reaping Booming Commodity Markets And Advancing Its Value-Creation Strategy

 

I’ve written many times of my admiration for SLC Agricola (OTCPK:SLCJY), as management has shown great aptitude in generating above-average returns from Brazilian farmland, while simultaneously looking to maximize the value of its land bank and shift toward a more asset-light strategy by monetizing owned acres at attractive prices and expanding its leased acreage for planting.

When I last wrote about SLC Agricola, I thought the valuation was “more interesting”. At the time, corn was trading at around $3.65/bu, soy at $10.03/bu, and cotton at $0.66/lb. Now those commodities are trading at around $5.60/bu, $14/bu, and cotton at $0.78/lb, so you can probably imagine what has happened to SLC Agricola’s share price since then (up ADRs are up close to 65%).

Not only does SLC Agricola continue to see strong yields from its farmland that are typically above the averages for Brazil, management is locking in attractive prices for the ’21 and ’22 crops through hedging. Management also executed on a very attractive transaction that will significantly expand the company’s leased acreage at good prices.

I don’t believe today’s crop prices are new normals, but I do believe that SLC Agricola’s hedging program will secure at least two more strong years of EBITDA (weather permitting), and I believe the asset-light model and above-average yields will continue to drive good long-term results … albeit not at 2020-2022 levels. I do still see worthwhile potential in the shares on a long-term basis, but investors need to appreciate that in the short term the share price is often heavily influenced by commodity prices (cotton and soy in particular).

 

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SLC Agricola Reaping Booming Commodity Markets And Advancing Its Value-Creation Strategy

Post-Pandemic Normalization Will Bring Some Challenges For Grupo Bimbo

 

As people stayed home during the pandemic, Grupo Bimbo (OTCPK:BMBOY) (OTCPK:GRBMF) was one of the packaged foods companies to benefit. The company definitely saw a hit to its foodservice channels, as well as vending and convenience stores, due to the lockdowns, but increased at-home consumption of breads and other bakery products drove strong growth in North America and Europe, leading to meaningful operating leverage.

As consumer habits normalize once lockdown restrictions go away and people feel more confident going out, I expect Bimbo face some challenges. Just as a shift to staying at home drove volume growth, a shift back toward pre-pandemic behaviors should pressure volumes. With that potential volume pressure, it will be even more important for management to execute on supply chain, manufacturing, and distribution initiatives (many of which were delayed during the pandemic) to offset volume/scale pressures.

I was lukewarm on Bimbo shares back in September, and while the shares have since underperformed the S&P 500, they have done pretty well relative to other packaged food companies. The shares do look undervalued today, with 20% or more upside in the near term.

These shares look roughly as undervalued as Gruma (OTC:GPAGF) (OTC:GMKKY), but I’d note that where Gruma has a strong ROIC and operating track record, and minimal M&A risk, Bimbo has a poor M&A track record and more work to do on operating efficiency. Gruma, then, is a more defensive play with some offensive/growth characteristics, while Bimbo is more of an ongoing self-improvement story.

 

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Post-Pandemic Normalization Will Bring Some Challenges For Grupo Bimbo

Gruma Offers An Interesting Mix Of Offense And Defense

 

Though there have been a few exceptions, defensive food stocks haven’t performed so well over the last six months or so, as investors have switched back to industries and stocks offering more leverage to post-pandemic recovery and growth. Mexico’s Gruma (OTC:GPAGF) (OTC:GMKKY) is no exception, as pretty solid financial performance has gone largely unrewarded in recent months.

I was lukewarm on Gruma back in September, mostly just because I thought the market had caught up with the story. I’m a little more bullish now, and I like the company’s combination of somewhat defensive basic food exposure to Latin America, growth opportunities in the U.S. and Europe, and margin leverage. I believe the shares trade at a greater than 15% discount to fair value now, and would still offer a decent mid-to-high single-digit return thereafter.

 

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Gruma Offers An Interesting Mix Of Offense And Defense

Schneider Electric Remains A Well-Rounded Play On Secular Growth Themes With A Reasonable Valuation

 

I’ve been a fan of Schneider Electric (OTCPK:SBGSF) for some time and the shares have done quite well over the last five years as the Street has come around to this strong player in automation, electrification, industrial software, grid automation and data/IoT growth. I have had some qualms about valuation, though, and I’m not entirely surprised that the share have lagged a bit since my last update.

I’m quite bullish on the growth prospects in electrification, including opportunities to facilitate automation and commercial building modernization, as well as grid modernization, not to mention Schneider’s leverage to industrial automation, industrial software, and data center infrastructure. I don’t believe mid-single-digit growth (4% for revenue, <5% for FCF) is a particularly aggressive assumption, and while these shares aren’t a screaming value today, I think they’re a solid long-term GARP option in an industrial sector that doesn’t offer a lot of clear bargains.

 

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Schneider Electric Remains A Well-Rounded Play On Secular Growth Themes With A Reasonable Valuation

Louisiana-Pacific Harvesting A Windfall In OSB, While Reinvesting In Siding

 

Reports of the demise of the oriented strand board (or OSB) boom were certainly premature when I last wrote about Louisiana-Pacific (LPX), as the combination of strong housing demand, some lingering COVID-19 disruptions, and unprecedented industry discipline has led to prices rising from around $800/msf when I last wrote about the company to almost $1,200 at the end of last week (as per Random Lengths) – staying far above past spikes to around $450/msf and a prior long-term average of around $280/msf.

How long the boom can last is a great question and I’ve given up trying to answer it. The plant restarts from West Fraser (WFG) and LPX will expand industry capacity by more than 5%, but prices are likely to stay high into the winter as inventories very slowly rebuild. In the meantime, LPX continues to run the OSB business with a profit/cash flow maximization strategy while prioritizing reinvestments into SmartSide, a plan that certainly won’t harm OSB prices.

I don’t have particularly good answers on valuation at this point. I don’t think OSB prices can stick at these levels, but it seems as though producers have learned from the past cycles, and the siding business continues to offer upside. I can argue for a near-term fair value of $60 or more, but the reality is that the shares are likely to trade pretty closely to OSB prices and price expectations in the near term.

 

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Louisiana-Pacific Harvesting A Windfall In OSB, While Reinvesting In Siding

Managing The COVID-19 Testing Decline Will Be Tricky, But Hologic In Strong Shape For The Next Chapter

 

While it is definitely too soon to just assume that the COVID-19 pandemic is over and done with, the rapid expansion of vaccinations does appear to be reducing transmissions, and with that, there has been a noticeable decline in testing in the United States. It remains to be seen, though, how many people will ultimately choose to be vaccinated, how new variants may impact the vaccinated, and how long the vaccines will be effective. With that, the path of COVID-19 testing in the U.S. is highly uncertain.

As a major player in COVID-19 testing, that creates definite challenges for modeling Hologic (HOLX) financials today. It’s inarguable that the pandemic has led to a significant expansion in the company’s diagnostics business footprint, but how quickly COVID-19 testing will scale down is a major unknown and has a significant impact on the financials.

I believe the core of Hologic is in good shape and that the company will be able to leverage some of the gains made during the pandemic to take the diagnostics business to a new level. I expect mid-single-digit core growth at Hologic from the post-COVID-19 trough, as well as further M&A, and I believe the shares still offer worthwhile upside to long-term investors. Less patient investors should be aware, though, that the shares could be quite volatile as the testing situation shakes out over the next two to three years.

 

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Managing The COVID-19 Testing Decline Will Be Tricky, But Hologic In Strong Shape For The Next Chapter

National Instruments Looking To 5G, Autos, And New Strategic Priorities To Drive Better Results

 

The balancing act between past performance and future opportunities is a tricky one, particularly when a company is implementing new business strategies and/or seeing meaningful new end-market opportunities. If you drive solely by looking in the rear-view mirror (focusing only on what a company has been), you’re going to have some problems. If you ignore what’s in the rear-view mirror, you’re also going to have some problems.

Test equipment and instrumentation specialist National Instruments (NATI) is an interesting case in point. The historical performance is not that exceptional – mediocre revenue growth little better than GDP growth, consistently okay FCF margins but no upward trajectory, and a trailing stock performance record that is pretty lackluster next to the S&P 500, let alone rivals like Keysight (KEYS).

Now the question is whether the future will be different. End-market opportunities like 5G (particularly mmWave) and auto electrification and autonomous driving are meaningful potential growth drivers, but a lot of the business is still linked to general economic cycles (as measured by the PMI). A focus on increased system sales and software should drive better margins, but there’s a lot to prove beyond “should”. Allowing that National Instruments certainly has room to surpass my expectations, I think the shares are at best reasonably priced today.

 

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National Instruments Looking To 5G, Autos, And New Strategic Priorities To Drive Better Results

Weaker Earnings And More Complexity At Geely Hit The Stock

 

It’s always complicated when it comes to Geely Automobile (OTCPK:GELYF) (OTCPK:GELYY), and I believe that complexity has had a negative impact on sentiment over the years. With the recent launch of yet another brand through a joint venture structure with parent company Geely Holding (“ParentCo”), it’s only getting worse, and the collaboration with the Volvo (OTCPK:VOLAF) brand, also owned by ParentCo, doesn’t really simplify matters either.

The earnings miss for the second half of the year doesn’t trouble me overly much, and I believe many investors will look at it as a “throwaway year” given the impact of the pandemic. I’m less excited about the ZEEKR venture, though, and while Geely continues to perform pretty well in China’s auto market, these latest moves raise fair questions about ParentCo prioritizing itself over Geely shareholders.

These shares have been exceptionally weak over the last month since my last update. While many other electric car plays sold off during that time, Geely hasn’t recovered to same extent so far. The valuation here is still attractive for long-term shareholders, but the complexity of the Geely-ParentCo relationship and the risks of self-dealing to the detriment of shareholders are risks to consider.


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Weaker Earnings And More Complexity At Geely Hit The Stock

Lattice Semiconductor - Growth, Margin Leverage, And Scarcity Value

 

Lattice Semiconductor (LSCC) shares have looked slightly mortal of late, with the shares up another 10% since my last update (and almost flat a week ago) but lagging the SOX by more than 10%. Nothing has really changed with the business, if anything the bullish arguments are a little stronger, but a very high valuation is a threat, particularly if the tech sector swoons again or the semiconductor sector starts to correct on worries of eventual normalization of lead times.

I still love the company and the opportunities here – the company’s dedication to the low-power FPGA space is leading to demonstrably superior products that deliver real value for users, and as edge applications grow, I expect even more share gains to come, as well as more margin leverage. I’d also note a scarcity value premium here. Not only is Lattice the only meaningful public FPGA pure-play left, it’s also a quality growth name in the mid-cap chip space, and after a multiyear wave of M&A, there aren’t so many of those left anymore.

This remains a “love the company, can’t get comfortable with the stock” situation. Valuation already looks unhinged from the fundamentals to me, so I could just as easily argue for a price 20% higher or 20% lower than today’s price.

 

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Lattice Semiconductor - Growth, Margin Leverage, And Scarcity Value

Philips Leveraged To Post-COVID Normalization And Self-Improvement

 

It's been a little quiet of late for Philips (PHG), with the shares almost flat since my last update, but still outperforming the broader med-tech sector by a modest amount. The sale of the domestic appliances business didn't generate that much excitement, even though management got a good price and there is now certainty for this item on the to-do list.

With the successful sale of the domestic appliance business, normalizing elective procedures and hospital capex in 2021, and further self-help in the years to come, I continue to believe these shares are undervalued.

 

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Philips Leveraged To Post-COVID Normalization And Self-Improvement

Wednesday, March 31, 2021

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