Emerging markets are growing hungrier for electronic components. Their economic development is resulting in more factory automation, infrastructure buildout, increased demand for electronic devices and a growing interest in greener technologies, all of which require electronic components, says Amitabh Passi, an Analyst at UBS Investment Bank.
“Many of these are the key underlying trends that are fairly critical to the uptake of the user connectors and components. And as that content goes up, it benefits the distributors. It also benefits the EMS guys who are actually manufacturing a lot of this equipment,” Passi said.
TE Connectivity (TEL) is one of Passi’s favorite names in electronic components. He says TEL is the largest connector manufacturer, with about 20% market share, and the company is improving its fundamentals and should benefit from recovering automotive demand.
“We foresee double-digit EPS growth over the next three to five years, free cash flow generation that’s $1 billion-plus per year, and it’s currently supporting about 8% to 9% free cash flow yield. And [TE Connectivity is] a company that’s trading at about 10 to 11 times earnings and about one times sales,” Passi said.
Interest rates are expected to improve and fuel Canadian life insurers‘ upside in terms of EPS, presenting opportunities for investors buying in companies currently trading at 10 times earnings, and with a longer-term investment horizon, says Tom MacKinnon, Analyst at BMO Capital Markets.
“What you’ve got to have is a little bit of longer time frame and the ability to stomach volatility. But if you’re going to get these guys at under 10 times next year’s earnings, and I think again price to book multiples versus ROE that are probably in the area of 10% to 15% below where they normally have been over the last 11 years, you’ve got some valuation upside,” MacKinnon said.
MacKinnon likes Manulife Financial Corporation (MFC), one of the largest Canadian life insurers. He says the company is transitioning from capital-intensive businesses in the U.S. into higher-ROE markets in Asia, which currently is about 35% of its bottom line.
“We see [Manulife] as an ROE improvement play and certainly as a capital player as well, and probably further on down the road, a global consolidator. So all at 10 times earnings next year and all trading at under its U.S. GAAP book value and a modest premium to its Canadian GAAP book value. So that’s one we like,” MacKinnon said.
Electronic-connector manufacturers are reaping the rewards from a secular trend toward increased connector content across the board, with companies in the sector having almost agnostic exposure to the success of various OEMs and not levered to one specific company, says Steven O’Brien, Senior Analyst at J.P. Morgan.
“Connectors are used in any product or any device that has electronic signals, and that’s pretty much everything these days. In any given industry, electronic content is growing, there is no denying that trend,” O’Brien said. “All these companies broadly benefit from that trend.”
O’Brien points to Molex (MOLX) as his favorite electronic-connector company. He says the company has good exposure to the faster-growing end markets — such as wireless infrastructure and devices, and automotive — and it is trading at a discount relative to peers.
“I like [Molex] firstly because I think they have good exposure to some nicely growing end markets. And then secondly, they actually have the lowest margins in the industry,” O’Brien said. “I see some good margin upside as sales grow, and I believe they capture about 25% to 30% leverage on incremental sales dollars.”
Large insurance brokers are investing in growing insurance opportunities abroad, where the macro environment presents a marked contrast to domestic price deterioration, low interest yield and continued pressures on exposure to a weak economic recovery, says Yaron Kinar, Analyst at Deutsche Bank AG.
“One is that they can grow in markets where GDP growth is faster than the domestic growth. Two, it means that they can focus on markets where insurance penetration is on the rise,” Kinar said. “And the third element is that your client base is becoming increasingly global and increasingly sophisticated.”
Kinar points to Aon Corporation (AON) as a large insurance broker with an international platform poised to benefit from global insurance opportunities. He also says the company is very efficient relative to peers, and its GRIP product is ahead of the competition.
“[Aon] has spent a lot of efforts and energy and money, capital on improving its systems, which should in theory, and time will tell, allow it to be a better high-margin revenue generator going forward, and with a lot more of these revenues to flow down to the bottom line,” Kinar said.
North American oil and liquids-rich shale development leads to handsome margins for upstream producers, and oil prices are expected to remain well above the required margin to make fracking in hard-to-reach reservoirs economical, says Duane Grubert, Senior Analyst at Susquehanna Financial Group LLLP.
“This is still a windfall profits environment. Most of the projects that I referenced — stuff like the Wolfberry or the Eagle Ford or the Bakken — only need about $60 oil long term to justify development,” Grubert said. “So these guys on the oil side are definitely in a high-operating-margin environment.”
Grubert points to SandRidge Energy (SD) as a company reinventing itself from an almost pure-gas company into an almost pure-oil company. Grubert is positive on names changing their strategies to favor higher oil production in the current oil-prices environment.
“We have some players — SandRidge is a notable example — that are deciding that now is the time to really make progress on oil. They are spending multiples of their operating cash flow on oil drilling, funding that through divestitures, basically making the case that this is the time to exploit these higher operating margins from oil and finding creative ways to fund that,” Grubert said.
E&P companies are moving toward oil and liquids-rich shale deposits in North America and away from natural gas as they chase better economics stemming from the high difference between oil and natural gas prices, says Joseph Magner, Managing Director at Macquarie Group Limited.
“You have some companies that I’ve talked about now spending 80% to 90% of their capital investment on crude and liquids-rich gas opportunities” Magner said. “Or you have companies that have gone from spending 100% of their capital on natural gas to companies that are now spending over half of their budget … on trying to ramp up investment in liquids-rich gas or oil opportunities.”
Magner points to Plains Exploration & Production Company (PXP) as an independent producer looking to develop its North American onshore assets. The company is currently reorganizing its deepwater assets into a more independent subsidiary, so that it can focus on the development of shales.
“Plains Exploration & Production is] hoping to capitalize that with some outside capital,” Magner said. “They can focus their investment dollars on the Eagle Ford, their California oil opportunities or other onshore projects that they have in the portfolio.”
Smaller-cap cardiac device companies bypass macroeconomic headwinds in the health care sector through individualized catalysts, offering opportunities for investors looking for alternatives to Big Pharma and big medical device companies, says Dr. Duane Nash, Senior Vice President at Wedbush Securities.
“[Smaller-cap cardiac device companies] tend to be more affected by individualized events than macro events, and what I mean by that is the results of their own clinical trials, for example, tend to have a far more profound effect on them than global macro events,” Dr. Nash said.
Dr. Nash points to Endologix (ELGX) as a small-cap medical device company making a device to treat abdominal aortic aneurysm. ELGX‘s alternative to open surgical procedures is less invasive, cheaper and requires shorter recovery time for patients.
“Endologix is competing against three major players, far bigger companies. And at the moment, they have about a 10% market share,” Dr. Nash said. “They’re making gradual improvements to their device, and I think in the next two years or so they should be able to increase their market share up to 20%.”
Oil prices are expected to overcome shorter-term obstacles in their rise to the triple digits during the next six to nine months, as surplus OPEC supply cannot keep up with global demand growing by 1.5 million barrels per year, says Amir Arif, Managing Director at Stifel, Nicolaus & Co., Inc.
“We are bullish as we look out 2012, 2013 and beyond, if the stocks are reflecting the good news in 2012 and beyond,” Arif said. “The problem is we might get some hiccups along the way before we get there. We are looking for oil to pull back towards the $85 to $90 range.”
Arif points to SandRidge Energy (SD) as one of his favorite oil plays with expected upside. He says SD is involved in the Mississipian Lime play in Oklahoma, an oil play which offers better economics than the Bakken shale or the Permian basin, and which is still not fully appreciated.
“It’s basically looking at names that we think have a lot of upside. In SandRidge‘s case, because they are onto a new emerging oil play that has not been factored into the stocks the way the Bakken or the Permian has been factored into some of the names out there.”
The North American drilling increase in hard-to-reach oil reservoirs — basins, shales, ultradeepwater — caused by high oil prices is resulting in increased pricing power for oil services companies, as E&Ps move to higher-quality equipment and fit-for-purpose assets, says R. Thaddeus Vayda, Managing Director at Stifel, Nicolaus & Co., Inc.
“If there is one thing the industry can do efficiently once prompted, it is add capacity: rigs, pressure-pumping kit, coiled tubing, ROVs,” Vayda said. “This won’t last forever. It never does. But in the here and now, it looks as though select North America-leveraged equipment and services investments can remain appealing well into 2012.”
Vayda likes National Oilwell Varco (NOV), which has 70% to 75% share of the drilling equipment manufacturing market. Vayda currently has a $95, 12-month target price on the company’s shares, and he says bookings for NOV could be $8 billion over the next 12 to 18 months.
“We’ve seen a fairly significant increase in ordering activity for all manner of drilling and completion assets — in large part the result of operator preference for newer, safer, more efficient kit that is well suited to the challenges of today’s drilling demands, both on- and off-shore,” Vayda said.
