Category: Shares

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Shares Small Cap

Resale looks like a bargain as Poshmark has $26 fair value estimate

Business Strategy and Outlook:

Poshmark is among the largest apparel resale platforms on the market, boasting an interactive marketplace that benefits from a triumvirate of secular tailwinds: social commerce, an ongoing mix-shift toward online retail sales, and the stratospheric growth of the apparel resale market. The firm’s strategy coalesces around four key priorities: product innovation, category expansion, international growth, and buyer acquisition. We take a neutral view of management’s roadmap, with our research leaving us unconvinced that Poshmark’s international thrusts are poised to generate excess returns for investors, and surmise that purportedly adjacent categories like consumer electronics, art, or pets may not be concordant with the firm’s apparel core competency.

As a slew of firms have entered the resale space, competition has arisen around exclusive access to customers, inventory assortment, and distribution channels, with long-term equilibrium remaining uncertain. Consolidation looks inevitable, particularly as the scope of those companies’ offerings see increasing overlap, commensurate with category, price point, and geographic expansion. Poshmark’s right to win hinges on its ability to convincingly answer the “why Poshmark?” query, attracting platform participants with some combination of competitive seller services, frictionless listing, quick inventory turnover, attractive fees, broad assortment, and authentication services.

Financial Strength:

Poshmark’s financial strength is viewed as sound. The firm carries no long-term debt, has $236 million in cash and cash equivalents on its balance sheet as of the third quarter of 2021, and figures to be free cash flow positive over two of the next three years. The management has adequate wiggle room to pursue moat-bolstering investments, while narrowing operating losses should provide a route to enduring profitability by our midcycle (2025) forecasts. Following its IPO, the firm’s capital structure has simplified meaningfully, retiring $50 million in convertible notes issued during the third quarter of 2020 that carried a panoply of derivative clauses. Shareholder dilution hereafter should be limited to those shares issued in the normal course of business, with approximately 8.6 million options and RSUs outstanding (just north of 11% of free float) as of the third quarter balance sheet date. Poshmark’s waterfall of investment priorities is viewed as consistent with other high growth firms: pursuing internal investments and strategic mergers and acquisitions.

Bulls Say:

  • Five straight quarters of operating profitability (ending in the third quarter of 2021) suggest a strong underlying business model once acquisition costs normalize. 
  • Early traction in Australia and Canada could augur well for long-term success in those markets. 
  • Adding APIs and analytics tools for wholesalers and liquidators could add another platform use case, while generating higher units per transaction, average order values, and fulfillment cost leverage.

Company Profile:

Poshmark is one of the largest players in a quickly growing e-commerce resale space, connecting more than 30 million users on a platform that sells men’s and women’s apparel, accessories, shoes, and more recently consumer electronics and pet products. The marketplace operates in four countries–the U.S., Canada, Australia, and India–with a capital-light, peer-to-peer model that dovetails nicely with prevailing trends toward social commerce, apparel resale, and an ongoing pivot toward the e-commerce channel. With $1.4 billion in 2020 gross merchandise volume, or GMV, we estimate that the firm captured just shy of 10% of the global resale market, as rolling lockdowns and tangled supply chains provided a meaningful impetus for channel trial during 2020 and 2021.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Technology Stocks

ResMed reported 2Q22 results reflecting strong revenue growth to US$894.9m, up +12%, or +13%

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Investment Thesis

  • Global leader in a significantly under-penetrated sleep apnea market. 
  • High barriers to entry in establishing global distribution channels. 
  • Strong R&D program ensuring RMD remains ahead of competitors.
  • Momentum in new masks releases. 
  • Bolt-on acquisitions to supplement organic growth.
  • Leveraged to a falling Australian dollar. 

Key Risks 

  • Disruptive technology leading to better patient compliance.
  • Product recall leading to reputational damage.
  • Competitive threats leading to market share loss.
  • Disappointing growth (company and industry specific).
  • Adverse currency movements (AUD, EUR, USD).
  • RMD needs to grow to maintain its high PE trading multiple. Therefore, any impact on growth may put pressure on RMD’s valuation.

Key Highlights 2Q22 Results

  • Revenue increased 12% (13% in constant currency) to US$894.9m driven by higher demand for sleep and respiratory care devices and a major product recall by one of the Company’s largest competitors. Across geographies, revenue in the Americas climbed +14%, in Europe, Asia, and other markets it increased +12%, and RMD’s software-as-a-service business saw +8% revenue growth. By product segment, globally in constant currency terms device sales increased by 16%, while masks and other sales increased by 10%.  
  • Non-GAAP operating income of $267.7m, up +5%. This equated to US$1.47 per share, up 4%.
  • Net income was up +12% to US$201.8m. 
  • Gross margin declined 230 basis points to 57.6%.
  • Diluted earnings per share was up +11% to US$1.37.
  • The Board declared quarterly dividend of US42cps. 
  • RMD’s balance remains strong with cash balance of $194m, $680m in gross debt and $496m in net debt, whilst debt levels remain modest, and the Company retains ~$1.6bn for drawdown under its existing revolver facility.

Company Profile 

ResMed Inc (RMD) develops, manufactures, and markets medical equipment for the treatment of sleep disordered breathing. The company sells diagnostic and treatment devices in various countries through its subsidiaries and independent distributors. RMD reports two main segments – Americas and Rest of the World (RoW) – with US its largest market. The company is listed on the Australian Stock Exchange (ASX) via CDIs (10:1 ratio). 

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Paylocity Wins Amid the War for Talent and a Bounce-Back in Labor Markets

Business Strategy and Outlook:

Paylocity delivered strong second-quarter fiscal 2022 results underpinned by a continued normalization of employment levels and growing demand for solutions to attract, manage, and retain employees amid fierce competition for labor and dispersed workforces. Amid tight labor markets and an intensifying war for talent, businesses are seeking solutions to attract and retain employees, which is creating industry tailwinds for all payroll and human capital management (HCM) players. Additionally, a sustained shift to dispersed workforces in a post-COVID-19 world is driving demand for HCM software that helps employers connect and manage remote employees or employees across multiple jurisdictions. Paylocity is expected to have capitalized on these tailwinds over the quarter through the appeal of the platform’s unique complimentary collaboration features such as social collaboration platform Community, and video and survey functionality. As with payroll and HCM peers, it is expected to uptake of these features aimed at driving higher employee engagement will entrench the software further into the client’s business and strengthen the customer switching.

Paylocity’s target market has naturally skewed upmarket in recent years as the platform and its embedded modules have evolved. Recent acquisitions including software integration tool Cloudsnap in January 2022 and global payroll provider Blue Marble in September 2021 position Paylocity well to cater for the needs of larger clients. To reflect this shift, the company has formally raised the upper limit of its target client to 5,000 employees, from 1,000 employees previously. At this stage, analysts maintain our longterm forecasts and take the announcement as a formalization of the current client mix, instead of a strategic shift upmarket.

Financial Strength:

The revenue growth estimated at a compound annual growth rate of 23% over the five years to fiscal 2026, driven by mid-single-digit industry growth, market share gains, and mid-single-digit revenue per client growth on greater uptake and monetization of modules. Over the same period, operating margins are expected to increase to about 20% from 9% in a COVID-19-affected fiscal 2021. This uplift is anticipated to be driven by operating leverage from increased scale, greater uptake of high margin modules, higher interest on client funds, and operating efficiencies from increased digital sales and service. Paylocity’s revenue increased an impressive 34% on the prior year. Following strong sales activity during the quarter and robust client retention, analysts have marginally lifted their full-year revenue and adjusted EBITDA forecasts 1% and 4%, respectively, to align with updated near-term guidance. EPS is expected to increase 14% to $1.48 in fiscal 2022, before growing at a CAGR of 32% to fiscal 2031 as Paylocity continues to grow scale and achieves operating leverage. 

Company Profile:

Paylocity is a provider of payroll and human capital management, or HCM, solutions servicing small- to mid-size clients in the United States. The company was founded in 1997 and targets businesses with 10 to 5,000 employees and services about 28,750 clients as of fiscal 2021. Alongside core payroll services, Paylocity offers HCM solutions such as time and attendance and recruiting software, as well workplace collaboration and communication tools.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Dividend Stocks Shares

Capable Hands Remain at the Helm of Magellan; Valuation Upside High as Shares Lose Steam

Business Strategy and Outlook

Magellan is an active manager of listed equities and infrastructure. The firm has a fundamental, high-conviction investment approach. Its flagship Global strategy has historically tilted toward IT, e-commerce platforms, and consumer franchises; preferring large, developed market multinationals. FUM have been attracted by consistently achieving excess returns with lower volatility and drawdowns relative to peers.

Magellan’s products are well-distributed. Its funds are featured across platforms.There is a focus on targeting retail investors, with product expansion an increasingly common driver of growth. After pioneering the first active ETF in Australia in 2015, Magellan has worked on attracting new FUM via its partnership initiatives, launching its own low-cost active ETFs, and introducing a new equity fund that caters to retirees seeking predictable income.

Morningstar analysts think Magellan has built the foundations for ongoing earnings growth, supported by its economic moat, product variety, and historically strong track record. Regardless, the potential earnings upside from these positive traits will take time to manifest. In light of Magellan’s recent underperformance, Mornigstars analysts believe a sustained improved track record will be the precursor to stronger fund inflows.

Morningstar analysts anticipate fee margin compression from investors trading down from Magellan’s core funds in preference for its low-cost ETFs, mix shift to other asset classes, and industry wide fee pressure. Continued strong performance is key to sustaining margins, as future FUM growth is likely to hinge more on market movements rather than net inflows given Magellan’s maturity and scale.

Capable Hands Remain at the Helm of Magellan; Valuation Upside High as Shares Lose Steam

Magellan has historically delivered above market returns with relatively low drawdowns. This has allowed it to rapidly scale in FUM to over AUD 93 billion and provides the foundation for continued earnings growth. While Morningstar analysts don’t believe it will be immune from the structural trend of investors moving to passive investments, ongoing competition among fund managers and major institutions in-housing their asset management, and is better placed than most active managers to address these headwinds. Magellan is moving beyond just managing money, to implementing new initiatives such as product expansion to attract new money. Morningstar analysts  believe shares are undervalued, but concur there are limited near-term earnings and share price catalysts due to recent underperformance. 

Chairman and CIO Hamish Douglass’ indefinite leave from Magellan . But morningstar analysts  don’t believe this is overly value-destructive for shareholders. In the interim, Chris Mackay and Nikki Thomas will work with Magellan’s investment team to manage its flagship Global Equity strategies. The strategies are in good hands. Mackay is Magellan’s co-founder, and was its chairman and CIO until 2012. Despite analysts’ conviction in Magellan, Morningstar’s analyst concern is not all investors may be willing to ride out this storm. Thus Morningstar analysts have lowered its fair value estimate to AUD 34.50 per share from AUD 38, after factoring in 3% more net outflows than before and further trimming our retail fee forecasts.

Financial Strength 

Magellan is in sound financial health. The firm has a conservative balance sheet with no debt, with its financial position also boosted by solid operating cash flows. As of June 30, 2021, Magellan had cash and equivalents of about AUD 212 million and financial investments with a net fair value of around AUD 453 million mainly invested in its own unlisted funds and listed shares. This should provide it with enough liquidity to cope with most market conditions. Its high dividend payout ratio of: (1) 90%-95% of the net profit after tax of its core funds management business before performance fees; and (2) annual performance fee dividend in the range of 90%-95% of net crystallised performance fees after tax reflects the capital-light nature of asset management.

Bulls Say

  • Magellan retains an intangible brand, supported by historically strong performance, which it has leveraged to hold on to client funds, attract new money and charge premium fees. 
  • Due to structural market trends and product expansion initiatives, the prospects for organic FUM growth is strong, notably from investors seeking to diversify exposure to international equities or gain a steady retirement income stream. 
  • Aside from domestic tailwinds from superannuation, Magellan’s distribution relationships in the much larger offshore markets of the U.K. and the U.S. should support growth.

Company Profile

Magellan Financial Group is an Australia-based niche funds manager. Established in 2006, the firm specialises in the management of equity and infrastructure funds for domestic retail and institutional investors. Magellan has been particularly successful in winning mandates from global institutional investors. Current FUM is split across global equities, infrastructure and Australian equities.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Small Cap

Capri Has Suggested The Two Brands (Jimmy Choo and Versace), When Mature, Could Combine For Operating Profit Of $450 Million

Business Strategy and Outlook

It is probable Michael Kors lacks the brand strength (and ultimately pricing power) to provide an economic moat for Capri. Powered by store openings and retail expansion in the 2010-15 period, Michael Kors became one of the largest American handbag producers in sales and units. However, its sales have declined from peak levels due to markdowns at third-party retail, store closures, and weakness in some categories. While Capri has reduced distribution to limit discounting of its bags, competition in the American handbag market is fierce, and store closures in the region continue. Michael Kors, though, has good potential in Asia, which Bain & Company expects will compose 50% (up from 37% at present) of the worldwide luxury market by 2025. It is foreseen the brand stands to win favor with Chinese consumers, but it is not foreseen for the brand to reach Capri’s $1 billion Asia sales target (up from $448 million in fiscal 2021) in the next 10 years given its limited tenure in the region relative to Coach and others. 

Capri spent a steep $3.4 billion to purchase Jimmy Choo and Versace to boost its status as a luxury house and reduce its dependence on Michael Kors. However, it is not likely these deals have changed Capri’s no-moat status as the acquired brands have more fashion risk, less profitability, and narrower appeal than Michael Kors. Capri is investing in store remodels, store openings, and expanding the set of accessories for both Jimmy Choo and Versace, but it is not seen these efforts will yield the intended gains, particularly given the severe interruption it is probable from COVID-19. While Capri has suggested the two brands, when mature, could combine for operating profit of $450 million and account for 30% of its total, it is not probable for this to happen until the end of this decade.

Financial Strength

Capri has debt, but it is seen as it is very manageable. The firm took on significant debt to fund its Jimmy Choo and Versace acquisitions, which came with a combined price tag of $3.4 billion. At the end of December 2021, it had total short- and long-term debt of $1 billion, but it also had more than $261 million in cash and $1 billion in available borrowing capacity. Moreover, during the COVID-19 crisis, it amended its revolving and term loan credit agreement so that most of its term loan that was due in December 2020 was extended to December 2023. Thus, Capri has no significant debt maturities prior to 2023. The firm’s debt/adjusted EBITDA was a very manageable 2.3 at the end of fiscal 2021, and it is foreseen this will fall to 0.8 at the end of fiscal 2022 on greater EBITDA and debt reduction. Capri has resumed share repurchases, which were suspended during the pandemic. The firm averaged more than $500 million in annual buybacks in fiscal 2015-20. It is now foreseen its share repurchases at an annual average of about $740 million over the next decade. However, Capri does not pay dividends.Capri plans to open new stores and remodel existing stores for all three of its brands, although these efforts stalled in fiscal 2020 due to COVID-19. Analysts forecast its fiscal 2022 capital expenditures will rise to $205 million (3.7% of sales) from just $111 million (2.7% of sales) last year. Long term, Analysts forecast Capri’s annual capital expenditures as a percentage of sales at 4.1% as management works to improve the performance at Jimmy Choo and Versace.

Bulls Say’s

  • Michael Kors is one of the largest brands in terms of units and sales in the high-margin handbag market, and it is likely, this positioning should aid its prospects as it looks to grow in complementary categories like footwear. 
  • Michael Kors has reduced its dependence on wholesale customers, which is viewed favorably as increased direct-to-consumer sales allow for better pricing and control over marketing. 
  • The acquisitions of Jimmy Choo and Versace afford diversification opportunities by bringing two luxury brands that maintain products with high price points into the fold.

Company Profile 

Michael Kors, Versace, and Jimmy Choo are the brands of Capri Holdings, a marketer, distributor, and retailer of upscale accessories and apparel. Kors, Capri’s largest brand, offers handbags, footwear, and apparel through more than 800 company-owned stores, wholesale, and e-commerce. Versace (acquired in 2018) is known for its ready-to-wear luxury fashion, while Jimmy Choo (acquired in 2017) is best known for women’s luxury footwear. John Idol has served as CEO since 2003 but will be replaced in the position by Joshua Schulman in late 2022. (Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Grainger Shows Strong End Market Growth to Close out 2021; but We See Shares as Still Overvalued

Business Strategy and Outlook

W.W. Grainger operates in the highly fragmented maintenance, repair, and operating product distribution market, where its over $13 billion of sales represents only 6% global market share (the company has 7% share in the United States and 4% in Canada). The growing prevalence of e-commerce has intensified the competitive environment because of more price transparency and increased access to a wider array of vendors, including Amazon Business, which has entered the mix. As consumer preference began to shift to online and electronic purchasing platforms, Grainger invested heavily in improving its e-commerce capabilities and restructuring its distribution network. It is the now the 11th-largest e-retailer in North America; it shrank its U.S. branch network from 423 in 2010 to 287 in 2020 and added distribution centres in the U.S. to support the growing amount of direct-to-customer shipments. Still, the company had work to do on its pricing. Grainger historically relied on a pricing model that applied contractual discounts to high list prices. Leading up to 2017, though, this model made it difficult to win new business. To address this problem, Grainger rolled out a more competitive pricing model. Lower prices hurt gross profit margins, but volume gains, especially among higher-margin spot buys and midsize accounts, have offset price reductions and helped the company meet its 12%-13% operating margin goal by 2019 (12.1% adjusted operating margin in 2019.

Grainger continues to expand its endless assortment strategy, albeit skeptical of the margin expansion opportunity for this business, given strong competition in the space from the likes of Amazon Business and others. Still, Grainger has distinct competitive advantages in its traditional business, such as its long-standing relationships with large customers and its inventory management solutions, which should help it earn excess returns over the next 10 years.

Financial Strength

As of the fourth quarter of 2021, Grainger had $2.4 billion of debt outstanding, which net of $241 million of cash, represents a leverage ratio of about 1.2 times our 2022 EBITDA estimate. Grainger’s leverage ratio is relatively conservative for the industry, in our view. We believe the company certainly has room to increase leverage if needed, but management looks to be committed to keeping its net leverage ratio between 1-1.5 times. Grainger’s outstanding debt consists of $500 million of 1.85% senior notes due in 2025, $1 billion of 4.6% senior notes due in 2045, $400 million of 3.75% senior notes due in 2046, and $400 million of 4.2% senior notes due in 2047.Grainger has a proven ability to generate free cash flow throughout the cycle. Indeed, it has generated positive free cash flow every year since 2000, and its free cash flow generation tends to spike during downturns because of reduced working capital requirements. By our midcycle year, we forecast the company to generate over $1 billion in free cash flow, supporting its ability to return free cash flow to shareholders. Given the firm’s reasonable use of leverage and consistent free cash flow generation, we believe Grainger exhibits strong financial health.

Bulls Say’s

  •  With a more sensible, transparent pricing model, Grainger should continue to gain share with existing customers and win higher-margin midsize accounts. 
  • As a large distributor with national scale and inventory management services, Grainger is well positioned to take share from smaller regional and local distributors as customers consolidate their MRO spending. 
  • Grainger operates a shareholder-friendly capital allocation strategy; it has increased its dividend for 49 consecutive years and has reduced its diluted average share count by nearly 45% over the last 20 years.

Company Profile 

W.W. Grainger distributes 1.5 million maintenance, repair, and operating products that are sourced from over 4,500 suppliers. The company serves about 5 million customers through its online and electronic purchasing platforms, vending machines, catalog distribution, and network of over 400 global branches. In recent years, Grainger has invested in its e-commerce capabilities and is the 11th-largest e-retailer in North America.

 (Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Shares Small Cap

Virgin Money Margins on the Rise, but the Loan Books a Little Lighter

Business Strategy and Outlook

Virgin Money UK consists of the CYBG business (demerged from National Australia Bank, or NAB), and the more recently acquired Virgin Money UK. In 2016, NAB demerged its U.K.-based operations in Clydesdale Bank and Yorkshire Bank, collectively known as CYBG. The CYBG merger with Virgin Money UK virtually doubled the size of the bank’s loan book and provided a foothold in the larger and faster growing London region. The bank’s loan book is split 80% mortgages, 12% business loans, and 8% personal (including cards) as at September 2021. 

Acquiring Virgin Money in 2018 was transformative for CYBG. A larger and more geographically diverse mortgage book lowers risk and presents cost saving opportunities, but also presents the opportunity to grow its business loan book under the Virgin Money banner. Aiming to maintain its share of the mortgage market, the bank wants to reduce its weighting to mortgages to 75% as it grows its business loan book.

Financial Strength

The capital structure and balance sheet are sound. Common equity Tier 1 capital was 15.2% as at Dec. 31, 2021, well above the 9.5% minimum capital benchmark. The bank has a longer-term dividend payout goal of up to 50%. The percentage of funding sourced by customer deposits was 83% as at Sept. 30, 2021, the elevated savings rate in 2021 helped the bank increase the weight of funds to cheaper business and personal current accounts materially. These current accounts and linked savings increased 19% in the fiscal 2021, making up 38% of funding as at Sept. 30, 2021 and up from 31% at end of fiscal 2020. Virgin Money UK received internal ratings-based, or IRB, accreditation from the U.K. regulator for its mortgage and SME/corporate loan portfolios mid-October 2018. Virgin Money UK is now authorised to use its own risk models in determining risk weighted assets, resulting in a reduction in risk weighted assets for the two portfolios and thereby improving its capacity to grow share.

Bulls Say’s 

  • Virgin Money UK is a well-capitalised and well-funded retail and small-business bank with long-established franchises in core regional markets. 
  • Management’s ability to successfully integrate the merger with Virgin Money is critical to our thesis. 
  • Legacy conduct issues have caused pain for shareholders despite balance sheet provisions and conduct indemnities provided by National Australia Bank. It have made no allowance for large penalties or customer remediation in our forecasts.

Company Profile 

Virgin Money UK was formed through the merger between CYBG PLC and Virgin Money. After being divested by National Australia Bank in 2016, CYBG went through a restructuring and recapitalisation process, with mortgages accounting for around 75% of its loan book. Following CYBG’s merger with Virgin Money, the loan book has been reshaped again, with mortgages now accounting for more than 81% of total loans, personal loans around 7%, and SME and business loans around 12%. The merger with Virgin Money does provide upside earnings potential, but operating conditions are tough, with business momentum slowing. An upturn in the earnings outlook is needed after several years of disappointment.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Sensata To Use Bolt-on M&A To Supplement Sensor Content Growth In Its Core Markets

Business Strategy and Outlook

It is understood Sensata Technologies is a differentiated supplier of sensors and electrical protection. The firm has oriented itself to benefit from secular trends toward electrification, efficiency, and connectivity, and it is supposed that investors will see meaningful topand bottom-line growth as upon an automotive market recovery. 

Despite the cyclical nature of the automotive and heavy vehicle markets, electric vehicles (EVs) and stricter emissions regulations provide Sensata the opportunity to sell into new sockets, which has allowed the firm to outpace underlying vehicle production growth by about 4% historically. It is alleged such outperformance is achievable over the next 10 years, given the expectations for a fleet mix shift toward EVs and Sensata’s growing addressable content in higher-voltage vehicles. 

It is observed, Sensata’s ability to grow its dollar content in vehicles demonstrates intangible assets in sensor design, as it works closely with OEMs and Tier 1 suppliers to build its products into new sockets. It is also believed the mission-critical nature of the systems into which Sensata sells gives rise to switching costs at customers, leading to an average relationship length of 31 years with its top 10 customers. As a result of switching costs and intangible assets, it is held Sensata benefits from a narrow economic moat and will earn excess returns on invested capital for the next 10 years. 

Over the next decade, it is anticipated Sensata to use bolt-on M&A to supplement sensor content growth in its core markets. Sensata established a leading share in the tire pressure monitoring system (TPMS) market in 2014 with its acquisition of Schrader, and it is implicit acquisitions will play a key role in allowing the firm to enter new, higher-growth, adjacent markets. Recent acquisitions of GIGAVAC and Xirgo will allow Sensata to compete in the electric vehicle charging infrastructure and telematics markets, respectively, which is likely to begin to bolster the top line and margins near the end of analyst’s explicit forecast and beyond.

Financial Strength

Sensata Technologies is leveraged, but it is held that its balance sheet is in good shape, and that it generates enough cash flow to fulfill all of its obligations comfortably. As of Dec. 31, 2021, the firm carried $4.2 billion in total debt and $1.7 billion cash and equivalents. Sensata closed out 2021 with a net leverage ratio of 2.8 times, which is squarely in management’s target range of 2.5-3.5 times. Over the next few years, it is probable Sensata to stay in its target leverage range as it continues to engage in supplemental M&A. Between 2023 and 2026, Sensata has $2.1 billion total in debt maturing, with $400 million-$700 million coming due each year. It is projected the firm to easily fulfill its obligations with its cash balance and cash flow—it is foreseen over $700 million in average annual free cash flow over Analyst’s explicit forecast. Finally, it is noted that Sensata has a variable cost structure that allows it to keep a relatively healthy balance sheet during difficult demand environments. Even with weak end markets in 2019 and 2020 that shrunk the top line, Sensata’s free cash flow generation held steady, with its free cash flow conversion jumping to 130% in 2020.

Bulls Say’s

  • Sensata should benefit from secular trends toward electrification, efficiency, and connectivity to continue outgrowing global vehicle production. 
  • Fleet management is an opportunity for Sensata to expand its margins and create a recurring base of revenue in an emerging, high-growth market. 
  • Sensata has some of the sensor industry’s highest margins and strong free cash flow conversion, providing it with capital to invest in organic and inorganic growth.

Company Profile 

Sensata Technologies is a leading supplier of sensors for transportation and industrial applications. Sensata sells a bevy of pressure, temperature, force, and position sensors into the automotive, heavy vehicle, industrial, heating, ventilation, and cooling (HVAC), and aerospace markets. The majority of the firm’s revenue comes from the automotive market, where it holds the largest market share for tire pressure monitoring systems. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Strong Revenue Growth Continued in Pentair’s Fourth Quarter, but Cost Inflation Pressured Margins

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Business Strategy and Outlook

Pentair is a pure play water company manufacturing a wide range of sustainable water solutions, including energy-efficient swimming pool pumps, filtration solutions, as well as commercial and industrial pumps. Pentair’s business is organized into two segments: consumer solutions and industrial & flow technologies. Consumer solutions (58% of Pentair’s sales in 2021) concentrates on business-to-consumer sales and includes aquatic systems as well as residential and commercial filtration. 

The aquatic systems business, which offers a full line of energy-efficient equipment for residential and commercial swimming pools (including pumps, filters, heaters, and other equipment and accessories), is the crown jewel in Pentair’s portfolio, as it is both its fastest-growing and most profitable business. Industrial & flow technologies (42% of sales in 2021) focuses on business-to-business sales and consists of industrial filtration (including the food and beverage end market), residential irrigation flow, and commercial and infrastructure flow.

Financial Strength

Pentair ended the fourth quarter of 2021 with $894 million of long-term debt while holding $95 million in cash and equivalents. Debt maturities are reasonably well laddered, with only about $88 million maturing in 2022. Furthermore, the company has an additional $764 million available under its revolving credit facility. The company is bound by a debt/EBITDA covenant that requires that the ratio not exceed 3.75 times.

Narrow moat-rated Pentair reported solid fourth-quarter results, as its full-year sales of $3,765 million and adjusted EPS of $3.40 both surpassed our previous estimates ($3,709 million and $3.35, respectively). For full-year 2022, management expects sales growth of 6% to 9% and adjusted EPS in the range of $3.70 to $3.80. After rolling our model forward one year, we’ve modestly bumped our fair value estimate for Pentair to $70 from $69, mostly due to time value of money as well as reversing the implementation of a probability-weighted change in the U. S. statutory tax rate in our model.

Bulls Say’s 

  • Pentair is a pure play water company poised to benefit from demand for sustainable and energy-efficient water solutions. 
  • The pool business continues to deliver solid revenue growth, consistent market share gains, and lucrative operating margins. 
  • Recent acquisitions of Pelican Water and Aquion will bolster Pentair’s portfolio of water solutions in the residential and commercial markets.

Company Profile 

Pentair is a global leader in the water treatment industry, with 10,000 employees and a presence in 25 countries. Pentair’s business is organized into two segments: consumer solutions and industrial & flow technologies. The company offers a wide range of water solutions, including energy-efficient swimming pool equipment, filtration solutions, and commercial and industrial pumps. Pentair generated approximately $3.8 billion in revenue and $686 million in adjusted operating income in 2021.

(Source: Morningstar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.

Categories
Global stocks Shares

Norfolk Southern’s Intermodal a Key Long-term Growth Opportunity

Business Strategy and Outlook

Norfolk Southern is a well-managed enterprise, and from the start of the rail renaissance in 2004 through 2008, it posted the highest margins among U.S. Class I railroads. However, its operating ratio (expenses/revenue) deteriorated to 75.4% in 2009 and remained stuck between 69% and 73% from 2010 to 2015. This pales in comparison to progress made by peers Union Pacific and Canadian Pacific, which lack Norfolk’s exposure to Appalachian coal. However, by 2017 the rail was back on track, and it has achieved record ORs in each year since, including an adjusted 60.1% in 2021. In recent years, Norfolk renewed its commitment to pricing discipline and margin gains, particularly via precision railroading initiatives, which have driven more efficient use of locomotive assets, labor, and fuel. It is anticipated incremental gains as the firm continues to refine its PSR playbook. Of note, in late 2019, former Canadian National CEO Claude Mongeau (2010-16) joined Norfolk’s board of directors in part to help bolster the rail’s PSR efforts. 

Norfolk hauls coal directly from Illinois and Appalachian mines, and transfers Powder River Basin coal eastward from the Western rails. Thus, coal-demand headwinds and changes in environmental regulations will probably remain a factor over the long run, despite near-term improvement off lows posted in 2020. That said, coal runs in unit trains hauling exclusively coal (often using customers’ cars), thus it is believed that the rail can continue to adjust its train and crew starts to match demand conditions. 

Norfolk generated healthy volume growth near 5% on average within its intermodal franchise over the past decade. In fact, intermodal revenue surpassed coal in 2014 and is now the highest-volume segment (roughly 60% of 2020-21 carloads versus 9% for coal). Capital projects targeting capacity and velocity improvement have helped the rail capitalize on net positive truck-to-rail conversion activity over the years. Norfolk’s domestic intermodal volume may face congestion-related constraints lingering into early 2022, but it is still seen as intermodal as a key long-term growth opportunity.

Financial Strength

At year-end 2021, Norfolk Southern held an ample $839 billion of cash and equivalents compared with $13.8 billion of total debt ($12.1 billion in 2020). Historically, the rail generates steady free cash flow, despite investing heavily in its network (capital expenditure averaged 16% of revenue over the past five years). Norfolk deploys this cash on dividends and share repurchases, and occasionally borrows to boost these returns to shareholders. Share repurchases eased briefly 2020 due to pandemic risk to cash flow, but they ramped back up by year-end, and it is held, repurchase activity to remain active in the years ahead. Norfolk Southern operates with a straightforward capital structure composed mostly of senior notes. In terms of liquidity, the rail also has an $800 million revolving credit facility and a $400 million accounts receivable securitization program for short-term needs–both programs are fully available and undrawn as of third-quarter 2021. In 2021, Norfolk’s total debt/adjusted-EBITDA came in near 2.5 times (2.7 times in 2020). It is projected 2.2 times in 2022. The historical five-year average is 2.4 times. Interest coverage (EBITDA/interest expense) was a comfortable 9 times in 2021, versus 7 times in 2020. Overall, Norfolk’s balance sheet is healthy and it is anticipated the firm will have no issues servicing its debt load in the years ahead.

 Bulls Say’s

  • Norfolk Southern reignited operating ratio improvement in 2016 after stagnating over the preceding six years. With help from precision railroading, the rail reached OR records in each of the past four years.
  • Norfolk Southern runs one of the safest railroads in the U.S., as measured by injuries per hours worked; this boosts service levels and helps to keep costs down. 
  • Compared with trucking, shipping by rail is less expensive for long distances (on average) and is four times more fuel-efficient per ton-mile. These factors should help support longer-term incremental intermodal growth.

Company Profile 

Class-I railroad Norfolk Southern operates in the Eastern United States. On roughly 21,000 miles of track, the firm hauls shipments of coal, intermodal traffic, and a diverse mix of automobile, agriculture, metal, chemical, and forest products. 

(Source: MorningStar)

General Advice Warning

Any advice/ information provided is general in nature only and does not take into account the personal financial situation, objectives or needs of any particular person.