I’m expecting high single-digit revenue growth from Sonova over the next three to five years, slowing toward a 5% to 6% growth rate over the longer term, and I’m expecting EBITDA margins to expand into the low-to-mid-30%s over the next few years. Between discounted cash flow and growth/margin-driven EV/revenue, I do think these shares offer enough upside to merit a closer look from investors.
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Sonova Seeing Strong Execution Collide With Macro Uncertainties
I didn’t find a particularly compelling risk/reward opportunity with the shares when I last wrote about the company in early February of 2021, and with the shares down almost 25% since then (underperforming peers like Stryker (SYK) and the broader med-tech space), I don’t feel like I’ve missed out on much. While there have been signs of progress here and there, the reality is that the company’s performance in the ortho space on a two-year stack shows share loss in major joints.
I don’t think the valuation is particularly demanding if Zimmer can generate around 3% long-term revenue growth, mid-30%’s EBITDA margins, and high single-digit FCF growth. The real question, though, is whether or not the company can generate the sort of differentiated growth that will get investors to take a closer look – low-growth med-tech is a tough set-up for making money and I do have concerns that this could be a value trap.
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Zimmer Biomet's Valuation Offset By Lackluster Growth And Limited Near-Term Margin Leverage
In terms of investor sentiment, it’s basically back to square one for AngioDynamics (NASDAQ:ANGO) after a fiscal first quarter where the reported numbers weren’t quite that awful, but where management commentary on several subjects cast a pall over the company’s near-term prospects.
The shares are down more than a third since my last update on the company, lagging Cardiovascular Systems (CSII) and Inari (NARI) by a wide margin, and lagging Penumbra (PEN) by an exceptionally large margin. It’s difficult to recommend the shares here, as value stories in small-cap med-tech don’t often work out well and many of the issues pressuring sentiment won’t resolve quickly. I do think today’s price undervalues the business as a going concern, but I don’t see a high likelihood of M&A interest and the company’s combination of sub-10% revenue growth and single-digit adjusted EBITDA margin is far from compelling.
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AngioDynamics Now Finds Itself Deep In The Street's Doghouse
This is an interesting time to evaluate PNC’s investment prospects. The valuation doesn’t stand out as exceptional relative to many other large banks (not to mention many smaller banks), but I like PNC’s skew to commercial lending and its strong credit quality history. If the economy does better than expected next year, PNC will likely be a laggard, but PNC is a good option for investors who may have a less robust outlook for 2023, but still want some bank exposure. I’d also note that in terms of P/TBV, P/E, and so on, PNC is trading below longer-term averages.
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PNC Financial Has A Better Mix Of Drivers In A Sector That's Still Off Its Highs
I can come up with at least a few reasons for some weakness in Pinnacle shares – the bank’s above-average deposit beta, aggressive opex spending growth, and dependence on loan growth among them – but even against a tougher backdrop for 2023/24, I think the shares still look attractive for growth-oriented investors willing to take on additional risk in pursuit of above-average returns.
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Pinnacle Financial Partners Undervalued, But Arguably Out Of Step With A Nervous Market
U.S. Bancorp has the “Main Street banking” exposure I still favor, but the bank’s leverage to corporate payments and merchant processing could be a near-term weakness if the economy slows more than expected, and I’m likewise still concerned about the bank’s deposit leverage through this next phase of the cycle. On the other hand, closing the Union Bank deal should relieve at least one sentiment overhang, and I think the shares are priced for a sub-2% core earnings growth rate that I believe the bank should be able to beat by a decent margin in the years to come.
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U.S. Bancorp: Valuation And A Vanishing Deal Overhang Should Help Address Underperformance
It’s true that adverse macro conditions don’t impact all companies equally, but for a company of American Eagle Outfitters, Inc.’s (NYSE:AEO) size, there’s not much it can do to escape an increasingly difficult macro environment. I’ve been impressed with management’s efforts in merchandising in the past, as well as their efforts to optimize inventory and supply chain and store operating costs (including optimizing the footprint). That can still help in an environment of double-digit declines in teen retail spending and a potentially oncoming recession.
It's been a while since I’ve written on American Eagle, and at the time of my last article, I didn’t like the valuation or risk-reward balance. Down about 50% since then, I’m more positive on the shares from a valuation point of view, but I do still have concerns about the macro environment - even the best house on the block is at risk if the neighborhood is on fire. Mid-single-digit revenue growth and mid-single-digit free cash flow margins can support a long-term annualized return of around 10%, but investors need to be willing to wait out a few more quarters of pressured results.
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American Eagle: Good Management In A Worsening Macro Environment
It's been quite a while since I last covered Butterfield, and since that last article the shares have more or less performed in line with the regional bank index. Low-to-mid single-digit core earnings growth should be enough to support a fair value above $40 today, but growth investors may regard this bank as too limited in its growth prospects to merit interest and more conservative value-oriented investors may be put off by the perception of elevated operating and regulatory risk, putting it in a sort-of investment twilight zone.
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Bank Of N.T. Butterfield & Son Underfollowed And Undervalued, Perhaps Capped On Growth
Investors are understandably nervous about 2023, as more and more companies are pointing to weakening trends and a more sober outlook for the next year. Heavy machinery is no exception, with investors concerned that strong backlogs will give way to weaker order trends and that a recent run of outperformance over other industrials will come to an end.
Deere & Company (NYSE:DE) has been stronger than most over the last two years, driven not only by strong demand for agricultural and construction machinery, but also self-help like growing precision ag and tech-driven ag businesses and margin improvement/efficiency efforts that have led to higher full-cycle margin projections. Valuation is not particularly cheap here, but if Deere can provide a strong beat-and-raise quarter with guidance to double-digit growth in FY’23, Deere could continue to outperform a while longer on the basis of its differentiated growth profile.
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When shares of a company like Jeld-Wen look cheap, it’s fair to ask yourself whether you’re underestimating just how tough things really or whether the market has overreacted and left the stock for dead. In many cases the answer can be “both”, and that could be the case here. I don’t feel like forward revenue growth of 3% to 4% and free cash flow margins in the 3% to 4% range are especially aggressive assumptions, but if pricing normalizes, they could well prove too aggressive and whatever undervaluation I see here could vanish quickly.
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JELD-WEN Struggling Now And Demand Could Erode Further Next Year
What comes next is the tricky bit - it's easy to climb onto the roof, but getting down can be more treacherous, and I do see some risk that expectations for 2023 are too high against a weakening macro backdrop. Likewise, management's own internal margin improvement targets may be too ambitious in the context of a less supportive end-market environment. The valuation already anticipates a lot of this, but I'd be cautious about buying in at this point in the cycle.
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Beacon Roofing Supply Making The Most Of Boom Times, But The Next Phase Could Be Tougher
This company hasn’t exactly covered itself in glory on a long-term basis. Despite rather strong margins and ROIC, the company hasn’t really been able to find growth – since 2000 revenue has grown at an annualized rate of 4%, while EBTIDA has grown about 4.6%. Adjusted free cash flow has done better (up around 7.5%), but the stock performance tells the tale – the shares have lagged the market and the industrial sector on an extended basis, with a 10-year annualized return around 6%.
That’s not an inspiring backdrop, but the company has been actively cutting costs and streamlining its portfolio, and management seems to appreciate the need to find growth opportunities and is targeting some logical areas that I think could hold some promise. I can’t say I love this company, but if it can deliver on what I think are pretty low expectations, I can definitely see upside from here.
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Brady Has An Opportunity To Be More Than It Has Been, But Execution Is Uncertain
I continue to like this bank’s blended exposure to both money center banking and Main Street banking trends, including its improving performance in trading and its strong rate sensitivity. While I do think a weaker macro background for 2023 remains a threat, I believe B of A is capable of mid-single-digit long-term core earnings growth and that such growth (as well as near-term earnings and ROTCE) support a fair value in the low-to-mid-$40’s.
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My issues with 3M still run deeper than all of this. I praised the company in my last article for finally taking some value-building steps (spinning off Health Care and attempting to ring-fence some of its legal liabilities), but the fact remains that the company has been painfully reticent to reposition itself for the future and is increasingly looking like a short-cycle cyclical focused on squeezing margin and cash flow out of legacy businesses.
Down a bit since my last update, 3M has continued to underperform the industrial group, and while there are a few worse performers out there (Stanley Black & Decker (SWK) comes to mind), there aren't many. I do see some relative value here, and the dividend is good, but I'm still quite concerned that management seems to have little vision for the future beyond "that worked in the past … so let's do that again".
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I look at Woodward’s leverage to the aviation recovery, and I think management has a fairly realistic (if not conservative) view on how build-rates will reaccelerate. I like the company’s industrial business in general, though the near-term outlook is shakier given ongoing issues in China. Trading at close to $100, I don’t see tremendous fundamental undervaluation, but I do acknowledge that this is a stock that could rerate more strongly as aviation builds accelerate and margins expand.
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Woodward Buffeted By Turbulence On Multiple Sides, But Results Should Improve
ESAB shares have lost about 10% of their value over that time, trailing Lincoln Electric (LECO) and the broader industrial space, but outperforming many other short-cycle industrials like Kennametal (KMT) and Sandvik (OTCPK:SDVKY) as investors grow increasingly nervous about a short-cycle rollover in 2023. I don’t think this is the best set-up for ESAB, as short-cycle industrial and construction markets could weaken in 2023, but I do think there is underappreciated value and potential in this business.
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Free To Set Its Own Course, ESAB Is Running Into Some Cyclical Worries
The valuation wasn’t great, but I thought Middleby was setting up as a “buy the dip” opportunity back in early March. That was absolutely the wrong call, as the shares have remained weak ever since, dropping around 17% and underperforming the market. There aren’t many good comps anymore, as most of Middleby’s competitors are part of larger conglomerates, but neither Marel (OTCPK:MRRLF) or Rational (OTCPK:RATIY) have been all that strong of late either.
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I’ll be very curious to see what management says about guidance when it reports fiscal first quarter earnings later this month. The initial guide for FY’23 back in August surprised the Street with its conservatism, and the recent earnings/guidance calls from heavy machinery companies have been relatively good. Moreover, at a time when many short-cycle businesses are starting to roll over, many heavy machinery companies are carrying good backlogs into 2023 and underlying activity/utilization is still healthy.
With the shares performing well, I don’t see as much undervaluation here. I think the shares are still priced for long-term annualized returns in the high single-digits (around 8%), but near-term upside looks capped at around the mid-$60’s without a stronger outlook. There are worse things than owning a good company at a reasonable price, but there are more options now for investors and I’m not as inclined to chase Donaldson.
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Donaldson Delivering, And Updated Guidance For FY'23 Could Be A Catalyst
Globus has declined about 5% since my last update, but that’s still better than the market’s performance and the performance of the broader medical device sector (down about 15%), not to mention other ortho competitors like NuVasive (NUVA), Stryker (SYK), and Zimmer Biomet (ZBH). Valuation is more debatable without a more sustained recovery in procedure volumes, but I still see Globus as a long-term innovation-driven winner in the ortho space.
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Globus Medical Showing Some Reacceleration And Innovation Can Continue To Drive Growth
Haemonetics is likely looking at strong plasma center demand for many more years, and I find the margin improvement plans to be credible. At the same time, management will be directing free cash flow into supporting organic growth opportunities and pursuing diversification and new growth through M&A. Haemonetics shares have been strong over the past year, but if double-digit growth over the next five years and longer-term growth in the high single-digits is attainable, the shares aren’t yet overvalued.
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Haemonetics Leveraging Strong Recovery Trends And Repositioning For The Future
