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.

Categories
Dividend Stocks

L3Harris Technologies Growth Drivers: Tactical Radios Replacement Cycle, National Security Satellite Asset Decentralization, International Sales Expansion

Business Strategy and Outlook

Defense prime contractors are not born, they’re assembled. L3Harris Technologies, the sixth-largest defense prime by defense sales, was made from the merger of equals between L-3 Technologies, a sensor-maker that operated a decentralized business focused on inorganic growth, and the Harris Corporation, a sensor and radio manufacturer that ran a more unified business. Underpinning the merger’s thesis was an assumption that additional scale would primarily generate cost synergies but that eventually, the firms would produce meaningful revenue synergies. 

Defense primes are implicitly a play on the defense budget, which is thought to be ultimately a function of a nation’s wealth and its perception of danger. The fiscal stimulus used to support the U.S. economy during the COVID-19 pandemic dramatically increased U.S. debt, and higher debt levels are usually a forward indicator of fiscal austerity. But it is alleged, a flattening, rather than declining, budgetary environment as is seen, that heightened geopolitical tensions between great powers are likely to buoy spending despite a higher debt burden. It is thought contractors will be able to continue growing despite a slowing macroenvironment due to sizable backlogs and the national defense strategy’s increased focus on modernization, and it is believed defense budget growth is likely to return to its long-term trend. 

Broadly, it is probable, with management’s thesis on the merger. Cost synergies to a large extent drove the 30-year wave of consolidation across the defense industry, which has largely generated shareholder value. Both L-3 and Harris had high revenue exposure to the defense sensors business and operated reasonably similar businesses, so it isn’t seen major execution risks in the merger. Arguably, L-3 was an ideal partner for a merger of equals because L-3 operated as a holding company and there are quite a few potential efficiencies from consolidating the firm into a more integrated firm. The three biggest firm-specific growth opportunities which are seen for L3Harris Technologies are the tactical radios replacement cycle, national security satellite asset decentralization, and international sales expansion.

Financial Strength

It is held, L3Harris is in solid financial shape. The firm increased debt by about $4.5 billion in 2015 to fund the acquisition of Exelis, a sensor-maker that was spun off from ITT and had been paying down debt since. The firm’s all-stock merger of equals with L-3 Technologies did not dramatically increase debt relative to size, and it is projected, a 2022 gross debt/EBITDA of roughly 2.0 times, which is quite manageable for a steady defense firm. The company is using the proceeds of portfolio divestitures for share repurchases, so it is anticipated EBTIDA expansion will be the driving force behind a decreasing debt/EBITDA over Analysts’ forecast period. While it is cherished the desire to compensate shareholders, it is likely that paying down debt may be more value accretive, as it would make more comfortable for analysts in decreasing their cost of equity assumption for the firm. While L3Harris has some exposure to commercial aviation (depending on definitions, roughly 5%-15% of sales), it is not anticipated the firm will be materially affected by the downturn in commercial aviation. As demand for defense products has remained resilient, it is not foreseen, for the firm needing to raise capital any time soon. That noted, L3Harris produces a substantial amount of free cash flow and is not especially indebted, so it is awaited that the company would be able to access the capital markets at minimal cost if necessary.

 Bulls Say’s

  • There is substantial potential for cost synergies from the merger with L-3 due to the decentralized organizational structure of the pre-merger entity. 
  • L3Harris is at the base of a global replacement cycle for tactical radios, which is likely to drive substantial growth. 
  • Defense prime contractors operate in an acyclical business, which could offer some protection as the U.S. is currently in a recession.

Company Profile 

L3Harris Technologies was created in 2019 from the merger of L3 Technologies and Harris, two defense contractors that provide products for the command, control, communications, computers, intelligence, surveillance, and reconnaissance (C4ISR) market. The firm also has smaller operations serving the civil government, particularly the Federal Aviation Administration’s communication infrastructure, and produces various avionics for defense and commercial aviation.

(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
Daily Report Financial Markets

Indian Market Outlook – 01 February 2022

Indian-Market-Outlook-01-February-2022Download

Categories
Daily Report Financial Markets

Japan Market Outlook – 01 February 2022

Japan-Market-Outlook-01-February-2022Download

Categories
Daily Report Financial Markets

Australian Market Outlook – 01 February 2022

Australian-Market-Outlook-01-February-2022Download

Categories
Daily Report

Morning Report Global Markets Update – 01 February 2022

Morning-Report-Global-Markets-Update-01-February-2022Download

Categories
Technology Stocks

Charter Claims More Than 70% Of Internet Access Market Across Territory

Business Strategy and Outlook

It is impressive, Charter’s aggressive effort to drive customer penetration by limiting price increases, improving customer service, and expanding its offerings to appeal to a variety of preferences. It is likely the firm will successfully navigate growing competition from the phone companies, though growth will likely slow in the coming years. Charter’s aggression extends to its capital structure, where heavy share repurchases have bolster shareholder returns but have also kept debt leverage high, which will likely add volatility to the share price and could limit financial flexibility. 

Charter’s cable networks have provided a significant competitive advantage versus its primary competitors–phone companies like AT&T–as high-quality Internet access has become a staple utility. It is anticipated the firm now claims about 70% of the Internet access market across the territories it serves, up about 9 percentage points over the past five years and still marching higher. Charter has been able to upgrade its network to meet consumer demand for faster speeds at modest incremental cost while the phone companies have largely ignored their networks across big chunks of the country. Phone companies, notably AT&T, are starting to increase fiber network investment, which is projected will hit Charter at the margin–the firm has faced less fiber competition than its major cable peers. However, it is held Charter will remain a strong competitor even when faced with improved rival networks. 

Wireless technology has emerged as a potential new competitor to fixed-line Internet access. Analyst’s sceptical of wireless’ ability to meet network capacity on a wide scale for the foreseeable future. Also, it is likely dense fixed-line networks like Charter’s will play an increasingly important role in powering wireless networks in the future. Charter also faces declining demand for traditional television services, but here again it isn’t seized investors should be concerned. The amount of profit the firm earns from television service has been declining for several years. Internet access, now the bedrock of Charter’s customer relationships, delivers the vast majority of cash flow today.

Financial Strength

Charter operates under a fairly heavy debt load, with net leverage standing at 4.6 times EBITDA, by analysts’ calculation, a level that has held steady in recent quarters. Charter’s management team has run with a net leverage target of 4.0-4.5 times EBITDA over the past several years, typical of firms under the influence of Liberty and John Malone. By the firm’s calculation, net leverage was 4.4 times EBITDA at the end of 2021. This debt level is higher than its peer Comcast, which has typically targeted net leverage of around 2.0-2.5 times EBITDA. On the other hand, Charter’s leverage is more modest than Altice USA’s at roughly 5.5 times EBITDA. Charter typically directs free cash flow and the proceeds from incremental borrowing to fund share repurchases as a means of keeping leverage within its target range as EBITDA grows. The firm believes that it could reduce leverage quickly if its borrowing costs or business outlook change materially in the future. The firm generated free cash flow of about $8.7 billion in 2021 and spent $17.7 billion repurchasing shares and partnership units held by Advance/Newhouse. As a result, net debt increased to $91 billion from $82 billion at the start of the year. Importantly, free cash flow will face headwinds in the coming years as Charter begins paying federal taxes, which are likely to be meaningful starting in 2022. Charter has actively managed its debt load in recent years, trimming interest rates and pushing out maturities. About $7.5 billion of debt comes due through 2024 and its weighted average maturity stands at about 14 years at an average cost of 4.5%.

Bulls Say’s

  • Like its cable peers, Charter’s networks provide a platform to easily meet customers’ growing bandwidth demands, which should drive market share gains and strong recurring cash flow. 
  • As the second-largest U.S. cable company, Charter has the scale to efficiently adapt to changes hitting the telecom industry. The firm will be a force in the wireless industry eventually. 
  • Holding prices down to drive market share gains will pay huge dividends down the road, pushing costs lower and cementing Charter’s competitive position.

Company Profile 

Charter is the product of the 2016 merger of three cable companies, each with a decades-long history in the business: Legacy Charter, Time Warner Cable, and Bright House Networks. The firm now holds networks capable of providing television, Internet access, and phone services to roughly 54 million U.S. homes and businesses, around 40% of the country. Across this footprint, Charter serves 29 million residential and 2 million commercial customer accounts under the Spectrum brand, making it the second-largest U.S. cable company behind Comcast. The firm also owns, in whole or in part, sports and news networks, including Spectrum SportsNet (long-term local rights to Los Angeles Lakers games), SportsNet LA (Los Angeles Dodgers), SportsNet New York (New York Mets), and Spectrum News NY1 

(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
Small Cap

New Breakfast Lineup Driving Impressive Growth for Narrow Moat Hostess

Business diagram on financial report with coins

Business Strategy and Outlook

Although the previous owners of the Hostess brand filed for bankruptcy in 2004 and 2012, we contend it was due not to a lack of brand equity but rather highly inefficient manufacturing and distribution systems, a powerful unionized workforce, and a high debt load. In the four years preceding the pandemic, Hostess averaged 6.4% organic growth, materially outpacing the sweet baked goods category. Market share gains were driven by regained shelf space that was lost during its 2012-13 hiatus, expansion into new channels (enabled by its differentiated direct-to-warehouse delivery system), and expanded breakfast and value brand offerings.

Hostess has created significant shareholder value via its disciplined acquisition strategy. Although the 2018 Cloverhill acquisition initially depressed margins, the business is now generating healthy profits, and the deal provided a breakfast platform and access to the club channel, where the firm is expanding the Hostess brand. 

Financial Strength

Although previous owners of the brand filed bankruptcy in 2004 and 2012, that Hostess Brands is a much different company now, having shed the highly inefficient manufacturing and distribution systems, powerful unionized workforce, and high debt load responsible for the insolvencies. The current company is an entirely new entity. After the 2012 bankruptcy, investors purchased only the brand rights and recipes from the bankruptcy court, freeing them of employee benefits and other labor obligations that had weighed down the company. The new company has a highly efficient cost structure and operates with a cost-effective direct-to-warehouse model, whereas the predecessor firm operated with a more expensive direct-store-delivery model.

That said, the firm targets a 3-4 times net debt/adjusted EBITDA, a bit higher than most packaged-food companies, given its plan to expand into adjacent categories via acquisitions. As of September 2021, the ratio stood at 3.3 times. But the firm generates an impressive amount of free cash flow. Hostess’ free cash flow as a percentage of sales should average 12% over the next five years, comparable to most packaged food companies. 

Bulls Say’s 

  • The firm’s DTW distribution model allows it to penetrate channels previously not accessible (channels difficult for the firm’s DSD competitors to access), providing attractive, untapped growth opportunities. 
  • Hostess’ acquisitions in the breakfast and cookie segments provide it with a great foundation to expand into adjacent categories. 
  • The Hostess brand has exhibited impressive staying power throughout its 100-year history, outlasting many nutritional and diet fads, and we think the firm’s commitment to invest behind further innovation should ensure this persists.

Company Profile 

Hostess Brands is the second-largest U.S. provider of sweet baked goods under the Hostess, Voortman, and Dolly Madison group of brands, including Twinkies, Cupcakes, Ding Dongs, Ho Hos, Donettes, and Zingers. In 2018, Hostess expanded its breakfast offerings with the purchase of Aryzta’s breakfast assets (the Cloverhill business), including a branded business and private-label deals, and in 2020 entered the cookie category via the Voortman tie-up. Although its roots stem from the 1919 launch of the Hostess Cupcake, the company filed for bankruptcy in 2012. Investors purchased the brands and restarted production in 2013, followed by a 2016 initial public offering. Most products are sold in the U.S., although third parties distribute some product to Mexico, the United Kingdom, and Canada. 

(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

Dr. Reddy’s Continues to Weather Generic Drug Erosion in Core Markets

Business Strategy and Outlook

Dr. Reddy’s Laboratories is a global pharmaceutical company based in Hyderabad, India. It manufactures and markets generic drugs and active pharmaceutical ingredients in markets across the world, but predominantly in the United States, India, and Eastern Europe. Indian pharmaceutical manufacturers have seen success over the past decade in penetrating the U.S. market, where regulatory hurdles are lower than in Western Europe. With competition on price in a commodified space, the entry of low-cost manufacturers has facilitated a deflationary price environment for generic drugs since 2015, putting substantial pressure on the margins of established manufacturers. Conversely, in India and other countries with lower generics adoption, so-called “branded” generics have seen notable success. 

Generic manufacturers have taken different approaches to combat margin pressure over the past few years. While some manufacturers have addressed competition by rationalizing their U.S. portfolio and discontinuing low-margin or unprofitable drugs, Dr. Reddy’s has remained focused on expanding its U.S. market share. While its U.S. portfolio has experienced marginally higher deflation compared with peers, its pipeline is increasingly leaning toward injectables and other complex generics that command higher margins and exhibit relatively more price stability.

Financial Strength

Overall, Dr. Reddy’s reported a relatively uneventful third quarter, with higher revenue across the board largely due to new product launches and market share gain. The company’s revenue grew 8% to INR 53.2 billion ($715 million) on a year-over-year basis driven by new product launches and higher sales volumes in the global generics business. North America generics, which represents the largest share of company revenue (35%), was positively affected during the quarter by launches for four new products but negatively impacted by erosion within in generic drug portfolio. On a sequential basis, revenue fell 8%, largely due to price erosion in generics and reduction of volume of COVID-19-related products.

As of the fourth calendar quarter of 2021, Dr. Reddy’s holds gross debt of INR 28 billion ($370 million), which is more than offset by the cash on the company’s balance sheet. With very low leverage, the company faces little liquidity risk. This compares favorably with other global generic manufacturers like Teva and Viatris, which are saddled with high leverage as a result of an aggressive acquisition strategy over the past decade. The company pays an annual dividend of $0.34 per share, which translates to a dividend yield of under 1%.

Bulls Say’s 

  • Dr. Reddy’s low-labor-cost operations based in India and vertical integration likely provide a low-cost edge. 
  • In the U.S. and Russia, Dr. Reddy’s has grown quickly in OTC generics, which is an attractive segment of the market with slightly higher barriers to entry than conventional retail pharmacy drugs. 
  • Dr. Reddy’s strong branded generic presence in emerging markets provides significant growth opportunities with less price competition than typically seen in developed markets.

Company Profile 

Headquartered in India, Dr. Reddy’s Laboratories develops and manufactures generic pharmaceutical products sold across the world. The company specializes in low-cost, easy-to-produce small-molecule generic drugs and active pharmaceutical ingredients. Its drug portfolio in recent years has included biosimilar drug launches in select emerging markets and has shifted toward injectables and more complex generic products. Geographically, the company’s sales are well dispersed across North America, India, and other emerging markets. 

(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
Commodities Trading Ideas & Charts

Soaring Steel Spreads Expected to Normalise, Maintaining BlueScope’s FVE at AUD 15.50

Business Strategy and Outlook

BlueScope’s strategy appropriately plays to its strengths and attempts to neutralise its weaknesses within its portfolio of legacy assets. Steel manufacturers produce largely undifferentiated products and have limited pricing power. Sustainable competitive advantage is typically generated by being the lowest cost provider. BlueScope’s Australian business operates at a relatively high cost and struggles to compete in highly competitive export markets. North Star is significantly more entrenched and operates toward the low end of the cost curve.

Over the past decade, BlueScope sensibly restructured Australian operations away from commodity export markets where the relatively high cost of production places it at a competitive disadvantage. The Australian operations are now tailored to the domestic market with a focus on shifting its sales mix to its value-add metal coated and painted product brands.

BlueScope is taking appropriate actions to manage its environmental, social, and governance risks. BlueScope is proactively investing in technologies to limit the carbon intensity of its steelmaking operations and has committed to a net zero emissions target by 2050.

Expecting a Normalisation in Steel Spreads at BlueScope; Maintaining FVE at AUD 15.50

A combination of supply side disruptions and large fiscal and monetary stimulus programs enacted in major economies in response to the pandemic have pushed steel prices and steelmaking spreads to unsustainably high levels. Indicative steelmaking spreads exceeded USD 1,000 at North Star and USD 500 at Port Kembla during 2021, well above long-term averages. Morningstar analysts expect BlueScope will benefit handsomely from these conditions over the next couple of years, particularly during fiscal 2022. However, Morningstar analyst longer-term view for steelmaking spreads is more subdued and expects a gradual return to historical spread levels largely beginning in fiscal 2023. 

Morningstar analysts maintain a fair value estimate for BlueScope Steel at AUD 15.50 per share following transition to a new covering analyst. While Morningstar analysts have maintained its fair value estimate, but have adjusted its near-term earnings estimates for the latest steelmaking futures curve. As a result, the prediction for fiscal 2023, 2024 and 2025 EBIT forecasts have increased 30%, 122%, and 32% to AUD 1.8, AUD 1.3 and AUD 0.9 billion, respectively. Offsetting a positive outlook for earnings is a slight reduction in implied underlying EV/EBITDA terminal multiple to 5.0 times from 5.6 times, aligning with recent historical levels.  Morningstar analysts maintain very high uncertainty, Standard capital allocation, and stable no-moat ratings. BlueScope currently screens at an 18% premium to Morningstar analyst fair value estimate

Financial Strength 

BlueScope has a strong balance sheet. As at the end of fiscal 2021, BlueScope’s net cash position was AUD 798 million (including operating leases) and had approximately AUD 3 billion in undrawn debt facilities. BlueScope’s balance sheet will be put to work over the next few years to fund a range of initiatives across Port Kembla, North Star, and the U.S. buildings segment. BlueScope is also strategically investing in sustainability programs associated with its commitment to net zero emissions by 2050. Longer term, BlueScope is targeting a relatively conservative net debt position of around AUD 400 million with at least 50% of free cash flows distributed to shareholders in the form of dividends and share buybacks.

Bulls Say

  • Incremental electric arc furnace capacity expansion within the U.S. will dampen North Star’s margins.
  • Investors may apply a risk premium to BlueScope’s relatively emissions intensive business. 
  • The removal of import tariffs on steel from the European Union has the potential to reduce U.S. domestic steel prices and lower North Star’s margins. The removal of tariffs on other countries’ steel has the potential to have a similar effect.

Company Profile

BlueScope is an Australian-based steelmaking firm with five steel related business units. The Australian Steel Products segment predominantly specialises in a range of high-value coated and painted flat steel products for the Australian domestic market. North Star is the group’s U.S. mini-mill specialising in the production of hot rolled coil for the U.S. construction and automotive sectors. Building Products Asia and North America comprise operations across Southeast Asia, China, India, and the U.S. West Coast involved in metal-coating, painting, and roll-forming. New Zealand Steel and the Pacific Islands business has steel operations across New Zealand, Fiji, New Caledonia, and Vanuatu. The Buildings North America segment specialises in non-residential building solutions.

 (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.