Mike Bailey, CFA, Director of Research at FBB Capital Partners
Overall theme: We favor cyclical companies that offer growth, income, and a reasonable valuation.
- ROP: Early innings of next capital deployment phase. ROP’s edge is buying and fixing poorly-run industrial companies. ROP plans to invest $7B in these types of deals over the next four years and we estimate that each $1B deal could boost forward earnings by ~3%. The company last month announced a $1B acquisition of a software and business services company called PowerPlan, suggesting that ROP is well on its way toward executing on the $7B long-term goal. We expect organic growth and acquisitions to help ROP exceed Wall Street estimates and with the stock trading only ~5% above a five year average, we view the shares as attractive. The company’s dividend, while small at a half a percent yield, will likely grow in the high teens, along with earnings growth.
- SCHW: Rising rates and shift to fee-only wealth management driving growth. SCHW is in a sweet spot this year, as tax cuts, higher interest rates, and massive inflows drive nearly 50% profit growth. While the tax cut benefit may wane this year, we see plenty of growth ahead as rate hikes as boost profits into 2020. Longer term, we believe a shift away from commission-based brokers to fee-only wealth management will drive high single-digit revenue growth for SCHW. Along with this growth, we see SCHW taking its dividend yield from below 1% currently, to somewhere closer to peer AMTD’s ~1.4% over the next few years. Investors are also getting this growth and income at a discount, with SCHW shares trading 9% below the prior five-year average.
- MCHP: Two ways to win as the semiconductor industry consolidates. We favor MCHP’s organic growth, its 1.4% dividend yield and its optionality as a fragmented industry scales up. We believe investors can make money with MCHP in two ways: 1) MCHP grows earnings by acquiring smaller semiconductor companies, or 2) a large peer buys out MCHP. We see very few chipmakers that are in a position to be both a buyer and a seller, suggesting the stock should have a scarcity premium. However, MCHP’s 11% valuation discount to its long-term average offers investors meaningful upside, in our view.
- Mike: All three
- Family: None
- FBB (as a firm): None
Macro theme: Strike while the iron is hot.
We recommend high-quality U.S. cyclical stocks as we head into the back half of the year with GDP growth well above trend and as stocks continue to trade with reasonable valuations. From a top down perspective, we are watching manufacturing surveys and leading economic indicators for a potential acceleration, which could surprise to the upside. At the same time, a bottoms-up analysis shows that S&P500 profits continue to beat expectations. What’s more, many of the risk factors that drove the Q1 market correction, such as inflation fears, trade war concerns, geopolitics, and rising volatility, have eased or reversed. Still, we are mindful of the Fed’s steady march towards higher interest rates, although Chairman Powell’s moves year-to-date have generally matched investor expectations. We see cyclical stocks as attractive within this framework of economic and profit growth, coupled with stock valuations that are in-line with five year averages.