Sensata Sensing The Recovery, But Still Offers Some Upside

It’s not true for every company nor every sector, but evidence continues to mount that the recovery is underway, as short-cycle industrials like 3M (MMM) and Gates (GTES) have offered relatively positive recent updates and car volumes continue to exceed expectations. I liked Sensata Technologies (ST) back in May as a relatively rare opportunity to get into a quality sensor and control company leveraged to the auto, industrial, aerospace, and HVAC markets, and the shares have risen a respectable 24% since then – more or less matching the recovery in the wider industrial space, but underperforming auto suppliers.

With management providing a meaningful boost to third quarter expectations last week on stronger auto sales, I’m still surprised these shares trade as reasonably as they do. There are some risks from newer sensing technologies, as well as more companies turning their eye toward the sensor market, but Sensata has its own product development and market expansion efforts underway, sensor penetration continues to increase across its addressed markets, and the company is leveraged to opportunities like vehicle electrification. The shares don’t look exceptionally cheap on discounted cash flow, but relative to its margins and returns, the shares do still look more substantially undervalued.

 

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Sensata Sensing The Recovery, But Still Offers Some Upside

American Eagle Has A Key Strategic Opportunity To Reconfigure Its Physical Store Costs

When I last wrote about American Eagle Outfitters (AEO) ("AE") and warned that “it could get worse before it gets better,” I was referring mostly to margin leverage and price competition from rivals like Abercrombie & Fitch (ANF); COVID-19 was not on my radar at that point. Even so, American Eagle has managed to outperform peers/comps like Abercrombie & Fitch, Buckle (BKE), and Urban Outfitters (URBN) since that last piece, so at least on a relative basis, I guess my overall positive stance held up.

All retailers are feeling the strain from COVID-19 and the recession, but this could be one of those crises that also creates opportunity for savvy management teams, and I believe American Eagle’s is one of those. With a large portion of the store base up for lease renewal, I think management has an opportunity to push for lower structural store costs and/or cut back the store base and counterbalance some of the deleverage pressures. I still expect American Eagle to be a low single-digit long-term grower, though, as strength at Aerie is counterbalanced by weakness in the legacy AE business. The shares do look modestly undervalued here, but improved visibility on sustainably higher margins would do a lot of good for the valuation.

 

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American Eagle Has A Key Strategic Opportunity To Reconfigure Its Physical Store Costs

AerCap Executing On The Muddle Through Plan

There's still a long way to go, but there are at least some signs of improvement in the airline industry - not that has really been reflected in the share price of AerCap (AER) since my last update on this leading aircraft lessor. Travel does appear to be recovering, though still down sharply, and the pace of bankruptcies has slowed, but current activity levels are still far too low for airlines to make money, and the risk of "zombie airlines" propped by government largesse is still real.

Specific to AerCap, though, not much has changed in my view. Yes, this is a highly-leveraged business and highly-leveraged businesses are always at elevated risk when their key markets are in severe downturns. That said, unless there's a resurgence of COVID-19 infections (and travel restrictions), the likely course of lease deferrals and reduced business activity seems endurable, and I believe AerCap can regain former levels of adjusted earnings in five to seven years.

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AerCap Executing On The Muddle Through Plan

Like A Phoenix, Melrose Is Currently On Fire, But It Will Rise From The Ashes And Take Flight

This is a bad time to be in the auto and aerospace businesses, and even worse if you have a lot of debt on your balance sheet. If that weren’t enough, Melrose’s (OTC:MLSPF, MRON.LN) “Buy, Improve, Sell” philosophy means that the assets it holds at any given time are not generally operating at peak potential, as there are almost always cost and business improvement initiatives underway at the company.

Still, I’m a believer in track records, and Melrose has a good one. This is a company that has logged several wins over the years, buying businesses, improving them, and then selling them on to new owners, and I believe the current assets held by the company are by and large quite good. Melrose doesn’t really buy troubled assets - the company buys good assets that it believes are mismanaged or under-managed.

Valuing Melrose is always complicated by the model. Sure, you can model the revenue and FCF from the current collection of businesses, but the reality is that every business in the portfolio is held to be sold sooner or later, and we all know how acquisition prices can deviate from real underlying value. Still, I believe Melrose isn’t likely to be forced to sell before it wants to. The company has shown price discipline in the past, and I believe the shares are currently undervalued.

 

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Like A Phoenix, Melrose Is Currently On Fire, But It Will Rise From The Ashes And Take Flight

Oracle Needs To Start Clocking Some Real Growth

It’s been a long time since I’ve written on Oracle (ORCL), mostly because it gets kinda boring saying the same things about the same companies - there are only so many ways to say “They generate good cash flow, but they haven’t made the right strategic choices to drive meaningful growth”. Since that last write-up, where I thought the shares had some value but weren’t necessarily compelling, they have generated a total return of around 33% - better than the S&P over that time, but below the returns from the likes of Microsoft (MSFT), Salesforce.com (CRM), and SAP (SAP).

Not a lot has changed. Oracle hasn’t seen a mid-single digit quarterly billings growth rate since mid-FY’18, though an easier comp in this year’s fourth quarter should allow another one. I like the growth in Fusion and opportunities like Gen2 OCI and Autonomous DB, but to borrow a concept from hockey, Oracle strikes me as a company that’s always chasing the puck, not one that reads the action on the ice and skates to where the action will be. The shares do look modestly undervalued, and I don’t think investors will get hurt badly here (unless the entire market, or at least the tech sector, gets trashed), but I also don’t think they’ll outperform over the long term with Oracle.

 

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Oracle Needs To Start Clocking Some Real Growth

Extremities Could Become A STAR Performer For Colfax

I was basically neutral on Colfax (CFX) as an investment idea back in early January, largely on valuation concerns, and the shares have modestly underperformed the industrial sector since then (by about 2%) and underperformed the S&P 500 by about 15%, while Lincoln Electric (LECO) (a name I preferred) has modestly outperformed its industrial peers (while underperforming the S&P 500 by about 8%). COVID-19 has hit both the welding (FabTech) and MedTech businesses, but operationally both remain more or less on track.

I do believe Colfax is leveraged to a short-cycle industrial recovery, and may see the benefits a little ahead of customers as distributors restock on improving demand. I also believe the MedTech business is leveraged to a strong second-half recovery as elective reconstructive procedures resume. One potentially exciting outlier is the proposed acquisition of Stryker’s (SYK) STAR total ankle system – a deal that would add to debt (already a concern on the Street), but would give Colfax one of the best total ankles on the market and round out its extremities offerings. I still don’t love the valuation on Colfax, but the prospective returns have at least climbed to the high end of the mid-single digits.

 

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Extremities Could Become A STAR Performer For Colfax

Becton Dickinson Trying To Leverage COVID-19 Opportunities While Fixing Some Longer-Term Issues

COVID-19 has created challenges for most med-tech companies, but Becton Dickinson (BDX) ("BD") already had a lot of balls to juggle before COVID-19 disrupted hospital and physician procedure counts. While COVID-19 has itself created some opportunities in testing and the pre-filled syringe business, longer-term issues in the drug-coated balloon and drug pump businesses have caused some headaches for management.

Becton Dickinson has actually been a pretty meaningful sector underperformer since announcing the deal for Bard back in 2017, though the shares are relatively popular with the sell-side on assumptions that BD will benefit from increased COVID-19 testing volumes, an eventual vaccine, resumption of elective procedures, and an eventual resolution of its Alaris pump recall. Although I don’t value BD has highly as those on the sell-side, I do believe the shares are still somewhat undervalued today.

 

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Becton Dickinson Trying To Leverage COVID-19 Opportunities While Fixing Some Longer-Term Issues

Meggitt Looks Undervalued, But Fleet Retirements Will Pressure Margins

Unlike most industrials, which got hammered early in the COVID-19 pandemic and have since largely recovered, the aerospace sector hasn't enjoyed the same sort of recovery, as investors remain worried about the uncertainties of a multiyear recovery path for air traffic and aircraft demand. Even relative to the beaten-down aerospace sector, Meggitt PLC (OTCPK:MEGGY) (MGGT.LN) has been hit hard, as investors fret over the company's reliance on programs like the 737 MAX as well as high-margin aftermarket sales for older aircraft.

I don't want to underplay the challenges that Meggitt is facing. It may well take four years or more to return to pre-COVID-19 product levels, and margins may not return to 2019 levels for five years or more, as the company absorbs lower-margin original equipment sales and loses more lucrative aftermarket business. Still, even with those negatives in place, I believe the shares undervalue the long-term value of the business, and this looks like a name for more patient investors to consider.

 

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Meggitt Looks Undervalued, But Fleet Retirements Will Pressure Margins

New Data Support The Idea That Neurocrine Biosciences Is Building A Credible Parkinson's Portfolio

I had previously expressed my concern that Neurocrine (NBIX) shares could remain weak given a lack of thesis-changing data catalysts on the horizon, and the shares have fallen another 17% since my last update. I see nothing wrong with the business, but the quality of the Ingrezza business is a known factor now and most of the company’s more exciting pipeline developments are still some distance away.

To that end, the recent presentations at the MDS Virtual Congress on the company’s NBIb-1817 Parkinson’s gene therapy program (licensed/partnered from Voyager (VYGR) and Ongentys (opicapone) are “nice to have” updates. I do believe that the lack of more robust positive data on the gene therapy program is a modest negative, though I also believe that the revenue potential of Ongentys remains somewhat underappreciated by investors.

I do continue to believe that Neurocrine is undervalued, but I also an ongoing risk that investors will ignore the name in favor of companies with more exciting near-term data updates.

 

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New Data Support The Idea That Neurocrine Biosciences Is Building A Credible Parkinson's Portfolio

Rexnord's Modest Relative Underperformance Looking More And More Like An Opportunity

Second quarter earnings were better than expected across the industrial space, but the reality remains that business conditions remain challenging. August industrial production was up from July and better than expected, but still down 0.4% year over year and signs of the hoped-for V-shaped recoveries are still intermittent at best. Likewise, non-residential construction isn’t looking particularly strong in 2021, as there’s a general reluctance to commit to new investments given the high economic uncertainty.

None of that is particularly good for Rexnord (RXN), and the shares have lagged the industrial sector since my last update on the company in May. I thought the shares were a borderline buy/hold call then, but relative valuation is starting to get more interesting and I like the company’s willingness to return to M&A to grow the business. I’ve thought before that Rexnord gets overlooked a bit by investors, particularly in light of good margin improvement in recent years and solid growth prospects, and this is an increasingly interesting name to me in the industrial space.

 

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Rexnord's Modest Relative Underperformance Looking More And More Like An Opportunity

The Truck Cycle Has Likely Bottomed, And Negotiations With Traton Could Be Fruitful For Navistar

Navistar's (NAV) story over the last two decades has been a difficult one, with the company losing significant share in its core medium-duty and heavy-duty truck markets and suffering repeated hits to its reputation from product quality issues (including, but not exclusively, the well-known EGR fiasco). Adjusted annual revenue growth over the past 10-15 years has been slightly negative, with very little in the way of meaningful free cash flow generation, and the shares have done almost nothing over that time.

The five-year returns haven't been so bad, though, and now-former CEO Tony Clarke has done some good things with the company. Even so, I believe Traton's improved offer for the company is a good starting point, and I am encouraged by the board's willingness to pursue negotiations. While a fully turned-around Navistar would indeed be worth more than Traton's offer, perhaps substantially more, I believe shareholders have to weigh the upside potential against the risk of the company coming up well short of the performance metrics that would drive that upside.

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The Truck Cycle Has Likely Bottomed, And Negotiations With Traton Could Be Fruitful For Navistar

An HD Supply Refocused On Facilities MRO, And More Reasonably Valued, Is A More Interesting Story

HD Supply (HDS) is, I believe, another example of how sooner or later valuation always matters. While this is a well-run industrial distributor with a lot of positive attributes, the valuation has historically been quite generous, as the Street was all-in on the “growth by M&A/consolidation” story, as well as improved margin leverage through scale. While the company has done pretty well operationally, the shares have sported only a mid-single-digit return (annualized) over the last five years due to what I believe was an inflated starting point.

There’s still a lot to like about this business. I previously worried that the company was too much of an M&A-driven “magpie”, assembling a collection of businesses that didn’t really make much sense together, but the company has since streamlined down to just its quality, relatively less-cyclical, facilities management maintenance, repair, and overhaul (or MRO) business. I do see opportunities for more consolidation-through-M&A, as well as opportunities to leverage advantages of scale to gain share and margin leverage over time. Valuation is now more reasonable, with the shares priced for a high single-digit to low double-digit return, albeit with a noticeable divergence between my cash flow-based fair value and my multiples-based fair value.

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An HD Supply Refocused On Facilities MRO, And More Reasonably Valued, Is A More Interesting Story

The Osram Deal Continues To Weigh Very Heavily On Ams AG

It’s not uncommon for the market to assign negative value to a deal and punish the acquiring company accordingly, but the degree of punishment being meted out to ams AG (OTCPK:AMSSY) over its acquisition of Osram (OSAGY) is on a level all its own.

Given its margins and near-term growth prospects from its 3D sensing business, ams would quite possibly trade at four times forward revenue on a standalone basis. Even if you factor in a steep discount for the company’s reliance on Apple (AAPL) (close to half of revenue), the fact is that the stock currently trades at an EV/revenue of less than 2x pro-forma 2021 revenue estimates.

There are a lot of things to dislike about the Osram deal, but with ams’s core sensing business performing well and still leveraged to opportunities like behind-OLED sensing (or BOLED), the discount seems extreme. Management at ams has given investors and analysts plenty to dislike, and plenty of reasons to avoid the stock, but expectations seem incredibly low now.

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The Osram Deal Continues To Weigh Very Heavily On Ams AG

The Street Hasn't Fully Embraced Alps Alpine's Recovery Story

COVID-19 has made life difficult for almost everyone, and Japanese electronic component manufacturer Alps Alpine (OTCPK:APELY) (6670.T) is certainly no exception. While the company had been enjoying some solid momentum in its smartphone camera actuator business, COVID-19’s impact on the auto industry has hammered the company, leading to a poor performance since my last update. Unlike many companies that have seen a hit from COVID-19, though, Alps Alpine shares haven’t recovered to the same extent.

There are certainly long-term risks to consider here. While Alps Alpine enjoys very strong share in optical image stabilizers (or OIS), it’s a highly competitive market. Likewise, management has the unenviable task of simultaneously reducing costs in its auto business while also repositioning that business toward advanced sensing, connectivity, and human-machine interface. Still, I believe the valuation is low relative to even modest expectations, and with smartphone and auto volumes picking up for the remainder of the year, these shares could do better.

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The Street Hasn't Fully Embraced Alps Alpine's Recovery Story

Continental AG Struggling Mightily, And The Market Isn't Pricing In Much Improvement

I've often said that investors should be slow to sell the stocks of good companies only because they look expensive. So does it follow that investors should avoid the stocks of lesser companies even if they look pretty cheap? That's my dilemma with Continental AG (OTCPK:CTTAY) (CONG.XE), as this global giant in auto parts has struggled mightily over the last few years and looks relatively ill-prepared to leverage the transition toward electrified powertrains.

On the positive side, Continental has much better leverage to advanced driver safety (including automation), as well as car connectivity and infotainment, not to mention a profitable tires business that generates attractive margins and cash flow. Low-to-mid single-digit revenue growth and low-to-mid single-digit FCF margin can support a high-single-digit return from here, and the shares likewise look undervalued on the basis of near-term margin recovery potential. Although I have some serious questions and concerns about this business, the valuation already reflects a lot of those issues and I have to wonder if the risk/reward balance skews more toward "reward" today.

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Continental AG Struggling Mightily, And The Market Isn't Pricing In Much Improvement

The Street Is Back On Board With Aptiv's Above-Average Growth Potential

Such was the fear and panic earlier this year that investors bailed out of even the strongest long-term electrification stories, including Aptiv (APTV). In relatively short order, though, investors have flipped from, “Hey, why don’t you let me out here?” to a Blues Brothers-style “Hit it!,” with the Street once again firmly on board with the well above-average growth potential offered by Aptiv’s portfolios in vehicle electrification, safety, connectivity, and infotainment.

I liked Aptiv back in May, and the shares have done well since then – though not quite as well as BorgWarner (NYSE:BWA) or Valeo (OTCPK:VLEEY). At this point, unlike with BorgWarner or Valeo, it’s tough to argue that the Street is still overlooking some upside. I like the M&A optionality created by the capital raise in the summer, and I do like the company’s leverage to some of the most attractive growth areas in autos (and industrials), but even with my own expectations already above the sell-side, it’s tough to make the numbers work now.

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The Street Is Back On Board With Aptiv's Above-Average Growth Potential

American Axle Outperforms On Costs, But Long-Term Revenue Leverage Is Still Debatable

It’s likely true that internal combustion engines will be with us for a quite a while, and particularly with respect to pick-ups, but I still believe exposure to electrification is important and American Axle & Manufacturing’s (AXL) (“American Axle”) relatively weak positioning here, not to mention its high leverage and dependence on the U.S. market, have been negatives in my view of the stock’s potential.

The shares are down about 20% since my last update, underperforming names I’ve preferred like BorgWarner (BWA), Dana (DAN), and Valeo (OTCPK:VLEEY). While I do believe the liquidity concerns that hammered the shares down into the $2s are largely over and done with, the company’s leverage to light trucks remains a mixed blessing in my book, and I remain concerned that the company doesn’t really have the wherewithal to be a big player in areas of the market that offer more growth. That said, while I don’t really like the company’s strategic positioning, the shares could still have upside into the low teens if U.S. SAAR numbers continue to beat expectations as the auto recovery unfolds.

 

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American Axle Outperforms On Costs, But Long-Term Revenue Leverage Is Still Debatable

Weir's Strong Mining Business Holding Up Well, But Exiting Oil & Gas Could Take Time

This is a bad time to have exposure to oil and gas capex, and fracking machinery in particular, as the vast majority of the North American fleet is idle and there’s really no demand for either new equipment or aftermarket parts. It’s not such a terrible time to be in the mining equipment business, though, and Weir Group’s (OTCPK:WEGRY) (WEIR.LN) strong aftermarket-driven business has held up quite well during this downturn.

Although I was already expecting a weaker outlook for oil/gas when I last wrote about the company, I wasn’t expecting what COVID-19 would ultimately do to the company’s core markets, and the shares have underperformed, including underperforming other mining names like Epiroc (OTCPK:EPOKY). Although I expect healthier demand for mining equipment in 2021, and I think the negative impact of oil/gas is probably more than amply reflected in the share price, it’s going to be an issue for sentiment until management sells the business. I do still see fairly attractive long-term upside here, but in the near-term outperforming the likes of Epiroc and Metso could be difficult so long as oil/gas remains so weak.

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Weir's Strong Mining Business Holding Up Well, But Exiting Oil & Gas Could Take Time

Rexel Shares Can Power Up Even Further On Green Retrofits And Automation-Driven Demand

Time will tell what actually happens in the real world, but the plans under consideration for significant commercial building renovations in North America and Europe, as well as reshoring and automation adoption, add potential growth drivers to a story at Rexel (OTCPK:RXEEY) (RXL.PA) that I’d already thought was under-appreciated by market. Add in potential efficiency gains from digitalization and share gains in North America, and there’s still a good bull story to tell here.

Rexel shares have done well since my last update, with the ADRs up about 75% and the local shares up closer to 35%. I still see appreciation potential in the low double-digits on a long-term annualized total return basis, and although Rexel has certainly recovered from the worst of the COVID-19 panic, I don’t believe the shares yet reflect the true potential of the business.

 

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Rexel Shares Can Power Up Even Further On Green Retrofits And Automation-Driven Demand

Grupo Bimbo May Be Coming Out Of Hibernation, As Improving Market Share Can Drive Better Margins And Stock Multiples

Grupo Bimbo’s (OTCPK:BMBOY) (BIMBOA.MX) mascot Osito may finally be coming out of hibernation, at least in the U.S., as recent market trends indicate that the company has regained some pretty meaningful share in the last couple of quarters. Whether that lasts, though, and allows the company to drive long-awaited margin leverage in North America is still a big question, and there’s still a lot of work for management to do to improve its Latin American business outside of Mexico, to say nothing of driving enough share growth and volume in other geographies to justify the investments made there.

These shares haven’t done much since my last write-up, which is basically what I expected, and they have lagged the likes of Gruma (OTC:GMKKY), Flowers (FLO), and Mondelez (MDLZ) over that time. I still have pretty mixed feelings about the company. Although the ROIC has been pretty reliably in the double-digits, the company’s growth by M&A strategy has produced mixed results at best, and progress on various self-improvement initiatives has been slow. If management can get FCF margins back into the mid-single-digits on a reliable basis, I think there’s value here, but that’s still a work in progress.

 

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Grupo Bimbo May Be Coming Out Of Hibernation, As Improving Market Share Can Drive Better Margins And Stock Multiples