Hey all,
Just realized I haven't posted (or written) in almost two months.
Things are fine.
I guess I'm enjoying the "luxury" of not really having to work/write when I'm not fired up to do so.
I'll probably get back to it before too much longer, but wanted you all to know I'm fine and haven't completely vanished.
best,
The Management
The shares of Celanese (CE) have performed fairly well on a year-to-date basis, up around 18% and outperforming the broader chemical space on soaring prices for acetic acid and vinyl acetate monomer (or VAM), and almost keeping pace with the S&P 500. Like with many cyclical names, though, the shares have started to underperform as investors anticipate normalizing prices and weaker 2022 profits.
As I’ve said in pieces on steel companies and other chemical companies, in the short term it’s tough to make money fighting the tape, and it’s tough to make money in cyclical commodity names when commodity prices and margins are heading lower off a peak. Longer term, though, I like Celanese’s market-leading and very efficient acetyl chain and engineered material businesses, and I think today’s price doesn’t really reflect the full value. Tactically, I’m cautious about recommending the shares today, but the valuation makes this a name to watch.
Read the full article here:
Celanese Stock Is Seeing Cyclical Sentiment Headwinds, But Long-Term Fundamentals Look Good
Discipline has been a good thing for Merit Medical (MMSI). This mid-sized med-tech has never had an issue with growth or product development, but the company hasn't had the best reputation for margin efficiency or wise capital allocation. With a new plan in place, and solid, consistent execution on that plan, things appear to be changing, and the shares have been doing well as a result.
There are definitely some worthwhile growth drivers here to watch. I like the opportunity with the SCOUT localization system and I'm looking forward to initial data on the WRAPSODY endovascular stent graft - a potential breakthrough device that could add around 10% to Merit's sales base (and at attractive margins). The shares anticipate at least some of this, though, and while I do see upside to around $80, a path to faster sales growth and/or stronger margins would be needed to unlock more value.
Read more here:
Merit Medical: Nothing Flashy, But Solid Execution Supports The Story
Since my last update, Calyxt (CLXT) has shifted strategy once again and named a new CEO to run the company. Though the strategy shift makes sense – a pure licensing approach instead of a mixed approach of licensing traits and selling some seeds – the reality is that it’s been about a year since the company moved toward a licensing model, and there’s not much to show for it. On top of that, the new CEO has no real relevant experience where the seed/trait-licensing business is concerned.
I do still think that Calyxt’s gene-editing approach to modifying crops has merit, but the reality is that there’s only about three quarters’ worth of cash on the balance sheet, and trait licensing agreements don’t typically include large upfront cash amounts. Though the potential returns of a successful outcome are indeed large, that path is becoming increasingly narrow and treacherous and this is really only a name for investors willing and able to take very speculative risks.
Read the full article at Seeking Alpha:
Calyxt Needs To Secure More Commercial Partners As Cash Dwindles
US Foods (USFD), the second-largest wholesaler food distributor in the country, hasn’t fared all that well since my last update. Down about 15% since then, the pandemic was an obvious unexpected adverse event, but Sysco (SYY) and Performance Food Group (PFGC) have fared better (up 2% and almost 12%, respectively), and there are ongoing concerns about US Foods’ ability to drive better operating leverage on the cost side.
I was lukewarm-to-positive on US Foods before, and that’s basically where I’m at again today. I like the leverage to independent restaurants and cash-and-carry, and I do think there are opportunities to benefit from consolidation in the industry. Achieving lower distribution costs is a key to-do item, though, and while I can see the path to get there, execution needs to improve.
If US Foods can couple mid-single-digit revenue growth with meaningful margin improvement, bringing FCF margins up to around 3% by the end of 2030 versus a long-term trailing average of 1.5%, these shares should offer attractive upside from here, but this is definitely an execution-driven story.
Read the full article here:
Prudential plc (PUK) recently completed the demerger of Jackson Financial (JXN.WI) and is now what investors have long wanted it to be a – pure-play provider of insurance savings and protection products to numerous growing, underpenetrated Asian markets, including China, India, Indonesia, and Thailand. While the shares have not done much since my last update, hurt in part by the ongoing COVID-19 pandemic, the modest decline is on par with AIA Group (OTCPK:AAGIY), the company’s main rival and comparable.
I continue to believe that Prudential is well-placed to generate attractive growth over the next decade, as it enjoys strong leadership in most of its top markets, where penetration rates are often still in the single-digits and where rising standards of living make retirement and supplemental health coverage a more realistic option for a growing percentage of the population. If Prudential can deliver on this opportunity and generate double-digit core earnings growth, the shares are about 20% undervalued in the near-term and offer longer-term annualized potential in the double-digits.
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Free Of Jackson, Prudential Plc Offers Attractive Exposure To Growing Asian Insurance Markets
I’ve been surprised by how well steel prices have held up this year. I expected more capacity restarts, but instead the industry has been shockingly disciplined, leading to quarterly results for ArcelorMittal (MT) that have exceeded some entire years from an EBITDA perspective. Better still, management continues to build confidence in the “it’s different this time” bull angle, as capex plans look restrained and targeted toward value-added capabilities and decarbonization, setting the stage for potentially huge returns of capital to shareholders.
I wasn’t that bullish on ArcelorMittal in my last write-up, though I did say, “I can see upside to the low-to-mid-$30’s on a “stronger for longer” steel market,” and that’s what has happened. By the same token, steel names I preferred more like Steel Dynamics (STLD) and Ternium (TX) (which I own) have done even better, so I don’t exactly regret my position that ArcelorMittal wasn’t the best idea at the time.
A lot of names in the steel space do look too cheap now, even with expectations of a downturn from 2022-2024 in place, and ArcelorMittal is no exception. It’s not hard to argue for a starting fair value at $35/ADR, and you can go into the mid-$40s without much difficulty. Sentiment, then, is a bigger concern now, as the market seems to be moving on from the steel story, and it remains to be seen if that stronger for longer story can drive another run in the share price.
Read more here:
ArcelorMittal Stock: Much Improved And Undervalued, But Sentiment Is Key To Another Run
The last six months haven’t been particularly kind to Euronet Worldwide (EEFT) shares, as the stock has declined about 20% since my last update. It likely won’t mitigate the disappointment for shareholders all that much, but it’s not just Euronet seeing weakness, as Fidelity National (FIS), Global Payments (GPN) and Western Union (WU) have all been weak, as resurgent COVID-19 infection rates threaten the recovery in leisure and travel-related payments volumes.
Competition from new payment tech/fintech entrants always is going to be a risk for Euronet, but I like what management is building. A slower recovery in travel, which hamstrings high-margin cross-border ATM revenue, is a near-term threat, but I do believe that travel will normalize eventually. In the meantime, the company has successfully repositioned the epay business for long-term growth, continued to grow the money transfer business, and started positioning its core REN/REV payment software platforms as “fintech in a box” solutions for a broad assortment of banking and business customers.
If my assumptions are right and Euronet can generate long-term revenue growth in the mid-to-high single-digits, with mid-teens FCF margins supporting high single-digit FCF growth, the shares look meaningfully undervalued today.
Read the full article here:
COVID-19 Pressuring Euronet, But The Future Is Bright For This Stock
Dell (DELL) has executed well in difficult circumstances, leveraging strong supply chain execution to at least partially offset component shortages and continuing to build up its hyperconverged and midrange storage businesses. Of course, there’s also the upcoming VMware (VMW) spinoff, a deal that will allow for meaningful deleveraging, a better credit rating, and returns of capital to shareholders.
That’s all good, and I do think Dell shares still have upside, but I do think management needs to also get the Street focused on the post-VMware story. Strong execution is all well and good, but in the short attention span theater that is Wall Street, analysts and investors often need “hooks”, and I would hope that management delivers something more than just a post-spin execution story at its upcoming Analyst Day.
Read the full article at Seeking Alpha:
Dell Will Need A New Story Soon, But The Valuation Still Holds Some Appeal
I thought that SPX FLOW (FLOW) offered a good return relative to its price back in late May, and apparently, Ingersoll Rand (IR) felt the same, as this would-be empire-builder in flow control made two bids for SPX FLOW this summer, including an $85/share all-cash bid, before walking away after SPX FLOW rejected its overtures.
Management has since initiated a “strategic review” but given the new strategic plan unveiled at the March Investor Day, consideration of a sale is really the only new option that could be on the table, and I think it will be tough to top an $85/share deal in the short term.
I do see meaningful self-improvement potential at SPX FLOW, and I’m always the guy going on about how “successful turnarounds can surprise and exceed investor expectations”. Turning down a no-risk $85/cash offer will no doubt lead to a little extra scrutiny on management’s execution of its turnaround/value creation plan, but I think they’re up to the task and patient investors may well be better off if they stay independent a while longer.
Read the full article at Seeking Alpha:
SPX FLOW's Go-It-Alone Strategy Is A Reasonable Bet On Its Turnaround Plan
As I noted in my last update on Gates Industrial (NYSE:GTES), the market was starting to move off of short-cycle industrials as investors pursued greener pastures for growth. I had thought that stronger first and second quarter earnings and healthy guidance would maybe lead to some rethinking, but so far I was only half-right – Gates, and many other short-cycle names, reported better results, but it hasn’t changed sentiment and several quality short-cycle names have continued to weaken.
Basically flat since my last update, Gates still looks interesting to me on a long-term basis. I like the long-term opportunity in chain-to-belt transitions in multiple industrial markets, as well as the opportunity to leverage further growth in automation and a switch to electrification in personal transportation. Although I see pretty interesting return potential, I wouldn’t ignore that sentiment issue where short-cycle names as concerned, as fighting the tape is a tough way to try to make money.
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Automation is an undeniable trend in the broad industrial end-markets that Applied Industrial Technologies (NYSE:AIT) serves, and management is positioning itself accordingly – acquiring capabilities in design, assembly, and integration to leverage growth opportunities as more and more industries/companies incorporate automation into their manufacturing and warehouse processes.
AIT isn’t just an automation story, it’s also a value-added industrial distribution story where management has wisely steered clear of fast-turn, low-value MRO components and has instead focused on higher-value critical components and service. This has led to something extremely rare in the industrial distribution space over the past decade – actual gross margin improvement.
AIT has historically had some of the strongest cyclical volatility in the space, and I am worried that as with other supposedly “short cycle” names like Parker Hannifin (NYSE:PH) (an OEM, not a distributor), the Street thinks the story is over now that manufacturing PMI is well above 55. I wouldn’t ignore that cyclical risk, but I think automation is a leverageable long-term trend for AIT, and the long-term prospective return is looking pretty interesting.
Read the full article here:
Automation And Catch-Up Capex Make Applied Industrial Technologies A Name To Watch
A hot U.S. renovation/remodel market and strong execution through the challenges of the pandemic have served Ferguson (FERG) well since my last update, with the shares returning more than 50% versus a little more than 30% for the S&P 500. That’s also not a bad performance relative to other distributors, with SiteOne (SITE) and Builders FirstSource (BLDR) doing even better, while Pool (POOL) has done about as well and Watsco (WSO) hasn’t quite kept pace.
Management has continued to do exactly what they said they would do – selling the less profitable U.K. business and pursuing the plan to become a U.S. business, including a dual listing earlier this year, a shift to U.S. GAAP for FY’22, and then a shift toward the U.S. listing being the primary listing for the company. On top of that, as the world gets back to something closer to normal, I would expect ongoing reacceleration in the serial tuck-in M&A program.
I like the business, but the stock valuation is a little more challenging now. The DCF-based valuation doesn’t suggest exceptional undervaluation, though I do still see upside on a multiples-based approach. Given healthy underlying markets and ongoing growth opportunities, I still lean favorably, but not quite as strongly as back in October of last year.
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Ferguson Executing Well In A Hot Residential Market
Cummins (CMI) is a proven high-quality operator, with strong market shares across its key markets, strong return metrics (ROA, et al), and a good reputation on Wall Street. Still, the cyclicality of the business and the often high valuation Wall Street has been willing to give the shares have meant that it hasn’t always been the highest-quality stock – the long-term returns compare well to the S&P 500 and other industrials, but there have definitely been stretches of underperformance.
This is an interesting point in Cummins’ life cycle. Not only is there an unusual truck cycle still left to play out, with component shortages pushing Class 8 volumes into 2022, with a likely cyclical decline in 2023, but Cummins has the unenviable task of maintaining leadership in its core legacy markets while positioning and transitioning to new technologies and markets like hydrogen and electrification.
I like Cummins, and I see decent long-term return potential in the stock today, but timing cycles and cyclical stocks is never straightforward. The market almost always anticipates the turn (selling off while current conditions are good, buying while current conditions are still poor), but it’s possible there’s more risk/room on the downside, as the peak-to-now decline is only about half that of peak-to-trough moves in prior cycles.
Read more here:
Cummins Stock Looking More Tempting, But Cycle Risk Remains A Concern
With supply still down relative to pre-pandemic levels and a strong demand recovery underway, North and South American steelmakers continue to enjoy exceptional price strength. The good times won't last for Ternium (TX), but stronger demand across its Latin American markets can offset some of the oncoming price weakness, and weaker volumes out of China could perhaps support prices at a higher-for-longer level than bears believe.
I've liked Ternium for a while (it's been my preferred steel pick), and with a 45% total return since my last update for Seeking Alpha - matching Cleveland-Cliffs (CLF) and Nucor (NUE) and outperforming ArcelorMittal (MT), Gerdau (GGB), Steel Dynamics (STLD), I don't regret that call at all.
At this point, I do still see some upside in the shares, and I think 2022 will still be a strong year for pricing and volume, but Gerdau is maybe more interesting on a risk/reward basis. Still, I think holding steel stocks into a down-cycle isn't the best idea, and while I can see growth drivers for Ternium beyond 2022 and I believe it's both well-run and undervalued, that cycle sentiment risk is a growing concern for me.
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Ternium Leveraging A Steel Supply Imbalance, With Demand Growth Opportunities Coming Later
The vehicle parts sector hasn’t had a great 2021, with concerns about shrinking vehicle production schedules in response to semiconductor shortages as well as margin pressure from cost inflation and supply chain challenges contributing to weak investor sentiment. Tenneco (TEN) has been doing better than most, though, and does at least have a year-to-date gain to show for itself, despite a roughly 11% drop since my last update.
I’m getting more positive on these shares again, as I think the weakness may be getting a little excessive. Management’s expectations seem rooted in reasonable, if not conservative, assumptions about OEM production schedules and margin leverage opportunities (or lack thereof), and the company continues to make progress on internal cost efficiency efforts and deleveraging.
Vulnerability to passenger vehicle electrification remains a long-standing worry here, as does the high level of leverage, as it will likely take another five years or so for Tenneco to get rid of its excess debt (which I define as net debt above 2x forward EBITDA). Opportunities in advanced suspension products, aftermarket parts, and commercial vehicle (and industrial) markets shouldn’t be overlooked, though, and I can argue for a fair value in the high teens today.
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The last couple of months have not been so great for Ciena’s (CIEN) share price performance, and the same is true on a year-to-date basis, as a broad comp group of Cisco (CSCO), Juniper (JNPR), and Nokia (NOK) have noticeably outperformed, while other comps like NeoPhotonics (NPTN) and Infinera (INFN) have had their own struggles.
I believe the main driver of this lagging performance is soft near-term guidance from management that supply constraints are going to prevent the company from shipping to underlying demand. I also believe the prospect of increased competition from coherent pluggables is a concern to some analysts and investors, though I’ve maintained for a while that I think the magnitude of the threat is likely both exaggerated and manageable by Ciena.
The lack of near-term upside is definitely a drawback, but I still like Ciena. Service providers will continue to spend on network expansion/upgrades, and the company continues to make inroads in the enterprise (Webscale) market. The Huawei replacement opportunity is still in place as a driver, as are opportunities to gain share in edge routing. All in all, I still expect mid-single-digit revenue growth and I see double-digit annualized return potential at today’s price.
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Ciena Struggling A Bit With Capped Near-Term Upside And Competitive Worries
Broadcom (AVGO) has continued to lag the SOX through mid-September of this year, though the shares have at least generated close to a 10% total return since my last update, as the company continues to generate exceptional margins in a capacity-constrained semiconductor market. Although Broadcom hasn’t been generating the most impressive growth in the space, it’s well worth remembering that Broadcom’s management runs the business with far more of a focus on long-term margins and full-cycle stability than most chip companies.
Broadcom shares continue to look meaningfully undervalued to me in an industry where there aren’t a lot of obvious bargains, particularly among the higher-quality names. I do believe there is some concern that Broadcom’s more aggressive business practices will come back to haunt the company later, as well as concerns that management will prioritize lower-growth, higher-margin targets in M&A. Those are valid worries to a point, but I believe Broadcom offers a solid double-digit return in the short term and a longer-term annualized potential return in the high single digits.
Read the full article here:
Broadcom - Still Undervalued, Still Seeing Growth Opps, And Still Somewhat Controversial
It’s been a while since I’ve written on Entegris (ENTG), but this is a semiconductor supplier where I’ve loved the story for a long time. And why not? Entegris focuses on specialty materials and systems for the semiconductor industry and is directly leveraged not only to volume growth, but increasing complexity in chip design. With good moats, strong underlying chip volume growth, healthy margins, and opportunities to apply its core capabilities into other growth markets (like bioproduction), there’s a lot to like.
The exception is valuation. That combination of strong underlying growth, margin leverage, and defensible market positions has led to a robust valuation that I find very difficult to reconcile to the fundamentals. Of course there will be growth/momentum investors to tell you how valuation doesn’t matter, and maybe this is a case where it’s true, but at this point Entegris is basically a leveraged bet on even more semiconductor industry volume and company-specific content growth, as well as opportunities in life sciences.
Read the full article here:
Entegris Offers An Exceptional Growth Story, And A Rich Valuation
Sensata (ST) has been outperforming sell-side expectations and converting sell-side skeptics to believers, leading to a 40%-plus increase in the average Street price target since my last update, but it hasn’t really helped where it counts most – Sensata’s share price is down a bit from my last update. They’re not alone, Aptiv (APTV) shares have been weak too, but a broad set of comparables like Amphenol (APH), NXP Semiconductors (NXPI), and TE Connectivity (TEL) have managed better returns.
At some point I do think that Sensata will get its due – not just for the quality of the underlying business, but also the company’s leverage to vehicle electrification (passenger and commercial), to increased aerospace electrification, and to telematics. I believe the shares are about 10% to 20% undervalued today and would still offer high single-digit long-term annualized return potential beyond that, making this a name to consider.
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Sensata Executing And Building A Long-Term Growth Story, But Still Undervalued
Waters (WAT) needed shaking up, and new CEO Udit Batra is doing exactly that. In addition to what Batra has cited as weak execution under prior management, I believe complacency and a lack of strategic vision (and/or a lack of understanding where the life sciences and biopharma markets were heading) put Waters on its back foot, leading to unimpressive performance relative to names like Agilent (A), Bruker (BRKR), Danaher (DHR), and Thermo Fisher (TMO) over the last five years.
I'm a fan of what Batra is doing with Waters, and I think the company is already emerging as a more formidable player. The only issue is that the market seems fully onto this story, if not ahead of the curve. While I do believe this new, better, strategic path can deliver better financial results, it's hard for me to see how that isn't already captured in the share price (and then some).
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Waters Back On The Right Path, But The Valuation Is Well Down The Road
Credit where due – Pentair’s (PNR) management has done a good job of streamlining and improving this business, shifting the sentiment away from Pentair’s legacy as a disappointing, under-executing, would-be empire-builder. There’s a lot to like about a business with a large aftermarket revenue mix, strong margins, and good market share, and there could be further portfolio transformation in the future.
All of that said, the strong growth in the Pool business over the last 12-18 months will make for tougher comps, particularly as the pandemic-driven remodel/renovation trend seems to be falling off. Moreover, while the mid-single-digit revenue growth and double-digit FCF growth I expect from Pentair compares well to many industrials, the valuation is already pretty fair today.
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Pentair Establishing Tough Comps, And The Valuation Is No Clear Bargain
Few auto supplier stocks have outperformed this year, but Aptiv (APTV) has at least managed to generate a positive double-digit year-to-date return while the sector is down nearly 10%. With the shares down a bit since my last update, and auto OEMs pushing forward even harder on electric vehicles, the valuation argument is getting a little more interesting to me.
I really like Aptiv’s leverage to high-voltage wiring, cabling, and connectors in battery electric vehicles (or BEVs), as this will be an almost-impossible e-powertrain component to in-source, but one that should be more profitable than average as well. I also believe the opportunity in Smart Vehicle Architecture (or SVA), a new way to approach electronic control for vehicles, is both significant and underappreciated relative to the hype around autonomous driving technology.
I can’t say that Aptiv is any kind of value stock, and there are several quality auto component suppliers that look undervalued today, but relative to a bull-case outcome for BEV-driven high-voltage electrical components, SVA platform wins, and advanced driver assistance systems (or ADAS), including autonomous driving, I’m warming up to this as a not-so-unreasonably-priced growth stock idea.
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Sentiment Has Cooled On Aptiv, But High-Voltage And SVA Remain Hot Opportunities
Writing about MetLife (MET) in March of this year, I was concerned that the strong run in the shares and a weak rate environment had left the stock vulnerable to a period of “blah” performance, and so it has been, with the shares basically flat since then despite some continuing positive developments in the business, including the sale of operations in Poland and Greece and strong variable investment income.
I consider MetLife a “what you see is what you get” sort of company; management has long been straightforward about its strategy and has been executing very well (and very consistently) on that plan. Other than a possible sale of MetLife Holdings (unlikely) and acquisitions in the group benefits and/or asset management space, I think what you see today is largely what you’re going to keep getting – a well-run insurance company that prizes consistent performance in high-return businesses (relative to risk/cost of capital) and that will return large amounts of capital to its shareholders.
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MetLife: Steady As She Goes For A Very Well-Run Insurance Titan
“Buy the dips” may be good advice, but it’s often tough to follow because meaningful pullbacks don’t usually happen without a reason, and that proximate cause is often scary in the short term. Such is the case with Philips (PHG) and its recall (and future litigation) of the DreamStation 1 sleep apnea machine. While there are billions in potential liability costs in play, it looks as though the market has overreacted to what should prove to be a manageable situation for the company.
Given that the market reaction would already seem to factor in a more-than-worst case scenario, this is a name for investors to consider, but only if they can be patient during the ups and downs of what is likely to be a multiyear resolution process. Long-term revenue and FCF growth of 3% and 6% can support a meaningfully higher price, but Philips management is likely back to square one when it comes to rebuilding its credibility with analysts and institutional investors.
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Philips's DreamStation Nightmare Could Be A Longer-Term Opportunity
Another of my “really like the company, don’t like the valuation” names, Ingersoll Rand (IR) has produced a mix track record since my last update on this industrial name – the shares are up more than 13% since that article, which is worse than the S&P 500’s return over that time, but more or less in line with the broader industrial sector. The “but”, though, is that Ingersoll Rand posted a couple of strong quarters and made some significant positive capital/business allocation moves, so I’d argue there’s been some “catch up” to what I saw as a high valuation.
I wish I could say that Ingersoll Rand was a bargain today, but I don’t see that. There’s another “but” here, too, though, and that is Ingersoll Rand’s exposure to what could be a stronger-for-longer industrial capex cycle, as well as upside to a more aggressive capital allocation and portfolio transformation plan. Including estimated M&A, I do see Ingersoll Rand set up for returns on the low end of the high single-digits, and that makes it a more tempting call.
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Ingersoll Rand: Leveraged To Strong Industrial Markets And Capital Reallocation
A lot of what Belden (NYSE:BDC) does isn’t particularly exciting – cables, connectors, networking components, and the like – but that’s not such a bad thing. Exciting opportunities often attract a great deal more attention, and while Belden may not have the sexiest product lines, they’re essential components to automated factories and warehouses, data centers, connected homes, and smart buildings.
On top of that leverage to multiyear growth in automation and connectivity, Belden is still a self-help story as management pivots the company toward higher-growth, higher-margin businesses, reduces costs, improves operating efficiency, and deleverages. Although the shares have already doubled off their 52-week low, I can still see a path to $65-$75, and mid-to-high single-digit longer-term appreciation beyond that.
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Belden - A Picks-And-Shovels Play On Automation And Connectivity
I sometimes wonder how much of a stock’s valuation can be explained by “behind the scenes” factors like convenience. Take Rockwell Automation (ROK) – these shares often look quite pricey, even relative to above-average growth, but they’ve continued to perform, and I wonder if that’s because it’s an easy call for institutional portfolio managers. Need exposure to automation? Buy Rockwell and call it a day.
I don’t mean that to sound as glib as it might – Rockwell is a legitimately strong player in automation, and management has taken serious steps to improve its positioning in attractive growth markets like logistics, semiconductors, and life sciences, as well as embrace industrial software. I just find the valuation a tougher sell given that the growth outlook isn’t as differentiated as the valuation might lead an investor to think.
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Among the large industrial distributors, Watsco (WSO) consistently stands out for its quality, and that quality has driven the shares to a decent performance since my last article on the company for Seeking Alpha – outperforming the industrial sector while matching the S&P 500 on a total return basis. There hasn’t really been any “magic” to this outcome, just a consistent execution track record, with incremental contributions from long-standing projects like digitalization and M&A.
It’s rare to write an article about Watsco that doesn’t include a “but the valuation” caveat, and that remains true today. I don’t think the stock is overpriced, but a prospective return in the mid-to-high single-digits may not be so exciting, and I do see some sentiment risk as analysts debate the near-term trajectory of residential HVAC demand. Were the shares to correct by more than 10%, the valuation argument would get quite a bit more interesting, and such pullbacks have happened from time to time.
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Watsco Continues To Execute Very Well, But End-Market Demand And Valuation Are Concerns
Writing about Emerson (EMR) in February, I said that while I thought the shares weren't all that cheap on an absolute basis, they still had some appeal as a "first among peers" pick within high-quality industrials and offered leverage to an eventual recovery in process end-markets. Since then, the shares have outperformed the S&P 500 and broader industrial sector, as well as Siemens (OTCPK:SIEGY), though haven't quite kept pace with ABB (ABB) or Rockwell (ROK) within the automation space.
My feelings haven't really changed that much. Discrete and hybrid automation markets are leading the recovery, but activity in process industries is picking up, and Emerson still has opportunities to grow its presence in more attractive markets like life sciences/biopharma. On top of that, I think there's meaningful portfolio transformation potential here. Valuation still isn't appealing on an absolute basis, but looking at what other industrials trade for, Emerson's better margins and returns (ROIC, ROA, ROTA), not to mention exposure to later-cycle markets, should merit at least a peer-level forward multiple.
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Emerson Offers Portfolio Transformation And Leverage To Process Market Recoveries
A.O. Smith (AOS) could be one of my case-in-points as to why I think both quality and price/value matter. I’ve never seen any serious arguments that A.O. Smith isn’t a high-quality, well-run company with decent growth prospects, but I wasn’t excited about the valuation back in early 2018 and the shares have meaningfully lagged the broader industrial space since then (by over 20%), not to mention water plays like Watts (WTS) and HVAC names.
I do still like A.O. Smith’s leverage to growth opportunities in markets like China and India, and I likewise think there is a path for A.O. Smith to become more of an ESG story with its U.S. operations through both more efficient water heaters (and boilers) and a growing water treatment business. The main issue remains valuation, as even a premium valuation based upon the company’s superior returns (margins, ROIC, ROTA, et al) doesn’t suggest significant undervaluation today.
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A. O. Smith Has Some Attractive Growth Angles, But The Valuation Isn't A Clear Bargain
It’s not hard to find articles talking about Weyerhaeuser (WY) as some sort of “can’t miss” idea, since the company can theoretically just hold off on timber sales and let the trees grow. That misses a lot of key points, not the least of which is that silviculture is more complicated than just letting trees grow. The reality is that Weyerhaeuser also has to navigate volatile Wood Products prices, and has to do so with management’s hands at least partially tied by a strict capital allocation policy.
On top of that, Weyerhaeuser is a “neither fish nor fowl” stock that doesn’t really fit well into any particular bucket. It’s not a growth stock, it’s quite cyclical, and while it can generate significant supplemental dividends in the good times, it doesn’t offer the stability or predictability in distributions that most income investors want.
Between those challenges and recent weakness in wood product prices, I’m not surprised that the shares have underperformed the S&P 500 since my last update. I do think the shares are undervalued, but I’m worried that the company’s capital allocation policy is an impediment and this is really only a name for patient investors who can tolerate above-average volatility.
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Weyerhaeuser Facing Weaker Prices, Limited Flexibility, And Mixed Appeal
On the whole, I wasn’t that bullish on infrastructure-leveraged names back in March of this year, as I thought a lot of good news was already getting priced into the stocks. Since my last article on the company, Cemex (CX) has done better than most, with a roughly 15% return versus a 12% gain at Martin Marietta (MLM), an 8% gain at Vulcan Materials (VMC), and an 8% decline at Holcim (OTCPK:HCMLY), not to mention low double-digit gains for Commercial Metals (CMC) and Insteel (IIIN), but Cemex has still lagged the S&P 500 over that time, with the shares mostly chopping around between $7.50 and $9 since first quarter earnings.
Given developments since then, I’m more bullish on Cemex, particularly as I think the outlook for pricing is pretty attractive on a multiyear basis. I do think the shares should trade above $10, but I do have some concerns that the market is overly concerned with recent peaks in non-residential construction indicators and may need to be “re-convinced” that the cycle isn’t over yet.
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Cemex Looking At A Pretty Attractive Setup While Investors Seem Worried About The Cycle
It’s been an interesting six months for Insteel (IIIN) since my last update on this under-followed manufacturer of steel reinforcing products. While pricing and volume have been strong, as has manufacturing leverage, and Insteel saw a favorable ruling in anti-dumping cases against imported reinforcing products, the shares have corrected on what I believe are growing concerns of an approaching peak.
In my last article, I said that I saw upside into the $40s on the passage of an infrastructure bill, and that happened in March, May, and early August, but the shares have pulled back almost 20% since then. I think there’s a “this is as good as it gets” concern in play with Insteel, and I understand that to a point, though I do think the infrastructure bill will be a positive for underlying demand. I could see another move into the $40s and upside to FY’22 expectations, but I would be careful about pushing my luck with what can be a painfully cyclical stock when the cycle rolls over.
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I’ve said before that timing the peak of commodity cycles is a difficult task and few analysts or investors get it right two cycles in a row. I’ve likewise said that it’s painful to hold commodity stocks once the market has moved to a post-peak mentality.
Both of those phenomena have been on display over the last six months at Gerdau (GGB), as this well-run Brazilian steel producer saw its ADRs shoot over $7/share, before retreating back and ending about 18% higher (total return) than where they were at my last update. That performance is better than what Usiminas (OTCPK:USNZY) or Companhia Siderúrgica Nacional (SID) managed over that time, but not as good as the performances from ArcelorMittal (MT), Nucor (NUE), or Ternium (TX).
The near-term outlook for Gerdau is still pretty positive, with strong improvement underway in Brazil’s construction market, as well as improvements in the industrial markets and markets in South America. The new U.S. infrastructure bill should add to steel demand for several years, but China’s environment-driven curtailments are still a key unknown. My bigger concern, though, is that the market has simply moved on for this cycle. Gerdau offers some decent long-term upside at this price, but corrections on cycle downturns can still be pretty brutal.
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Gerdau Set For Record Cash Flows, But Investors Seem To Have Moved On
Growth has historically been a challenge for Bruker (BRKR), as management was previously more focused on margin improvement and hadn’t historically done a great job of fostering R&D (or M&A) aimed at growing the company’s addressable markets outside of more staid legacy research and industrial markets in nuclear magnetic resonance (or NMR) spectroscopy and matrix-assisted laser desorption/ionization (or MALDI) spectroscopy.
That was the story around seven and a half years ago, and I’m happy to say that management has managed to find a better path that combines improved revenue growth prospects and better margins, including margin uplift from a larger/richer aftermarket business. In particular, management has highlighted multibillion-dollar opportunities in a range of life science and clinical markets, while meaningfully improving margins since that 2014 article.
Bruker still faces meaningful competition from Agilent (A) and many others, and it’s fair to note that the company doesn’t have the attractive leverage to bioproduction like Danaher (DHR) or Thermo Fisher (TMO) (or Agilent). Still, on the basis of what Bruker does have, including sizable addressable life science research and clinical market opportunities, the growth opportunity here looks good. Valuation is another story, but that’s not so surprising for a life sciences equipment company today.
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Bruker's Renewed Focus On Growth Has Lit A Fire Under The Shares
I’m fond of saying that successful turnarounds can significantly exceed investor expectations, but it’s also true that some companies struggle for years to make any real headway with their self-improvement projects and leave investors with little to show for their patience. Such has been the case with Lanxess (OTCPK:LNXSF) (LXSG.DE), where efforts to reshape the business toward more value-added, less-cyclical specialty chemicals have yet to produce the hoped-for benefits.
Lanxess shares have been notable underperformers since my last update on the company, with the shares underperforming the S&P 500 by close to 70% (a 9% loss versus a 62% gain for the S&P 500) and the performance relative to the STOXX Europe 600 index has likewise been pretty lousy (44% underperformance). Simply put, the company hasn’t generated the revenue, profit margins, or free cash flows that were expected, and investors bailed out in favor of more promising names.
Lanxess shares do look modestly undervalued, but that still rests on the assumption that the ongoing shift toward higher-margin businesses, including the pending acquisitions of Emerald Kalama and International Flavors and Fragrances' (NYSE:IFF) microbial control business, will drive sustainably higher margins. That may well be more benefit of the doubt than management has earned, and the shares do trade in line with their historical valuation norms, suggesting that investors are largely expecting more of the same here.
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MaxLinear (MXL) is proving its doubters wrong, myself included. Although I’m not throwing in the towel yet on my prediction that MaxLinear will struggle to achieve lasting traction in PAM-4 against competition from Marvell (MRVL) and Broadcom (AVGO), the company is executing very well in Connectivity and Broadband and has growth opportunities outside of PAM-4 in Infrastructure. Just as important, the company is doing exceptionally well on margins, which is an underappreciated driver of long-term semiconductor valuations.
Connectivity is looking like a stronger-for-longer growth driver now, helped in large part by strength in WiFi 6/6E, while the outlook for broadband is a little tougher to call – bill of material growth has been impressive, but there’s still a risk that the pandemic pulled demand forward. Then there’s the PAM-4 business – if MaxLinear can win substantial second-source business from Amazon (AMZN) and replicate that with other hyperscale customers, there is meaningful upside, to say nothing of the possibility of leveraging growing regulatory pressure on Broadcom.
My estimates were, and are, above the sell-side, but it’s still tough to make the valuation work. At best, the shares look fairly-valued today, but then there is still a case to be made of further beat-and-raise quarters that drive even higher revenue and margin expectations. From a practical viewpoint, though, there’s definitely positive momentum in this business that’s tough to ignore, and the shares have risen more than 30% since my last update, handily beating the SOX.
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The last five years have been good ones for medical technology investors, with the iShares U.S. Medical Devices ETF (IHI) up almost 180%, well ahead of the S&P 500 and nearly matching the NASDAQ. Smith & Nephew (SNN) has not participated in those good times, though, as the shares have been a notable laggard next to the broader med-tech space as well as more direct comparables like Stryker (SYK) and Integra (IART), both of which have also lagged the IHI over the last five years.
I believe a lot of this underperformance has been self-inflicted, including ongoing reinvestment in slower-growing markets and underinvestment in more attractive market opportunities like robotics and extremities. Now, though, Smith & Nephew has patched some of these holes and maybe better-leveraged to growth opportunities across its diverse end-markets than the Street is pricing into the shares today.
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Smith & Nephew Leveraged To Post-Pandemic Normalization And Self-Help
Credicorp (BAP) has unfortunately pivoted toward a “good house in a bad neighborhood” story since my last update on this leading Peruvian bank, with the election of leftist Perú Libre (“Free Peru”) candidate Pedro Castillo roiling the market in Peru and leading foreign capital to bail out.
While Castillo has tried to walk back some of his more inflammatory campaign rhetoric, he did campaign on an explicitly Marxist platform that included advancing a new constitution, eliminating Peru’s Supreme Court, nationalizing some businesses/industries, and renegotiating state contracts. What that all will mean for Credicorp’s business and operating environment is anybody’s guess; Castillo’s party has relatively modest power in Peru’s Congress, the election was close, and his cabinet was approved by a relatively narrow margin (73 to 50), and that could limit what he can accomplish.
For Credicorp, I still believe that over 7% long-term core growth is attainable, and that would normally support an attractive return potential at this price, as would the near-term ROE outlook. While there is still double-digit upside after applying a larger discount rate to account for the elevated political/operating risk, this is a name suitable only for aggressive investors willing to take the risk that Peru will still fare relatively well under this new regime.
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The market is by no means a perfect discounting mechanism, but when you stumble across on oddly-undervalued stock it’s at least worth checking your basic assumptions. Such is the case with Meritor (MTOR). I can understand why investors may have some apprehensions about an approaching peak in commercial vehicle production, but that seems more than discounted in the share price today.
Meritor management has built credibility with successful execution on multiple margin-improvement and growth initiatives (the “M series” of M2016, M2019, and M2022), and the company has also assembled a credible platform for participating in future truck electrification. Low single-digit long-term revenue growth and ongoing improvement in FCF margins within the 3% to 5% band I talked about years ago can drive a fair value around $30 today, and the shares likewise look undervalued on a margin-driven multiples basis.
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Meritor Already Discounting A Significant Correction In Commercial Vehicles
In a healthy market for asset managers, AllianceBernstein (AB), continues to stand out in a positive way, with a better than 35% total return since my last update that compares pretty well to peers like Artisan (APAM), BlackRock (BLK), Franklin Resources (BEN), and T. Rowe Price (TROW). This solid performance has not only been driven by a generally cooperative market, but also AB’s own strategies to drive growth in assets under management (or AUM) and improve the fee mix.
I really don’t see a reason to get off this strong horse at this point. While the valuation isn’t quite the bargain it once was, I still see the prospect of double-digit total annualized long-term returns here, and I think there’s more AB can do to grow the business. Management has been actively remixing AUM toward active equity and alts, and I believe there’s more to come both organically and through M&A.
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BBVA (BBVA) is one of those companies that seems continually beset by doubters and skeptics, even though the company has been one of the more consistent earnings performers among European banks over the last 20-plus years. Most recently, bearish analysts have fretted about the risks from the Turkish operations (even though they’re well-contained), weaker results in Mexico (even though it’s improving), and ongoing lackluster performance in Spain (a valid concern).
With the sale of Compass to PNC (PNC) complete, BBVA has surplus capital and management has already committed to a meaningful buyback of 10% of shares. I do believe management may take another look at M&A in its home market of Spain, or possibly in other markets, and that could be a risk to sentiment, but the shares continue to look undervalued on long-term core growth in the mid-single-digits.
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Despite ongoing growth in e-commerce and strong demand for cargo freighters, Air Transport Services Group (ATSG) has struggled to much headway this year. The shares have rebounded some since late July, but they’re down about 6% since my last update, and the company lags other transports like Atlas Air (AAWW), Deutsche Post DHL (OTCPK:DPSGY), FedEx (FDX), and UPS (UPS) on a year-to-date basis as well.
I believe at least some of the lagging performance has been due to the negative impact on the business from weaker passenger-related leasing revenue (tied to COVID-19), but that headwind should ease from here. In the meantime, the company not only continues to find more customers for its freighters, driven by strong e-commerce traffic, it’s making a sizable commitment to further passenger-to-cargo conversions in the coming years, as well as leveraging opportunities to serve an aging B757 cargo fleet with A321 conversions from its PEMCO joint venture.
I still see fair value in the low-to-mid-$30s, but this is a difficult company to model given frequent changes to the capex plans, and it’s not a particularly popular stock on the Street despite its leverage to ongoing e-commerce growth and Amazon (AMZN) in particular.
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Air Transport Services Group: Leveraging Strong Air Cargo Demand
Most companies have found recent semiconductor shortages to be a hassle, but a somewhat manageable one – at worst, they have capped near-term upside. Not so for Itron (ITRI), with this metering and grid technology company posting a significant miss-and-lower quarter in early August on persistent chip shortages. While many sell-side analysts have charactered this as “revenue deferred, not revenue destroyed”, I note that they haven’t really modelled any sort of “catch up” in 2022 or beyond.
Itron shares are down about 10% since my mid-March article flagging them as an attractive GARP story with strong leverage to grid automation and modernization. I still believe that to be an entirely valid thesis, though clearly there needs to be some remedial work done on “reenforcing” the supply chain, as this isn’t the first time that a component shortage has hit the company’s results (there were issues in 2018 as well).
In contrast to the sell-side, I am modeling some catch-up revenue growth in the years after 2022, so I do run the risk of excessively high expectations for 2023-2026, with a long-term revenue growth rate still in the 6% to 8% range. Although weaker near-term earnings and margins compromise the multiples-based valuation, the shares do now look attractively-priced on a longer-term discounted cash flow basis.
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Itron's Supply Challenges Reset The Story, But Long-Term Drivers Still In Play
I’m glad to see STMicroelectronics (STM) (“STMicro”) getting more of its fair due in the market, as that hasn’t always been the case with this diversified chip company. Up almost 25% since my last update, doubling the return of the SOX in that time, but still lagging on a year-to-date basis, STMicro has benefited from another beat-and-raise quarter, as well as greater confidence about the security of the company’s book going into what will likely prove to be peak lead-times.
I’m beginning to see a stronger case for even more growth from STMicro over the next decade than I’d previously modeled, with STMicro leveraged not only to well-understood opportunities in autos, but also other industrial power markets, as well as 3D sensing, MCUs, and IoT. If STMicro can generate long-term growth more on the order of 9% over the long term, not impossible given underlying volume growth in markets like EVs, automation, and IoT, there is still worthwhile upside.
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STMicroelectronics Stays On Track As A Top Power Play
