Thursday, February 16, 2017

Neurocrine Biosciences Building Toward Bigger Things

Quarterly reports aren't often major events for pre-commercial biotechs, though management often uses these opportunities to give updates on clinical programs. There wasn't much from Neurocrine Biosciences' (NASDAQ:NBIX) fourth-quarter report and conference call that moves the needle on valuation, but management did at least lay out some more details about its clinical programs and timelines, as well as information about the expected launch of Ingrezza later this year for tardive dyskinesia.

The biggest change in my view of Neurocrine from my last, fairly recent, update is the addition of BIAL's opicapone to the pipeline. This asset adds about a dollar to my fair value and appears to me to be the sort of lower-risk "quarters among the couch cushions" type of deal that I wish more companies would do. I continue to believe that Neurocrine's shares are undervalued and that investors can look forward to multiple events in 2017 that will lend greater clarity to the real value of the company's clinical assets.

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Neurocrine Biosciences Building Toward Bigger Things

Cielo Leveraged To A Recovering Brazil, But There Are A Lot Of Moving Parts

On the surface, Cielo (OTCQX:CIOXY) would look like a good play on Brazil's eventual economic recovery. While the merchant acquiring space in Brazil is getting more competitive, Cielo's relationships with Banco do Brasil (OTCPK:BDORY) and Bradseco (NYSE:BBD) supports strong market share and Brazil's relatively low card penetration rate suggests above-average growth potential in the years to come. Go below the surface, though, and there are a lot of competitive risks to consider, as well as potential changes to the regulatory environment that would meaningfully alter the company's business mix.

I like Cielo, and I think it's one of the better-known, higher-quality plays on Brazil. I would be careful about getting a good margin of safety going in, though, and I'm not convinced that's on offer today. While my double-digit required rate of return may be too steep and my expectation of high single-digit FCF growth may be too conservative, I think Cielo is close to fair value and the added competitive and regulatory risk factors push me a little more toward the sidelines.

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Cielo Leveraged To A Recovering Brazil, But There Are A Lot Of Moving Parts

Inconsistency And Credibility Bedevil Novadaq Technologies

Revisiting bad calls is never fun, but such is life. Novadaq (NASDAQ:NVDQ) has been quite a disappointment, with the shares down about 30% since my last write-up, and down significantly relative to the medical device space as a group over the past year (the iShares Medical Devices Index is up 32% versus Novadaq's 28% dive). While investors have worried about the potential competitive threat of larger companies like Stryker (NYSE:SYK) in the imaging space and the risk that capital spending will shrink in 2017 due to uncertainties regarding the U.S. insurance/reimbursement landscape, Novadaq has muddied the waters with yet another strategic shift and relatively poor communication with the Street.

I won't argue that Novadaq's recent switch to a more flexible sales model with less upfront capital commitment is a bad move, but it seems like the company switches strategy almost every year, and it continues to be less than fully transparent with the moving parts of its business (sales of particular line items like SPY/PINPOINT, LUNA, DermACELL, etc.). Given the recent guidance for a significantly worse fourth quarter and 2017, Novadaq is firmly back into a "show me" valuation situation.

While I think the underlying technology does work, can/will be adopted to a significant degree, and can support a $1 billion/year business, Novadaq needs to log multiple quarters of clear progress to build confidence in the story. I do think the shares are undervalued today, but I've followed stories like this before in the med-tech space and it can take a while for the business plan to get sorted out.

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Inconsistency And Credibility Bedevil Novadaq Technologies

At This Valuation, Fox Factory Has To See Its Expansion Opportunities Pay Off

Near a 52-week high and up almost 90% over the last year, Fox Factory (NASDAQ:FOXF) has done well for investors. There's certainly a lot to like in the company's progress with gross margins over the last few years, and winning business from Ford (NYSE:F) and Toyota (NYSE:TM) for new off-road trucks is certainly good for the growth story in the powered vehicle business.

The "but" is that at this sort of valuation, the company pretty much has to see all of its major drivers go right. This isn't a quality call; I think Fox Factory is a good company with a strong outlook. My problem is that it looks as though it takes a long-term compound FCF growth rate in the high teens to drive a fair value above $30 today, and that seems like a high hurdle to meet (let alone surpass).

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At This Valuation, Fox Factory Has To See Its Expansion Opportunities Pay Off

FLY Leasing Has Little To Show For Meaningful Improvement

Although FLY Leasing (NYSE:FLY) has transformed in a meaningful way since 2015, you really wouldn't know it from the share price performance. The stock is down about 10% since my last write-up on the company, and even though the intervening period hasn't been very good for any of the publicly-traded aircraft lessors (companies like AerCap (NYSE:AER), Air Lease (NYSE:AL), and Aircastle (NYSE:AYR)), FLY has been the weakest performer of this bunch.

I believe some of the underperformance can be explained by the company's weaker lease rate factor, its lower adjusted pretax margin, and its lower adjusted ROE. It's possible that the market also sees FLY Leasing as more vulnerable to a tighter credit market and an aircraft market where sale-leaseback transactions are less profitable due to an influx of capital into the market. Still, FLY has been doing better of late, and while the entire sector has been strong over the past year, FLY's lagging performance doesn't seem entirely fair. While FLY Leasing's lack of a dividend will be a negative to some investors, reallocating the capital to buybacks makes sense in this case, and I believe these shares are undervalued below $16 to $18 a share.

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FLY Leasing Has Little To Show For Meaningful Improvement

After A Successful Turnaround, What Propels Lundbeck Further?

Danish pharmaceutical company Lundbeck (OTCPK:HLUYY)(LUN.CO) has done what a lot of sell-side analysts thought they couldn't do - pair new product launches with an operational restructuring and drive a turnaround in the business. With that, the shares have more than doubled over the last three years and have outperformed a large number of the company's European peers (Ipsen (OTCPK:IPSEY) and Actelion (OTCPK:ALIOY) being notable exceptions).

Now the question turns to "what next?" and that is where the story gets a little less rosy. I do believe that there is still upside to the company's core growth portfolio (drugs like Abilify Maintena, Northera, Trintellix, and Rexulti), but most of these drugs have serious entrenched generic competition to surmount, not to mention the risk of competing novel compounds.

What's more, Lundbeck has pared down its R&D efforts to a very focused, but very limited, pipeline and new product launches are not likely to be a major driver in the near term. Further operational outperformance shouldn't be underestimated, but I would expect Lundbeck to settle into a quieter "middle age" now, and the share price appreciation is more in keeping with my typical expectation from a drug stock.

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After A Successful Turnaround, What Propels Lundbeck Further?

Tuesday, February 14, 2017

Dassault Systemes Priced Like The Leader It Is

Between strong share in its core CAD/CAE markets, good margins, healthy cash flow, and a collection of markets that the company may have only penetrated by about 10%, I understand why Dassault Systemes (OTCPK:DASTY) trades at hefty valuation multiples. What's more, when you consider the prices that companies like Siemens (OTCPK:SIEGY) and Hexagon (OTCPK:HXGBY) have paid for acquisitions in the space, I can understand why some investors are comfortable with the multiples, and particularly considering the possibility that revenue growth can be healthy for a number of years. While this is too expensive to be a core holding in my own portfolio, it's hard not to like a business that is at the heart of industrial software at a time when many companies like Honeywell (NYSE:HON) and General Electric (NYSE:GE) are talking up the importance of software and digitization in industrial markets over the next five to 10 years.

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Dassault Systemes Priced Like The Leader It Is

Capital Bank Financial Keenly Focused On Some Of The Best Bank Markets

A lot of banks have talked about using M&A to grow their presence in banking markets with attractive demographic trends like the Carolinas, Georgia, and Florida, but Capital Bank Financial (NASDAQ:CBF) has shown more commitment than most. Created amid the chaos and disruption of the credit crisis, Capital Bank's experienced management has used multiple M&A transactions to build a credible banking franchise with a solid presence in multiple attractive metro areas.

And now for the "but". There are a lot of things to like about Capital Bank - an improving deposit mix, solid loan growth (and an improving mix), asset sensitivity, and ample surplus capital to support additional M&A. The "but" is that the valuation already amply reflects all of this, and the shares only make sense to me on the basis of M&A takeout valuation, and I think management here would rather prove that it can integrate the CommunityOne deal and drive attractive synergies before considering a sale.

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Capital Bank Financial Keenly Focused On Some Of The Best Bank Markets

Gemalto In A Bruising Transition Period

It has been a while since I've written on Franco-Dutch digital security company Gemalto (OTCPK:GTOMY) (GTO.PA) (GTO.AS). I thought the shares looked interesting back in February of 2013 on the potential to benefit from growing 3G/4G adoption and the conversion to EMV chip cards, and the shares did alright in the following two years (albeit with volatility). Starting around mid-2015, though, circumstances changed dramatically for the worse in the company's mobile SIM card business, and recent pressures from the payment/EMV business have made things worse.

I believe the company, and the shares, are in a tough transition period. I don't think mobile SIM cards will ever be a driver for the business, and I'm not sold on the prospects for mobile payments and contactless EMV cards to drive meaningful long-term value. I do believe, though, that the company's position in security platform/services, enterprise security, government, and machine-to-machine can drive worthwhile growth in the years to come.

The shares do look undervalued today on the basis of revenue growth in the neighborhood of 4-5% and FCF growth around 7-9%. That said, for those who can stomach the risk of missing out, waiting a little longer to make sure there isn't another shoe to drop may be a better decision in terms of long-term risk/reward. In terms of the mechanics of buying the shares, the U.S. ADRs do trade, but there is better liquidity in the European markets and most brokers now handle these trades at reasonable prices.

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Gemalto In A Bruising Transition Period

Sunday, February 12, 2017

Forward Air Shuffling Forward

Market leadership and hard-to-replicate assets don't ensure success, as seen at Forward Air (NASDAQ:FWRD) in recent times. While the shares have been performing better of late, and there seem to be some signs of positive momentum in the business, the three-year performance compared to the S&P 500 or other transportation and logistics companies like Old Dominion (NASDAQ:ODFL), Hub Group (NASDAQ:HUBG), J.B. Hunt (NASDAQ:JBHT), and C.H. Robinson (NASDAQ:CHRW) hasn't been great, as the company has struggled to translate a bigger revenue base into better bottom-line performance metrics.

Business does seem to be improving, as FWRD's top-line performance in the fourth quarter and guidance for the first quarter were good relative to expectations, and the company is seeing long hoped-for operating leverage in its Pool Distribution business. The problem is that the share price moves have largely captured this. I think Forward Air will have its work cut out to generate long-term growth above the mid-single digits, and even if corporate tax reform reduces its tax rate to the mid-20%'s, it's hard for me to see a fair value much above $50.

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Forward Air Shuffling Forward

United Community Banks Leveraging Its Deposit Base, Capital, And Service Model Effectively

Most banks these days are telling similar stories. While larger banks are focused on tightening up spending and holding down the fort until rates increase, smaller banks are by and large trying to take advantage of healthy demand for commercial real estate and business loans, while also looking for opportunities to deploy surplus capital into M&A to grow their business.

Insofar as all that goes, United Community Banks (NASDAQ:UCBI) isn't all that unusual. Nevertheless, I think there are some attributes about this bank that do stand out. The company has tried to prioritize customer service and that may pay off in the form of stickier deposits as rates rise. At the same time, management has been focusing a lot of its attention on growing specialty lending businesses that allow it to step away from the more intensely competitive commodity lending categories. UCBI also has the benefit of serving growing communities and leveraging a relatively attractive deposit base.

Like so many banks now, it's hard for me to argue that United Community Banks shares are undervalued. That said, they do seem priced for a high single-digit total return (which isn't bad), and this bank could see additional benefits if the new president's administration comes through with plans to lower corporate taxes, reduce regulation on banks, and stimulate economic growth.

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United Community Banks Leveraging Its Deposit Base, Capital, And Service Model Effectively

Pacific Premier Bancorp Seems To Be Living Up To Its Name

Given the melt-up in bank stocks, I think it's wise to be skeptical if not downright suspicious when a bank screens as undervalued. In the case of Wells Fargo (NYSE:WFC), for instance, there's the bank's well-publicized fraudulent account issue to explain the discount, and in a few cases here and there investors can find smaller banks trading at a discount in large part because they're below the radar screen of most analysts and investors.

To be sure, my growth expectations for Pacific Premier Bancorp (NASDAQ:PPBI) aren't conservative, but I do believe the bank could double its adjusted earnings between 2017 and 2020/2021 and double them again over the ensuing five years. I like this bank's leverage to "prudently aggressive" lending and its stated desire to deploy surplus capital into M&A to further grow the business. While the shares are expensive on a tangible book basis (at least on the basis of what has normally been reasonable for the bank's ROTCE), there could be upside into the $40's as this bank's lending continues to outgrow its peers and it continues to improve its deposit base.

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Pacific Premier Bancorp Seems To Be Living Up To Its Name

CVB Financial's Valuation Looks Hard To Live Up To

There are a lot of meaningful positives that come up when evaluating CVB Financial (NASDAQ:CVBF). Not only is this the largest independent commercial-oriented bank left in Southern California, and just inside the top 20 for California banks in overall deposit share, it's a well-run bank with a conservative business plan centered around sticking to its knitting and driving continuous improvement in execution.

The "but", the issue for so many banks now, is valuation. Even if I try to model as many positives as I can reasonably think of now (a lower corporate tax rate, stronger economic growth, lower expenses from lower compliance burdens, lower deposit betas, etc.), it's still a challenge to get to a $25 fair value from discounted earnings. So while I think CVB Financial will continue to gain share in its core markets and leverage its remarkable high-quality deposit base, there's just only so much I could ever be comfortable paying for that, and I can't see how the numbers work out now.

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CVB Financial's Valuation Looks Hard To Live Up To

Okay Results From ABB Not Enough When The Market Wants A 'V-Shaped' Recovery

Investors and analysts look for 2017 to be a big rebound year have had to dodge multiple buckets of cold water as companies have reported earnings in January and February. ABB (NYSE:ABB) is the latest entrant on a list that has included companies like Honeywell (NYSE:HON), 3M (NYSE:MMM), Siemens (OTCPK:SIEGY), and Emerson (NYSE:EMR) indicating that while 2017 will likely be better than 2016, it's not going to be a year where everything is back to normal and growth returns to a level at, or above, long-term expectations.

Even though ABB's fourth quarter report wasn't that bad, the market didn't like what it heard and particularly the notes of uncertainty from ABB's management. While ABB came in a little better than I'd expected (particularly with respect to free cash flow generation), this story is playing out more or less like I thought it would from an operational perspective. I continue to look for ABB to grow revenue and FCF at long-term rates of around 3% to 6%, supporting a fair value of around $25.

Although ABB has its issues (rising competition in power grids, exposure to more commoditized segments of discrete automation, relative weakness in areas like controls and software), it also has exposure to recoveries in emerging markets like China and eventual recoveries in multiple commodity-driven markets.

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Okay Results From ABB Not Enough When The Market Wants A 'V-Shaped' Recovery

Aspen Technology Weathering The Storm, But New Opportunities Should Be Pursued

For a business that is enormously dependent upon the energy, chemical, and engineering and construction (or E&C) sectors, Aspen Technology (NASDAQ:AZPN) is holding up quite well. Credit that, I think, to the company's management team and the strong suite of value-adding software products that help process industry managers optimize their processes and enhance productivity.

Valuation is still a serious issue for me with this stock. I fully acknowledge that high-quality companies, can, do, and should trade at premium valuations, but that still leaves little room for mistake. That said, I believe Aspen would be an attractive asset to a number of companies in the process automation space, and I believe that should keep a floor in for the stock. In terms of what would change my opinion, I would very much like to see Aspen build upon its established expertise in hydrocarbon-based process industries and expand into other process industries like food/beverage, metal/mining, pulp/paper, water, and so forth. Management has indicated some interest in doing so, and I believe this could be a meaningful future driver for the company.

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Aspen Technology Weathering The Storm, But New Opportunities Should Be Pursued

Even After A Big Run, Atlas Air May Have More To Give

I didn't go into my latest round of due diligence on Atlas Air (NASDAQ:AAWW) expecting to find a bargain. While the shares couldn't sustain the spike brought about earlier in 2016 with a major agreement with Amazon (NASDAQ:AMZN), the shares did start a strong rally toward the end of summer, and the shares rose another 25% or so after the U.S. presidential election (despite the uncertain ramifications of the new administration's policies on international trade). And yet, while there are a lot of unknowns about future margins and the air cargo supply/demand balance still isn't great, these shares just might still be too cheap.

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Even After A Big Run, Atlas Air May Have More To Give

Uncertain Times Will Test Expeditors International

Expeditors International (NASDAQ:EXPD) is an uncommonly well-run company and that has led to some pretty healthy valuation multiples over the years. Now, though, investors are worried about what a new administration in Washington, D.C. could mean for international trade, not to mention concerns about shrinking margins in both the air and ocean freight businesses and ongoing investments intended to drive future market share growth.

Expeditors is more or less what seems to pass for cheap now; it's not all that cheap on an absolute basis, but it's at least reasonably priced. That said, there are meaningful uncertainties regarding the company's operating environment right now and this recent run of underperformance (six straight quarters below expectations on revenue, three on EPS) may continue a while longer. Along those lines, Expeditors' asset-light, conservative model does well in tougher times but improvements in underlying transportation/shipping markets could favor asset-heavier companies and less well-run operators that may see more margin leverage in any sort of upturn.

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Uncertain Times Will Test Expeditors International

Wednesday, February 8, 2017

Hub Group Grabbing Share, But Backfilling The Margins Is Important

I can't fault for Hub Group's (NASDAQ:HUBG) growth strategy, as the company has used acquisitions and execution to build itself to mid-teens share of the domestic intermodal market and a top-five position in the domestic truck brokerage sector. I'm not worried about the growth potential in intermodal, as I think the market is only about 25% penetrated, but I would like to see the company make more progress on profitability as margins have slipped, free cash flow has become erratic, and recent trends in ROIC aren't so favorable.

I don't see anything unfixable about Hub Group, but the shares have enjoyed a good run since the election (up about one-third) and the valuation already seems to incorporate expectations for lower corporate taxes and increased economic activity. As is too often the case, then, this looks more like a "consider on a pullback" idea today, though I suppose more momentum-inclined investors may feel differently given the recent earnings report and the prospect of more clarity on pro-business policies from the new administration.

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Hub Group Grabbing Share, But Backfilling The Margins Is Important

Tuesday, February 7, 2017

Technical problems

Sorry that last week's articles didn't get posted here until now ... there were some issues w/ the blogging platform that took time to sort out.

Fifth Third's Current Performance Underlines The Need For North Star

Whether you look at just the period since the election or the last twelve months, Fifth Third (NASDAQ:FITB) has had a pretty remarkable run in an admittedly strong tape for bank stocks. What's arguably more remarkable is that the performance has come despite minimal loan growth (up just 2% since the end of 2014) and a decline in core pre-provision earnings. Even further, I don't think there's really a meaningful metric you can look at and declare Fifth Third a top operator.

On the other hand, the market is a forward-looking entity and I won't argue that Fifth Third's prospects aren't looking better now. Guidance for 2017 doesn't call for robust growth, but it was better than expected, and management continues to position its North Star program as a major transformational effort for the business. I am not giving full credit to the North Star efforts at this point (there's still too much of a "trust us … it'll work" element to the disclosed details), but each incremental 1% of long-term adjusted earnings growth translates to about 10% incremental fair value, so there is at least a path to a higher valuation here.

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Fifth Third's Current Performance Underlines The Need For North Star

U.S. Bancorp On Track But Not On Sale

It's probably fair to say that if you tried to play a "I like the company, but the stock looks expensive" drinking game with my writing in recent months, you'd put your life at risk. Be that as it may, it remains a familiar takeaway with U.S. Bancorp (NYSE:USB) - a high-quality super-regional bank that rarely commits unforced errors, runs itself very well, and is typically recognized as a top-notch bank by investors.

Even allowing that a bank like U.S. Bancorp should trade a premium, it's hard for me to be bullish now. Management has already largely optimized the capital position and the bank's effective tax rate is low enough that corporate tax reform likely won't be a huge boost. What's more, it's not particularly asset-sensitive. There are potential positives in the form of less regulatory burden, good performance in commercial lending, and further growth in fee-generating businesses, but I wouldn't look to buy U.S. Bancorp unless it somehow fell below $50 in the near term.

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U.S. Bancorp On Track But Not On Sale

Wells Fargo Has Dug Itself Into A Hole, But It Won't Be There Forever

Sooner or later, Wells Fargo (NYSE:WFC) will move beyond its current set of problems (many of which are/were self-inflicted) and get back to the business of generating attractive returns from an exceptional retail banking franchise. The problem with "sooner or later", though, is that later can sometimes be a lot later, and there's a not-so-fine line between investing with a long-term focus on living in denial.

Certainly there are a lot of things going against Wells Fargo right now, but the bank is not falling apart and the new administration's policies are likely to be good for banks and could be particularly good for a more "regulatory-challenged" bank like Wells Fargo. These shares actually look slightly undervalued on the basis of mid single-digit long-term earnings growth, but of course there is the risk that these recent problems cause greater long-term problems than I assume.

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Wells Fargo Has Dug Itself Into A Hole, But It Won't Be There Forever

Lackluster Results Don't Help The BB&T Story

BB&T (NYSE:BBT), like almost every bank, has gotten a bump since the election. Even so, it has been outperformed by many of its peers since the election (up around 18% versus 19% to 35% for U.S. Bancorp (NYSE:USB), Fifth Third (NASDAQ:FITB), Regions (NYSE:RF), Wells Fargo (NYSE:WFC), and PNC (NYSE:PNC)), and fourth quarter results weren't a particularly strong rebuttal to the idea that BB&T has near-term growth challenges.

I believe that BB&T has been taking steps recently, and will continue do so into 2017, that will better position the company for long-term growth, but it's harder to argue that there will be incoming outperformance to support higher multiples in the near term. Although I still like this bank, I think the valuation already embeds higher growth than is expected from the likes of Fifth Third, U.S. Bancorp, PNC, and Wells Fargo, and I can't make a compelling "buy this instead of that" argument at this time.

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Lackluster Results Don't Help The BB&T Story

PNC Financial Waiting For Multiple Drivers To Get Into Gear

PNC Financial (NYSE:PNC) has had a solid run since the election, with the shares still up more than 25% from the start of November on investor enthusiasm over the prospect of lower tax rates, stronger economic growth, less regulation, and reflation. While PNC management is still finding it challenging to grow lending in the current environment, management is looking to address this issue while also looking for ways to build up its fee-generating businesses and continue on with its branch operation improvement strategy.

Modeling isn't particularly easy right now, as the Street seems more than happy to factor in the benefits of a lot of policy shifts that have been only vaguely outlined so far. To that end, I am factoring in drivers like improving spreads and lower deposit betas, but I haven't yet changed my tax rate assumptions for PNC. My assumptions work out to mid single-digit mid-term and long-term earnings growth and a low double-digit return on tangible equity, and PNC is not particularly cheap on either an absolute or relative basis.

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PNC Financial Waiting For Multiple Drivers To Get Into Gear

Tuesday, January 31, 2017

Illinois Tool Works Running Like A Machine

The business plan at Illinois Tool Works (NYSE:ITW) may not be the most exciting, but management deserves a great deal of credit for running this business with a high degree of discipline and focus. Illinois Tool Works knows what it does well and intends to keep pushing the boundary on how well it can do it. Although that means that this company will seldom ever be the "flavor of the month", the company's strong operating track record and free cash flow generation make it a potential core holding at the right price(s).

To me, Illinois Tool Works looks priced more or less on par with 3M (NYSE:MMM) in terms of likely returns, and both are more expensive than Honeywell (NYSE:HON). Management's growth goals are ambitious, but not unreasonable, and are predicated on continuing on with what it already does well (… but just doing it a little better). As I wrote recently with 3M, I'd be more or less okay with holding Illinois Tool Works today in a long-term portfolio, but the valuation is high for what I like to see in new buys.

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Illinois Tool Works Running Like A Machine

Honeywell Still Better Than The Market Wants To Believe

Honeywell (NYSE:HON) hasn't done badly since I last wrote about this conglomerate. In fact, among what I'd consider to be its peer group (including names like 3M (NYSE:MMM), GE (NYSE:GE), Dover (NYSE:DOV) and so on), Honeywell has done okay, with a nearly 10% improvement in its share price. That's not as good as the double-digit improvements at Illinois Tool Works (NYSE:ITW) or Dover, but it's not exactly a disgrace either.

Honeywell doesn't have the same upside to a near-term turnaround in the industrial economy that I would expect from ITW or Dover, but it is nevertheless well-positioned for long-term growth trends like automation, civil aerospace, industrial software and specialty chemicals. What's more, there's more than the normal level of negative chatter around Honeywell, with investors fretting about the CEO change and an entrenched (although not really supported, in my opinion) belief that Honeywell has underinvested in R&D and innovation. Provided that Honeywell can deliver mid-single-digit growth over the long term, I think a double-digit total return is possible from here, and I think Honeywell is still worth consideration as a potential buy.

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Honeywell Still Better Than The Market Wants To Believe

3M's Balanced, Diversified Portfolio Maybe Not The Best Play Today

I have been favorably inclined toward 3M (NYSE:MMM) for quite some time, and I continue to think that 3M's CEO Inge Thulin is doing a great job running this global conglomerate. 3M generates very strong margins, but continues to pursue initiatives that should boost them further over the next three years, and does so while continuing to spend sizable amounts on R&D. The company is also solid from a free cash flow perspective, and has been a relatively good steward of shareholder capital with management willing to sell businesses that no longer meet management's long-term returns targets.

The bad news is that 3M is not cheap and not necessarily the best-positioned company for the current circumstances. 3M's global leverage should be a positive as emerging markets recover and the company's net exporter status does give it some leverage to potential corporate tax changes in the U.S., but it's not all that leveraged to U.S. infrastructure, its tax rate is already pretty good, it would be vulnerable to a stronger dollar and/or trade wars, and its balance between defensive and growth-oriented industries doesn't give it huge leverage to a recovering U.S. economy. While I'm in no rush to sell 3M today, it's hard to argue for this name as a must-own.

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3M's Balanced, Diversified Portfolio Maybe Not The Best Play Today

'Steady As She Goes' For Microsemi

Microsemi (NASDAQ:MSCC) has some good things going for it. As a very large (if not the largest) supplier of chips to the defense industry, the company stands to benefit from spending growth, and it is seeing good growth in higher-margin product lines acquired in its buyout of PMC-Sierra. What's more, content is increasing in its commercial aviation business, the satellite market is finally looking good again, and the 100G roll-out should support its optical components business.

That's all fine, but Microsemi's shares aren't cheap on a standalone basis, and I'm not entirely sure how the market will react to a "steady as she goes" quarter and guidance with no real news on the M&A front. There are still multiple potential bidders out there that could acquire this company at a meaningfully higher price and still reap attractive earnings accretion, but relying on M&A to support a valuation is at best risky. While I'm still a willing holder of these shares (largely on the prospect for a bid), it's harder to recommend that new buyers come in unless they are comfortable with the risk/reward trade-off between a firm bid and M&A speculation evaporating.

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'Steady As She Goes' For Microsemi

Tenaris Has A Lot Of Appealing Qualities, But Undervaluation Isn't One Of Them

The Tenaris (NYSE:TS) story is an odd one. As far as companies hugely exposed to oil and gas drilling activity go, Tenaris has held up better than most through this downturn, with quarterly operating income only recently turning negative and EBITDA remaining positive throughout. Adding to the strangeness, this is a company that will make a double-digit EBITDA margin in a trough year, and has seen EBITDA margins go north of 30% in peak years, despite the fact that industry capacity is usually around double the level of demand (or more) in all but the best of years, and there are numerous commodity producers in China and South Korea willing to operate at razor-thin margins (or take losses) to stay busy.

What's not so odd is that this company's shares have strengthened on expectations that 2016 will mark the bottom for the U.S. onshore energy sector, and that important markets like Argentina will likewise contribute to meaningful growth in the coming years. While I think Tenaris is a well-run company and I am bullish on the prospects for the company's efforts to improve its mix and go-to-market strategy to drive better results, the shares already trade above what would seem fair in a normalized scenario.

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Tenaris Has A Lot Of Appealing Qualities, But Undervaluation Isn't One Of Them

HD Supply Looking To Potentially Play Multiple Trump

While the recent downturn hammered industrial-exposed distributors like MSC Industrial (NYSE:MSM), Fastenal (NASDAQ:FAST), and Grainger (NYSE:GWW), HD Supply (NASDAQ:HDS) was more or less able to go about its business and continue growing. Due to its much different end-market exposures (facilities maintenance, water, and construction), HD Supply has continued to grow revenue and expand its margins, leading to a meaningful outperformance over the last three years relative to the likes of MSC, Fastenal, Grainger, and Wolseley (OTCQX:WOSYY) (with which it shares more in common).

Looking ahead, even though non-residential construction seems to be slowing and water infrastructure spending continues to click along at a slow pace that frustrates its bulls, I think HD Supply could still have potential catalysts to drive higher revenue and earnings. HD Supply would be a meaningful beneficiary of a lower corporate tax rate and would likewise be well-placed to benefit from the incoming administration's pledges to significantly increase federal spending on infrastructure. Projecting real numbers on the basis of campaign pledges is always a tricky business, and I haven't changed my tax rate assumptions yet, but if this administration delivers, it could support a fair value of $50 or higher for this distributor.

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HD Supply Looking To Potentially Play Multiple Trump

Wednesday, January 18, 2017

Busy Neurocrine Biosciences Faces A Phase II Setback

Although Neurocrine Biosciences (NASDAQ:NBIX) shares have been getting buffeted around as investors worry about the potential impact of the incoming administration's policies on drug pricing and the potential for competition to the company's major programs, management has been doing a respectable job of handling what they can. In particular, the company continues to focus its efforts on building awareness and establishing the initial launch plans for its lead wholly-owned drug valbenazine in tardive dyskenesia.

Clinical trial results fall outside of the spectrum of what biotech management teams can control, though, and Neurocrine disappointed the Street Tuesday night with negative results from its Phase II T-FORWARD study of valbenazine in adults with Tourette's. Although this particular indication was not a meaningful contributor to the stock's fair value, and there may still be a path forward, it's more bad news at a time when the shares and market sentiment toward biotechs are already weak.

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Busy Neurocrine Biosciences Faces A Phase II Setback

Saia Heading Northeast And Looking To Unlock More Leverage

The last five years have been good to Saia (NASDAQ:SAIA), as this smaller less-than-truckload (or LTL) carrier has grown its way into a top-10 market position and seen its share price climb over 400%, trouncing ArcBest (NASDAQ:ARCB) and YRC Worldwide (NASDAQ:YRCW), and doing quite a bit better than Old Dominion (NASDAQ:ODFL) as well.

While the company's tonnage growth has been relatively modest (up less than 1% on a compounded basis since 2009), it has been able to improve pricing at a mid single-digit clip, while meaningfully improving its operating ratio by prioritizing better service and more efficient operations. Looking ahead, the company's expansion into the Northeast should drive meaningful revenue growth and help the company improve its operating leverage and asset turnover. The shares isn't like cheap today, though, so this looks more like a name for the watch list than a near-term buy.

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Saia Heading Northeast And Looking To Unlock More Leverage

Tuesday, January 17, 2017

JPMorgan Benefiting From Calm Credit, A Strong Competitive Position, And Potential Catalysts

Among the larger banks, JPMorgan's (NYSE:JPM) post-election performance has been on the higher side of average (up about 25%), but the shares have been a standout (along with Bank of America (NYSE:BAC)) over the past year as the bank has been leveraging its strong market share and competitive positions as it waits for rates and economic conditions to improve.

Credit quality has been good and likely can't get much better, but loan demand can improve if the economy grows from here and higher rates should drive better spreads. What's more, JPMorgan and the rest of its large bank peers could be in place to benefit from a less stringent regulatory environment and a lower tax rate. While the shares look priced for a high single-digit return absent a meaningful reduction in the bank's tax rate, a meaningful reduction of the tax rate could drive a fair value into mid-to-high $80's.

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JPMorgan Benefiting From Calm Credit, A Strong Competitive Position, And Potential Catalysts

A Significant Recovery Already Being Factored Into MSC Industrial Shares

Cyclical stocks have a way of surprising on both ends. When things get bad, some sell-side analysts (and institutional investors) turn tail and declare that the sector can never come back. Of course, when things do recover and valuations start baking in "permanent prosperity" we are all treated to those memorable "it's different this time..." notes.

I certainly didn't think MSC Industrial (NYSE:MSM) was going to see the huge post-election run that it had. While the most manufacturing-exposed of the major distributors (which includes names like Grainger (NYSE:GWW) and Fastenal (NASDAQ:FAST)), the run in the sector already reflects a lot of optimism about the impact of lower corporate taxes, greater infrastructure spending, improved pricing, and a strong all-around recovery in the U.S. economy. I'm reluctant to completely bail out of a long-held position, but the valuation now seems to reflect a strong rebound with high single-digit FCF growth this year forward for quite some time.

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A Significant Recovery Already Being Factored Into MSC Industrial Shares

Monday, January 16, 2017

First Community's Valuation Seems To Assume A Lot Of Positive Breaks

Stock prices (and valuations) across the banking sector have shot up since the election, with investors baking in expectations for valuation-friendly policy changes like lower corporate tax rates and less regulatory burden. Time will tell how many of these expectations become reality, but I think First Community Bancshares' (NASDAQ:FCBC) 35% rally (closer to 45% at the peak) is overdone.

Try as I might, I can't figure out exactly how to get in tune with the growth expectations that investors seem to be baking into the valuation here. I certainly see how a lower tax rate can boost the cash earnings stream, and I can at least understand the argument that potential new policies more favorable to extraction industries like lumber, coal and gas would help a bank with a footprint largely in southwestern Virginia and southeastern West Virginia. All of that said, it seems to me that you have to assume a mid-teens long-run return on equity and use a single-digit discount rate to get to today's value and that seems like an ambitious set of assumptions.

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First Community's Valuation Seems To Assume A Lot Of Positive Breaks

Knight Transportation's Leverage To A Trucking Recovery Amply Reflected In The Shares

It stands to reason that a company that is much more leveraged to trucking spot prices would outperform its peers when those spot prices start to show improvement. It also doesn't hurt when you're an above-average operator in terms of efficiency and margins. Knight Transportation (NYSE:KNX) wears both of those crowns, and the shares have been quite strong in what had been a challenging year for the truckload carrier market prior to the late fall.

There's a lot to like about Knight, as the company challenges Heartland (NASDAQ:HTLD) for the top spot in "clean" operating ratios and it has a long and strong track record of return on invested capital. What's more, the company's diversified customer base and spot rate exposure should serve it very well if/when capacity starts tightening up. The "but" is valuation; Knight's strong metrics and leverage to a recovering trucking market may argue for a premium, but 10x 2017 EBITDA is too rich for my blood at this point.

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Knight Transportation's Leverage To A Trucking Recovery Amply Reflected In The Shares

Thursday, January 12, 2017

Heartland Express Has Some Blockages When It Comes To Growth

As problems go, Heartland Express's (NASDAQ:HTLD) collection of challenges could certainly be worse. Long one of the best-run truckload operators out there, Heartland runs an exceptionally tight ship. This company's history of tight cost control, relentless efficiency, and high standards for driver performance has led to excellent operating ratios, good asset turnover, and strong operational metrics, which have in turn translated into good cash flows and excellent returns on capital.

The problem for shareholders, though, is that this already-excellent company doesn't have a lot of levers to pull to do meaningfully better. An improving trucking market will certainly help, but it likely won't help Heartland as much as other operators and the company still has some distance to go before returning to the sort of margins it generated before the Gordon deal (if that is even possible). Heartland does look reasonably valued on an EBITDA basis, though, and in this market "reasonably valued" is often about the best you can find.

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Heartland Express Has Some Blockages When It Comes To Growth

Monsanto Holding Serve Ahead Of Regulatory Debates

There's no question that the biggest value-driving events for Monsanto (NYSE:MON) are yet to come, as this leading agriculture technology company will have to go through what is sure to be a rigorous regulatory oversight process to get to the finish line with its would-be suitor Bayer (OTCPK:BAYRY) and deliver the $128/share in cash that a successful deal promises.

In the meantime, Monsanto is Monsanto. The ag market is still in recovery mode, and 2017 is not likely to be a banner year for acreage, but Monsanto is doing well with new launches in South America and continues to upgrade its product portfolio in North America. What's more, Monsanto has long been an R&D-driven story and management hasn't been shy about continuing to reinvest and expand that research pipeline. While the shares do trade above my estimate of standalone fair value, it seems as though today's price factors in only about a 20% chance of the deal going through, and that strikes me as a reasonable risk/reward.

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Monsanto Holding Serve Ahead Of Regulatory Debates

Teradyne Should Redeploy Capital Toward Growth

Not all semiconductor equipment is the same, and while Teradyne (NYSE:TER) is essentially a co-duopolist with Advantest (NYSE:ATE) in the back-end semiconductor test space (and a pretty well-run company on balance), it's hard for me to see this market offering a lot of attractive long-term growth opportunities. It does tend to support solid margins and cash flows over the full cycle, though, and that gives Teradyne the resources to consider its long-term options.

As is, I think Teradyne is basically fully valued today. The "but" is that the company has a healthy balance sheet and the opportunity to buy its way into new growth markets. The company's early position in collaborative robotics is one such example, and there are a lot of places Teradyne could go in industrial automation from here. By the same token, the company could make complementary acquisitions to augment existing test businesses; these deals wouldn't likely be growth drivers, but could make sense from longer-term synergy and cash-on-cash return perspectives.

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Teradyne Should Redeploy Capital Toward Growth

Axcelis Following A Different Plan As Semiconductor Tool Spending Ramps Up

Relative to the other semiconductor tool companies that I follow, Axcelis's (NASDAQ:ACLS) basic operating plan and drivers seem a little different than most. While the company is not unaffected by the drive toward new architectures in logic and memory chips, it's not as core to the story as it is for companies in other areas of the tool market like thermal processing, metrology, and packaging.

For Axcelis, the story is about carving out more share against Applied Materials (NASDAQ:AMAT), better addressing the full range of customers' ion implant needs, and exploiting growing investment in equipment for memory and "non-leading edge" chip types like sensors. Although I don't think Axcelis will achieve the same sort of margins I expect from Ultratech (NASDAQ:UTEK), Rudolph (NASDAQ:RTEC), or Nanometrics (NASDAQ:NANO), the market doesn't expect that either and there may still be some upside as the company heads towards a revenue peak in the next couple of years.

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Axcelis Following A Different Plan As Semiconductor Tool Spending Ramps Up