Investors Seem Refocused On Eagle Bancorp's Operations

Eagle Bancorp (NASDAQ:EGBN) was smacked hard in July on news of an investigation tied to potential related party transactions involving former CEO Ron Paul, but it seems like the market has calmed down about that issue and instead refocused on what is a pretty high-quality Washington, D.C. area growth story underpinned by healthy loan growth. Although spread compression remains an ongoing risk, the shares are up about 15% from my last article and have recovered about a third of the investigation-driven decline.

I believe Eagle shares are still undervalued, and I'm more comfortable about the possible risk from the investigation, as management has pointed to comprehensive insurance coverage for just such events. While I don't want to underplay the risk of weaker loan demand, tighter spreads, and a deteriorating credit cycle, those are more industry risks than company-specific risks, and I believe Eagle is still looking at a healthy long-term core earnings growth despite a likely low point in 2020.

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Investors Seem Refocused On Eagle Bancorp's Operations

Commerce Bancshares Richly Rewarded For Its Quality And Stability

I’ve made the point many times before that valuation doesn’t drive stocks as much as many investors seem to think – stocks don’t go up just because they’re cheap, and likewise don’t go down just because they’re expensive. I didn’t expect the nearly 15% move in Commerce Bancshares (CBSH) since my last update, but then I also didn’t expect the relatively aggressive decision to launch an accelerated share repurchase program, and in this environment, investors really love those upfront capital returns.

My core view on this bank really hasn’t changed, though. It’s an exceptionally well-run bank and an uncommonly conservatively-run bank. Although Commerce won’t suffer as much spread compression as its low-cost deposit base would otherwise suggest, I’m not going to pay more than 18 times next year’s earnings for a bank likely to grow its pre-provision profits at a very low single-digit rate for the next five years.

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Commerce Bancshares Richly Rewarded For Its Quality And Stability

Accuray Drifting, And Critical Mass Seems Far Away

Another quarter is in the books and not a lot has changed for Accuray (ARAY). This remains a perpetually frustrating story as the company has meaningfully improved the functionality of its systems, but those improvements haven’t shown up in orders, revenue, market share, or profits. While new data, reimbursement, and product enhancements could give a spark to CyberKnife, and China remains an attractive opportunity in concept, it’s going to take still more time for those to develop into real drivers.

Pre-market indications are that Accuray is going to sell off on fiscal first quarter results, but I didn’t find them all that bad. Still, I don’t see that near-term spark to shift sentiment or drive investors to take another look at the shares, so while I think Accuray probably deserves to trade closer to the mid-single-digits, the company is still a long way from critical mass in orders or revenue and catalysts are slow to emerge.

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Accuray Drifting, And Critical Mass Seems Far Away

The Market Seems Focused On Cognex's Long-Term Potential Over Short-Term Troubles

Institutional investors aren’t famous for their patience, and growth investors are typically even more unforgiving when their growth darlings come in a few ticks below expectations. And yet Cognex (CGNX), which posted over 20% year-over-year revenue contraction and once again guided down, is getting off relatively light, or at least in the immediate post-earnings period. 

Don’t get me wrong – I like Cognex and I think it’s one of the best plays on logistics automation and the “factory of the future” theme. I’m just surprised that the Street is still comfortable paying over 30x 2021 EBITDA during this cyclical downturn. I think the long-term potential return here is still okay, but I’d love a more pronounced “buy the dip” opportunity again.

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The Market Seems Focused On Cognex's Long-Term Potential Over Short-Term Troubles

FEMSA's Sluggish Margins Give Some Fodder To Bears, But The Business Is Fine

Relative to a slowing Mexican economy, particularly in the consumer sector, FEMSA’s (FMX) third quarter results were pretty good, but Wall Street doesn’t care so much and bears will no doubt fret about the still-weak same-store trends in Health, the sluggish margins at OXXO, and management’s willingness to deploy capital into non-traditional business ventures. I’m tempted to say “let them fret,” as I believe FEMSA management has proved itself many times over, but as a shareholder, of course, I’d like to see the shares trading closer to my assessment of fair value. While I do see some near-term challenges in OXXO’s margins and maybe some longer-term uncertainty in what management may do with the Coca-Cola FEMSA (KOF) stake, I still like the direction of this business and I think the ADRs should trade over $100 despite some near-term weakness in the Mexican consumer space.

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FEMSA's Sluggish Margins Give Some Fodder To Bears, But The Business Is Fine

Steel Dynamics Holding Up Through Tough Demand Conditions

I wasn’t bullish on the prospects for the U.S. steel sector when I last wrote about Steel Dynamics (STLD) and Nucor (NUE), and the additional destocking and steel price weakness that I expected back then has in fact taken place. While both Steel Dynamics and Nucor saw nasty declines into late August, the share prices have since recovered, reducing the incremental declines in the share prices to the low single digits.

As the market gets more realistic about the real health of the steel market (and the U.S. industrial economy), I get a little more bullish on Steel Dynamics, as this earning cycle has seen another $165 million come out of the average sell-side 2019 EBITDA estimate and about $225M come out of the 2020 number (after roughly $100M adjustments back during second quarter earnings). I’m still concerned about the health of the U.S. economy, the prospects for an end to the U.S.-China trade dispute, and potential competitive capacity additions, but were Steel Dynamics to take another trip toward the mid-$20’s, I’d have to consider picking the shares as a cyclical trade idea.

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Steel Dynamics Holding Up Through Tough Demand Conditions

ON Semiconductor's Performance Isn't Pretty, But Better Days Are Ahead

I had a mixed view on ON Semiconductor (ON) back in May, as I thought the shares had some appeal on drops below $20, but that there was also still a lot of risk in the outlook as I felt sell-side analysts were too bullish about a second half recovery. That’s all largely come to pass, as ON has continued to struggle with weaker demand in autos and industrials and high inventories, and sell-side expectations have headed down through the year.

Buying below $20 has worked and I continue to believe it will in the near term. I think the market overdid it with the post-earnings jump, as ON’s guidance wasn’t that good, but I guess Texas Instruments (TXN) reset the bar such that any good news was welcomed. While I still believe there are some potholes on the road directly ahead, I like ON’s long-term leverage to EVs, server/cloud power, factory automation/IoT, and renewable energy. Investors can also consider names like Infineon (OTCQX:IFNNY) and STMicro (STM) for those same reasons, but I believe a fair value in the low-to-mid $20’s is sufficient to warrant consideration.

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ON Semiconductor's Performance Isn't Pretty, But Better Days Are Ahead

What Drove Comerica Up Is Now Weighing It Down

It's hard enough for banks to position themselves optimally for one part of the rate cycle; getting both sides right is vanishingly rare, and so it is with Comerica (CMA). It's easy to find fault now with this bank's failure to position its balance sheet for an eventual switch from tightening to easing, but few were calling for that when Comerica's asset-sensitive balance sheet was driving double-digit core PPOP growth. What's more, a lot of the things the bank did right in recent years, including capital optimization and its successful GEAR UP expense-reduction program, have more or less robbed the bank of levers to use now to offset spread compression on this still highly rate-sensitive balance sheet.

Comerica's valuation seems to be pricing in mid-single-digit short-term earnings erosion and low single-digit long-term core earnings erosion, and I think that's harsh. Likewise, the shares trade below 9x my forward EPS estimate, which is a double-digit discount to its peer group. I can see how that would appeal to value-driven investors, but I'd also note that Wall Street demands growth and Comerica could well be looking at no PPOP growth until early in 2021, leaving the shares in "value trap" limbo.

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What Drove Comerica Up Is Now Weighing It Down

Umpqua Punished For Short-Term Challenges, But The Long-Term Opportunity Remains Attractive

Although Umpqua (UMPQ) remains one of my favorite mid-cap banks, there's no question that the company's performance since my last write-up has been poor, with the shares down about 11% and trailing its regional peer group by about 15% to 20%. That's definitely not the performance you should expect from a good bank, but I see a disconnect here - even though Umpqua has been hit hard on much weaker than expected spread margins, the pre-provision operating performance hasn't been that bad.

I've reduced my near-term earnings expectations fairly substantially as the year has gone on, but I still believe Umpqua can generate high single-digit long-term core earnings growth, and I think Umpqua will be a longer-term winner in a sector where regional and community banks are going to come under increasing pressure from larger super-regional banks that can leverage a larger base of business to compete more aggressively on price and invest huge sums in IT. I guess the current sentiment makes this a contrarian call, but with a 5% yield and what looks like an unfairly low valuation, this is a name I'm considering adding now.

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Umpqua Punished For Short-Term Challenges, But The Long-Term Opportunity Remains Attractive

Further Restructuring At Alcoa Is Welcome, But Macro Pressures Are Still In Play

All you might really need to know about how things have been going at Alcoa (AA) is that sell-side expectations for 2019 EBITDA were around $2.4 billion in January and the average estimate is now around $1.6 billion. With demand hurt by weak global auto production and slowing economies around the world, and exacerbated by the U.S.-China trade tensions, alumina and aluminum prices have disappointed relative to initial expectations, and Alcoa hasn’t been able to do nearly enough on the cost side to offset that pressure.

I feel a little bad about being hard on Alcoa, given that I think management’s recently-announced portfolio review and restructuring plans are a sound move. The problem is that this is still an overleveraged commodity company that is too far up the price curve and too much at risk to Chinese production volumes. The shares do look too cheap to me at around 4x-5x 2020 EBITDA (including pension liabilities), but too much is riding on a successful restructuring for my comfort.

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Further Restructuring At Alcoa Is Welcome, But Macro Pressures Are Still In Play

Fanuc Logs Another Weak Quarter, But The Worst May Be Over

As is the case at Yaskawa (OTCPK:YASKY), it looks like investors are pretty willing to overlook another weak quarter from Fanuc (OTCPK:FANUY), and another reduction in guidance, on the idea that the bottom has been reached and business will improve from here. While I agree with that basic philosophy, I’m still concerned about the extent to which a recovery has already been priced into the shares, as the valuation would already seem to anticipate mid-teens FCF growth on a long-term basis with a single-digit discount rate.

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Fanuc Logs Another Weak Quarter, But The Worst May Be Over

Nidec's Motor Story Looking Better And Better

I don't know that I'll ever bring myself to the point of saying "valuation doesn't matter", but companies and stocks like Nidec (OTCPK:NJDCY) (6594.TO) do sometimes push me in that direction. It's tough to see how Nidec is undervalued relative to reasonable expectations, but I believe investors need to at least consider the possibility that Nidec will generate "unreasonable" revenue and profit growth in the coming years on the back of a very strong technology portfolio in electric motors.

In the here and now, Nidec is struggling to meet sell-side earnings expectations, as stronger than expected order inflow and customer interest, particularly in auto traction motors and e-axles, lead the company to accelerate its product development and ramp up spending. I believe this will be money well spent, but Nidec's valuation wouldn't lead you to think it's exactly an undiscovered story, even if it's not a household name among U.S. investors.

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Nidec's Motor Story Looking Better And Better

Investors Should Ask If THK's Relatively Attractive Valuation Is Too Good To Be True

Veteran investors know better than to just accept every cheap-looking stock as a gift, some of them are more like a sketchy van with “Free Candy” scrawled on the side. That brings me to THK (OTCPK:THKLY), an automation supplier that has certainly recovered, but not to the same valuation extent as others like Fanuc (OTCPK:FANUY) and Yaskawa (OTCPK:YASKY) and may actually be trading at a relatively attractive valuation.

There are definitely some “buts” with THK to consider. First, just as is true for Fanuc and Yaskawa, calls for a cyclical bottom in the September quarter may be too optimistic. Second, THK has seen rivals like Hiwin gain ground by competing on price. Third, THK has a comparatively unattractive segment (the auto parts business) that lacks near-term drivers beyond underlying market recovery. Still, with semiconductor equipment demand set to improve and machine tools quite possibly bottoming, this could be a time to reconsider this name.

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Investors Should Ask If THK's Relatively Attractive Valuation Is Too Good To Be True

The Market Shrugs Off Another Weak Quarter From Yaskawa Electric

It’s certainly true that the stock market is a discounting mechanism that looks beyond current results in assessing a company’s value. But it’s also true that investors can get ahead of themselves, and particularly so with companies they like, and I think that’s the case at Yaskawa Electric (OTCPK:YASKY) now. Investors ignored another weak quarter from this leading automation player, content to assume that the bottom is in sight and results will soon start to improve from here.

I have no problem with the overall assumption that Yaskawa is bottoming out. My problem is that the market is assuming a growth rate from here that’s just too high (or using a discount rate that’s just too low), and I struggle to reconcile the likely path of Yaskawa’s earnings and cash flows with today’s valuation. I don’t like taking a negative stance on companies I like, and particularly when I do think they’re near a cyclical low, but I’m struggling to connect the valuation dots on a company already trading at over 18x FY21 EBITDA and nearly 14x FY22 EBITDA.

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The Market Shrugs Off Another Weak Quarter From Yaskawa Electric

Fire-Related Outages Sap Momentum At Universal Stainless & Alloy Products

Trying to play the up-cycle in aerospace through the specialty alloy companies has been tricky, and in the case of Universal Stainless & Alloy Products (USAP) that’s been complicated further by a fire-related production outage that made a noticeable impact on third quarter production and financial results. On top of that, the company continues to be challenged by surcharge mismatches and challenging end-market conditions in multiple key markets.

USAP shares have clearly been weak since my last update, with at least some of that weakness tied to nervousness about whether the 737 MAX delays would lead to inventory and order adjustments among aerospace customers. USAP is a tiny, almost uncovered, company and it operates in a challenging near-commodity industry, and end-market turbulence is no help. I do think that the shares trade at much too wide of a discount now, but given past challenges in out-earning its cost of capital, investors shouldn’t fool themselves into thinking this is a valuation layup.

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Fire-Related Outages Sap Momentum At Universal Stainless & Alloy Products

Carpenter Posts A Mixed Quarter, But Business Is Ramping

Driven in large part by aerospace demand and improved volume at its Athens facility, the shares of Carpenter Technology (CRS) are up about 20% since my last update on the company. That makes Carpenter a relative standout versus peers like Allegheny Technologies (ATI), Haynes (HAYN), Kaiser (KALU), and Universal Stainless (USAP), but that was a while in coming as shareholders had their patience tested by a slower than expected ramp.

I do see some risks to Carpenter, primarily from its energy and industrial markets, but on balance I like the prospects for an ongoing run of record margins in the Specialty Alloy Operations (or SAO) segment. With fair value in the low to mid $50's, I still see an argument for owning the shares, though it likely won't be a smooth upward move given concerns in the market about aerospace production schedules, the health of the oil/gas market, and so on.

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Carpenter Posts A Mixed Quarter, But Business Is Ramping

PTC Jumps On Signs That Stability And Predictability Are Coming Back

PTC (PTC) has had a rough year, with the shares down about 18% on a year-to-date basis in what has been a pretty good year for software in general and comps/peers like Ansys (ANSS) and Dassault (OTCPK:DASTY). While I thought PTC’s valuation looked somewhat demanding going into a tricky macro environment for 2019, the company’s last three quarters have been quite choppy, with a series of bookings misses and worries about the company’s ability to translate “great interest” among customers in IoT and augmented reality (or AR) into actual bookings and revenue.

PTC’s fiscal fourth quarter wasn’t flawless, and the macro environment is still challenging, but it would seem that the business has stabilized relative to management’s expectations and sell-side forecasts. While I do still see some risk in 2020 from a weaker macro spending environment, I believe PTC can grow revenue at a roughly 10% annual rate and generate significant margin expansion, supporting a higher fair value and an attractive prospective return from here.

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PTC Jumps On Signs That Stability And Predictability Are Coming Back

STMicro Building Credibility Ahead Of A Major Ramp

I wouldn’t call STMicroelectronics' (STM) third quarter “perfect”, but it was good and not nearly as disappointing as Texas Instruments’ (TXN) update. More important, I think, is that this quarter helps build management credibility (as they guided to a stronger second half 2019 early this year), as the company continues to execute even against a worse-than-expected backdrop. With the company looking at some major product introductions/ramps over the next couple of years, including SiC MOSFETs, IGBTs, MCUs, and 3D sensors, I believe this good execution in a tough environment is quite encouraging.

I recommended picking up STM shares below $17.50, and investors got a couple of chances to do that after my last article ahead of a nearly 30% jump in the share price. The shares no longer trade below my DCF-based fair value, but buying below DCF value is usually only an option when the market has really soured on a chip company. I do still see upside from here, though, and I think it may be possible to establish a position and look to add if/when the tech sector gives you a periodic pullback.

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STMicro Building Credibility Ahead Of A Major Ramp

MSC Industrial Executes Decently Against Lowered Expectations

MSC Industrial's (MSM) management to close out its fiscal 2019 on a relatively okay note, with the company beating expectations at the core operating income line despite mounting end-market headwinds. MSC Industrial isn't doing as well on gross margin as Fastenal (FAST), and I'll talk about this later, but management is at least explicitly targeting margin improvement efforts in fiscal 2020 at both the gross margin and operating margin lines.

It's tough for an industrial distributor to make great strides during an industrial downturn, but the good ones often pick up market share during these times. I haven't been impressed with MSC Industrial's management in recent years, and this downturn would be a good time for it to pick it up and improve execution. Here in the mid-$70s, valuation is more challenging and the management really needs to execute on sustained margin improvement to justify a substantially higher price on a DCF basis, though an EV/EBITDA approach is substantially more forgiving.

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MSC Industrial Executes Decently Against Lowered Expectations

Choppy Near-Term Trends And LNG Order Uncertainty Hitting Chart Industries

With so much of Chart Industries' (GTLS) upside tied to unbooked orders for LNG capital equipment, I can understand why worries about pushed-out timelines for large LNG export facilities would be hitting the shares. On top of that, the outlook for midstream capex in 2020 isn't very good and the slowdown hitting many industrial end-markets is likely to lead to lower industrial gas orders. As LNG prices have recently hit multiyear lows, I suppose it's not so surprising that Chart shares are near a 52-week low and the shares are down more than 20% from the time of my last update.

While understandable, I'm not so sure this downturn is entirely reasonable. True, the LNG outlook has risk to it; orders could get delayed or disappear altogether under certain circumstances. But at this point, I think a lot of the LNG opportunity has been derisked; I can't say that Chart is trading just on the value of its industrial gas business, but it's pretty close - if the E&C business would grow only 2% from 2019 levels (with mid-single-digit growth from the D&S businesses), the shares would be around fair value in my model.

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Choppy Near-Term Trends And LNG Order Uncertainty Hitting Chart Industries