Applied Materials, Inc. (AMAT) is set to increase earnings leverage and regain the top place in the equipment industry with strategies put in place by the company’s new first-rate management team, says Patrick Ho, Analyst at Stifel Nicolaus & Co., Inc.
“Applied Materials still will trade along the general trends of the group and how its peers move, but on a potential three- to five-year basis, there is a company-specific story that I believe provides with the most upside opportunity over an extended period of time…they’ve brought in new leadership, and leadership that I have a significant amount of trust and confidence that they will get the company lighted and to a point where I believe they’ll become an outperformer and a leader in the industry once again,” Ho said.
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AMAT‘s team is let by Gary Dickerson, who as President is one of the most respected executives in the semi-cap industry, and CFO Bob Halliday, one of the best in the semi-cap industry and the technology industry as a whole, Ho says. Ho is confident that the new management’s track record will bring significant opportunities to Applied Materials and position the company to be back on top in the equipment industry.
“I believe as they continue to execute their strategies, they’ll have a significant opportunity to increase their earnings leverage, particularly when you compare it to a lot of their peers in the industry. I don’t believe that there is a company that can deliver the earnings leverage that Applied could over the next two to four years, if they execute their strategy successfully,” Ho said.
Intel Corporation (INTC) is expected to emerge as one of the few survivors of the ruthless implementation of Moore’s Law in the semiconductor industry, monetizing its manufacturing capabilities with its own product and also engaging in foundry partnerships with fabless companies, says John Pitzer, Managing Director, Global Technology Strategist and Analyst at Credit Suisse Group.
“It’s our view that Intel will be the last man standing on Moore’s Law. Before they are right, they will find multiple ways in which to monetize that in their core business by bringing out incremental performance that people will pay for, and in the nontraditional markets of tablets and smartphones by getting down their cost points and performance points that other people won’t be able to match,” Pitzer said.
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Intel further monetizes its advanced semiconductor manufacturing capabilities by partnering with other companies in foundry partnerships. Its leadership in this segment, Pitzer says, is expected to result in the world gathering at its factories for advanced chips.
“What you are seeing is Intel‘s manufacturing lead is stretching out, but Intel is now signing up foundry partners. The most public one was Altera (ALTR) about a month and a half ago who has historically been a customer at TSM. Altera has decided to use Intel because they have a better manufacturing process. We think Cisco (CSCO) will also start to build chips at Intel, as well as Apple (AAPL). This is all based upon this view that Intel will be the last man standing on Moore’s Law. They will continue to stretch out their manufacturing lead, and the world will be forced to be on the path to their door,” Pitzer said.
Alliant Techsystems (ATK) is expected to face decreased demand on both the commercial and the defense side of its ammunition business, as the stockpiling of ammunition by civilians winds down after legislative concerns, and the wars in Afghanistan and Iraq wind down and defense budgets decline, says Michael F. Ciarmoli, Vice President and Equity Research Analyst at KeyBanc Capital Markets Inc.
“First, on the military side, with the wars in Afghanistan and Iraq winding down, we expect there to be less demand for ammunition in the field. We also couple that with the budget pressures hitting the Pentagon and what will likely be force structure cuts, specifically to the Army and Marine Corps. We are seeing curtailments of training. We think that’s all going to hit military ammo demand and production, and we see ammo funding potentially falling by as much as 40% to 50% over the next five years,” Ciarmoli said.
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Ciarmoli has an “underweight” rating on ATK, and he says that although the stock has seen a good run relative to its defense peers, there are profitability headwinds as more normal patterns resume.
“We do think, as we start to see more normal buying practices, or just a cooling off of some of these legislative concerns, that will pressure some of their commercial ammunition revenues as well. The stock has had a very good run; it’s been one of the outperformers within the defense sector. I think a lot of that stems from the company shoring up its balance sheet and, again, some of this increased activity around gun legislation, which has really stoked the sales of their commercial ammunition,” Ciarmoli said.
Microchip Technology Inc. (MCHP) is expected to meet inventory goals in the June quarter, thus leading to a jump in wafer starts and ultimately a spike in MCHP’s margins, and MCHP will also benefit from exposure to many end markets in the U.S. and internationally, says Harsh Kumar, Managing Director at Stephens, Inc.
“[Microchip] had built up a little bit of inventory in the downturn in the December quarter. They took a furlough on pay across the board, and they took their wafer starts down, which affected their margins. I think that in the June quarter, they will probably have met their inventory goals, which will lead to a spike in wafer starts, which will lead to a spike in utilization, which will ultimately lead to a spike in margins, which I think will be here to stay,” Kumar said.
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Kumar believes that MCHP has been misunderstood by investors and should also be looked at because of the company’s exposure to the burgeoning automotive and industrial end markets, as well as its exposure to the housing market in the U.S. and abroad.
“We think it is very misunderstood in the minds of the investors. But Microchip has exposure to the automotive market and the industrial market, which are doing well right now, but they also have exposure directly to the housing market both in the U.S. and internationally, as well as the consumer markets. When you think of homes, think of coffee makers, appliances, garage store openers, sprinkler systems, any kind of electronic tool that you might have, they have exposure to all that,” Kumar said.
Avago Technologies Ltd (AVGO) could see an uptick in 2Q13 at the introduction of Apple’s (AAPL) next smartphone, while seeing a longer-term growth opportunity through its exposure to LTE-based mobile devices, says Doug Freedman, Analyst and Managing Director at RBC Capital Markets.
“It’s actually been an underperformer because of the handset transition going on over at Apple where they are — Apple in the past has been about a 20% customer for them. And the weakness at Apple is well-known, and investors are very afraid of what impact that’s going to have on the second-quarter earnings from Avago. They are an off-quarter company. So they will have a July quarter-end for their Q2, and that could start to see the uptick of the next phone introduction out of Apple,” Freedman said.
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Freedman says the shorter-term weakness will yield to the longer-term thesis of growing LTE smartphone adoption, leading to AVGO-supplied increased semiconductor content in these types of phones.
“Longer term, the thesis on Avago relates to their exposure to LTE-based handsets, and I view them as a company that will win an increasing amount of content as the market moves to bring LTE to the mainstream phone volumes,” Freedman said.
Marvell Technology Group Ltd.’s (MRVL) cash flow appears undervalued given the semiconductor company’s exposure to the PC and storage ecosystem and the ongoing shift from hard disk drives to SSD, a technology that requires higher semiconductor content, says Doug Freedman, Analyst and Managing Director at RBC Capital Markets.
“[A] name I think looks very inexpensive is Marvell. They are actually more exposed to the PC and storage ecosystem. When I look at Marvell, they are managing a transition from disk drive to solid state disk drives. When we go to solid state disk drives, they get more content, so they get to sell more dollars of semiconductors into a solid state drive than they do from a more traditional disk drive, a hard disk drive,” Freedman said.
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Freedman says MRVL also has a wireless business that may represent a drag to the company’s revenue, but nevertheless the company is undervalued to the point it does not change the mispricing of the company, and management continues purchasing stock.
“They also have a wireless business that they have been funding that is not contributing to earnings. If anything, it’s probably a significant drag to the present cash flow at the company. And with or without the drag of wireless, the company’s cash flow in my opinion is very undervalued. And their balance sheet is being used to continue to buy back a significant amount of company’s stock,” Freedman said.
James C. Roumell is President and Lead Portfolio Manager at Roumell Asset Management. He invests using a deep value strategy, and he revealed in a recent interview that he was “fortunate enough to develop a relationship with Marty Whitman” of Third Avenue Value. This “became my guiding philosophy,” he said. The portfolio Roumell runs is dedicated to “finding value through out-of-favor, overlooked or misunderstood securities.”
One of the largest investments in the fund is Ultra Petroleum Corp. (UPL):
“We think Ultra has great assets. They are long-life assets. They have an average life of about 17 years. We’re bullish long-term on natural gas, but more importantly, with Ultra you don’t have to be that bullish on natural gas. Because they are such a low-cost producer, they don’t need dramatically high prices to succeed. The industry median all-in lifting cost is $6.31 per Mcfe, and Ultra’s is at $3.00. They anticipate that if gas prices go from $3.50 to $4.50 per Mcf, they can double Ultra’s EBITDA from $600 million to $1.2 billion. There is a lot of leverage in the model, it’s a very well run business,” Roumell said.
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Roumell Asset Management has added 395,000 shares in the first quarter of 2013 to its position in the company which now totals almost 526,970 shares and Mak Capital has also recently established a new position in Ultra of 1.65 million shares, the largest new institutional buyer. According to this SEC filing, Soros Fund Management also recently established a position with a purchase of 417,000 shares. Also according to the SEC filing, Soros Fund has 700,000 shares of Ultra reserved under a call option.
Caterpillar Inc. (CAT) is on track to increase its stock price to around $110, with a low-end guide of $7 per share for 2013, as the company pulls through the weak mining segment and increases production in its construction equipment, says Brian K. Langenberg, Principal and Founder of Langenberg & Company, LLC.
“Caterpillar (CAT) looks interesting over the next two to three quarters. Last year they overbuilt excavators, particularly in China, which rolled over in mid-2012. Mining has also gotten whacked, and we’ve seen multiple guidance cuts. But the worst is behind them. The stock trades at $90 to $91, and the low-end guide for 2013 is $7 per share,” Langenberg said.
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Langenberg expects CAT‘s construction equipment production to increase in late 2Q or early 3Q, and though mining will remain weak, he predicts CAT‘s stock price will rise significantly from current levels.
“Construction equipment, which is more important to the company than mining, production is going to increase in late 2Q or early 3Q and against easier comparisons. Mining, given strong capacity utilization, may remain weak, but won’t kill them. The stock can hit $100 easily, maybe even $110,” Langenberg said.
Genworth Financial (GNW) is writing new higher-priced mortgage insurance while working through losses from the recent economic downturn, turning its income statement slowly around while currently trading at about 30% book, says Nathan Snyder, Co-Portfolio Manager and Managing Director of Snow Capital Management.
“We are patient enough to own this company at 30% of book. With that as a backdrop, I would like to own that company because as earnings turn around, book value turns around dramatically. The other businesses aren’t doing well either. So they turn around all these businesses both from a pricing standpoint and getting rid of dead weight in the portfolio, and they have enormous leverage to the income statement,” Snyder said.
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Some of the mortgage-insurance price increases have come as a result of the government deciding to exit the business, sending the rates up, Synder says. He adds that although the losses from the previous crises were extraordinary, he expects mortgage insurers to work through their book and replace lower-priced with higher-priced business.
“FHA is the largest mortgage insurer in the country, and the government has decided to get out of the mortgage insurance business as fast as they can. As a result, they have probably tripled, if not more, the prices that they charge for that type of insurance. There are three large mortgage insurance companies left in the marketplace. They suffered extraordinary losses associated with the financial crisis. They have been working through that book of business and losing money all the way. However, they continue to write new business at higher prices, and that new business has been through new underwriting standards,” Snyder said.
Aetna (AET) has improved margins after having grown and taken market share from competitors, correcting an underpricing of its business and becoming one of the larger holdings in the contrarian value portfolio of J. Dale Harvey, Founder, CEO and CIO at Poplar Forest Capital LLC.
“Aetna is an interesting story. We have owned it for a few years, and there was a period where they were out trying to grow and take market share. In doing so, especially in businesses like that, sometimes if you take market share, you’re doing it because you mispriced the business. They had big chunks of business that they had underpriced. When we looked at it we said, ‘OK, the opportunity here is, they’ve grown too fast, they’ve underpriced business; the results are depressed as a result. As they reprice that and rework their book, margins should improve.’ And they have,” Harvey said.
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Harvey invests in companies that have temporary short-term issues that represent opportunities for investors with a longer-term horizon, and he starts with the assumption that he will be invested for at least three years.
“When everyone is worried about the short-term and we see long-term opportunity, that provides an opportunity for us to invest. We look for financially strong companies. We prefer companies that have a history of paying dividends. We focus on normalized earnings and normalized free cash flow and ask what the business should be worth when things are going well again. We have a 30-stock portfolio, so it’s reasonably concentrated, focused on our high-conviction ideas,” Harvey said.
