Thursday, March 23, 2017

Qualys Has To Execute Better To Live Up To Its Multiple

Potential is a tricky thing. There's no question that significant growth potential can fuel the valuation on software stocks like Qualys (NASDAQ:QLYS), but failure to execute on that potential can bring about sharp corrections and high levels of volatility. Qualys has had its challenges on the execution front over the years, but the roughly 35% increase in the share price over the last year leads me to think that investors are back to focusing on the potential, as the company looks to leverage sizable ongoing cross-selling opportunities, new product launches, and an improved go-to-market strategy.

While the opportunity is there, at least in terms of dollar volume of addressable market, I think a 5x EV/revenue multiple on 2017 is an ample reflection of that opportunity, particularly for a company that has had something less than a history of seamless execution. While the company's SaaS approach has its advantages and the Internet of Things (or IoT) is a credible opportunity, the valuation is a challenge for a company that I don't see as bringing game-changing technology into the security space.

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Qualys Has To Execute Better To Live Up To Its Multiple

PTC Looking To IoT To Drive The Next Leg

Like fellow CAD/PLM software developer Dassault (OTCPK:DASTY), PTC (NASDAQ:PTC) has almost always looked expensive by conventional valuation metrics, but the shares have nevertheless outperformed the market over the last decade as the company has built a strong business on the back of its CAD and PLM software offerings. Now, as the industrial world embraces the next wave of automation, PTC is looking at its suite of Internet of Things (or IoT) offerings to drive the next wave of growth.

PTC is on strong footing in the emerging industrial IoT space with its partnerships with the likes of GE (NYSE:GE) and Amazon (NASDAQ:AMZN), and the market potential is there. PTC shares could still have double-digit annualized upside from here if the company can deliver high single-digit revenue growth and high teens FCF growth, but it is not as though those are conservative assumptions for a company whose underlying demand is still tied to cyclical industries. I would also note that M&A potential is a potential floor here, as even with the high multiples there would likely be several interested parties in a bid for PTC.

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PTC Looking To IoT To Drive The Next Leg

Radiant Logistics Applying A Familiar Model To A Fragmented, Growing Sector

The third-party logistics (or 3PL) industry is huge, with some estimates of the addressable opportunity ranging from $160 billion to $190 billion just in the United States. Radiant Logistics (NYSEMKT:RLGT) isn't targeting all of that, or at least not yet, but the company's operations in truck and intermodal brokerage and freight forwarding do cover around one-half to two-thirds of the potential market. Radiant is still a relatively small player in comparison to companies like C.H. Robinson (NASDAQ:CHRW), XPO (NYSEMKT:XPO), Landstar (NASDAQ:LSTR), and Echo (NASDAQ:ECHO), but the company's growth-by-acquisition strategy has been used successfully many times over in this space and its addressable markets remain very fragmented.

At this point, it looks to me like the Street may be too skeptical about Radiant. While there have been recent challenges from soft demand and excess capacity, those circumstances seem to be improving. Uncertainty about U.S. trade policy is another risk factor, as is the possibility that the company will overpay for future acquisitions and/or struggle to integrate them. Recognizing those risks, I still believe there are meaningful opportunities here as the business scales up, and I think the shares look pretty interesting below $6/share.

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Radiant Logistics Applying A Familiar Model To A Fragmented, Growing Sector

Signature Bank Has Its Challenges, But The Valuation Is More Interesting

While Signature Bank (NASDAQ:SBNY) went along with the banking sector in its post-election run, the prior underperformance up to that point means that the trailing twelve-month appreciation in the stock is only about 10% - well below the performance of many bank stocks. As is often the case when former high-flyers start underperforming and/or trading at reasonable (or at least more reasonable) multiples, it's definitely worth asking if there's opportunity.

In the case of Signature, I'm cautiously optimistic. I believe the company can maintain a mid-teens earnings growth rate, and that supports a fair value a little bit above today's price. I'd also note that the company's combination of growth and returns on capital suggests that it's undervalued on a TBV basis. While weak trends in the taxi medallion portfolio and possibly slower multi-family lending should be watched and the shares aren't a clear-cut bargain, the stock could have some relative appeal compared to other banks (many of which are quite richly valued now).

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Signature Bank Has Its Challenges, But The Valuation Is More Interesting

Tuesday, March 21, 2017

UCB Needs Clinical Success To Drive Upside

Not unlike Denmark's Lundbeck (OTCPK:HLUYY) (LUN.KO), which I own, Ipsen (OTCPK:IPSEY), and Almirall (OTC:LBTSF), UCB SA (OTCPK:UCBJY) (UCB.BR) is an interesting mid-cap European pharmaceutical company that gets relatively little attention from U.S. investors, even though UCB generates close to half of its revenue in the U.S. Part of the issue is likely the low liquidity of the ADRs, and I would suggest that investors who are considering UCB look at the European shares instead.

I think UCB's price today is interesting for investors who can take on higher-than-average risk. Unlike Lundbeck, which doesn't have an especially robust early-stage pipeline, UCB has numerous NMEs in trials, and clinical data read-outs in 2017 should help frame some of the long-term opportunity. What's more, the company is approaching the release of very significant Phase III data on romosozumab (or "romo") in osteoporosis and strong data on non-vertebral fractures could be a meaningful driver. Success with romo and those high-risk Phase II read-outs could drive another $5 to $8 per share in value.

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UCB Needs Clinical Success To Drive Upside

Self-Improvement Not Quite Enough For Innophos

Innophos (NASDAQ:IPHS) has come back strong from an awful 2015, with the shares up more than 90% over the last year after a nearly 50% drop in 2015 brought about by a run of weak performance tied to iffy demand and more import competition. New management is targeting common-sense drivers for internal self-improvement, but the company's end markets remain soft and pricing is still weak. While I do think there is room for meaningful margin improvement from here, it's hard not to see today's price as an ample reflection of those expected improvements.

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Self-Improvement Not Quite Enough For Innophos

INC Research Looks Like A More Focused, Higher-Risk CRO Option

As I said in a recent piece on PRA Health Sciences (NASDAQ:PRAH), there's a lot to like about the contract research organization (or CRO) sector as trial complexity increases, R&D budgets continue to grow, and drug companies look to shift toward their specialties and more variable-expense models. Within this competitive space, INC Research (NASDAQ:INCR) has looked to stand out with an intense focus on Phase II-IV support, a greater skew towards smaller companies, and a more intense focus on a few specific therapeutic indications.

Whether this differentiated strategy will work is (and/or how well), in my mind, the key question for the stock. What INC Research is doing makes sense, but it's a riskier strategy given how much spending is accounted for by larger companies and the reliance of smaller companies on market-based funding. Performance has been more erratic here of late, with soft trends in new bookings (although the company tends to be conservative here). That said, if INC can navigate through this tough stretch and drive long-term revenue growth in the high single digits, with FCF growth in the double digits, the shares look undervalued below $50.

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INC Research Looks Like A More Focused, Higher-Risk CRO Option

Lonza Tied To Attractive Markets

Lonza (OTCPK:LZAGY) has done well since I last wrote about this Swiss specialty chemicals company, with the shares up 100% as the company has continued to see solid performance in both its pharma/bio and specialty chemical operations. While the acquisition of Capsugel is a big one, the expansion into finished oral doses (hard capsules) for the pharma/consumer health industries makes sense and should add value despite a hefty price tag.

Lonza's shares are a so-so value proposition, and there are risks that Capsugel's expense structure won't offer as many synergy opportunities as hoped. That said, the growth opportunities in biologicals, ADCs, advanced pharmaceutical ingredients, cell therapies, nutriceuticals, and hygiene are significant and can support today's valuation.

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Lonza Tied To Attractive Markets

Wolseley Needs To Focus On What It Does Best (U.S. Distribution)

It's hard to find fault with Wolseley's (OTCQX:WOSYY) (WOS.LN) recent performance. The UK shares are up more than 30% over the past year, outdoing peers like HD Supply (NASDAQ:HDS) (up almost 28%), Home Depot (NYSE:HD) (up around 13%), Lowe's (NYSE:LOW) (up about 11%), and Watsco (NYSE:WSO) (also up about 11%), not to mention others like Travis Perkins (OTCQX:TPRKY). Helping the cause has been strong growth in the U.S. business, with like-for-like growth steadily in the mid-single digits despite deflationary pressures, as the company continues to grow share.

There are certainly more ways for Wolseley to improve. Fixing, or better still selling, the businesses outside North America would likely be a good long-term move, and give the company some extra capital with which to pursue growth initiatives in the U.S. like expansion into adjacent distribution/MRO markets. What's more, the remodeling market should continue to support growth while a recovery in the industrial sector will be a welcome tailwind. The hang-up, as is so often the case, is with valuation. While the shares don't seem unreasonably priced on an EV/EBITDA basis, the free cash flow outlook is not as strong, and it's hard for me to regard this as much more than a hold.

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Wolseley Needs To Focus On What It Does Best (U.S. Distribution)

The Expectations For West Pharmaceutical Look Hard To Meet

I'm accustomed to finding a lot of companies/stocks with the basic pattern of "love the company, not comfortable with the valuation on the stock," but West Pharmaceutical Services (NYSE:WST) dials that up to 11. I really like the company's strong share in biologics delivery systems/components, its overall share in components and systems for injectable drugs, and its leverage to higher-margin, higher-growth proprietary products serving a market that I believe is set for good volume growth for the long term. What I don't like is that it would appear that not even long-term annualized FCF growth in the mid-teens or a 15x forward EBITDA multiple is enough to drive a fair value above today's price.

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The Expectations For West Pharmaceutical Look Hard To Meet

Catalent's Price Is A Little Hard To Swallow

It's frustrating to find a company/stock combination where you really like the basic business and where the stock has underperformed, but where the shares also still look too expensive. Such seems to be the case with Catalent (NYSE:CTLT). I like the pharmaceutical contract manufacturing business, and I like Catalent's strong leadership across multiple formulation technologies and its efforts to grow the biologicals business, but it is hard to model a credible outlook that leads to the conclusion that the shares are too cheap today.

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Catalent's Price Is A Little Hard To Swallow

Thursday, March 16, 2017

PRA Health Sciences' Special Mix Could Have More To Offer

It's hard enough to find undervalued stocks today, and a stock that is already up more than 40% over the last year and within a few percentage points of its 52-week high is not initially the most promising candidate. To be sure, PRA Health Sciences (NASDAQ:PRAH) is not conventionally cheap on backward-looking multiples and there are valid concerns that the CRO market could be in for a harder stretch as biotech funding dries up and Big Pharma pushes another round of consolidation. On the other hand, PRA's strong foundation in clinical trial management and its growing capabilities in strategic outsourcing and data/analytics shouldn't be ignored, and I believe there are opportunities here for the company to outgrow its addressed market.

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PRA Health Sciences' Special Mix Could Have More To Offer

Zoetis: A Well-Loved Leader

A company with leading share in almost every relevant segment of a $24 billion market, strong margins, and strong barriers to entry arguably should trade at healthy multiples, so I can't say that the valuation of Zoetis (NYSE:ZTS) comes as much of a surprise. What's more, the company isn't done growing and expanding, as the company can still target share growth in Europe, market growth in emerging markets like China, margin improvement, and expansion into adjacent markets/products. Even so, the valuation gives me pause, as I believe it already factors in strong growth and over $2.1 billion in free cash flow in 2026.

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Zoetis: A Well-Loved Leader

Even With Strong Growth Prospects, Advanced Disposal Services Looks Pricey

Solid waste stocks have enjoyed a good run of late, and Advanced Disposal Services (NYSE:ADSW), the latest entrant into the publicly-traded group, has gone along for the ride. The enthusiasm isn't unreasonable on the surface, as ongoing growth in housing, economic growth, reflation, and the prospect for a less environmentally-focused administration all support a generally favorable outlook for the industry.

For Advanced Disposal in particular, there are also company-specific drivers that support a bullish growth outlook, including the prospect for further accretive M&A. All of that said, the valuation here seems more than healthy to me, particularly given the company's vulnerability to higher rates and the possibility that interest deductibility may go away in the process of corporate tax reform. While I do like the outlook for growth and expanding margins, I can't get comfortable with paying a double-digit multiple on forward EBITDA nor assuming ongoing double-digit FCF growth on a long-term basis.

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Even With Strong Growth Prospects, Advanced Disposal Services Looks Pricey

Monday, March 13, 2017

KMG Chemicals Underfollowed But Not Unloved

Knowing when to exit a successful position is one of the hardest things in investing; good companies have a way of surprising you, and the market is often willing to reward excellence with higher multiples than the fundamentals might otherwise support. So while I thought KMG Chemicals (NYSE:KMG) was fairly valued a couple of years ago when I last wrote about this small specialty chemical company, I can't say I'm all that surprised that the shares are up another 25% or so since then (doubling the S&P 500 and doing pretty well against a grab-bag of other specialty chemical names).

Unfortunately, I find myself in a familiar position with the shares. I don't doubt that management can and will find more value-adding M&A opportunities, but the shares already seem to factor in positive developments from here. While I think a credible argument can be made for a fair value near $40, that really doesn't leave much upside for a company that I think will find organic revenue growth somewhat challenging to achieve.

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KMG Chemicals Underfollowed But Not Unloved

Kraton's Story Is A Little Complicated, But Can Still Offer Some Value

It's been a while since I last wrote on Kraton (NYSE:KRA), but I had some valuation issues and thought there might be opportunities to buy the shares at lower prices. Those opportunities did in fact materialize (there have been at least three meaningful pullbacks) and the shares have recently been quite a bit stronger - up over 60% in the past year despite multiple negative revisions and challenging input cost developments.

Kraton could still offer some upside here, but management has to execute. Efforts to shift the company toward higher-value applications have delivered mixed results, and the size of the Arizona Chemical deal is such that strong execution/integration is an absolute must. I do like the increasing diversification of the business, though, as well as its exposure to non-hydrocarbon inputs and relatively attractive markets like construction/infrastructure, medical, and adhesives. With the company potentially on a trajectory toward 20% EBITDA margins and meaningful improvement in free cash flows, $30 looks like a pretty reasonable fair value.

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Kraton's Story Is A Little Complicated, But Can Still Offer Some Value

Beijing Enterprises Can Unlock Value With More Consistency And Execution

Not all investors are comfortable with state-owned conglomerates like Beijing Enterprises Holdings (OTCPK:BJINY) (0392.HK) and that's okay. These companies can be opaque and complex, and managements will make capital allocation decisions that, at a minimum, aren't in the short-term best interests of shareholders. That said, Beijing Enterprises Holdings (or BEH) may be worth a closer look, as the company's foundation in gas distribution should offer ongoing growth and cash flow potential, while the water and waste businesses likewise can benefit from utility demand growth in China.

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Beijing Enterprises Can Unlock Value With More Consistency And Execution

Santen - An Overlooked Play On An Overlooked Space

Ophthalmology doesn't really get much attention from most drug companies, and I suppose I can't blame them - the entire global market is estimated to be worth around $25 billion in 2017 while Celgene's (NASDAQ:CELG) cancer drug Revlimid annualizes close to $8 billion in sales alone. In other words, relative to the opportunities in disease categories like cancer and auto-immune, it's not necessarily a huge moneymaker. Nevertheless, just because the space doesn't have broad appeal doesn't mean that there aren't money-making opportunities, and I think you could argue that the avoidance of the area works in the favor of companies like Japan's Santen Pharmaceutical Co. Ltd. (OTCPK:SNPHY).

While Santen's U.S. ADRs have decent liquidity, I don't think many investors pay much attention to this company, even though it is one of only three companies in the world with a full range of ophthalmic drugs. With the company holding strong share in Japan and China, building its business in the EU, and about to enter the U.S., I believe Santen could be looking at some meaningful growth opportunities in the coming years that aren't fully reflected in the share price.

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Santen - An Overlooked Play On An Overlooked Space

Thursday, March 9, 2017

Electrolux Can Do Better From Here

At first glance, there's a lot not to like about Electrolux (OTCPK:ELUXY). While this international appliance maker is competitive with companies like Whirlpool (NYSE:WHR), BSH Hausgeräte and GE's (NYSE:GE) former appliance business in terms of market share, the company's margins have been underwhelming and the company has also seen lackluster (or worse) performance in businesses like small appliances and markets like Brazil in recent years. Worse still, a transaction with GE that was supposed to significantly increase its North American business, improve its product breadth and drive margin synergies was turfed on anti-trust concerns (with Haier (OTCPK:HRELY) benefiting).

And yet, I think there are solid reasons to consider these shares. I don't think Electrolux can get to Whirlpool's double-digit North American margins, but it doesn't have to; just a couple of points of margin improvement overall would make a difference. What's more, the company has a clean balance sheet and a lot of M&A options in both its core appliance and professional equipment businesses. If I'm right about Electrolux being able to generate a 6% to 8% EBITDA and FCF growth on the back of okay top-line demand, a slow recovery in Brazil and better operating margins, 10% to 15% undervaluation seems reasonable, with a decent dividend as a bonus.

Electrolux's ADRs aren't always as liquid as an investor might want, so readers may want to consider the shares listed in Sweden as a more liquid option.

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Electrolux Can Do Better From Here

While Performing Well, The Expectations Around Agilent Are High

I was skeptical about Agilent's (NYSE:A) prospects for outperforming its peers back in the summer of 2015, but since then, Agilent shares have comfortably outperformed peers like Waters (NYSE:WAT), Thermo Fisher (NYSE:TMO), PerkinElmer (NYSE:PKI), Bruker (NASDAQ:BRKR), and Shimadzu with a 30% run that has also handily beaten the S&P 500. Management has done a better job than I'd expected of improving margins and streamlining/refocusing the business, and Agilent has also done better than I'd expected in the pharma space on the back of a strong liquid chromatography product cycle.

At the risk of sounding like a broken clock, the valuation on the shares still concerns me. The new (and improved) Agilent has been generating FCF margins in the mid-teens and while I think management can deliver upside on operating margins and asset efficiency, I'm not sure that meaningfully exceeding 20% FCF margins is highly likely. So while I do think Agilent is a good company in the life sciences tools space (and performing well), it's hard for me to get comfortable with a valuation that already assumes double-digit long-term annualized free cash flow and/or a forward EV/EBITDA multiple more than twice the likely growth rate over the next three to five years.

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While Performing Well, The Expectations Around Agilent Are High

Wednesday, March 8, 2017

Schneider Electric Looking To Earn Back Some Investor Love

Schneider Electric (OTCPK:SBGSY) has made a series of moves over the years to position itself as a leading player in automation and control, low and medium-voltage products, and electrical distribution, but it hasn't done shareholders all that much good. Relative to ABB (NYSE:ABB), Rockwell (NYSE:ROK), and Siemens (OTCPK:SIEGY), Schneider shares have been laggards over the past few years and the company has seen erosion in both margins and returns on capital.

I believe energy efficiency and automation are trends that are simply not going to go away in the coming years, and I think Schneider is well-positioned to reap benefits from them. That said, I can understand why investors are nervous about management's capital allocation priorities and its ability to drive meaningful improvement in financial operating metrics. While Schneider is not my top pick from either a valuation or quality standpoint, there does seem to be a potential opportunity here at this price that investors may want to consider.

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Schneider Electric Looking To Earn Back Some Investor Love

Restructuring The Business Could Unlock Meaningful Value For Fujitsu

As I wrote about Fujifilm (OTCPK:FUJIY) last week, that company is a relatively rare example of a Japanese conglomerate that has moved reasonably quickly to transform itself in response to changing market realities. If Fujifilm is the "after" picture, Fujitsu (OTCPK:FJTSY) is more like the "before" picture, as weak profitability in its manufactured products continues to weigh down the margin and cash generation potential of its more competitive services operations. Fortunately, management is not blind to these realities and has already initiated a process to transform the business away from its legacy hardware operations.

As of now, the Street isn't buying the notion that Fujitsu will move itself away from low-to-no profit businesses like PCs, phones, servers, and chips and re-base itself around IT services. Even though I believe the business restructuring efforts will likely lead to no net long-term revenue growth (as growth in the IT services business is canceled out by sales and divestments), I think lifting the burden of these lower-margin businesses will allow for FCF margins to improve into the low-to-mid single digits, supporting a fair value more than 25% higher than today's price.

Readers should note that Fujitsu's ADRs are not particularly liquid. With that said, I would suggest investors consider buying the Japanese shares (6702.T); most of the better brokers now support international trading and the hassle/costs are not too onerous.

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Restructuring The Business Could Unlock Meaningful Value For Fujitsu

Tuesday, March 7, 2017

A Growing Specialty Mix And Improving Acrylics Bode Well For Arkema

France's Arkema (OTCPK:ARKAY) (AKE.PA) is far from unusual in trying to shift away from commodity chemical businesses in favor of specialty businesses with higher margins and less competition, but the company has nevertheless done a good job of making that shift. I believe that at least 70% of the company's earnings can now legitimately be said to come from specialty businesses, and it has the opportunity to buy its way toward an even richer mix.

In addition to the better growth and margin potential of specialty businesses like adhesives and sealants, Arkema's commodity acrylics business could be looking at a cyclical improvement in the coming years. Looking at the cash flow potential of the business, the shares look as though they could be 5% to 10% undervalued, which I believe is enough in this market to merit a closer look. I would note that Arkema's U.S. ADRs aren't as liquid as an investor might like though, and so I'd suggest at least considering the Euronext-listed shares.

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A Growing Specialty Mix And Improving Acrylics Bode Well For Arkema

Sunday, March 5, 2017

Fujifilm's Long Transformation Process Heading In The Right Direction

Japanese companies used to have a well-deserved reputation for being stodgy; while concepts like just-in-time inventory were adopted relatively quickly, many companies have allowed themselves to become lumbering conglomerates that are slow to jettison operations with poor future prospects for growth or economic returns.

That's not so true with Fujifilm (OTCPK:FUJIY), as this company has launched two significant transformations in the past two decades - one designed to give the company life after the decline of photographic film and a more recent one intended to offset weakening prospects for office equipment. Fujifilm is arguably underrated for its healthcare business and it is this part of Fujifilm that has the best prospects for taking the business forward. Although success in drug development is by no means assured, even modest expectations would seem to support a fair value 10% higher than today's price.

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Fujifilm's Long Transformation Process Heading In The Right Direction

For Vinci, Strong Concessions Can Backstop A Contracting Recovery

France's Vinci (OTCPK:VCISY) (SGEF.PA) is a bit of an odd company in a few respects. Its contracting business is overwhelmingly large in terms of its revenue contribution, but it generates less than a third of the company's income, and the shares of this contractor and concession operator often seem to behave more like a bond than equity. It's also very much a France-centric company in terms of its revenue and earnings base, but most of its growth potential lies outside France and outside Europe.

Those quirks aside, I think this is an interesting name to look at right now. Close to 70% of the company's operating income is in high-margin, low-risk concession businesses that should continue to grow and that are supported by long-term contracts. What's more, the other 30% should see improving operating conditions as the French government moves forward with significant building projects and as industrial and energy markets recover around the world. With a double-digit annual total return potential and a roughly 3% dividend, I think Vinci merits further due diligence.

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For Vinci, Strong Concessions Can Backstop A Contracting Recovery

Rolls Royce Looking To New Civil Aerospace Deliveries To Lift Cash Flow

Commercial aviation engine suppliers make up a relatively small world, as there are really only a half-dozen companies in North America and Europe that offer competitive solutions, and most of those don't compete across the board. Rolls Royce (OTCPK:RYCEY) is a name that is probably best known for a business it's not even in (the luxury car business is owned by BMW (OTCPK:BMWYY)), but this is the third-largest aircraft engine maker and a significant player in the markets for widebody and business/regional engines.

This is an interesting time for Rolls Royce, as the company is about to see new widebody programs ramp up (which isn't actually that good for margins), older programs wind down (which is bad for margins), and likely not much progress in non-aviation areas like marine. What's more, there are well-publicized challenges with widebody aircraft these days, as many operators are turning to more efficient, more capable next-gen narrowbody planes instead.

Although the next couple of years are likely to remain challenging, and an accounting change will hammer reported earnings (but not cash flow), I believe there's an argument to be made that Rolls Royce shares are priced to generate double-digit total returns from here.

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Rolls Royce Looking To New Civil Aerospace Deliveries To Lift Cash Flow

Meritor Pursuing Bold Goals As Markets Bottom Out

There's a marked contrast between the passenger and commercial vehicle sectors now, with ample worries that the former is peaking and growing hopes that the later is bottoming out. As a commercial components player, the prospect of improving market conditions is bullish for Meritor (NYSE:MTOR), although 2017 is likely to still be a challenging year.

What's more interesting about Meritor is the bold targets that management has laid out for growth over the next few years, including 20% outperformance relative to the underlying markets. Although I don't believe Meritor will get there without M&A (which I don't model), it has been building a much better track record for itself in recent years, and I don't dismiss the possibility that the company will do better than expected. That said, today's price already seems to assume meaningful improvement at the company, and it may make more sense on a risk/reward basis to wait in the hopes of temporary disruptions or disappointments creating a more opportune entry price.

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Meritor Pursuing Bold Goals As Markets Bottom Out

Wednesday, March 1, 2017

Valley National's Slow Climb Back Up The Mountain

Banks that rely on spread income, and particularly those with expensive funding sources, have had their challenges in recent years and that includes Valley National (NYSE:VLY). On the plus side, this conservatively-run bank has a well-deserved reputation for strong underwriting and a willingness to turn over rocks and sift through the couch cushions to find ways to cut costs without compromising the long-term viability of the franchise. What's more, this company has shown that it can (and will) do deals, and it pays a healthy dividend relative to its peer group.

In this new operating environment for banks, "fairly valued" is the new cheap, and Valley National doesn't look all that overpriced to me. That said, the company is not exactly flush with capital at the moment, and I think it's fair to be concerned that future M&A could be more dilutive. Likewise, I have some concerns about the bank's positioning with respect to its loan book and its capital, but tailwinds like a lower tax rate and a less stringent regulatory environment could both help.

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Valley National's Slow Climb Back Up The Mountain

Varonis An Interesting Play On New Corporate IT Demands And Threats

Enterprises generate tremendous amounts of data and collecting, aggregating, interpreting, and securing it is a major set of challenges for IT departments. Varonis (NASDAQ:VRNS) is an interesting take on that reality, as well as the increasing realization that sometimes the greatest threats to a company's IT/data security come from within, as the company's platform of products is designed to collect, analyze, and help manage large amounts of user-generated unstructured data that exist within a corporate/enterprise IT environment.

Varonis shares are up about 50% over the past year, but still more than a third below their debut price, as the company has had its challenges living up to initial expectations regarding license growth and margin leverage.

Although Varonis's addressable market may well be quite large (multiple billions of dollars), operating leverage is a tricky question and competition from large established players like Symantec (NASDAQ:SYMC) and Dell, not to mention small upstarts, is unlikely to lessen from here. Taken in the context of growth software stories, Varonis isn't that expensive, though, and the tight bunching of sell-side expectations leads me to think that the shares could react strongly to surprises (good or bad).

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Varonis An Interesting Play On New Corporate IT Demands And Threats

Policy Jitters Creating An Opportunity With Techtronic

Although I don't write on it often, Hong Kong's Techtronic (OTCPK:TTNDY) is a company that I've enjoyed following for a long time. The company behind well-known brands like Ryobi and Milwaukee are tools and Hoover and Dirt Devil in floor care, Techtronic has done a good job over the years of growing revenue and improving margins and ROIC (its performance on free cash flow has been less impressive). What's more, there's still room for the company to gain share in established markets like the U.S., add to its assortment of product offerings, expand into other markets, and drive more operating efficiencies.

The "but" is that investors have been frustrated lately by slower progress on margin improvements and worried about the potential ramifications of the new administration in Washington, D.C. As I don't believe Techtronic has outsized vulnerability to potential trade restrictions, and does have options for dealing with them, I think this could be an opportunity.

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Policy Jitters Creating An Opportunity With Techtronic

West Fraser Sandwiched Between Healthy Markets And Trade Policy Uncertainties

After a tough decade, things have at last turned up for lumber company West Fraser (OTCPK:WFTBF) (WFT.TO) and its peers. Operating rates in North American have been in the vicinity of 90% and housing starts have been slowly grinding higher. What's more, the company's own constant focus on costs and self-improvement has positioned it to make the most of the upturn in demand.

The "but" is the uncertainty regarding trade policy between the U.S. and Canada. West Fraser is a Canadian company, and while it produces about 40% of its lumber in the U.S., that leaves another 60% vulnerable to potential tariffs. My base case is that the outcome of this trade dispute is not crippling to West Fraser, Canfor (OTC:CFPUF) (CFP.TO), or Interfor (OTC:IFSPF) (IFP.TO) (nor unfair to Weyerhaeuser (NYSE:WY)), and that West Fraser's shares are currently priced at a bit of a discount on the assumption that there's a continuing build toward 1.6M to 2.0M housing starts in 2019/2020.

While West Fraser's ADRs do have the dreaded "F," they do offer some liquidity. The Canadian shares are far more liquid, though, and most brokers facilitate trading on Canadian exchanges without too much difficulty.

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West Fraser Sandwiched Between Healthy Markets And Trade Policy Uncertainties

Sunday, February 26, 2017

Share Growth And Operating Leverage A Powerful Mix For Trex

Things have been going pretty well for Trex (NYSE:TREX), sending the shares up more than 50% over the last year and up over 90% over the last three years. Residential remodeling spending has been growing around 5% to 6% a year for several years. Trex continues to gain share within the decking space, and improved volumes have unlocked a meaningful amount of operating leverage.

I would expect 2017 to be another good year for remodeling spending, and it is possible that government policy changes (regarding taxes in particular) could lead to higher disposable income and/or consumer confidence sufficient to keep up the momentum beyond the next year. Even so, and even acknowledging the meaningful operating leverage potential still in the business, the valuation seems to already anticipate a lot of those improvements. You have to be comfortable with the idea that Trex can generate double-digit compound free cash flow growth across the next decade to find much value here, and that seems like a pretty bullish set of assumptions to me.

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Share Growth And Operating Leverage A Powerful Mix For Trex

Back To The Future With Wright Medical

As a shareholder, I'm pleased to see that Wright Medical (NASDAQ:WMGI) shares have done well since my last update after third quarter earnings. Management continues to do a good job running this business and there may well be legitimate underappreciated opportunities to outperform on the top line (new product introductions, share gains) and bottom line (better expense leverage) in the next few years.

Even so, it looks as though the Street is moving back to a "what if they get bought out?" sort of mentality, as the shares do seem to be factoring in quite a bit of growth and margin improvement from here. I don't like to bet against good management teams and good product stories, so I'm still content to hold tight with my position in Wright Medical, but I'd be a little more cautious about buying in on the assumption that a big M&A payday is right around the corner.

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Back To The Future With Wright Medical

Modine Looking To Break From Its Past

Modine Manufacturing (NYSE:MOD) has some work to do. Not only have the shares been lackluster performers compared to broadly-defined peers like BorgWarner (NYSE:BWA), Dana (NYSE:DAN), Valeo (OTCPK:VLEEY), and Lennox (NYSE:LII) for some time now, the weak history with respect to margins, revenue growth, returns on capital, and cash flow suggests that that underperformance is not unreasonable.

Management hasn't been sitting still, though, and there is perhaps a more bullish outlook now. Multiple restructuring efforts have seen several plants closed over the past decade and tens of millions of dollars taken out of the cost structure more recently. What's more, management significantly accelerated its mix shift away from vehicles with what looks like a logical and reasonably priced deal. If these improvements can move the company close to a 10% EBITDA margin, there may be an argument that the shares are undervalued, though the lackluster free cash flow generation is a risk factor that I wouldn't ignore.

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Modine Looking To Break From Its Past

Valuation Complicates An Otherwise Interesting Story At W.R. Grace

W.R. Grace's (NYSE:GRA) shares have enjoyed a healthy valuation for most, if not all, of the time since the company emerged from bankruptcy, and that probably explains at least some of the underperformance relative to other specialty chemical companies like Albemarle (NYSE:ALB), BASF (OTCQX:BASFY), and Evonik (OTCPK:EVKIF) over the last few years. And that's the problem with valuation - there is a lot to like about W.R. Grace, one of the leaders in an oligopolistic sector and a chemicals company with uncommonly good margins, but it takes some stretching to drive an attractive fundamentals-based fair value.

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Valuation Complicates An Otherwise Interesting Story At W.R. Grace

CapitaLand Evolving With The Times

Singapore's CapitaLand (OTCPK:CLLDY) (C31.SI) really hasn't done much for investors since the last time I wrote on this high-quality property developer. Although the shares have outperformed peers/comps like China Overseas (OTCPK:CAOVY) and City Developments (OTCPK:CDEVY), I don't think "less bad" is what investors should shoot for, and sentiment has been weighed down by tougher conditions in the Singapore and China property markets, skepticism about the sector as a whole, and a slower progression towards management's ROE goals.

CapitaLand shares do still look undervalued, and I think CapitaLand will be a long-term winner in the space. What's more, I think the company's efforts to invest in Vietnam and pursue an asset-light model will give shareholders a better growth and return mix down the road. That said, the U.S. ADRs are not especially liquid (the Singapore-listed shares are much more liquid, though) and I believe this is a difficult type of company for individual investors to track, benchmark, and analyze.

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CapitaLand Evolving With The Times