Despite a weak economic recovery in the U.S., a recession in Europe, and decelerating growth elsewhere (notably in emerging economies China, India, and Brazil), the S&P 500 has rallied 15% since early June. Low volumes helped encourage the rally.
Equity participation in the rally from both institutional and retail accounts has been lower than normal. U.S. equity mutual funds have experienced outflows of nearly $90 billion this year, while bond inflows have exceeded $200 billion. Underinvested money managers are looking to put money to work ahead of year end, which for some is October 31. If funds continue to raise their exposure, the current rally could have further to go. Against this backdrop, we highlight some investments that have lagged their peers or the market this year and where we see specific catalysts that could propel them to catch up in coming months.
Deere & Co. (DE)
Investment Thesis: Farmer income remains strong, implying that farmers are willing to spend more and corn prices are historically high. Q4 is seasonally stronger given bonus depreciation.
Catalysts: A strong Q4 result would provide confidence that issues from Q3 were overdone. Concerns over the U.S. drought will lessen and Brazil could continue to surprise on the upside. Additionally, 2013 EPS guidance could be better than expected.
Potential Investor Pushback: Issues raised with Deere's Q3 earnings release were unique in that DE is generally very good at execution, which has caused some pause in the name. Also, there are fears that North American farm is at its peak and that the U.S. drought will have a negative effect.
Valuation: $90 target price at 11.5x CY'14 EPS discounted back one year.
Investment Thesis: The company revenue outlook is strong supported by ongoing growth at strategic accounts, continued growth in high profile wins like Salesforce.com (CRM) and Pandora (P), traction in IO Turbine, and a broadening out of OEM agreements with Cisco (CSCO) and NetApp (NTAP). There is further upside potential to GMs as the company's software offerings continue to ramp within the mix.
Catalysts: The main catalyst would be sales ramp up of strategic accounts. The recent significant customer wins should drive revenues (including Salesforce.com, Pandora, a few Chinese internet companies). 20 of Fusion-io's customers who have purchased over $1mn in product are less than one year old. In addition, recent strategic tie-ups with Cisco and NetApp not only broaden the channel but demonstrate Fusion-io's competitive edge.
Potential Investor Pushback: This is just a component company and eventually the margins will come down. While FIO trades at an EV/Sales of 4x consensus CY13 analyst consensus forecast, superior revenue growth and potential upside to estimates support a premium valuation to storage vendor and next-generation data center peers.
Valuation: FIO trades at an EV/Sales of 4x consensus CY13 analyst consensus forecast.
Gardner Denver (GDI)
Investment Thesis: Buy-side expectations for 2013 are for earnings to be down, sell-side expectations are for flat earnings, following huge negative EPS revisions in the LTM. The bar is very low, and earnings upgrades could drive the stock higher If the current management team fails to execute, the company is likely to be acquired i.e. there is a floor on the downside. The company is buying back a lot of stock, which will help drive EPS growth next year, and support the stock near term. GDI will outperform if the natural gas price starts to appreciate, given its pressure pumping business. The valuation multiple has contracted by 50% over the past 12-18 months, and appears to have now found a floor. Uncertainty over management team allows for opportunity - no one is giving it any credit now, so it is not difficult to positively surprise.
Catalysts: (1) CEO appointment, (2) current share buy back authorization is used up, and the Board will approve another round of buy backs, (3) potential acquisition of the company by strategic or financial buyers (several peers have been acquired in recent months - RBN, Hamilton Industrial out of UTX etc).
Potential Investor Pushback: (1) Huge uncertainty over the outlook for the hydraulic frac pumping market in the EPG segment. (2) Concerns the pressure pump aftermarket will roll over as the rig count shrinks in the U.S. (3) Concerns around the high European exposure of the IPG segment. This is not news - look at the EUR/USD move in recent weeks / months; also GDI has unveiled a restructuring plan to take out a lot of costs in its European plants especially in the UK and Germany, and move costs down to Italy - this should allow European EBIT to grow, even with no revenue growth, (4) Concerns the management team is not strong enough, in light of CEO's recent departure, and a lot of turmoil. The CEO's departure was arguably because of all the turmoil he created; the current interim CEO could well get the job of long-term CEO, which would help with the stability at the company; the divisional heads know their businesses well, and at EPG in particular he has been around the industry for decades.
Lam Research (LRCX)
Investment Thesis: LRCX will benefit from a recovery in NAND capex, which is at a bottom. LRCX has continued to gain market share in its core segments and Etch, as a segment, has continued to outgrow the WFE and will benefit from double patterning.
Catalysts: (1) Intel win on 14nm: LRCX can potentially announce a 14nm etch win at INTC. The company has historically had no market share at Intel for Etch. We think this could potentially change at 14nm. 14nm is being ramped in Q4, and (2) Analyst day in November: LRCX is hosting the analyst day in November and is going to present a combined operating model for LRCX and NVLS.
Potential Investor Pushback: (1) Increasing opex. We think that much of the news is already baked in, and (2) NAND capex is disappointing. We think that much of the news is already baked in and NAND capex is already at bottom.
Eli Lilly (LLY)
Investment Thesis: LLY is not a perfect story, and the view on its late-stage pipeline is still evolving. However, its outlook materially improved with the Sola release. Pipeline expectations on the stock are very low, and positive news on this front could drive material upside on the stock. Furthermore, its attractive dividend yield (>4%) and long-term guidance on expense management provide downside support to the stock.
Potential Investor Pushback: Sola is the catalyst that is debated the most and has the most risk-reward. While we hope for perfect data on Oct 8, we think that even good data could lead to a scenario in which at the minimum the FDA accepts the filing for this product. Expectations are still fairly conservative on the Street (peak <$500MM); acceptance of filing by itself could drive positive movement on the stock as estimates rise on the Street.
Catalysts: (1) Solanezumab (Phase 3, Alzheimer's Disease, Oct 8th, 30th): Following encouraging top line press release that saw a partial lift in the stock, the detailed data will be the next step in providing dimension to the commercial potential. (2) Baricitinib (Phase 2, Rheumatoid Arthritis): Expectations could rise to close to $750MM to $1Bn (from currently ~$300-400MM) before the end of the year on the back of positive data release at a medical conference in November and announcement of a phase 3 trial initiation prior to the end of the year, (3) Ramucirumab (Phase 3, Breast cancer, 4Q): Release of phase 3 data for this generally under-the-radar asset in lucrative breast cancer indication could materially raise peak estimates from current range of ~$350MM, particularly since it has active programs in several other indications.
Jive Software (JIVE)
Investment Thesis: JIVE's long-term growth prospects in the emerging enterprise social software (ESS) market remain strong, and the ESS market could grow to $5.5 billion in 2016, up from $750 million in 2011. Over time, JIVE would continue to grow its ESS market share (it currently has greater than 9% share), which is why investors could use any pullbacks in the share price to buy its shares.
Catalysts: The use of social software in the enterprise will increase dramatically over the next 3-5 years. JIVE currently has the most feature-rich solution in the market today and is the industry leader, independent social software vendor in the nascent ESS market.
Response to Potential Investor Pushback: The shares have come off quite a bit over the last few months given a modest deceleration in billings and concern that each sale takes a large amount of evangelization given its newness, which may be tough in a choppy selling environment.