Wednesday, September 28, 2016

Cummins Seems To Be In A Period Of Transition

I liked Cummins (NYSE:CMI) back in February, when the sell-side's predictable doom cycle had price targets (and the share price) below $100 and the shares looked cheap even on modest long-term growth expectations. Since then, the shares have climbed about 20% - in the same ballpark as other commercial vehicle component companies like Allison Transmission (NYSE:ALSN), Dana (NYSE:DAN), and Tenneco (NYSE:TEN).

Now, though, investors are looking at a situation where the company is a little further through the ugly part of the cycle and where margins have held up pretty well, but where the shares now bake in more robust expectations. Cummins still has the wherewithal to do something significant through M&A, but management's caution here is both cause for celebration (being careful to preserve value) and concern (is there a thesis-changing deal out there?). That said, many of Cummins' customers continue to push ahead with internal engine efforts, and I think the risk/reward equation is more balanced today.

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Cummins Seems To Be In A Period Of Transition

Weak Freight And Iffy Organic Growth Remain Issues For Wabtec

Wabtec (NYSE:WAB) runs a business model that has long relied on serial M&A and that is not going to change. What has changed, though, is that the company's key North American freight rail market has weakened considerably and is likely to stay in the doldrums for some time. That puts even more pressure on management to execute on the opportunities available in growing the transit business, growing its freight business outside North America, and continuing to execute on margins.

Not many businesses generate steady double-digit ROIC, and for all of the (valid) concerns about Wabtec's reliance on M&A, I think that detail should not be ignored. What's more, even amid a sharp downturn in its freight business, margins have remained quite solid. If management can execute on long-term opportunities in transit and freight, particularly overseas, there is enough potential business out there to support a higher fair value for the stock.

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Weak Freight And Iffy Organic Growth Remain Issues For Wabtec

Monday, September 26, 2016

Geely Has Seen The Market Shift From Hesitancy To Hope

I've liked Geely (OTCPK:GELYY) (0175.HK) for a while, and I thought the company's refreshed line-up would reignite growth in 2016, but this Chinese auto OEM is doing much better than I'd expected. Sales growth has been well ahead of overall trends in China on the strength of new SUV models like the Boyue and Emgrand GS, and next year will see the first launches of products designed on a joint platform with parent company-owned Volvo.

The Hong Kong-listed shares are up almost 130% since my last update in late February (while the U.S. ADRs do trade, the Hong Kong shares are much more liquid). While the strong market reaction to Geely's new products has led me to significantly increase my fair value since then, I think you have to make some pretty bold assumptions to consider these shares fundamentally undervalued today. A lot could still go right for the company, but the risk-reward balance isn't as favorable as before.

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Geely Has Seen The Market Shift From Hesitancy To Hope

Thursday, September 22, 2016

Ongoing Outperformance At Valeo Continues To Build Value

Valeo (OTCPK:VLEEY) (VLOF.PA) doesn't have the most liquid ADRs and it is not a household name for most American investors, but this French auto components component continues to demonstrate why it's worth following. The shares are up more than 65% from my first article on the company for Seeking Alpha, and up another 15% or so since my April update, as the company continues to post double-digit content growth and exceptional order growth that paves the way for strong revenue and earnings growth over the next three to five years.

Valeo shares still appear to be priced for double-digit annual total returns. A slowdown in car sales in Europe and/or North America looms as a risk, but Valeo is well-placed with what seem to be inevitable trends towards greater adoption of LED lighting, advanced sensors/cameras, telematics, and automobile electrification and emissions control.

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Ongoing Outperformance At Valeo Continues To Build Value

Lundbeck Fails In Alzheimers

A little while ago, H. Lundbeck (LUN.KO) (HLUYY) put out a press release stating that its 5-HT6 receptor antagonist idalopirdine failed its first Phase III study (STARSHINE) in Alzheimer's, due to a "weak efficacy profile". While there are still two other Phase III studies underway, that's a pretty damning description from management, and I'd be shocked if either remaining study delivers meaningfully positive results.

This was always a high-risk, low-probability crap-shoot. While Lundbeck does do a very good job of creating/engineering drugs that are better than their class peers (generally by controlling how much they impact various receptors), the whole 5-HT6 class looks like a lost cause at this point.

The news came out after the close in Lundbeck's home market, but the ADRs were down about 12% last I looked. I had zero revenue from this program in my model, so it doesn't change my fair value at all, but clearly there were investors factoring in some option-like upside from the program.

It's too bad that yet another Alzheimer's drug candidate failed, but Lundbeck will be fine. They have another, very early-stage Alzheimer's program (a vaccine approach), but Lu AF357000 for schizophrenia is really the valuable part of the pipeline today.

Please note that I own shares of Lundbeck as of this writing

Wednesday, September 21, 2016

Tenneco Looking Almost Too Good Lately

A healthy skepticism, bordering on paranoia, is a good asset for investors to have. I liked Tenneco (NYSE:TEN) earlier this year on the prospects for content gains to drive growth above industry build rates and for investors to come around to the realization that growing light vehicle electrification isn't going to mean the end of internal combustion engines (at least not in 10 to 20 years). That said, I was surprised to see the shares climb more than 25% from that last article, as many auto/truck component companies have enjoyed a strong rally since the summer.

My skeptic spidey-sense is still tingling a little, though, because the shares still look undervalued. Strong demand for Tenneco-containing vehicles like the Ford (NYSE:F) Super Duty and F150 and General Motors' (NYSE:GM) Silverado, Sierra, and Escalade, and surprising resilience with Volkswagen's (OTCPK:VLKAY) Jetta platform are all positives, as is the margin leverage. Still, with my models now pointing to a fair value closer to $60, I'm a little concerned that I'm overlooking something. On the other hand, for those in the "don't worry, be happy" camp, business continues to develop nicely here, as the company logs beat-and-raise quarters, benefits from numerous model launches, and still looks like it has more to offer in terms of upside.

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Tenneco Looking Almost Too Good Lately

More Optimism Driving Dana

When I wrote about Dana Holding Corp. (NYSE:DAN) back in February, I thought that the shares were undervalued and leveraged to a change in sentiment. I didn't think sentiment would change so far so fast, though, and the shares are up almost 30% since then. That's on par with fellow mixed light and commercial vehicle components company Tenneco (NYSE:TEN), and better than Allison (NYSE:ALSN) and BorgWarner (NYSE:BWA), not to mention American Axle (NYSE:AXL).

Even though commercial and off-highway vehicles are still about 40% of the business (and still pretty weak), the market seems to be feeling better about these markets now. Looking specifically at Dana, the company is leveraged to light vehicle programs like the Ford (NYSE:F) Super Duty and Jeep Wrangler that could fare relatively well in the coming years and is also skewed more toward medium-duty commercial vehicles (which have held up better than heavy duty).

These shares do still look undervalued, and the upcoming analyst day in November is a chance to "rally the troops" on Wall Street and build on the momentum that has driven the stock since the summer.

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More Optimism Driving Dana

Allison Transmission Grinding Through A Rough Patch

The North American commercial truck market is still in pretty rough shape. While August vehicle orders showed sequential growth for both Class 8 trucks (up 37%) and Class 5-7 trucks (up 10%), both were down on a year-over-year basis (down 29% and down 5%, respectively). For Class 8 trucks, that's a year and a half of consecutive Y-O-Y declines in the monthly numbers, while Class 5-7 trucks have seen negative annual comps in three of the last four months.

That's a tough backdrop for Allison Transmission (NYSE:ALSN), the leading manufacturer of automatic transmissions for heavy-duty vehicles, but Wall Street has minded too much. While the shares are down a bit over the past year, they are up almost 20% from my last article, just a little below Cummins (NYSE:CMI) and Twin Disc (NASDAQ:TWIN), though the latter has been much more volatile. Investors seem to be encouraged by Allison's ability to retain strong share and good margins through this downturn, as well as the prospects for increased share on product roll-outs by customers like Navistar (NYSE:NAV) and PACCAR (NASDAQ:PCAR).

I still like Allison. It's not tremendously undervalued relative to the operating and macro risks, but it is priced for double-digit returns. More to the point, management seems to be following a sensible plan and one that I think can add share in important under-penetrated markets like metro Class 8 and international over time.

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Allison Transmission Grinding Through A Rough Patch

Wall Street's Skepticism About BorgWarner's Future May Still Mean Opportunity

Back in February, I thought BorgWarner (NYSE:BWA) shares were stuck in the difficult-to-invest space between good long-term potential and tougher short-term results (not to mention weak sentiment). Since then the shares are up about 10%, which is on the lower end of the auto parts/components companies I follow more closely (Continental's (OTCPK:CTTAY) ADRs have done worse, barely up at all, while Lear (NYSE:LEA) has done better than BorgWarner, and Valeo (OTCPK:VLEEY), Dana (NYSE:DAN), and Tenneco (NYSE:TEN) have done quite a lot better).

The central long-term debate around BorgWarner remains whether or not the company can maintain a significant presence in passenger vehicles, as major manufacturers like Volkswagen (OTCPK:VLKAY), Daimler (OTCPK:DDAIY), and Toyota (NYSE:TM) increasingly turn toward partial or full electrification for passenger vehicles. BorgWarner management still has a credibility gap brought on by lowered guidance and the company's goals for vehicle content/share post-2020 could well prove ambitious. That said, I continue to believe that the company's powertrain business and Remy assets are underappreciated and that there is upside even amidst a peaking/plateauing North American car market.

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Wall Street's Skepticism About BorgWarner's Future May Still Mean Opportunity

Tuesday, September 20, 2016

Growth Reacceleration Has Rebuilt Middleby's Multiple

When I last wrote about Middleby (NASDAQ:MIDD), I thought that a mix of concerns about growth had created a pretty rare opportunity to pick these shares up at a reasonable valuation. Since then, organic growth has improved and the shares are up around 40%. While I do think there is ample room for Middleby to improve its residential business, opportunity to improve is not the same thing as capability. I'm also a little more concerned about the company's potential growth leverage from M&A if/when interest rates start moving higher.

The valuation on Middleby shares has returned to its more normal level of overvalued in my eyes. Although the company is likely only at 10% share (or less) of its addressable market and its debt level isn't that high relative to EBITDA and/or free cash flow, roll-up stories usually reach a point of diminishing returns and the underlying market growth rate isn't that high. Middleby will likely eventually need to centralize its operations more than it has and I'd like to see the company pursue service-oriented business. Nevertheless, this is a stock I'd keep on a watch list with an eye toward taking advantage of future pullbacks.

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Growth Reacceleration Has Rebuilt Middleby's Multiple

Without Major Improvements, Manitowoc Foodservice Looks A Little Overcooked

I can appreciate scarcity value, and I can appreciate the appeal of a company that enjoys strong share in a large, fragmented market and has only recently returned to sounder operating and management policies. Even so, it's hard for me to get comfortable with the valuation on Manitowoc Foodservice (NYSE:MFS). While I definitely think its "right-sizing" and margin improvement efforts will pay off, I think the company's business mix and the underlying growth potential of the foodservice industry are limiting factors.

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Without Major Improvements, Manitowoc Foodservice Looks A Little Overcooked

Sunday, September 18, 2016

Advanced Semiconductor Needs Driving Advanced Energy Industries

This has been a good year for smaller providers of capital equipment to the semiconductor industry, with names like Brooks (NASDAQ:BRKS), Ultratech (NASDAQ:UTEK), Rudolph (NASDAQ:RTEC), MKS (NASDAQ:MKSI) and Orbotech (NASDAQ:ORBK) up around 20% to 30%. Advanced Energy Industries (NASDAQ:AEIS) has left them in the dust, though, as this company has seen its share price improve almost 60% year to date, and over 75% over the past year. Better still, this isn't just sizzle and hot air - orders for upgrades and expansions tied to new 3D chip architectures are driving real, honest-to-goodness growth in the semiconductor business and solid margins as well.

How much further can it go? Semi cap equipment is even more cyclical than semiconductors, and the stocks tend to overshoot (sometimes wildly) both to the good and to the bad). I like the prospects for design wins extending AEIS's run of semiconductor growth, just as I like the prospects for advanced 3D architectures to expand the market. I'm also bullish on the potential of markets/end-users like OLEDs proving to be larger than currently expected.

The "but" is that a lot of this is already in the share price. Valuations have moved up pretty significant from January/February of this year, and AEIS's valuation already assumes pretty meaningful improvement in revenue and EBITDA margins. While I'm not ruling out the possibility that continuing outperformance will drive higher estimates, this looks more like a growth/momentum/cyclical recovery story than any sort of value play today.

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Advanced Semiconductor Needs Driving Advanced Energy Industries

Execution Remains ON Semiconductor's Biggest Opportunity ... And Its Biggest Risk

While I thought ON Semiconductor (NASDAQ:ON) was undervalued back in February, the company's history of iffy execution relative to past margin targets and the cyclical weakness in the analog chip space were offsetting concerns. The shares are up almost 50% since then, though, which is about 10% better than the performance of the SOX over that same time, not to mention Texas Instruments (NYSE:TXN) and NXP (NASDAQ:NXPI) (though STMicroelectronics (NYSE:STM) was quite a bit closer).

Investors are certainly feeling better about the health of the chip space, and metrics like lead times would seem to support that. With ON, there's also above-average potential to grow on the back of increasing content in autos, phones, and computers. Even more significant for ON, though, is the potential to drive better margins (where the historical record is admittedly mixed) and drive real synergy from the upcoming merger with Fairchild (NYSE:FCS).

I come up with a wide range of potential values for ON Semiconductor and that seems appropriate given the confounding mix here of the potential to do better and the historical realities of the company's performance. Better days are certainly possible… but then, so too is an "Atmel (NASDAQ:ATML)-like" outcome of years and years of frustrating performance. My core DCF fair value (including Fairchild) is around $10.50 now, but there is definitely potential into the mid-to-high teens if management truly can maximize its growth and margin opportunities.

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Execution Remains ON Semiconductor's Biggest Opportunity ... And Its Biggest Risk

Thursday, September 15, 2016

Update on Lexicon

Since Seeking Alpha no longer allows meaningful updates to articles, I'll just post this here.

Lexicon announced on Sept 14 that the FDA was pushing back the PDUFA date on telotristat etiprate by 90 days (to the end of February). This was apparently triggered by a request for additional data analyses from the company and the agency's need for more time to review that.

This is not a positive development, but it's difficult to gauge its materiality. Obviously it takes away a "nice to have" positive news item, but it really doesn't impact the sales potential. The company had very little to say about this at today's BAML conference presentation, but it didn't sound like this was an especially material request.


Wednesday, September 14, 2016

Mellanox Is Taking Some Hits, But The Pessimism Seems Overdone

When I last wrote about Mellanox (NASDAQ:MLNX) in March, I ended with the following:
"The good news is that these shares seem to routinely post 25% pullbacks that give patient investors a chance to reload. At this point, I'm more inclined to wait for one of those freakouts than chase the shares today."
Since then, the shares have pulled back a little more than 25%, with a big drop in late April/early May around earnings, a rally, another decline in July/August around earnings, and an attempted rally from mid-August to mid-September that hasn't held.

Nothing much has really changed in how I view (or value Mellanox). Intel (NASDAQ:INTC) is making plenty of noise with Omni-Path, some potential Mellanox customers are adopting it, and that is having an impact on Mellanox. But that was always expected (at least by me) - the bigger question is whether Intel is really changing the game in a more meaningful way, and I don't think that's the case. I believe Mellanox will continue to be volatile, but I still believe in the basic story and that the mid-$50's is a reasonable fair value.

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Mellanox Is Taking Some Hits, But The Pessimism Seems Overdone

Lexicon Checks A Key Box

There are times when it feels like the companies I own/follow conspire to make sure I can't take days off. That was the case on Friday, when Lexicon Pharmaceuticals (NASDAQ:LXRX) announced the first top-line Phase III results for its key drug sotagliflozin in Type 1 diabetes. The results were positive, taking the stock up almost 20%, but they don't answer all of the remaining questions on this drug.

I continue to believe that Lexicon is meaningfully undervalued, with about 50% upside to my new fair value. Lexicon still needs to fully prove out the efficacy and safety of sotagliflozin in Type 1 diabetes and Sanofi (NYSE:SNY) needs to do its part with the Type 2 indication. What's more, investors would do well to remember that the FDA can be very demanding and unpredictable when it comes to new treatments for diabetes. That said, I think the risk-reward here is still interesting and worthwhile.

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Lexicon Checks A Key Box

Roper Technologies Looking A Little Wobbly Of Late

I don't write on Roper Technologies (NYSE:ROP) as often as I probably should; mostly because its collection of niche businesses makes it something of a P.I.T.A. to conduct the in-depth due diligence that I like to do. That said, you can look at Roper as either one of the most complicated simple businesses or one of the most simple complicated businesses out there in industrial conglomerate land - there are a lot of moving parts, but they're unified by an overall commitment to defensible niches, good margins, and keen attention to the generation of re-investable cash flows.

In some respects, Roper today reminds me a little too much of Dover (NYSE:DOV) for comfort - a conglomerate being hit hard by energy, but with other worrying patches of weakness appearing. That said, the shares have beat the S&P over the past year and they don't really screen as "cheap." I'd need to bump my long-term revenue growth estimate by about 0.5% to get the DCF to today's price, but Roper does seem priced to generate high single-digit annual total returns from here and that's not exactly "bad" either.

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Roper Technologies Looking A Little Wobbly Of Late

Sunday, September 11, 2016

Parker-Hannifin Looking Ahead To Better Days

When I last wrote about Parker-Hannifin (NYSE:PH) I absolutely underestimated the market's willingness to look past a rough calendar/fiscal 2016 and start hoping for a strong V-shaped recovery in 2017. I thought Parker-Hannifin offered value back in January, but I definitely didn't expect the 40%-plus move in the stock - in-line with Eaton (NYSE:ETN) and Atlas Copco (OTCPK:ATLKY), but still on the high end of the range of the industrials I follow more closely.

A healthy skepticism bordering on paranoia is a good asset for investors, and that's particularly true when you think a stock is worth meaningfully more than before a big run. I don't think a long-term expectation of 4% revenue growth or 6% FCF growth is that bullish (and my expectations for FY 2025 are about 4% lower than that last article), but with a weak year rolling out of the model, it does support a fair value of about $125 today.

That's not a big premium to today's price, but there aren't many quality industrials trading at a discount today, and as I said, seeing any discount after the big run makes me wonder if I'm missing something.

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Parker-Hannifin Looking Ahead To Better Days

Mueller Looks Hard-Pressed To Reward The Market's Rediscovered Optimism

One of the ongoing mysteries of the market that I have yet to solve is the almost evergreen enthusiasm that investors have for water-related companies. While stocks like Mueller Water Products (NYSE:MWA) and Xylem (NYSE:XYL) do have their periods of relative underperformance, it seems like there's a strong "will to believe" behind this sector that doesn't seem related to the actual underlying long-term free cash flow growth or ROIC prospects.

Be that as it may, I'm not going to look a gift horse in the mouth - I thought Mueller looked undervalued earlier this year and the 50% move in the stock since then is definitely more than I'd expected. It's also more than I think is merited by the fundamentals. I understand that housing activity and municipal spending are both looking better, and this company has been doing well with margins in its core business, but even my expectations for almost a decade of sustained double-digit FCF margins (something the company hasn't achieved before) and solid mid-single-digit revenue growth isn't enough to generate a fair value above today's stock price.

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Mueller Looks Hard-Pressed To Reward The Market's Rediscovered Optimism

Atlas Copco Muddling Through, But At A Richer Valuation

As was the case with so many industrial names, investors had a nice buying opportunity with Atlas Copco (OTCPK:ATLKY) early this year. I liked the stock back in January, and the ADRs are up about 40% since then - more or less matching Sandvik (OTCPK:SDVKY), Metso (OTCQX:MXCYY), Eaton (NYSE:ETN) and Caterpillar (NYSE:CAT), but edging out other industrial/tool names like Ingersoll-Rand (NYSE:IR), Stanley Black & Decker (NYSE:SWK), and Graco (NYSE:GGG).

Also, as is the case with so many high-quality names (and I'm thinking of companies like Honeywell (NYSE:HON), 3M (NYSE:MMM), and the like here), the improvement in the share price of Atlas Copco seems to have outpaced the improvement in business outlook. I continue to believe Atlas is an excellent company, and the total returns from here don't look awful, but it comes up short of my 10% total return target, and I'd rather wait on the sidelines in the hope of a better price.

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Atlas Copco Muddling Through, But At A Richer Valuation

Thursday, September 8, 2016

Dover Needs To Do Better

Back in February, I thought that Dover (NYSE:DOV) looked undervalued on the basis of long-term fundamentals, but that it "lacked a spark". The shares have done better than I expected since then, rising about 20% and moving past my high $60's fair value; that performance was a bit better than 3M's (NYSE:MMM), and quite a bit better than Honeywell's (NYSE:HON), but not as good as Illinois Tool Works' (NYSE:ITW) or Atlas Copco's (OTCPK:ATLKY) (all of which I liked better as companies and long-term prospects).

With more cuts to guidance since then and signs of weakness outside of energy, I remain concerned about Dover. In particular, above and beyond general market and macro weakness, I'm concerned about how Dover's management portrays and models its performance and that there's no real value to this company's conglomerate structure. While on one hand that could make Dover an interesting activist target, it could also mean middling (or worse) performance if it sticks to its recent operating philosophy.

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Dover Needs To Do Better

Maxwell Still Stuck In A Turbulent Transition

It's been practically a boilerplate warning in my prior articles on Maxwell (NASDAQ:MXWL) that this energy tech company's stock is likely to be very volatile as the company tries to cross the bridge between the Chinese hybrid bus and wind businesses that got it this far and the company's real future in applications like passenger autos, trucks, and perhaps rail and grid-scale utility markets.

With that, I'm not altogether surprised that there was a big downward revision after the last quarter and that the shares are down about 20% from the time of my last write-up.

Maxwell has frustrated a lot of investors for quite a while now, but I think there is one aspect to this story that isn't often discussed. While many energy tech companies have gone out of business because they couldn't continue to fund their large R&D needs while commercial partners tried out their technology, Maxwell has been able to use its China business to partially subsidize this extended R&D/field trial process.

Although success for Maxwell is by no means assured, companies like Continental (OTCPK:CTTAY), Valeo (OTCPK:VLEEY), and Volkswagen (OTCPK:VLKAY) are pushing on with increased electrification of passenger cars and that does represent at least a potential long-term opportunity for this electricity storage/delivery specialist.

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Maxwell Still Stuck In A Turbulent Transition