Wednesday, December 7, 2016

Littelfuse's Valuation May Seem Demanding, But The Business Is Appealing

A lot of investors prize businesses with strong share in COGS/opex-oriented businesses with barriers to entry. Littelfuse (NASDAQ:LFUS) certainly fits the bill, as circuit protection products like fuses and suppressors and sensors tend to sell for low individual ASPs, but they are ubiquitous and customers prize reliability (you don't want a TV or CT scanner failing because of a $1 fuse). What's more, auto OEMs are adding more and more sensors and fuses to new models and the migration towards more electric power (including 48v architectures and all-electrics) should offer more content growth opportunities for Littelfuse.

I've made my peace with the fact that companies like Littelfuse and Sensata (NYSE:ST) (which aren't apples-to-apples comps) aren't going to often look cheap, but the strong performance of the shares (up about 35% over the past year, and up about 70% over the past three years) and the high multiples do at least lead me to pause. That said, the low double-digit long-term FCF growth implied by the current valuation doesn't strike me as ridiculous. I'd wait for a better entry point, but that could be a long and frustrating wait and stronger than expected growth in the auto business could support even higher multiples.

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Littelfuse's Valuation May Seem Demanding, But The Business Is Appealing

A Tough Macro Environment Is Masking Some Improvement At PolyOne

It has been a while since I've written on PolyOne (NYSE:POL), and I wasn't all that fond of the valuation on this specialty chemical company back in that last article in 2013. Since then, the share's performance has been about half that of the S&P 500, though somewhat less disappointing relative to other chemical companies like Schulman (NASDAQ:SHLM), Clariant (OTCPK:CLZNY), and Westlake (NYSE:WLK).

Performance has been hurt not only by execution issues in the acquired Spartech business, but also a weakening macro environment, and this most recent quarter was the first in over two years to show year-on-year revenue down (though organic growth was still negative absent an adjustment for energy-based pricing).

The investment prospects for PolyOne are more interesting to me now. I like specialty chemical companies, and I think PolyOne has a lot going for it with an array of value-adding capabilities. I also like that management has been shoring up some weaknesses and continuing to push the company in the direction of "value over volume" and toward a model that could conceivably produce double-digit ROICs on a more consistent basis.

Valuation isn't a slam-dunk, but I've learned that it is worth paying attention when quality specialty chemical companies look reasonably priced on a discounted cash flow basis, as the market is often willing to pay premiums to that value in healthier economic times.

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A Tough Macro Environment Is Masking Some Improvement At PolyOne

State National May Be Unusual And Almost Unknown, But It's A Business Worth Following

I like insurance companies and I especially like companies like Arch Capital (NASDAQ:ACGL), Argo (NASDAQ:AGII), and W.R. Berkley (NYSE:WRB) that do things a little differently than the typical insurance company. Well, State National (NASDAQ:SNC) may take the cake in that respect, as this is a pretty unusual insurance company compared to most publicly traded "P&C" insurance companies. While I do expect competition will limit returns to some extent, I think State National can maintain mid-teens ROE and generate enough adjusted cash earnings growth to support a fair value close to $16 today.

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State National May Be Unusual And Almost Unknown, But It's A Business Worth Following

Tuesday, December 6, 2016

South State Bank Pairing Organic Growth With A Growing Focus On M&A

I'm confident that South State Bank (NASDAQ:SSB) is going to be a meaningfully larger bank in three to five years' time, and I'm reasonably confident that it will not compromise its quality to get there. While management already has a credible plan in place to drive above-average growth by organic means, they have also made it clear that M&A is going to continue to be a meaningful factor in the company's long-term growth plans.

South State is at an interesting point in its growth story. The bank is about to break through the $10 billion threshold in assets and that's going to increase its regulatory/compliance costs, but I expect additional deals in growth markets along the I-85 corridor and southeastern coast will be coming and will help offset some of those costs with further growth. While South State Bank doesn't look cheap today, it's closer to its fair value than most and this would be a name I'd watch in the hopes of taking advantage of an eventual normalization in bank valuations.

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South State Bank Pairing Organic Growth With A Growing Focus On M&A

Safran Building Toward Better Days

It hasn't been the smoothest ride for aerospace companies, but France's Safran (OTCPK:SAFRY) is nevertheless worth a closer look. Safran is a tier one supplier in the aerospace market, and through its alliance with General Electric (NYSE:GE), a leading player in narrowbody aircraft engines. While the launch of a new engine program will pressure margins in the short term, aftermarket sales should start improving and management seems focused on removing the company from underperforming business lines.

The sale of the security business is going to bring a lot of cash to Safran and there are still concerns about what management will do with that money. Although management hasn't sounded particularly eager for M&A, and there aren't many deals out there that would seem to really improve the company, the Street is still batting around various names as potential targets. While this potential M&A is a significant swing factor, mid single-digit revenue growth and improving margins can drive a fair value more than 10% better than today's price, making these shares worth a closer look.

Investors/readers should note that Safran's ADRs are rather liquid, and while the home exchange shares are even more liquid, there should be adequate liquidity with the ADRs for most investors' needs.

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Safran Building Toward Better Days

Sunday, December 4, 2016

Washington Federal Hoping A New Model Can Drive More Growth

Until relatively recently, Washington Federal (NASDAQ:WAFD) was pretty much a thrift - residential mortgages made up a large majority of the loan book, and the company financed those loans with a funding mix that skewed heavily toward savings accounts and CDs. In recent years, though, this multi-state Western regional bank has tried to become more like larger peers such as Wells Fargo (NYSE:WFC), U.S. Bancorp (NYSE:USB), and Umpqua (NASDAQ:UMPQ), with a turn toward more commercial lending.

I don't like how Washington Federal has been losing deposit share in many states, nor the already-high loan/deposit ratio. As the bank is not very asset-sensitive, I worry that the near-term drivers for near-term growth are relatively limited. I do believe that management is making a good call in diversifying its loan book, but I'd like to see more progress on accumulating lower-cost deposits and a willingness to look a little harder for better uses of capital.

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Washington Federal Hoping A New Model Can Drive More Growth

Westamerica Bancorp Struggling As A Supreme-Quality Bank In A Lower-Quality World

By a lot of metrics, Westamerica Bancorporation (NASDAQ:WABC) has a legitimate claim to being one of the best banks in the country, or at least one of the best small-cap banks. This Northern California-based bank produced numbers during the credit crisis/recession that were better than what many banks produce today, and the bank's service-oriented approach to business banking has made it a strong player for business deposits within its footprint.

But there's an ironic twist to this narrative. A lot of what has made Westamerica so good, particularly its rigorous underwriting discipline, is weighing heavily on the bank today. Credit quality is still excellent, but loans have declined at a double-digit rate for five years running and a shocking amount of the company's asset base is invested in securities because management can't find worthwhile loan opportunities. With that, valuation is a mystery to me. Even if I were to assume that ROE could double over the next five years, I don't see the path to today's valuation.

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Westamerica Bancorp Struggling As A Supreme-Quality Bank In A Lower-Quality World

Umpqua Seems Short Of Growth Drivers

Oregon's Umpqua (NASDAQ:UMPQ) is something of a case-in-point as to why I'm reluctant to overpay for stocks (and bank stocks in particular). When I last wrote about this high-quality bank back in 2014, I thought the shares looked expensive. Since that time, the shares are actually down about 5% - rare for most bank stocks and all the worse when compared to the performances of regional rivals like East West (NASDAQ:EWBC), Washington Federal (NASDAQ:WAFD) and Pacific Continental (NASDAQ:PCBK).

What's worse is that even after this run of underperformance, the shares still don't look all that cheap. Not only is Umpqua not all that asset-sensitive, it also lacks real leverage in more than a handful of major markets. Add in a loan book that is overweighted to commercial real estate and multi-family residential lending, an elevated cost structure (which is liable to be tough to tame) and weakening yields, and it's a tough near-term outlook. While there is definitely room for improvement, Umpqua may find it hard to go much above 10% ROE in the foreseeable future, and that limits the value proposition today.

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Umpqua Seems Short Of Growth Drivers

Fortive Could Be A New Industrial Star

When you carry the legacy of Danaher (NYSE:DHR) with you, expectations are going to be high. That is already the case for Fortive (NYSE:FTV), as this high-quality industrial conglomerate has debuted with a premium valuation and high expectations for growth. That said, those expectations aren't necessarily unreasonable, as the company's existing businesses already enjoy good market share, solid margins, and attractive free cash flow.

Valuing a stock like Fortive is tricky. If you exclude the impact of future M&A, you're largely missing the point of the business (which is to add value by skillful M&A selection, integration, and execution). On the other hand, modeling the impact of future M&A is a level of guesswork above and beyond the assumptions that underlie all modeling. Consequently, while Fortive doesn't look particularly cheap today (particularly after the post-election run), I wouldn't ignore it simply on the basis of valuation and would, at the very least, keep this on a watch list.

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Fortive Could Be A New Industrial Star

Glatfelter Needs To Rejuvenate Volume Growth

It's been a while since I've written on Glatfelter (NYSE:GLT), but this specialty paper and engineered fiber product company has remained frustratingly underpowered on growth, with year-over-year revenue contraction reported in every quarter since the fourth quarter of 2014. Meanwhile, Finland's Ahlstrom has been on much better footing with respect to volume growth, revenue growth, and margin improvement.

Glatfelter isn't unfixable, but it is going to take time and I don't think the company has any obvious quick fixes. What's more, there's a surprising amount of volatility here - the shares' 19% drop on the day of its last earnings was arguably excessive, but the subsequent post-election rally likewise seems more than a little optimistic. I believe the underlying markets for many of Glatfelter's specialty products can support mid single-digit long-term revenue growth, but the specialty paper business is likely in long-term decline and there's still work to be done to improve the specialty businesses. With an okay valuation today, but not especially bright prospects for near-term volume growth, these shares look uninspiring after the rally.

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Glatfelter Needs To Rejuvenate Volume Growth

Capital City Bank Needs Scale To Leverage A Good Deposit Franchise

As a bank focused largely on northern Florida, Capital City Bank Group (NASDAQ:CCBG) has had a tough go of it. The serious credit losses and recession that followed the housing bubble led to a significant contraction in the balance sheet and the firm's largely rural, largely retail branch network has established a high-cost base that has pushed returns on equity into the low single-digits.

There are some intriguing opportunities here. The bank has the capital to do some M&A and its core north Florida markets seem to be poised for above-average growth. If management can find the way to better-leverage its branch network and reduce operating costs, the profit leverage would be substantial. Likewise, with the bank having made meaningful progress on credit clean-up, larger banks could find the combination of low-cost deposits and elevated expenses very appealing as a takeover target. Unfortunately, the stock has shot up almost a third since the election, and it is difficult to see the obvious upside now.

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Capital City Bank Needs Scale To Leverage A Good Deposit Franchise

Sunday, November 27, 2016

BancorpSouth Seems To Have A Harder Path To Growth

Sometimes different is better. Bank of the Ozarks (NASDAQ:OZRK) has focused on specialized real estate lending in the South to fuel exceptional growth, while Ameris (NASDAQ:ABCB) has used serial M&A to acquire footholds in multiple Southern growth markets. In the case of BancorpSouth (NYSE:BXS), though, I'm less certain that its different strategy of targeting mid-sized geographies with less competition is going to work out as well over the long run.

There are positives to this story. BancorpSouth should be approaching the end of some serious regulatory issues that have restricted its operations (particularly with respect to M&A), the company's capital position is fine, and the company's credit situation looks healthy. What's more, it generates a significant amount of fee/non-interest revenue and there is still operating cost leverage left to achieve. All of that being said, the market seems to be already pricing in mid-teens long-term growth, and I don't think that leaves a lot of room for disappointment or outperformance.

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BancorpSouth Seems To Have A Harder Path To Growth

Once Overlooked, Microsemi Is Now The Belle Of The Ball

It's been a long, and sometimes strange, trip with Microsemi (NASDAQ:MSCC). It wasn't that long ago when writing positively about this semiconductor company generated a lot of negative feedback from the peanut gallery, but management has stuck to its plan and reshaped Microsemi into a diversified semiconductor company with multiple growth drivers and good margin leverage potential. The market has recognized this improvement too, with the shares up over 130% over the last three years and up more than 50% over the past twelve months.

Now Microsemi is a relatively popular name - it's on multiple sell-side "Top Pick" lists and the stock is in play as an M&A target. I do believe there is a credible case that Microsemi could be a target, if for no other reason than M&A is a reasonable way to drive earnings growth in the semi market today and the recent wave of consolidation has thinned the herd of eligible and worthwhile targets. Given the upside potential of a deal, I'm inclined to hold on to what I have but I will note that it's not really plausible (in my opinion, at least) to validate today's price on a standalone basis.

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Once Overlooked, Microsemi Is Now The Belle Of The Ball

Iberiabank In The Middle Of A Tough Balancing Act

While the share price at IBERIABANK Corp. (NASDAQ:IBKC) ("Iberiabank") has rocketed up since the election (along with many, if not most, other bank stocks), there are still a lot of areas where management has work to do. The energy portfolio has shrunk, but credit quality has worsened, and there are some legitimate concerns about how management has been managing excess liquidity in a low-rate environment.

As is often the case with most stocks, a lot of it comes down to valuation. If Iberiabank were trading around 1.5x tangible book, I'd be excited about the deposit footprint and the toeholds in multiple growth markets across the South. As it is, though, I think the Street is more than rewarding the stock for the improvements in operating efficiency, the probable loan growth trajectory, and the possibility of a more constructive regulatory environment.

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Iberiabank In The Middle Of A Tough Balancing Act

Ameris Has A Lot Of Opportunities To Grow, But It's Not Cheap

If you like banks with above-average prospects for growth over the next three to five years (and beyond), Ameris (NASDAQ:ABCB) could be right up your alley. If you're looking for a quality overlooked opportunity trading below fair value, I don't think you're going to find as much to like here.

Ameris has been an aggressive acquirer and has built an interesting franchise in southern Georgia and northern Florida, as well as focused lending operations targeting segments like agricultural lending, SBA, and mortgages. Add in the potential from ongoing expense leverage and above-average growth in the region in which it operates, and I think Ameris has above-average growth potential. Trading close to 3x tangible book, though, and already pricing in high teens earnings growth, it's hard to call this a value.

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Ameris Has A Lot Of Opportunities To Grow, But It's Not Cheap

Tuesday, November 22, 2016

Better Days Ahead For Wärtsilä

This has been a challenging year for Finland's Wärtsilä (OTCPK:WRTBY) (OTC:WRTBF), as the sharp downturn in the energy market has continued to weigh on energy-related orders like drillships and gas carriers. When I last wrote about Wärtsilä, I didn't think investors needed to be in a hurry to buy up shares, and the stock's roughly 5% move since then doesn't leave me feeling as though I've missed much. That said, I believe things are looking up for this business.

While Wärtsilä's oil/gas-related business has definitely been hurt, the company's diversification is paying off as cruise operators continue to order new vessels. Although cruise ships take longer to build and deliver than merchant or energy vessels, they are potentially much more lucrative to Wärtsilä in terms of total addressable content beyond engines (electrical systems, automation, etc.). What's more, the company's power gen business has been gaining share and looks well placed to benefit from the growing demand for flexible baseload and peak load generation.

All told, while these shares are not wildly undervalued, and 2017 is unlikely to see a strong earnings rebound, they do look priced to generate a low-double-digit annual return. With a lot of skepticism around the name and a lot of worry about the oil/gas business, I think there could be an opportunity to start looking at a contrarian position here.

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Better Days Ahead For Wärtsilä

Bradesco Isn't Out Of The Woods, But The Credit Cycle May Be Bottoming

Banco Bradesco (NYSE:BBD) has had a rough time of it recently, as Brazil's weak economy has hurt demand for loans, pressured deposits, and led to greater credit losses. This isn't a unique situation, as other banks like Itau Unibanco (NYSE:ITUB), Banco do Brasil (OTCPK:BDORY), and Banco Santander Brasil (NYSE:BSBR) have seen similar pressures and stresses, but Bradesco has been the weakest of these performers over the past year (just slightly worse than Itau) and the strong rally that had pushed these shares up 50% to 100% has sharply reversed in recent days.

The good news for Bradesco is that it is at least plausible that the credit cycle has bottomed out and the company's capital position is okay. The worse news is that the recovery in Brazil could be slow and stretched out over many years - not unlike what the U.S. banking sector has seen. While I think management's inability to accurately predict worsening credit trends as the cycle dragged on is a concern, as is the indictment against the CEO, I do believe that the bank can return over time to ROEs in the high teens to 20% and generate high-single-digit to low-double-digit earnings growth, supporting a fair value above $10 for the ADRs.

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Bradesco Isn't Out Of The Woods, But The Credit Cycle May Be Bottoming

Knocked Back By Energy, Green Bancorp Looking To Rebuild The Growth Story Next Year

Energy lending has hamstrung many banks and Green Bancorp's (NASDAQ:GNBC) previously outsized exposure to the energy sector has come back to bite this small Texas lender. Management is moving fairly aggressively to exit its energy lending business and pivot toward lending growth opportunities in Dallas and Austin, but weakness in the Houston metro area remains a concern, as does this company's funding base.

I like Green Bancorp's portfolio banker lending model, and I think the underlying growth in major Texas metro areas like Dallas, Houston, and Austin can support above-average loan growth. That said, there's a lot of competition within Texas, and management needs to prove that it can carve out a durable differentiated lending franchise and expand its base of lower-cost deposits. The current valuation already assumes a lot of improvement (and long-term earnings growth in the range of 20%) and that doesn't leave much room for excitement from me.

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Knocked Back By Energy, Green Bancorp Looking To Rebuild The Growth Story Next Year

Wednesday, November 16, 2016

New Management Needs To Unlock Bancolombia's Potential

Bancolombia's (NYSE:CIB) ADRs haven't done too bad over the past year (up about 5%), but they've lost about a third of their value over the past three years, and investors have been suffering through a five-year stretch of weakening margins and returns. While some of the pressures have been external to the bank, poor management and aggressive M&A played a meaningful role. Bancolombia saw a change at the top earlier this year when Juan Carlos Mora Uribe replaced Raul Yepes, the CEO who oversaw that weak five-year period, and there is definitely a lot of work to do.

The good news is that, although Bancolombia's capital is depleted, the bank is starting from a workable footprint. A leading deposit-gatherer and lender in Colombia, Bancolombia can do a lot better than it has in its consumer/retail banking operations while operations in Central America offer some scope for improvement as well. It takes only relatively modest performance improvement to drive high-single-digit earnings growth and a fair value above $38, but Colombia is a still a commodity-driven economy with a competitive banking sector and Bancolombia's capital position doesn't allow for a lapse in discipline in underwriting.

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New Management Needs To Unlock Bancolombia's Potential

A Recovery In Argentina Can Take Banco Macro Further, But Mind The Risks

Argentina's Banco Macro (NYSE:BMA) has already had a pretty solid year, with the shares up 26% over the last 12 months on improving prospects for Argentina's economy. In fact, Banco Macro has been something of a standout, as Galicia (NASDAQ:GGAL) has climbed about 15% and BBVA Francs (NYSE:BFR) has fallen more than 15% over the same time period. Even so, better things could still be ahead.

Banco Macro is the third-largest private bank in Argentina and conservatively run, leaving the company with a good credit position and ample capital and liquidity to benefit from the improving Argentine economy. While I do expect Banco Macro's ROE to decline (due in large part to the distortions created by inflation), I believe the company can post double-digit earnings growth. If that's a reasonable expectation, a fair value of close to $80 is in play.

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A Recovery In Argentina Can Take Banco Macro Further, But Mind The Risks

Thursday, November 10, 2016

Banco De Chile Looks Like An Island Of Relative Stability

Compared to South American neighbors like Brazil, Argentina, Venezuela, and Colombia, Chile's economy has held up well despite its heavy reliance on mining for export income. That said, growth has been slowing, sentiment is weakening, and there has been more grumbling about the government in the richest Latin American economy (as measured by GDP per capita).

That leaves Banco de Chile (NYSE:BCH) in an interesting spot. Banco de Chile has long been a standout performer among Latin American banks, with double-digit annualized asset growth over the last five years and double-digit earnings growth over the past decade, as well as strong credit, spread, and margin performance compared to rivals like Santander Chile (NYSE:BSAC), BCI, and Itau CorpBanca (NYSE:ITCB). At the same time, though, loan growth has been slowing and spreads have been tightening.

Assuming that Banco de Chile can continue to generate ROEs near 20% over the long term, the shares have some appeal at this price for investors who want exposure to the above-average growth potential of Latin America but with a lower degree of risk.

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Banco De Chile Looks Like An Island Of Relative Stability

With Western Alliance Bancorp, 'Different' Seems To Mean 'Better'

With a $4 billion market cap and meaningful institutional ownership, I can't say that Western Alliance (NYSE:WAL) is ignored or overlooked, but I'm surprised that a run of the numbers suggests potentially meaningful undervaluation here. While the company's intense focus on commercial lending and lending outside of its core footprint does represent a risk, the company's focus on more specialized types of lending is a strong positive, there is ample room to grow its deposit-gathering footprint and the company's strong internal capital generation creates a lot of long-term opportunities.

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With Western Alliance Bancorp, 'Different' Seems To Mean 'Better'

Southside Seems Priced Like A Better Bank Than It Appears To Be

Considering the size of the economy and the above-average population growth, it makes sense that both investors and other banks are interested in Texas-based banks. Although worries that weak oil/gas prices would undermine the entire state's economy pressured the shares of many Texas banks earlier this year, many have rebounded strongly and now sit at or near 52-week highs.

Southside Bancshares (NASDAQ:SBSI) is one such bank, and while I'm certainly interested in finding some good investment ideas in the Texas bank sector, I'm not convinced this one qualifies. In its favor, Southside could be an acquisition target for a bank looking to acquire a bigger presence in East Texas, and banks ranging from larger super-regionals like BB&T (NYSE:BBT) and U.S. Bancorp (NYSE:USB) to other Texas-based banks like Hilltop (NYSE:HTH) and Prosperity (NYSE:PB) are looking to build their deposit share in the state. Against that, though, is more leverage than I'd like, a heavily CRE-dependent loan book, and a valuation that already factors in some pretty solid growth expectations.

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Southside Seems Priced Like A Better Bank Than It Appears To Be

Tuesday, November 8, 2016

Dry Powder, Clean Exposures, And Valuation Make Hilltop Holdings Worth A Look

Like many other Texas banks, Hilltop Holdings (NYSE:HTH) got hit hard earlier this year, only to come back strong and recently challenge its 52-week high. While there is enough diversity to make the notion of a "typical" Texas bank a questionable one, Hilltop at the very least doesn't have the large energy lending exposures that have tripped up some of its comparables.

What Hilltop does have, though, is a strong capital position that can support expanded lending and M&A, not to mention an asset that can be sold (its insurance business) to fund additional moves. Hilltop also has a pretty clean credit profile and a management team that knows how to build (and sell) banking businesses. While the valuation isn't hands-down cheap, there does seem to be enough value and potential here to make it worth a closer look from investors shopping for some bank stock ideas.

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Dry Powder, Clean Exposures, And Valuation Make Hilltop Holdings Worth A Look

3M Executing, But Not Excelling

Investors who want to own large industrial conglomerates have some tough choices to make today. Solid companies like Illinois Tool Works (NYSE:ITW) don't trade cheaply, and many of the stocks that do look undervalued have issues attached - whether it's the uncertainty of Honeywell's (NYSE:HON) new strategy/management, the execution and market issues at Dover (NYSE:DOV), or the timing of end-market recoveries for companies like Eaton (NYSE:ETN).

3M (NYSE:MMM) looks to me to be on the Illinois Tool Works side of the ledger. I can't argue that the stock is undervalued, or at least not in terms of meeting my normal minimum return requirements. I can live with the argument that many investors will take a lower return on 3M shares in exchange for the lower operational volatility and higher reliability, but this isn't a business that looks poised for a big turnaround and there are some ongoing questions about how management is addressing future growth drivers.

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3M Executing, But Not Excelling

Aptose Remains In Limbo

In a market that has turned unfriendly toward biotechs, Aptose Biosciences' (NASDAQ:APTO) ongoing execution issues and cash drain have become serious issues. It has taken over a year (and counting) to resolve a clinical hold on APTO-253, and that's an execution shortfall that the company can ill-afford given the progress other companies are making with clinical candidates for hematological cancers and the need for real clinical data to support further capital raises.

The good news is that the company appears to be close to a resolution of the clinical hold with APTO-253 and the resumption of Phase I testing. The other good news is that the company has added another interesting preclinical asset for its hematology pipeline. The bad news is that this is all about "potential" and potential is the one asset small biotechs never seem to lack. What's more, the company is going to need to raise capital and the share price weakness is going to increase the dilution.

It's hard to stay bullish on a biotech that has needed more than a year to reformulate a drug and resolve its clinical hold (when that is really the only value-driving asset the company has), and that's particularly true given the risk that Aptose may have to raise money with little-to-no human clinical data. There's still upside here; if APTO-253 and CG-806 work, they can redeem a lot of these issues down the road. But make no mistake - this is a highly speculative pick that is not so far removed from gambling.

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Aptose Remains In Limbo

Brocade Looks Like Another Typical Broadcom (Avago) Deal

Broadcom (NASDAQ:AVGO) (or more precisely, the company previously known as Avago) knows what it wants in M&A and is not afraid to go for it. Management loves to find companies with few competitors, stable revenue, cost synergy potential, and a product/market assortment that slots in opportunistically with the existing business. So even allowing for an ongoing shift away from fibre channel toward Ethernet, Brocade (NASDAQ:BRCD) checks the boxes that Broadcom looks for and looks like a solidly accretive deal.

The Brocade deal appears to add around $10/share to my fair value estimate for Broadcom, and even if Brocade's fibre channel SAN switch business should suffer even greater erosion from the adoption of Ethernet switches, Broadcom has strong existing products there as well. The biggest downside I see to this deal is that it limits Broadcom's short-term M&A options. A rival bid for NXP (NASDAQ:NXPI) (which was not too likely either way) now seems even less likely and likely so too a bid for a company like Xilinx (NASDAQ:XLNX) that could more meaningfully broaden Broadcom's horizons.

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Brocade Looks Like Another Typical Broadcom (Avago) Deal

Wright Medical Checking The Boxes

Investors often seem to get bored with the actual execution of business plans, and I think that's at least partly responsible for the ongoing weakness in Wright Medical (NASDAQ:WMGI) shares. It's also been a weak stretch since early August for many of the company's peers, with Integra (NASDAQ:IART) and Zimmer Biomet (NYSE:ZBH) down as well, and Stryker (NYSE:SYK) just barely up.

Wright Medical continues to have a strong position in one of the fastest-growing segments of medical devices, and the company's Augment biologic has significant growth potential from here. The company has also largely tied up its hip implant litigation and at a cost that was within the prior bounds established by management.

Management has also been delivering successfully against its merger synergy targets, and I believe the company is on track for strong growth over the next ten years as new products drive more adoption of upper and lower extremity procedures. With a fair value in the mid-$20s, Wright Medical shares still offer worthwhile upside.

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Wright Medical Checking The Boxes

Can Prosperity Bancshares Build Value Outside Of M&A?

I thought Texas-based Prosperity Bancshares (NYSE:PB) looked like an interesting value back in late January of 2015, and the shares are up more than 10% since then but it has not been a smooth ride. Like other Texas banks, including Cullen/Frost (NYSE:CFR), Texas Capital (NASDAQ:TCBI), International Bancshares (NASDAQ:IBOC), and Green Bancorp (NASDAQ:GNBC), Prosperity shares had a rough time from late 2015 into early 2016 on worries that the steep decline in energy prices would undermine the bank's credit quality and loan growth in Texas and Oklahoma.

There are signs of weakness that shouldn't be ignored, including rising unemployment and shaky commercial real estate numbers in Houston, but Prosperity continues to have a strong credit quality profile, a good efficiency ratio, and a very disciplined overall approach. On the other hand, loan growth is weak and I have more doubts now about Prosperity's ability to grow outside of M&A. I believe that Prosperity can post mid-to-high single-digit earnings growth from here (equating to a low double-digit ROE down the road), but that no longer supports a compelling buy thesis.

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Can Prosperity Bancshares Build Value Outside Of M&A?

After A Post-Panic Rebound, It's Harder To Find Value In Texas Capital Bancshares

Quite a few banks with heavy Texas exposure took a beating in the market from the fall of 2015 through the spring of 2016, and Texas Capital Bancshares (NASDAQ:TCBI) took one of the heaviest beatings. But like Cullen/Frost (NYSE:CFR), Prosperity Bancshares (NYSE:PB), Comerica (NYSE:CMA), and BOK (NASDAQ:BOKF), Texas Capital has recouped a lot of that damage.

Texas Capital remains structured for significant growth, as loans continue to grow at a double-digit year-over-year clip, driving strong net interest income growth, while credit may be stabilizing. The question, then, is how much you want to pay for a very focused, growth-oriented Texas bank with ample room to expand. Banks like Bank of the Ozarks (NASDAQ:OZRK) underline some of the difficulties in valuing growth banks (they often, if not almost always, look expensive), and even mid-teens earnings growth isn't enough to generate a compelling fair value right now.

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After A Post-Panic Rebound, It's Harder To Find Value In Texas Capital Bancshares

Synovus Facing Some Tough Decisions

Credit where due - Synovus Financial (NYSE:SNV) management has done a great job over the last three or four years. One of the weakest mid-cap banks in the depths of the credit crisis, Synovus has done a very good job of cleaning up its credit, reinvesting in the business, and building up its capital position. With that, the return on tangible equity has improved about four points, tangible book value has improved about 10%, and the shares have solidly outperformed many regional peers.

But there is what I believe to be a very relevant "now what?" question with Synovus. Management has been returning capital to shareholders (which the market has certainly appreciated), but I think there's a choice to be made now whether to continue with the "slow and steady" approach of improving profitability through cost efficiency, continue a shift toward more C&I and retail lending, and maintaining solid buybacks, or whether to deploy capital more aggressively with M&A.

On its own, I don't think Synovus is particularly cheap right now. I do think the bank will return to low double-digit ROEs in time and I think the interest sensitivity here is appropriate, but the valuation seems right for all of that. Given the bank's footprint, though, ongoing M&A remains a real possibility - whether as a buyer or a seller.

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Synovus Facing Some Tough Decisions

Thursday, November 3, 2016

MSC Industrial Paddling Hard Just To Stay In Place

I was cautious on MSC Industrial (NYSE:MSM) a quarter ago, and the stock's slightly negative performance since then (down about 1%) is better than I'd expected - not to mention better than what other distributors like Grainger (NYSE:GWW), Fastenal (NASDAQ:FAST), and Lawson (NASDAQ:LAWS) have managed over the same time.

And yet, the operating environment remains severely challenged - the metalworking index remains in contraction, industrial production is soft, and MSC's core heavy manufacturing sector is still struggling, not to mention ongoing pressure on industrial distributors as a group.

While MSC Industrial did get a bump after fiscal fourth quarter earnings, I think a lot of that was relief and the shares look more or less fairly priced right now. I'm still looking for mid single-digit revenue growth and high single-digit FCF growth, and I do expect an eventual recovery in manufacturing and industrial MRO demand, but I still also believe that distributors are looking at a more challenging future.

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MSC Industrial Paddling Hard Just To Stay In Place

Lundbeck Takes A Few Hard Knocks

The stock market is a funny place when it comes to pharma/biotech. Analysts and investors can say that they're not really counting on a high-risk drug, but when that drug fails they nevertheless whack expectations commensurate with having had some pretty meaningful expectations. So when Lundbeck (OTCPK:HLUYY) (LUN.CO) announced disappointing (but not entirely surprising) results from its experimental Alzheimer's drug idalopiridine back in September, it seriously damaged the positive sentiment and momentum that had been carrying the stock.

Idalopiridine isn't the only issue. Trintellix continues to underwhelm and Abilify Maintena's ramp continues to be erratic, and the company recently saw a setback with a proof-of-concept clinical trial that could have helped expand Trintellix's market. On the other hand, Lundbeck's existing business continues to perform quite well otherwise, expense reductions are really making a difference, and management seemed to suggest that there are pre-clinical candidates that could come to the clinic faster now that idalopiridine has failed.

My fair value is about 6% lower now, largely due to tweaking some expectations and another downward revision in Trintellix. With a fair value of close to $41/ADR, these shares look more interesting again as a buy candidate. I am certainly concerned about the ongoing issues with Trintellix uptake and a thin pipeline, but those concerns seem more than reasonably discounted by the market.

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Lundbeck Takes A Few Hard Knocks

JPMorgan Keeps On Doing What It Does

The good news/bad news about large banks is that not all that much really changes from quarter to quarter. Banks with strong underwriting practices and good market positions tend to maintain that from quarter to quarter, and the biggest changes are often external macro factors like rate changes. With JPMorgan Chase (NYSE:JPM), then, I can't really call it a surprise that the bank had a solid third quarter with strong outperformance in its trading business and more modest, but still meaningful, outperformance in its banking operations.

Very little has likewise changed with my valuation and sentiment. It sounds as though loan growth is still strong and rate increase expectations are modest, while credit quality seems okay. These shares are still a little undervalued, but cheaper stocks in the large bank sector — like BB&T (NYSE:BBT), Wells Fargo (NYSE:WFC), and PNC (NYSE:PNC) — do have something of a "cheap for a reason" element to them.

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JPMorgan Keeps On Doing What It Does

Tuesday, November 1, 2016

Illinois Tool Works Delivering On The Growth Angle

Wall Street is not only a "what have you done for me lately" type of place, it also often likes to project ahead to the next problem to come. So while Illinois Tool Works (NYSE:ITW) is offering the sort of growth that investors would love to see from Dover (NYSE:DOV), 3M (NYSE:MMM), or Honeywell (NYSE:HON), the emphasis among some analysts seems to be on whether the company has already hit peak margins and/or whether the company is being too stingy with its M&A practices.

I still think Illinois Tool Works is a high-quality company, and I've been impressed with the growth that the company has managed since my last update - very, very few large-cap industrials have seen their organic revenue growth accelerate as 2016 has gone on, and margins continue to expand. I do think the valuation is pretty full now, but I freely admit that Illinois Tool Works has been exceeding my own expectations.

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Illinois Tool Works Delivering On The Growth Angle

The Ultratech Two-Step Continues

Although the market has cooled a bit on semi equipment names in recent months, Ultratech (NASDAQ:UTEK) continues to be its own worst enemy as revenue and order growth remain frustratingly erratic. On the positive side, the company enjoys a strong presence in advanced packaging and the support of major customers like Taiwan Semiconductor (NYSE:TSM), and it does seem as though the company's LSA tools are getting another look at 7nm and 10nm nodes. On the negative side, competition remains a real threat and it just seems like management cannot get this business on a steady trajectory.

A fair value in the mid-$20's is still valid assuming ongoing order growth in advanced packaging and 28nm laser annealing, with growth in inspection, nano, and sub-28nm annealing more of a "it'd be nice if it happened..." While the company does have over $9/share in cash on the balance sheet, it may be difficult for management to translate that into a meaningful M&A transaction.

These shares continue to have that "if they just get out of their own way" potential, but I can't argue that investors should favor this name over other equipment companies like Advanced Energy (NASDAQ:AEIS), Rudolph (NASDAQ:RTEC), and Orbotech (NASDAQ:ORBK) given the consistent inconsistency.

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The Ultratech Two-Step Continues

Honeywell: Turbulence And Opportunity

One of the more common recommendations you see with investment writing and sell-side research is "consider buying on a pullback". While it is certainly true that the market will periodically freak out for no particularly good reason(s) and take down good companies/stocks with it, a lot of those pullbacks come when companies stumble and the market overreacts. In other words, buying on dips often requires buying into trouble on the basis of the belief that the trouble is fixable and temporary.

I believe that is the case with Honeywell (NYSE:HON) today. Investors are understandably nervous about the upcoming CEO transition, and the new CEO has big shoes to fill. Investors are also troubled by the weakness in aerospace, as Honeywell is seeing program startup costs (OEM incentives) weigh heavily on results. Longer term, though, this is a company that has already cast its lot with a pivot toward automation, software, and R&D/innovation-driven revenue growth. I do see a risk that these shares could chop around for a bit, but I believe this is a good name to consider as a long-term core holding.

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Honeywell: Turbulence And Opportunity

FEMSA Comes Through Again

FEMSA's (NYSE:FMX) third quarter wasn't flawless, but it was a good quarter that showed ongoing progress in most of the initiatives that matter most to management and to the creation of shareholder value. While the "will they/won't they?" with the Heineken stake is likely to drag on, there are a lot of irons in the fire with Coca-Coca FEMSA (NYSE:KOF) and plenty of growth opportunities for the retail operation.

I haven't made too many meaningful changes to my model, and most of the change in my fair value calculation come from changes in the value of the Heineken stake (which I value at current prices) and exchange rates. With a fair value of $103 and a runway to several years of above-average growth, I believe FEMSA is worth considering as a buy candidate, particularly on the frequent pullbacks that seem to come with these shares.

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FEMSA Comes Through Again

A Respectable Start For The New FirstCash

The value of the First Cash-Cash America merger was never going to be established in just one quarter, but FirstCash (NASDAQ:FCFS) does seem to be off to a decent start, and it looks as though the U.S. business could be stabilizing. Meanwhile, the Latin American business continues to grow nicely, and the company will soon be taking its first steps into South America.

I'm still concerned that the U.S. market isn't going to offer much long-term growth, but I do believe FirstCash can achieve worthwhile operating synergies from the merger and use the relatively rich cash flow streams to fund growth initiatives in markets more promising for growth. I'm adjusting my model slightly to account for the third quarter and management's guidance, and my fair value of $55 still offers worthwhile upside if I'm right that the U.S. business will chip in low growth and good cash flow, while the Latin American business continues to grow nicely.

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A Respectable Start For The New FirstCash

Milacron Leveraged To Further Input Substitution And Emerging Markets

Milacron (NYSE:MCRN) is a sort of testament to those investors who are hardcore followers of Peter Lynch's philosophy of looking around your house and office and wondering "who makes that?". Milacron doesn't make anything you own yourself, but its plastics processing equipment is used to make a wide variety of plastic products that are used throughout the auto, packaging, consumer goods, electronics, industrial, and medical sectors.

Demand for plastics has outstripped GDP for many years running, and I expect that will continue to be the case, as OEMs substitute heavier, more expensive materials like metal with plastic wherever possible. Likewise, I expect demand to continue to grow in emerging markets like China, India, and Brazil as consumers buy more packaged goods. While Milacron's debt level is significant, future cash flows should allow the company to manage this debt while continuing to grow the business.

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Milacron Leveraged To Further Input Substitution And Emerging Markets