Thursday, June 10, 2021

Hurco Seeing Real Evidence Of The Turn

 

There have been some “fits and starts” to the post-pandemic recovery, including mixed trends on capital spending and manufacturing activity in some sectors, but with fiscal second quarter results in hand, Hurco’s (HURC) recovery seems to be solidly underway, and looking around the industry, I expect “recovery growth” over at least the next few quarters.

Hurco has lagged the broader industrial sector since my last update, but done a little better than my own “peer group” of metalworking-driven companies. The stronger evidence of recovery should be good for the stock from here, and I do believe the shares are undervalued below $40 in the near term (and priced for longer-term annualized returns in the double-digits), but this is an unfollowed, illiquid company, so investors need to understand the risk that this remains overlooked for an extended period of time.

 

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Hurco Seeing Real Evidence Of The Turn

More 'Hurry Up And Wait' For Accuray, But The China Opportunity Is Coming Through

 

It’s been a rough go for Accuray (NASDAQ:ARAY) since my last update on the shares. The combination of a weaker tape for small-cap med-tech and a lackluster fiscal third quarter hasn’t been a good one for the shares, which have lost close to 20% of their value since that last article – despite not much real change in the outlook. I get that Accuray is a frustrating stock to hold, and it has been for some time – investors have been waiting years for the supposed advantages of the CyberKnife system, the improvements to the Tomo platform, and the opportunities in China to deliver, and we’re still not quite there yet.

That said, I do believe the opportunity in China is real, and the technological improvements to Accuray’s systems, as well as a shift toward more hypofractionation in radiation oncology could finally be the right combination to unlock the potential here. I continue to believe that $6 to $7 is a fair price for now, but if the opportunity in China lives up to its potential, a double-digit share price is not hard to imagine.

 

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More 'Hurry Up And Wait' For Accuray, But The China Opportunity Is Coming Through

Citigroup Still Has A Lot Of Work And Potential Gains, Ahead Of It

 

It’s still early days for Jane Fraser’s tenure as the CEO of Citigroup (NYSE:C), but she’s off to a good start with the Street generally liking the news of the company’s plan to exit its non-core global consumer banking businesses. It remains to be seen what the company will do with respect to building up the U.S. operations, including potential M&A, but focusing on businesses with higher prospective returns is definitely the right move.

Citigroup shares have slightly outperformed the larger banking group since my last update, and I continue to think there’s a good argument for owning these shares as a play on a leaner, more profitable bank with strong global corporate finance capabilities and an improving core consumer bank. Low single-digit long-term core growth can still support a double-digit annualized return from here, and I believe this is an interesting risk/reward opportunity for investors willing and able to take more risk.

 

Read the full article here: 

Citigroup Still Has A Lot Of Work And Potential Gains, Ahead Of It

As COVID-19 Enthusiasm Fades, Abbott Labs Worth Closer Watching

 

I wasn’t all that bullish on Abbott Labs (ABT) back in the summer of 2020, as although I view this as a very high-quality med-tech company, the valuation seemed too rich. Add in my concerns about COVID-19 testing contraction in 2021 and beyond (something I’ve mentioned in reference to Agilent (A), Hologic (HOLX), and Thermo Fisher (TMO) among others more recently), and I didn’t like the set-up for the shares.

Since then, the shares have risen about 12% - less than half the gain of the S&P 500 and about 700bp shy of the larger med-tech group. That’s not quite enough to put Abbott in my “unfairly cheap” bucket just yet, but the prospective long-term return is now closer to the high single-digits and that’s enough to get my interest. Add in M&A optionality, and this is definitely a name to watch, if not consider outright.

 

Continue reading here: 

As COVID-19 Enthusiasm Fades, Abbott Labs Worth Closer Watching

Broadcom Executing Well, But Still Not Getting Its Due

 

Broadcom (AVGO) has remained a somewhat frustrating stock to own – I say “somewhat”, because while the shares aren’t far from their all-time high (about 5%) and have risen around 60% over the past year, they’ve still continued to lag the broader semiconductor space a little bit. I suspect this is due in part to the fact that management runs the business for long-term margins and growth (as opposed to shorter-term metrics), as well as the slower-growing software assets.

In any case, I continue to believe that Broadcom offers a good mix of quality and value. Broadcom has exceptionally strong businesses in multiple growing markets (including switching/routing, broadband access, custom ASICs, and front-end phone components), and I like the combination of mid-single-digit long-term revenue growth potential and exceptional (high 50%s) non-GAAP operating margins. With those drivers, I believe Broadcom shares should trade closer to the mid-$500s.

 

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Broadcom Executing Well, But Still Not Getting Its Due

JPMorgan Likely To Leverage The Recovery To Earn Even Higher Returns

 

Some companies are good defensive plays, others are good offensive plays. A rare few are both, and I believe that JPMorgan (JPM) qualifies. Strong operating scale and risk management practices mitigated the damage from the pandemic, and the company is now well-positioned to leverage its scale to drive even more share growth in the recovery, leading in turn to greater profit growth and share price appreciation.

I follow a lot of well-run banks, but I believe JPMorgan is still the best of the bunch, and I believe 17.5%-plus ROTCEs are possible on a long-term sustained basis, as well as GDP-plus growth, as the bank is one of the few capable of functioning as a truly national banking franchise in both commercial and retail banking.

As the Street has shifted from a preference for quality to a preference for growth, JPMorgan has lagged some this year, but as a long-term investor, I don’t need my holdings to beat the peer growth every month I hold them. I still see a high single-digit annualized return potential here, and though JPMorgan is not the cheapest bank, I think the combination of quality, value, and long-term opportunity should keep it in serious contention for most investors.


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JPMorgan Likely To Leverage The Recovery To Earn Even Higher Returns

Monday, May 31, 2021

Important Announcement

Hello all,

It has been a long time since I've updated the format of the blog, and a few things about the platform have changed (including support for various functions).

The long and short of it is that I'm pondering whether maintaining this site is worth the bother. I'd like to hear from you if you find this useful. You can use the article comments or email me; whatever you find more convenient. I know there are many people who'd prefer to just read in silence, but feedback will determine whether I update the blog, keep it as is, or close it/delete it entirely.

Thanks for any feedback you all choose to provide. 

Best,

SS

<<EDIT>>

I wanted to add a bit to this in the interests of clarity. I am NOT contemplating an end to my research/writing at this point. So, I still plan to write about the companies/stocks that interest me. I am mostly just curious if this blog is a useful place for you all to come to find my work.

In years past, I sometimes wrote for multiple publishers at once, so this was a useful "central locale" to see what I was up to. Now, though, about 99% of my work is for Seeking Alpha, and they have their own ways to follow my work - which may be more convenient for you all.

So, again, no thoughts today about quitting the work. Just wondering if people get use out of this particular page/portal.

Thanks again!

Another Tough Quarter For FEMSA, But Recovery Comes Next

 

As Mexico’s economy reopens and recovers after the COVID-19 pandemic, FEMSA (FMX) has started to come back to life as well. Traffic is starting to improve in FEMSA’s OXXO stores, and margins have held up surprisingly well through this challenging time.

There are still multiple attractive drivers for FEMSA, including the expansion of the OXXO concept (particularly in Brazil), leveraging new distribution agreements (selling more Modelo through its distribution agreement with ABInBev (BUD)), launching the spin digital wallet, and driving more scale in the pharmacy business. On the other hand, there are also challenges, including standing doubts about the company’s capital allocation into lower-margin areas like logistics and distribution.

I’m still positive on FEMSA and I still see the prospect of double-digit long-term annualized returns on the back of mid-to-high single-digit revenue and FCF growth. Although management’s focus on long-term opportunities isn’t necessarily in sync with the Street’s fixation on short-term results, I believe patience will be rewarded.


Read more here: 

Another Tough Quarter For FEMSA, But Recovery Comes Next

Lexicon Pharmaceuticals Still A Very High-Risk/High-Reward Biopharma Name

 

As the clock keeps ticking, Lexicon Pharmaceuticals (LXRX) have continued to skid – falling about a third since my last update as investor enthusiasm over the company’s opportunity to disrupt the heart failure market with its SGLT-1/2 inhibitor Zynquista as faded. While nothing has changed, that’s actually part of the problem – Lexicon is going to need a partner to successfully launch this drug, and every month without a partner erodes Street confidence in the long-term potential of the drug.

Valuing Lexicon today remains exceptionally difficult as there are a lot of unknowables that have a big influence on the valuation. If AstraZeneca (AZN) and Lilly (LLY) (and Boehringer Ingelheim) report strong positive data from the DELIVER and EMPEROR-Preserved studies of their SGLT-2 drugs in patients with preserved ejection fraction, differentiating Zynquista in the market will be even harder. Likewise, if Lexicon has to go it alone (as opposed to securing a larger pharmaceutical company to market/co-market the drug), the road ahead is considerably rockier.

I’ve reduced my fair value on Lexicon to account for a longer, slower revenue ramp on Zynquista. Still, it’s worth mentioning again that this is a stock where the price could move rapidly on the basis of competitor clinical updates, FDA action on the Type 1 diabetes indication for Zynquista, and/or the results of the company’s Phase II proof-of-concept studies for pain drug LX9211.


Read more here: 

Lexicon Pharmaceuticals Still A Very High-Risk/High-Reward Biopharma Name

Advanced Energy Industries: Temporary Supply Challenges Don't Hurt The Long-Term Case

 

Severe supply constraints for semiconductors and other electronic components claimed another victim with Advanced Energy Industries’ (AEIS) second quarter guidance, sending the shares down 10% in response. Although the shares have recovered some lost ground, they’re still down a bit from the time of my last update and have underperformed peers like MKS Instruments (MKSI), Comet Holdings (COTN.SW), and Delta Electronics (OTC:DLEGF).

On a core level, I’m not too troubled by these supply-related disruptions to the business. The Semiconductor business remains in very strong shape with respect to market share, backlog, and capacity growth, and I expect improving demand in the Industrial segment through 2021. I still expect AEIS to generate long-term revenue growth of around 5% to 6% and FCF growth in the high single-digits, and at today’s price those growth rates support a double-digit annualized prospective rate of return.

 

Follow this link to the full article: 

Advanced Energy Industries: Temporary Supply Challenges Don't Hurt The Long-Term Case

Worries About Growth Keeping A Lid On PRA Group Shares

 

Despite some strong quarterly results, PRA Group (PRAA) shares have gone nowhere fast this year, as investors remain more concerned about future growth prospects than excited about strong recent performance. This is understandable, to a point, but I do believe the Street is undervaluing the long-term value of meaningful efficiency improvements in the operations even if the future supply of collectable receivables is lower than previously hoped.

My fair value range on PRAA shares has been in the $40 - $46 range over my last two updates (here and here), and that's basically still the case, as model refinements narrow that valuation range to $41 to $45. A faster pace of purchasing would likely be the best source of near-term upside, followed closely by an even better sustained trend of cash operating costs, while a return to more activity in legal-channel collections and bankruptcies may not be as well-received by the Street.


Read the full article here: 

Worries About Growth Keeping A Lid On PRA Group Shares

FirstCash Likely Past The Worst, And The Long-Term Growth Potential Comes Back Into Focus

 

Pawn shop operator FirstCash (FCFS) is still in for a few more rocky quarters, but recent data from the company do support the idea that pawn loan demand is bottoming out. It’s going to take time to rebuild retail inventories and pawn loan balances, but the arrow is pointing up and I expect the story to once again shift toward the long-term growth opportunities ahead of the company in Latin America.

As is often the case, the share price has moved ahead of the actual improvements in reported numbers. Up about a third from my last update, I can’t say that the Street is ignoring or avoiding this name now. Still, assuming the company can get back on a trajectory to mid-single-digit growth (relative to pre-pandemic norms), the shares do still offer solid upside on the basis of improving cash flow generation in the U.S. operations funding more dividends and buybacks and a long growth runway in Latin America outside of Mexico.

 

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FirstCash Likely Past The Worst, And The Long-Term Growth Potential Comes Back Into Focus

Tenneco Roars Ahead Of The Pack On Strong Earnings, Guidance, And Build Outgrowth

 

When I last wrote about Tenneco (TEN) I said that I saw, “a path to a significantly higher share price” in the mid-teens, but that the execution risks were still high. Not only did Tenneco deliver a very strong first quarter, but it was also one of the few parts suppliers to guide to both higher full-year and second quarter earnings, as Tenneco’s business mix has left it relatively well-shielded from the semiconductor shortages hitting the sector.

I believe Tenneco’s heavy debt load and business mix still merit a higher discount rate than its peer group (which it has smoked in terms of share price performance since my March piece), but the company has definitely bought itself breathing room on the debt issue and showed some impressive operating leverage this quarter. I still think this is a difficult “thread the needle” story, but I can support a cash flow-based fair value in the mid-to-high teens.

 

Read the full article here: 

Tenneco Roars Ahead Of The Pack On Strong Earnings, Guidance, And Build Outgrowth

Wednesday, May 26, 2021

SPX Flow Continues To Build A More Positive Case For Itself

 

As a long-term investor, I try not to spend too much time fretting over short-term price movements, but I do think the recent performance of SPX FLOW (FLOW) highlights the impact valuation and expectation can have on performance. SPX FLOW shares are up modestly (around 7%) since my last update, lagging the mid-teens performance of the larger industrial group, despite what I thought was a strong Investor Day presentation and a very good set of first quarter results.

I like management’s “80/20” strategic plan and the decision to focus more attention on growth opportunities in the Nutrition & Health and Industrial segments, as well as the decision to deploy more capital into M&A. I think management’s target of mid-teens adjusted operating margins in 2023 could be a little aggressive, but I do think the company is on a better path now as it transitions from a turnaround story to a quality (if cyclical) growth story.

Between the Investor Day presentation, the first quarter results, and trends I see across the company’s end-markets, I’m more comfortable with more bullish assumptions, and I think M&A could push the longer-term revenue growth rate closer to the high end of the mid-single-digits. Assuming that FCF margins move into the low double-digits (and there could be upside here if management really delivers on efficiency efforts), I think there’s a potential high single-digit long-term annualized return here, and that’s pretty attractive on a relative basis.

 

Read more here: 

SPX Flow Continues To Build A More Positive Case For Itself

The Pullback In Pacific Biosciences Makes For A Much More Interesting Opportunity

 

As the frenzy that drove many growth stocks, particularly in life sciences, to eye-watering multiples earlier this year has faded, Pacific Biosciences (PACB) (“PacBio”) shares are getting more interesting to me again. To be as clear as I can be right from the beginning, I think PacBio has great technology and growing use-cases in sequencing, and I think the company now has exceptional management and a good growth plan. My only major issue is valuation.

I’m modeling long-term revenue growth (2020-2030) of close to 30%/year on a compound basis, with operating profitability in 2026 and positive free cash flow in 2025, and I believe the company could exit 2030 with a FCF margin north of 30% - though a lot depends on the strategic decisions made between now and then and the implications those will have for R&D and SG&A spending. More to the point, I believe PacBio has the best long-read sequencing technology out there, and with significant improvements in throughput and cost, I believe the use of long-read technology is going to accelerate significantly in the coming decade.

PacBio isn’t conventionally cheap today, and I wouldn’t really expect it to be, as there is momentum in the business, strong partnerships, and good funding/liquidity. A continuation/reacceleration of this sell-off to $20 or below would make for an easy decision, but even in the mid-$20’s it’s a tempting name.

 

Read the full article here: 

The Pullback In Pacific Biosciences Makes For A Much More Interesting Opportunity

Neurocrine Biosciences: Pandemic Pressures And Few Pipeline Catalysts Continue To Weigh On NBIX

 

About the best thing I can say about Neurocrine Biosciences (NBIX) so far for 2021 is that the shares have managed to outperform a weak tape for biotech (the SPDR S&P Biotech ETF (XBI) is down about 10% versus Neurocrine’s flattish performance), though that comparison looks much worse for NBIX shares over a 12-month period.

I’d previewed some of the drivers of this weakness in earlier pieces – namely challenges to the Ingrezza franchise from the pandemic and a pipeline with few high-probability value-driving readouts. Indeed, Ingrezza has been quite weak, and while blaming that weakness on the pandemic is plausible, it doesn’t fix anything.

I still own these shares and I’m still bullish on the long-term potential, but I’ve cut back my Ingrezza expectations (again). I continue to believe that crinecerfont is an underappreciated asset, but with a pipeline still weighted more toward early-stage assets (there will be several Phase II studies underway by the end of 2021), this is a stock that could take some time to work again.

 

Read the full article at Seeking Alpha: 

Neurocrine Biosciences: Pandemic Pressures And Few Pipeline Catalysts Continue To Weigh On NBIX

Alnylam Executing To Plan, But Catalysts Could Be Harder To Find In The Near Future

 

RNA interference (or RNAi) specialist Alnylam Pharmaceuticals (ALNY) has held up okay in what has been a tougher tape for biotech, with the shares down about 5% since my last update versus a 15% decline for the SPDR S&P Biotech ETF (XBI). Since that last article, Alnylam has posted a couple of good quarters, as well as some positive incremental data on significant clinical programs.

Alnylam is likely going to find itself in a “hurry up and wait” trading pattern for a few quarters, and that can be tough for the share price. Key data on the amyloidosis program won’t be coming until 2022, and early-stage updates on other clinical programs aren’t likely to move the shares all that much one direction or another.

I do believe, though, that these shares are more than 20% undervalued today, and there are numerous early-stage clinical programs that could drive substantially higher value as they mature (assuming clinical success, of course). There are risks here, including clinical trial failure and competitive drug development, but I believe Alnylam still ranks as a high-quality biotech idea.

 

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Alnylam Executing To Plan, But Catalysts Could Be Harder To Find In The Near Future

Renesas Electronics Looking To Rise Like A Phoenix From A March Fab Fire

 

Between a painful inventory correction in 2019, the 2020/2021 pandemic, an earthquake, and a March fire in a key fab, Renesas Electronics (OTCPK:RNECF) (OTCPK:RNECY) (6723.T) has been snake-bit here of late, leading to a weak share price performance – the shares are down about 8% since my last update (the ADRs have done modestly better), underperforming the SOX by close to 10% over that short period.

Renesas has scrambled to minimize and mitigate the impact of the fab fire, and they’ve done quite a good job here. Far from a “lost year”, Renesas is still likely to see very strong revenue growth in 2021 on recovering auto and industrial demand, with solid margin leverage even accounting for the unexpected fire-related costs.

The biggest risk I see for Renesas is that the company ends up losing more microcontroller (or MCU) share in autos to NXP Semiconductors (NXPI) and others like Texas Instruments (TXN) and STMicro (STM), and that efforts to diversify the company’s addressable markets (including the Dialog Semi acquisition) don’t go to plan. I think those risks are more than captured by the share price, though, and I believe the shares offer an attractive double-digit long-term annualized return.


Read the full article here: 

Renesas Electronics Looking To Rise Like A Phoenix From A March Fab Fire

Tuesday, May 25, 2021

Weaker Margin Guidance Overshadowing Progress At Veeco Instruments

 

I’ve written this several times in the past, but it bears repeating – margins matter more in sectors like semiconductor equipment than some analysts and investors believe. Semi equipment company Veeco (VECO) is doing pretty well from a revenue and order flow perspective, and I believe the business is on the cusp of meaningful acceleration, but weaker margin guidance weighs on valuation in the near term and has driven underperformance since my last update.

Veeco is a company that has long struggled to get its ducks in a row, but I believe the outlook is bright. In addition to a strong-moat position in data storage, Veeco has growth opportunities in areas like annealing, EUV mask blanks, GaN chip production, and chip packaging that shouldn’t be ignored. The shares need better margin momentum to outperform, but in a sector that offers few bargains, Veeco is worth a look on its leverage to ongoing capacity expansion spending.


Read the full article here: 

Weaker Margin Guidance Overshadowing Progress At Veeco Instruments

ITT Inc. Already Seeing Strong Incrementals Ahead Of A Full Revenue Recovery

 

Expectations were already high for late-reporting ITT Inc. (ITT), but this multi-industrial nevertheless managed a good top-line beat and an even better performance on margin leverage. Better still, the company broke with a general trend of relatively conservative guidance for the rest of 2021.

I previewed my "but" in the last piece; namely, that Street expectations had already risen pretty notably for this company. The shares have lagged a bit since that last piece, rising around 10% and slightly outperforming the S&P 500, but slightly underperforming the broader industrial sector. Again, I think already-high expectations are part of the issue, as well as a little more investor wariness about auto volume growth in 2021 on component shortages.

Bargains are few and far between in the industrial sector today, and I think ITT can still outperform as important end-markets like aerospace, chemicals, and refining recover in 2022 and beyond. I'd categorize the potential returns here as more "okay" than "compelling", but it is still a relative bargain compared to many industrial names and one that I think has better exposure to later-moving sectors as the recovery matures.

 

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ITT Inc. Already Seeing Strong Incrementals Ahead Of A Full Revenue Recovery

A Bumpy Initial Recovery Hasn't Really Hurt Fastenal

 

High-multiple stocks can often be more vulnerable to disappointments, but that hasn’t been the case for Fastenal (FAST). Despite three straight monthly misses on sales and a very slight negative downward trend in sell-side EPS expectations, the shares have held up well since my last article – appreciating another 10%-plus since then. That’s a little worse than the wider industrial sector, including the recovery star Parker-Hannifin (PH), and worse than Grainger (GWW) (which has risen more than 20% since the time of my last Fastenal article), but still better than the S&P 500.

The reopening/recovery of the U.S. manufacturing sector has been a little bumpy, and I wouldn’t be surprised if that is the case for the remainder of 2021, but I don’t see it as a major threat to Fastenal. The company continues to outgrow the underlying economy and there’s a potential path to better margins for at least the next year or two, as well as a growing revenue base as the company expands the reach of the business. Valuation is still problematic, but it’s tough to see how these shares would trade at conventionally cheap multiples without a serious market decline.

Follow the link to the full article: 

A Bumpy Initial Recovery Hasn't Really Hurt Fastenal

Truist Building Toward Better Growth And Margins

 

Southeastern banking giant Truist (TFC) has continued to lag many of its peers since my last update (and over the last year), as the market has been pretty impatient regarding the expected savings from the SunTrust merger and stabilization in the net interest margin. Still, the shares are up around 25% since that last article, more than doubling the return of the S&P 500.

Although I don’t believe that Truist shares are wildly undervalued (few of the quality banks are), I do believe that there’s still a relative value trade here, and I still believe that Truist isn’t getting its full due. With one of the best operating footprints in the country, surplus capital to accelerate growth, and a potential “goldilocks” operating environment for a few years, I believe Truist has a good chance to deliver beat-and-raise quarters, particularly as I believe that this slower, more deliberate pace of merger integration could ultimately drive better-than-expected long-term benefits.


Read the full article here: 

Truist Building Toward Better Growth And Margins

Monday, May 24, 2021

BRF S.A. Boosted By A Strategic Investor, But Operating Conditions Are Challenging

 

I liked the valuation on BRF (BRFS) shares back in March, and the shares have since outperformed (up more than 25% since then, but that outperformance has a great deal more to do with the recent acquisition of BRF shares by Marfrig (OTCPK:MRRTY) than the current fundamentals, as BRF remains pressured by higher production costs and challenging international markets.

I don't see the near-term pressures abating, and BRF is going to be hard-pressed to continue raising prices at the pace of recent quarters (17% to 22%). Likewise, I don't see the international markets getting easier in the near-term.

I do still like the long-term potential of BRF's ongoing turnaround, and the involvement of Marfrig does raise the question (again) of whether BRF could be a merger/takeout candidate. The valuation argument isn't as compelling today, though, and I look it as more of a borderline buy.


Read the full article here: 

BRF S.A. Boosted By A Strategic Investor, But Operating Conditions Are Challenging

A Welcome Pullback At STMicroelectronics, But The Lead-Time Story Still Carries Risk

 

I went neutral on STMicroelectronics (STM) (“STMicro”) with my last update on the shares, largely because I just couldn’t reconcile the valuations across the sector with the likely growth and margin trajectories. I was also concerned about the high levels of lead-times – a situation that has in the past telegraphed weaker returns from chip stocks as order patterns normalize.

Since that last piece, STMicro shares have declined about 15%, underperforming both the chip sector as well as more specific competitors like Infineon (OTCQX:IFNNY), NXP Semiconductors (NXPI), and ON Semiconductor (ON), though longer-term performance timelines (two years and beyond) still largely favor STMicro over many peers.

I’m a little conflicted on recommending these shares now. I like STMicro’s strong leverage to auto and industrial electrification through not only silicon carbide (or SiC) but other chip types as well, not to mention opportunities in 32-bit MCUs (and embedded processing more broadly), IoT, RF, and sensing. I also like the fact that the shares are back down to a level where I see attractive long-term return potential. What I don’t like is that lead-times are still quite high across the industry and these shares could crack $30 in a correction.

 

Follow this link to the full article: 

A Welcome Pullback At STMicroelectronics, But The Lead-Time Story Still Carries Risk

More Fear And Uncertainty Around II-VI Isn't So Bad For Long-Term Investors

 I’ve said this many times in the past, but it bears repeating – while “buying the dip” is an often a good-to-great long-term strategy with good companies, it’s not always easy to do it. The markets surely do freak out from time to time and offer up seeming bargains, but most often a “buy the dip” opportunity comes about because there are real concerns in the market about the short-term prospects for the company in question. 

That brings me to II-VI (IIVI). I didn’t like the core fundamental valuation on the shares back in February, though I was still bullish on the long-term prospects for this leading (if complicated) optical and materials technology company. With the shares down about 25% since then on fears that the company is overpaying for Coherent (COHR), not to mention worries about near-term end-market demand and an overall cooling on expensive growth, the shares look a lot more interesting for long-term investors today.

 

Read the full article: 

More Fear And Uncertainty Around II-VI Isn't So Bad For Long-Term Investors

Bank Of America's Run Of Outperformance Fairly Values The Longer-Term Opportunity

 

I liked Bank of America (BAC) ("B of A") back in the summer of 2020, as I thought the market reaction to the near-term pressures on the banking sector were extreme relative to the long-term opportunities for this leading consumer and commercial bank. Since then, the shares have largely outperformed most of the bank's mega-cap peers (Citigroup (C), JPMorgan (JPM)) with a roughly 85% total return, though a few (PNC (PNC) and Wells Fargo (WFC)) have done better.

With the run in the shares, I'd say that the market fairly values the opportunity I see for Bank of America. I do expect the company to leverage its strong franchise, scale, and IT capabilities to continue gaining share in the fragmented U.S. banking market, but I don't see the outsized returns I saw before.

 

Click here to continue: 

Bank Of America's Run Of Outperformance Fairly Values The Longer-Term Opportunity

Lattice Seeing Revenue Acceleration And Moving To Double Its Addressable Market

The Lattice Semiconductor (LSCC) story continues to work, particularly with revenue accelerating nicely in the first quarter and management offering a credible outlook for mid-teens or better growth over the next three to four years. I have had my qualms about paying such a rich price for this stock (currently trading at around 15x expected 2021 revenue), but the shares have continued to outperform the broader semiconductor sector so far this year.

I know some investors were hoping for more operating margin leverage in management’s recent Analyst Day guidance, but I do think the company’s decision to continue investing in R&D and expand into the mid-range FPGA market is a good one for the long-term. I can’t, and won’t, defend the valuation, but I believe the underlying quality of the company and the growth story remain good.

 

Read more here: 

Lattice Seeing Revenue Acceleration And Moving To Double Its Addressable Market

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.


Read the full article here: 

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