Top trade ideas (Tues, Oct 31)

St. Joe (JOE - USA) is poised for growth owning around 170,000 acres in the appealing and tax-friendly Florida Panhandle, which has recently gained traction as a residential haven away from urban chaos. Despite its previous label as "dead money" due to a lack of catalysts, the region's growing population and desirability are now propelling JOE's potential, with expectations of a 30% to 50% annual revenue growth and even higher earnings growth. The shares are believed to be trading at a single-digit multiple on Adjusted Funds from Operations (AFFO) for 2024, presenting substantial undervalued asset value. The notable aspects favoring JOE include land appreciation during high inflation times, especially with likely continued low interest rates, and an anticipated population shift from cities to serene locales like the Panhandle. This migration, driven by urban unrest and tax burdens, positions JOE as a lucrative investment to capitalize on the influx of affluent individuals seeking a better living environment, thereby driving JOE shares higher in the foreseeable future.

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The author makes a compelling case that auto lending leader Ally Financial is set for significant upside as higher rates allow it to reprice its loan portfolio while deposit costs lag, driving margin expansion. Ally holds a dominant competitive position in prime auto lending thanks to advantages of scale and longstanding OEM relationships. The author explains Ally has strategically transformed its funding mix from expensive corporate debt to lower-cost and sticky retail deposits, now comprising 80% of funding. With credit reserves boosted and portfolio turnover coming, the author sees an inflection to EPS potentially exceeding $6 in 2024-2025 as higher-rate loans replace maturing loans. This well exceeds the current run-rate below $4. The author contends Ally deserves to re-rate higher to a 12.5x P/E once earnings inflect, supporting a $75 price target. Ally's focus on super-prime and prime borrowers also provides resilience. With potential for over 200% upside, 5% dividend income while waiting for the inflection, and an industry-leading position, the author makes a strong case for Ally Financial.

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Housing: White Brook continues to invest in Builders First Source (BLDR) and believes the stock is materially undervalued. While higher interest rates have substantially slowed the existing housing market, new homes are being built at an above-consensus rate. Fundamentally, the United States continues to be under-housed with occupancy of housing at all-time highs, even if particular markets most impacted by the technology sector (SF, Seattle) and a reversal of work from home practices (Miami, Phoenix, exurbs) now see a substantial decline in existing home sale prices. Tactically, the nation’s largest home builders have adapted to the interest rate environment by adjusting the size of homes built and by subsidizing new customer loans. New housing permits and starts have been far above worst case expectations, and materially better than what would have been expected unless there was a housing shortage, given the current mortgage rate environment. Further supported by solid renovation activity, Builders continues to generate prodigious free cash flow. Over the medium term, the country’s insufficient housing position will have to be rectified, and Builders is well positioned.

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The author believes Otter Tail is significantly overvalued, with 40-50% downside, as its municipal pipe business is peaking and set to see declining earnings. The author values the stable utility segment at $31/share based on typical utility multiples. The smaller manufacturing segment is worth $7.50/share. But the market is pricing the municipal pipe segment at $43.50/share by applying an unsustainable utility multiple to peak 2023 pipe earnings inflated by temporary supply chain disruptions. With pipe pricing already declining, the author expects pipe earnings to fall 80% from peak 2023 levels as conditions normalize. Applying reasonable multiples, the author sees Otter Tail's fair value at just $44-54 in 2024, compared to its current overvalued price.

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The author makes a strong case for Allison Transmission's undervaluation given its wide moat in automatic truck transmissions and investments securing its position in vehicle electrification. The core North American on-highway segment drove a 4% sales increase last quarter on robust medium-duty truck demand. Although the off-highway segment declined, the author expects a rebound as energy M&A activity resolves. Stronger pricing expanded margins 230 basis points, allowing earnings growth even as heavy truck markets cool. Looking ahead, the author sees tailwinds from replacement demand as fleet ages rise and international penetration of Allison's more efficient automatic transmissions. The author contends Allison's 80% medium-duty truck share provides resilience against cyclicality. Having already commercialized hybrid transmissions for buses, Allison is focused on integrated e-axle systems as the backbone of future electric powertrains. Although risks exist around competition in electrification, the author believes Allison's technology investments and customer stickiness can maintain its competitive advantages. Trading at a discount to fair value despite these strengths, the author sees a big upside in shares.

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Inter Cars, a market leader in auto parts distribution in Central and Eastern Europe (CEE) and ranked #2 in Europe, presents an attractive investment proposition with a sub 10x EPS, high insider ownership, and a history of steady performance since its IPO in 2004. Despite recent margin compressions due to high cost inventory from late 2022, the company's sales growth continues at over 20% per annum. Leveraging a unique franchise system known as “affiliate branches” and a central logistics model, it's expanded its product offerings beyond auto parts into areas like commercial vehicles, marine, and motorbike spares, among others. Notably, it's created networks like the Q-Service Castrol network to ensure quick delivery of high-quality parts and additional support services to member garages. Sales data shows a growth in international markets with the majority of its sales now outside Poland. The company's leadership under CEO Maciej Oleksowicz and significant insider ownership, underscored by a 26.30% stake by OK Automotive Investments B.V. (controlled by the CEO), provide a solid governance structure. Despite facing competitive pressures from players like LKQ and GPC, and the gradual market transition towards electric vehicles, Inter Cars' consolidated position in the fragmented European market, along with its strong relationship with independent repair shops, positions it well for continued growth. The firm's valuation metrics when compared to peers like LKQ and GPC, coupled with its organic growth strategy, hint at a potentially undervalued stock with room for price appreciation. This is further supported by the firm’s strategic focus on automation, logistics efficiency, and market consolidation in the CEE region, which could see it continue its trend of mid to low teens growth in the coming years.

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