Thursday, 24 April 2014

Timken - pleasingly approaching 52 week highs and spin-off catalyst still awaits

Timken has been a strong performer over recent months.  I first became interested in the ball bearings / steel company as an actual investment back in December (link here). 


I actually hedged the position with a short in sector peer SKF (Swedish listed) which (in SEK terms) has actually fallen in price over the last four or five months.  That's the ideal long-short combination! 

 
Part of my interest in the company was based on the upcoming spin-off angle as Timken's 'bearings' and 'steel' divisions were to demerge from each other.  Today's Q1 numbers highlighted that this will become a reality at the end of June.  Good news from a catalyst perspective. 


As my earlier linked note above discussed, trying to work out the company's forward valuation is not easy given the underlying volatility of some of the markets the group is supplying (light vehicles being particularly difficult at the moment, by contrast other areas like aerospace were much better).  Geographically this was shown by the contrast between the company's sales experiences in North America versus Europe/Asia...
 


...and from an earnings perspective any boost came more from on-going efficiency/cost control drives than anything else. 


If you pull all of that together there were a few tweaks to Timken's full year guidance, two positive and one negative. 


From a balance perspective some small sales/EPS uplifts are enough to counter the mild cash flow deterioration especially as the company has basically no industrial debt. 

The debt side flexibility is going to be important come the spin-off / demerger.  The forward combined valuation is going to be influenced on the respective balance sheets the bearings and steel side are given.  Convention would suggest investors will favour the more international / growth centred bearings business but the combined entity today valued at around a x11 forward EV/ebit ratio is offering a good start.  I note free cash flow generation is only equivalent to just over a 2% yield which is a bit skinny but the optionality of the spin-off counters this. 

Putting it all together the spin-off catalyst should help keep the share firm over the next couple of months.  It may be better to travel than arrive but even with the share close to the 1 year high point again of around US$64 there is enough to keep me invested.  Now let's see the spin-off details and go from there. 

Caterpillar: risk-reward has intensified further on the share

Back in January I wrote that a Caterpillar share price of above US$90 was saying something optimistic about the world economy.  Well what does a US$105 share price say, especially in the context of the proximity of the company's ten year share price high?

 
Of course Caterpillar themselves have contributed to this recent share price appreciation.  Back in January they announced a new US$10bn share buyback equal to over 15% of market cap and today the company upped its corporate numbers:
 

The above has some interesting aspects especially the contrast between Caterpillar's experiences in its 'construction' and 'mining/resource' divisions with the former being revised up...and the latter being revised down. 

In terms of materiality the construction side is now a third larger than Caterpillar's resource interests and profitability is almost four times as high (on an operating profit basis).  In time the resource division offers optionality from these levels...but this is over time.  As the company's comments above note, mining capex constraints are continuing to have an impact. 

Also noteworthy was the operating profit evolution which was very cost control centric with dullness on the sales/price lines. 


 
So where does this leave us with Caterpillar shares today?  Well, investors are still paying prospectively mid-teens EV/ebit multiples for the share.  That seems full...unless you are a believer that construction related demand for Caterpillar's services will remain strong and the mining side will start to pick up. 
 
It is always better to travel than arrive and risk-reward has intensified further on the share. 
 
 


Altria - the stock should go over US$40

The last time I wrote up the Altria quarterly results in January, I concluded that it was 'rudely on sale' (at a price of under US$35).  The share has picked up since then but is there further to go?


At first glance EPS guidance was good as:

'Altria reaffirms its 2014 full-year adjusted diluted EPS guidance to be in a range of $2.52 to $2.59, representing a growth rate of 6% to 9% from an adjusted diluted EPS base of $2.38 in 2013'.

And all the other attributes that Altria stands for such as a high dividend yield...

'Altria’s annualized dividend yield was 5.0%. Altria expects to continue to return a large amount of cash to shareholders in the form of dividends by maintaining a dividend payout ratio target of approximately 80% of its adjusted diluted EPS'

...and both market share...
 

...and margin gains in their core smokeable products (Marlboro etc) continued. 


 
And then there is the global brewer SABMiller stake which has started to rise in value again as perception towards the emerging markets has improved - and it could be worth a lot more if ABInBev ever bids for it, as often mooted. That's worth, at current market prices, a cool US$24bn.  Now, any sales inevitably runs into taxation concerns and the like (although as the Vodafone/Verizon discussions have shown, much of this taxation overhang can apparently be legally avoided).  Let's take a 20% discount on this value and take the resulting US$19bn off the Altria EV.  That leaves us with US$69bn...and an underlying 'stub' value for Altria's tobacco business below x10 EV/ebit FY14e.  That still seems light. 
 
Put it all together and to expect a US$40+ Altria share price still seems a reasonable expectation.  Add in that 5% dividend yield and that's a solid combination for investors. 

After a great run, getting harder to justify holding onto my residual Eli Lilly position

So Eli Lilly hit my hoped-for 2014 target of a US$60 share price (see here). 


Well to be fair Lilly hit this level in early March and has been going sideways since.  Even though I did top-slice the holding during late February/early March I have been waiting for the next set of quarterly results to make a call whether to exit the stock in full or not. 

Today's results are not the only event to consider though.  Additionally there is the big animal health purchase from global pharma sector peer Novartis which was announced on Monday (link here).

Everyone knew the Q1 numbers would be messy (with products like Cymbalta and Evista going off patent etc this was inevitable).  As I talked about over the last four or five months, the Eli Lilly story was not about short-term earnings momentum. 

 
Nevertheless even I was slightly disappointed by the extent of the negative pricing seen, even outside of the US where the patent expiries were the most pressing. 
 


As for guidance, it was mildly nibbled down.  Nothing dramatic but slightly disappointing. 


 
Reaction to the above mentioned deal with Novartis - in contrast to the reaction of the shares of both Novartis and Glaxo on Monday - was also muted.  The deal had industrial logic (bulking up of an already strong business) but to have to wait a year or two until accretion kicks in is unusual at a time of low interest rates. 

Pulling it all together the call of -2% pre-market feels about right pushing it closer to that US$58 first  support level.  A failure at this level and the share falls into that dangerous near the mid US$50s 'no man's land'.  As noted back in my original notes (see the link above) I described Eli Lilly at the time of my original purchase as 'so dull it has to be good'.  A good extent of that dullness has been priced out now it is getting harder to justify a position - both technically and fundamentally.  More insights from the conference call. 
 
 

Some other European presentation highlights today: Air Liquide, Heineken, Michelin

Lots of numbers already out today...but here are a few European corporate presentation charts that caught my eye:

Back in December I wrote up the first investor day in many years held by the French listed industrial gases concern Air Liquide (link here - a posting which includes a 100+ year share price chart!) and bought some stock in February in the low Euro90s on the generalised market weakness at the time.  Judging by today's numbers, this story continues apace with impressive growth beyond underlying industrial markets. 

 I will be looking to augment my position at any price in the low Euro90s. A strong hold for now.


By contrast, back in February, I described Heineken shares as 'I am not that excited'.  They have pushed on a little with the market since then but have run out of steam in my view and there are far more interesting consumer plays I have been accessing in recent months. 

 
 
Aside from the general market improvement, the company is lapping easier comparisons which improves some of the quarterly headlines.  The reality is though that the dull FY14 guidance is maintained.  At a current low teens prospective EV/ebit valuation and a sub 2% yield there is no need to get involved.  


Finally Michelin.  Shares in the French tyre manufacturer have been strong over the last year but are under pressure today. 


Why is this?  Slightly cautious comments about Eastern European demand plus some negative trends in price-mix have overhung the stock today.  I also note that the implied free cash flow yield is just over 3%.  This pays the dividend...but is not in 'cash flow machine' territory. 


Tyre stocks have been great investments over the last few years but not today.  Have another look below Euro80. 

Unilever - good progress but they note the 'tough, muted, volatile' backdrop

Unilever had their Q1 numbers out today.  Back in January I had 'talked about a £22 level to buy them, but this never happened.  With the share at x18/19 earnings I am happy to wait - undoubtedly dividend focused investors will find the 4% yield suitable compensation'. 

Well...they never got back there and despite a small dip today are around the £26 level (for the London quote):

 
 
Unilever numbers were fine...although the currency hit shown below was the biggest proportionately I have seen in this earnings round.  I always keep a special look out for pricing and this was positive in all regions except Europe, so two ticks out of three here.  

 
I also liked this chart from their presentation document - a nice/simple summary view on the world: 'tough', 'muted' and 'volatile'.  Not any environment for mega deals or rampant stock markets then?!

Unilever - unlike their great peer P&G (whose numbers I wrote up here earlier today) - does not quantify forward guidance.  I am not sure if this is ideal...but it is the reality.  So the below chart is what market watchers have to work with.  The comments are fine...but so they should be at the current x19 prospective p/e rating.  Clearly an attraction is the 3.9% dividend yield but, from a total return perspective, I would still prefer to wait for a price nearer the above mentioned £22 level.


After all...we live in a 'tough...muted...and volatile' world after all, don't we?

 

 

Patience (but yield) with P&G

The last time I wrote about P&G in February, it was to highlight the FX translation volatility which was overhanging numbers (link here) leading to the conclusion that:

'with an EV/ebit ratio currently in the x14s it is not too bad versus some peers. Additionally 5-6% shareholder yield (via dividends and buybacks) is pretty attractive versus 10 year Treasuries at a sub 3% yield.


Procter & Gamble is not a cheap share but as an alternative to a bond, you could do worse.  It certainly recently has traded like a bond...that US$76 level looks interesting'

Yesterday's guidance continued to show a low single digit earnings progression guidance (and implied sensibly positive pricing comparing 'all-in' sales growth with 'all-in' EPS growth).  Not that exciting...but at least positive.
 


A little bit more positive was the returning value to shareholders which has now edged up to c. US$13bn and a firmer 6% yield


As for risks, FX matters still weigh heavily followed by unrest in the Middle East and Ukraine.  A useful 'risk primer' for the world...and suggests that FX and emerging market matters weigh more heavily for the balance of 2014 than core demand levels. 


So overall any need to stop waiting for a return to US$76 to add new money to any P&G holding?  I don't think so.  I like the slightly enhanced yield but that is not enough to induce me to pay up to buy the share right here, right now.  Patience.