TechnologySpecialistsof Equity Research: October 5, 2016 KBCM Topics: CFX, AOS, MSM, FLS, MFS, WBC, PH, NNBR, GBX, GWW PCS Topics: AMD, INTC, MRVL, MU, NVDA, ON, SYNA, MU Price Target Changes Ticker Company Old Price Target New Price Target Analyst AOS A.O. Smith Corporation $103.00 $107.00 Barger WBC WABCO Holdings Inc. $116.00 $124.00 Barger Estimate Changes Ticker Old 2016E New 2016E Cons. Old 2017E New 2017E Cons. Old 2018E New 2018E Cons. Analyst NNBR 1.62 1.65 1.60 2.00 2.12 1.88 -- -- -- Barger GBX 5.70 5.70 5.81 4.17 3.97 3.57 -- -- -- Barger GWW 11.45 11.50 11.54 12.30 12.30 12.47 -- -- Barger MU 0.05 0.06 0.00 0.61 0.83 0.75 -- 0.77 1.65 Twigg Important disclosures for the companies mentioned in this report can be found at https://key2.bluematrix.com/sellside/disclosures.action. Please refer to the analysts' recently published reports for company-specific valuation and risks. KeyBanc Capital Markets Inc. Member NYSE/FINRA/SIPC
Industrial: 3Q16 Industrial Earnings Preview Barger 3 Industrials: Ahead of C3Q earnings season for our Industrials coverage, we remain cautious overall as recent due diligence (trade shows, channel work, etc.) points to a tepid demand environment and we expect outlook commentary to remain reserved. Despite this, valuations remain elevated. We highlight key names within our coverage around the quarter. Within our Industrial Machinery group, we are positive on NNBR (raising estimates for refinancing) and GBX (expect favorable FY17 guidance; note, we are trimming FY17/FY18 estimates but remain meaningfully above consensus). Within our Industrial Manufacturing group, we are positive on PH (progress on internal initiatives) and CFX (international welding demand and Fab Tech margins offsetting N. American weakness). Conversely, we are cautious on MFS (lowering estimates given risk of additional deferrals from key QSR customers) and FLS (lowering estimates given muted recovery in MRO activity and new project uncertainty). Lastly, within our Industrial Distribution coverage, we are positive on MSM (believe reported Sep./ Oct. sales could highlight stable to slightly better underlying trends). Conversely, we are cautious on GWW (note, slightly bumping up estimates to reflect July/Aug. sales, though remain cautious on the Company s outlook). Price Targets: In conjunction with our 3Q earnings preview we are raising our PTs on Overweight-rated AOS (from $103 to $107) and WBC (from $116 to $124). Consumer: 3Q16 ORV/Motorcycle Checks: Industry ORV Retail -MSD, Motorcycles -LSD/MSD Hamann 4 Powersports: We highlight key takeaways following our 3Q16 ORV/motorcycle industry channel checks. Overall, industry ORV trends appear to be trending -MSD in the 3Q (relatively even with 2Q16), with the promotional environment remaining aggressive. PII lost share with ORV trending -HSD/LDD (vs. -LDD in 2Q), with the decline largely attributed to the recall issue. We reiterate our Sector Weight rating as we remain comfortable on the sidelines as we await greater improvement in retail and for the recall issues to be behind the Company. While ACAT also lost share (-MSD/HSD, similar to last quarter), we reiterate our Overweight rating ($22PT) as we remain positive on the Company s longer-term product initiatives. For motorcycles, industry retail is tracking -LSD/MSD (vs. -HSD in 2Q), with improving trends due to easier comps. Indian/ Victory remain share gainers, while HOG (-MSD) continues to lose some share. We reiterate our Sector Weight rating on HOG and remain cautious. We maintain our -10.0% domestic unit shipment estimate for the 3Q, although we believe risk is skewed to the downside given a soft retail environment as well as the Company s commitment towards flat inventory levels vs. last year. Technology: Notebook ODM Tracker Update McConnell 5 Semiconductors: Notebook ODM Tracker: Q3 Closes on a Strong Note; Introducing Q4 Unit Shipment Estimate of Flat Q/Q. Q3 closes on a strong note. Our Q3 unit shipment estimate increases to +10% from +9% q/q. Introducing a Q4 unit shipment estimate of flat q/q/-7% y/y. We remain buyers of Intel (INTC, Overweight, PT $44) and ON Semiconductor (ON, Overweight, PT $16). Technology: Good Earnings on Strong Memory Demand Twigg 6 Micron Technology, Inc. (MU, Sector Weight): Good Earnings on Strong Memory Demand: Micron posted the anticipated revenue beat and raise amid strong memory demand, though high expenses remain a concern in FQ1 and limit EPS upside. We expect memory pricing to remain strong through the end of the year; however, we anticipate pricing pressure to resume by mid-2017, especially in NAND as competitors race to ramp 3D NAND. We remain Sector Weight. Strong memory demand drives revenue beat and raise. Accounting changes add roughly $0.14 to FQ1 non-gaap EPS guidance. Remain Sector weight; bit supply outlook could be too low in 2017. Disclosure Appendix 7 Page 2
3Q16 Industrial Earnings Preview Industrial Insights COLLABORATIVE RESEARCH Executive Summary PRIMARY CALL: Remain CAUTIOUS ahead of 3Q16 earnings season Key Investment Points Executive Summary PRIMARY CALL: Remain CAUTIOUS ahead of 3Q16 earnings season Expect 3Q16 results could be in line to modestly lower on conservative expectations... Channel work and multiple industry conferences including IMTS (Chicago), MINExpo (Las Vegas) and IAA Truck Show (Hanover, Germany) suggest a slow start to the 3Q with some sequential improvement as the quarter progressed. We think Distributor and Short Cycle demand likely saw more sequential improvement than heavier equipment: FAST and GWW August sales mixed. GWW directionally positive (+1% organic); FAST organic sales flat. In our view, capex-driven end markets are more challenged due to overhang from idle equipment and uninspiring end market demand trends. We think outlook commentary will be reserved as companies remain focused on self help Recent rally in commodity prices and more stable end markets have yet to translate into new orders. Early looks to out-year suggest continuation of weak demand for some industrial markets. Easier YPY comps could improve optics, but we do not expect near-term positive demand inflection point. We expect continued restructuring and price competition as companies manage through excess capacity and lower utilization rates. Recent rally in coverage universe stretching multiples toward higher end of historical range Our industrial coverage universe is up an average 18.5% YTD vs. +6.1% for the S&P 500 and +10.1% for the XLI. In some cases, we believe valuations and consensus estimates contemplate trough demand levels, suggesting investors expect an inflection in growth into 2017-2018. We believe shares of industrial companies will turn more on outlook commentary than actual 3Q results. Should sentiment turn more negative, we think names exposed to capex-oriented products could be most at risk while names with greater automotive and aerospace exposure could see relative stability. Names we highlight around 3Q16 earnings Upside CFX, GBX (expect FY17 guidance), MSM (increasing estimates), NNBR (increasing estimates), PH. Downside FLS (lowering estimates), GWW, MFS (lowering 2016E; maintaining 2017E). Note: Our upside/downside cases are related to the 3Q16 earnings period only and do not replace or supplant our longer-term ratings. Steve Barger / (216) 689-0210 sbarger@key.com Jeffrey D. Hammond / (216) 689-0236 jhammond@key.com Ryan Cieslak / (216) 689-0298 rcieslak@key.com Kenneth Newman / (216) 689-3184 knewman@key.com James Picariello, CFA / (216) 689-0447 james.picariello@key.com Ryan Mills / (216) 689-7462 ryan.mills@key.com Sym Rating Target Mkt. Cap. (M) AOS OW $107.00 $8,878.3 CFX SW NA $3,720.6 FLS SW NA $6,246.5 GBX OW $40.00 $1,148.5 MFS OW $19.50 $2,235.2 MSM OW $80.00 $4,470.8 NNBR OW $29.00 $514.4 PH OW $136.00 $16,952.4 GWW SW NA $13,627.6 WBC OW $124.00 $6,360.2 Page 3
3Q16 ORV/Motorcycle Checks: Industry ORV Retail -MSD, Motorcycles -LSD/ MSD Scott W. Hamann / (216) 689-0228 / shamann@key.com Shawn Cain / (216) 689-5748 / shawn_a_cain@key.com Following our 3Q16 ORV/motorcycle checks, we believe that ACAT ORV retail is -MSD/HSD and PII ORV retail is tracking -HSD/LDD, with the decline largely attributed to the recall issue, which we believe to be more transitory in nature as the Company makes progress repairing affected vehicles and as retail declines moderated slightly during September. With respect to motorcycles, strong Indian and Victory momentum continues as the two appear to be trending (+MSD) as some of the newer bikes/ride Command are gaining traction. Our contacts also indicate HOG appears to be losing slight share, with retail trending -MSD despite ramping up its promotional efforts. Key Investment Points Industry Motorcycle Retail Tracking -LSD/MSD; ORV Trending -MSD. For the motorcycle industry, we believe trends have improved moderately during 3Q16 to -LSD/MSD vs. -HSD in 2Q16. To that end, we believe a majority of the improvement is due to an easier compare; further, our contacts indicated that softness continues to be more pronounced in oil & gas/agriculture-dominated markets (-HSD+). Our contacts indicated that Indian, Victory and, to a lesser extent, Kawasaki were share gainers, with Honda and HOG losing slight share. ORV appears to be trending -MSD in 3Q16, relatively even with 2Q16. The sales cadence throughout the quarter pointed to a moderation in the declines during September; as PII continues to work through its recalls and comps eased. HOG Retail Trending -MSD; Slight Improvement During September on Easier Comp. Our recent channel checks point to HOG retail trending -MSD in 3Q16, moderately better than the -8.6% retail trend in 2Q16. Cadence throughout the quarter was indicative of slower trends during July/August and a moderate pickup in September (flattish) against an easier compare, according to Polk and prior management commentary. Further, HOG was more aggressive with its financing promotions, offering 0.99% APR on most of its MY16 models (scaled back slightly to 1.99% APR in October), compared to just the XL883 and Street models in 2Q16. All in, while we are maintaining our -10.0% domestic unit shipment estimate, given we are below the Street, we believe risk is skewed to the downside if the Company does want retail inventories to be flat vs. last year. Indian Momentum Continues; Victory Trending up MSD. Our channel checks again indicate that Indian and Victory have been solid share gainers as retail tracked +MSD in 3Q16. That coupled with a higher Indian dealer count leads us to believe the Company will be able to achieve solid DD retail growth during 3Q16. Further, despite tough comps, our contacts indicate that Slingshot is trending roughly flat. PII ORV Trending -HSD/LDD in 3Q16. Following -LDD ORV trends during 2Q16, our contacts indicated that 3Q16 trends point to a HSD/ LDD decrease in retail (-LDD April/May, -MSD/HSD in September). Our dealers said that despite recent issues, the recalls, in general, are moving smoothly; however, the Company continues to cede modest share to Can-Am given the success of its SxS's. All said, we await a greater improvement in retail and for the recall issues to be behind the Company until we get more constructive. ACAT ORV Trending -MSD/HSD in 3Q16. Our contacts indicate retail trends for ORV are tracking down MSD/HSD in 3Q16, similar to last quarter, despite easier comps. Further, while "No Brainer" ended, the Company followed it up with an evenly aggressive "Ride Away Days" promotion. With regard to inventory levels, most contacts we spoke to said inventory was slightly higher than they would like; however, the quality is much better than a year ago as the percentage of current vs. noncurrent has improved significantly. Page 4
Notebook ODM Tracker Update Q3 Closes on a Strong Note; Introducing Q4 Unit Shipment Estimate of Flat Q/Q Q3 closes on a strong note. We now expect unit shipments of 11.83 million in September, up 5% m/m versus our prior estimate of 11.55 million, or up 2% m/m. The shipment upside is attributable to better-than-expected monthly shipments at Compal and Wistron, partially offset by weaker shipments at Quanta due to modest order pushouts to Q4. Supply chain conversations indicate that the upside is due to stronger consumer model orders from two Asian PC OEMs and a North American PC OEM, supported by our checks in Asia last week. Semiconductors Michael McConnell 503.821.3890 mmcconnell@pacific-crest.com Hans Chung, CFA 503.821.3944 hchung@pacific-crest.com Our Q3 unit shipment estimate increases to +10% from +9% q/q. Given shipment upside in September, our Q3 unit shipment estimate now increases to +10% q/ q/-7% y/y from +9% q/q/-8% y/y. Supply chain conversations indicate that the upward revision is largely driven by strength in North America, recent stabilization in China and improving corporate PC demand. Introducing a Q4 unit shipment estimate of flat q/q/-7% y/y. Noting improved sentiment on notebook PC demand, we expect Q4 notebook ODM unit shipments to be flat q/q, or down 7% y/y, in line with notebook ODMs expectations for flat to low single-digit percentage q/q growth in Q4 and five-year seasonality of +1% q/q. Sentiment on notebook end demand is improving. Our conversations with PC OEMs and notebook ODMs signaled improving sentiment on notebook end demand. While end demand in North America remains an outlier of strength, recent stabilization in China and improving corporate demand have raised confidence on sell-through for the remainder of the year. As a result, notebook ODMs are turning more optimistic that notebook industry units could decline by a middle single-digit percentage in 2016, up from prior forecasts for a high single-digit percentage decline y/y. We remain buyers of INTC and ON. We remain buyers of INTC due to: (1) improving sentiment on notebook end demand, (2) Intel s sell-in versus PC supply chain sellout in Q2 at the low end of normal ranges (see page 2), and (3) stronger server component orders from hyperscale customers. We also believe 2H Skylake ramps should be tailwinds for ON given its content and share gains in the new Skylake platforms. Other notebook-exposed companies under our coverage universe include AMD, MRVL, MU, NVDA and SYNA. Stock Implications Positive, Negative, Neutral Company Stock Rating Target Price Mkt Cap. Advanced Micro Devices, Inc. AMD SW NA $6.95 $5,706.0M Intel Corporation INTC OW $44.00 $37.66 $183,253.6M Marvell Technology Group Ltd. MRVL SW NA $13.02 $6,854.4M Micron Technology, Inc. MU M NVIDIA Corporation NVDA SW NA $68.45 $43,192.0M ON Semiconductor Corporation ON OW $16.00 $12.22 $5,103.1M Synaptics, Incorporated SYNA M Page 5
Micron Technology, Inc. Good Earnings on Strong Memory Demand Micron posted a revenue beat and raise as anticipated amid strong memory demand, though high expenses remain a concern in FQ1 and limit EPS upside. We expect memory pricing to remain strong through the end of the year; however, we anticipate pricing pressure to resume by mid-2017, especially in NAND as competitors race to ramp 3D NAND. We remain Sector Weight. Weston Twigg / 503.821.3875 wtwigg@pacific-crest.com Daniel Baksht, CFA / 503.821.3873 dbaksht@pacific-crest.com NASDAQ: MU Rating: Price Target: Sector Weight NA Price: $17.80 MU $17.80 (+1% Y/Y) Nasdaq (+11% Y/Y) Key Investment Points Strong memory demand drives revenue beat and raise. Micron posted a revenue beat and raise as anticipated as DRAM and NAND demand is high while supply remains tight. FQ1 (Nov.) non-gaap earnings guidance was light and would have been well below consensus without revised accounting. High FQ1 expenses should begin to decline in FQ2 as new product qualifications and shipments are completed, though variable compensation will likely remain. Accounting changes add roughly $0.14 to FQ1 non-gaap EPS guidance. Micron is getting more aggressive with its accounting policies, a decision we disagree with. The company will now be excluding stock-based compensation and amortization of acquisition-related intangible assets, worth roughly $50 million per quarter (around $0.04 to $0.05 EPS impact). It has also extended the depreciable life of DRAM equipment to seven years from five years, worth roughly $100 million per quarter (around $0.09 to $0.10 EPS impact). Remain Sector Weight; bit supply outlook could be too low in 2017. Micron expects 2017 DRAM industry bit supply to be just middle to high teens growth and NAND industry bit supply to be just high-30% to low-40% growth. However, we anticipate DRAM bit growth in the low-20% range as 1x nm ramps accelerate (and Micron noted that it may grow bits over 30% in F2017) and NAND bit growth around 53% (Micron may grow over 40% in F2017). In other words, supply may be higher than expected, which could reduce pricing, a risk to the stock by early to mid-2017, in our view. We see near-term fair value between $15 and $21. $35 $30 $25 $20 $15 $10 $5 Bull Case $31 (+74%) Bear Case $9 (-49%) 11/15 12/15 01/16 02/16 03/16 Sources: Company reports, FactSet, KeyBanc Capital Markets Inc.. Company Data 52-week range $9 - $19 Market Cap. (M) $18,458.6 Shares Out. (M) 1,037.00 Enterprise Value (M) $24,403.6 Avg. Daily Volume (30D) 27,021,500.0 SI as % of Float 7.5% Net cash/market cap (27.6)% Sources: Company reports, FactSet, KeyBanc Capital Markets Inc. 04/16 05/16 06/16 07/16 08/16 09/16 10/16 Estimates FY ends 8/31 F2016A 1Q17E 2Q17E 3Q17E 4Q17E F2017E F2018E EPS (Net) $0.06 $0.19 $0.22 $0.21 $0.20 $0.83 $0.77 Cons. EPS $0.00 $0.09 $0.14 $0.22 $0.31 $0.75 $1.65 Previous $0.05 $0.09 $0.15 $0.18 $0.19 $0.61 -- Revenue (M) $12,399.0 $3,810.2 $3,689.5 $3,674.2 $3,739.9 $14,913.8 $14,484.2 Cons. Revenue $12,327.1 $3,460.6 $3,400.4 $3,516.1 $3,710.2 $14,140.8 $15,545.5 Previous $12,385.7 $3,482.7 $3,333.5 $3,339.4 $3,440.2 $13,595.7 -- Y/Y growth (23.4)% 13.7% 25.7% 26.8% 16.3% 20.3% (2.9)% Valuation EV/Sales 2.0x -- -- -- -- 1.6x 1.7x Sources: Company reports, FactSet, KeyBanc Capital Markets Inc. Page 6
Disclosure Appendix Important disclosures for the companies mentioned in this report can be found at https://key2.bluematrix.com/sellside/ Disclosures.action. Please refer to the analysts' recently published reports for company-specific valuation and risks. Reg A/C Certification The research analyst(s) responsible for the preparation of this research report certifies that:(1) all the views expressed in this research report accurately reflect the research analyst's personal views about any and all of the subject securities or issuers; and (2) no part of the research analyst's compensation was, is, or will be directly or indirectly related to the specific recommendations or views expressed by the research analyst(s) in this research report. Rating Disclosures Distribution of Ratings/IB Services KeyBanc Capital Markets IB Serv./Past 12 Mos. Rating Count Percent Count Percent Overweight [OW] 314 41.70 65 20.70 Sector Weight [SW] 429 56.97 53 12.35 Underweight [UW] 10 1.33 0 0.00 Rating System Overweight - We expect the stock to outperform the analyst's coverage sector over the coming 6-12 months. Sector Weight - We expect the stock to perform in line with the analyst's coverage sector over the coming 6-12 months. Underweight - We expect the stock to underperform the analyst's coverage sector over the coming 6-12 months. Note: KeyBanc Capital Markets changed its rating system after market close on February 27, 2015. The previous ratings were Buy, Hold and Underweight. Additionally, Pacific Crest Securities changed its rating system to match KeyBanc Capital Markets rating system after market close on April 10, 2015, in conjunction with the merger of the broker dealers. The previous ratings were Outperform, Sector Perform and Underperform. Page 7
Other Disclosures KeyBanc Capital Markets is a trade name under which corporate and investment banking products and services of KeyCorp and its subsidiaries, KeyBanc Capital Markets Inc., Member NYSE/FINRA/SIPC ( KBCMI ), and KeyBank National Association ( KeyBank N.A. ), are marketed. Pacific Crest Securities is a division of KeyBanc Capital Markets Inc. KeyBanc Capital Markets Inc. ( KBCMI ) does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. This report has been prepared by KBCMI. The material contained herein is based on data from sources considered to be reliable; however, KBCMI does not guarantee or warrant the accuracy or completeness of the information. It is published for informational purposes only and should not be used as the primary basis of investment decisions. Neither the information nor any opinion expressed constitutes an offer, or the solicitation of an offer, to buy or sell any security. The opinions and estimates expressed reflect the current judgment of KBCMI and are subject to change without notice. This report may contain forward-looking statements, which involve risk and uncertainty. Actual results may differ significantly from the forward-looking statements. This report is not intended to provide personal investment advice and it does not take into account the specific investment objectives, financial situation and the specific needs of any person or entity. No portion of an analyst s compensation is based on a specific banking transaction; however, part of his/her compensation may be based upon overall firm revenue and profitability, of which investment banking is a component. Individuals associated with KBCMI (other than the research analyst(s) listed on page 1 of this research report) may have a position (long or short) in the securities covered in this research report and may make purchases and/or sales of those securities in the open market or otherwise without notice. As required by FINRA Rule 2241(C)(4)(A), financial interest, if any, by any research analysts listed on page 1 of this report will be disclosed in Important Disclosures, Company-specific regulatory disclosures located above in the Disclosure Appendix. KBCMI itself may have a position (long or short) in the securities covered in this research report and may make purchases and/or sales of those securities in the open market or otherwise without notice. As required by FINRA Rule 2241(C)(4)(F), if KBCMI, or its affiliates, beneficially own 1% or more of any class of common equity securities in the subject company(ies) in this research report, it will be disclosed in Important Disclosures, Company-specific regulatory disclosures located above in the Disclosures Appendix. This communication is intended solely for use by KBCMI clients. The recipient agrees not to forward or copy the information to any other person without the express written consent of KBCMI. Page 8