Cabot Stock of the Month Issue: April 13, 2023

Market Review

The broad markets have improved nicely in the past month, albeit with a recent pullback. Leading sectors were Communication Services, Consumer Staples, Healthcare, Technology, and Utilities. Style-wise, large-cap growth stocks beat their value peers, gaining 3.64% for the month.

The employment picture remains healthy, with 236,000 jobs added in March, taking the unemployment rate down to 3.5%. This was the slowest job growth in two years, so economists are hoping that will slow inflation—and the Fed’s rate hikes!

Housing prices continued to decline, just by 0.2%, to $363,000 nationwide, while housing starts ticked up by 9.8%. Inventory is still depleted, but rates are making it tough on new buyers, especially in the lower-end segment of the housing market.

Manufacturing remains strong, while interest rates—helped by another rise by the Fed—crept up.

Earnings season is on the horizon. FactSet estimates that the forward 12-month P/E ratio for the S&P 500 is 18.0, below the 5-year average (18.5) but above the 10-year average (17.3).

Here at Cabot, we’re delighted by the rebound, but remain cautious. Judicious stock picking is the key to a prosperous and progressive portfolio.

Feature Recommendation: TransMedics Group, Inc. (TMDX): Revolutionizing the Organ Transplantation Industry

My recommendation today comes from Tyler Laundon, Chief Analyst of Cabot Early Opportunities and Cabot Small-Cap Confidential.

In our interview, Tyler said that a company that he is most excited about is TransMedics (TMDX). “It is developing an organ care system for transplant surgeries. The backbone of the company is its Organ Care System (OCS), which is a portable device that keeps donor organs warm and functioning almost as if organs are still in a human body. The company is also able to monitor organ health. It’s an example of a company that’s revolutionizing a market that not only is great for humanity but also is becoming a really viable business. Lots of work to do and very logistics-heavy with many challenges but an exciting story that not many investors are aware of.”

On its website, TransMedics says: “The company was founded to address the growing need for healthier organs for transplantation. We are focused on transforming the standard of care—increasing organ utilization, improving patient outcomes, and reducing transplant costs.”

Here’s a summary of Tyler’s original recommendation of TransMedics:

“There are hundreds of thousands of people around the world dealing with end-stage organ failure. The underlying causes are demographic trends contributing to chronic disease. The solution is organ transplant. And there are loads of people that have elected to donate organs after their death.

“But the standard of care for organ transplant storage—cold storage organ preservation—just isn’t cutting it.

“Cold storage basically consists of flushing a donor organ with cold pharmaceutical solution, putting it in a plastic bag, and putting it on ice in a cooler.

“Organs on ice, with no oxygenated blood supply, don’t last that long. They get injured (i.e., ischemia). Since they’re not functioning there’s also no way to assess their viability for transplant. And there’s no real way to tweak how these organs are handled to optimize their use for transplant.

“The end result is that damaged organs can lead to post-transplant complications. Or they are too damaged to be any good and are just thrown away.

“The unfortunate truth is that only two out of ten lungs are used and only three out of ten hearts are used.

“TransMedics Group (TMDX) is a small MedTech company addressing the unmet market need for more and healthier organs for transplantation, specifically in the heart, lung and liver markets.

“The company’s revolutionary technology is called the Organ Care System (OCS). OCS replaces a very old standard of care, cold storage, that is too static to meet the dynamic needs of today’s organ transplant market.

“The elevator pitch is that the OCS does a better job at preserving organ quality, assessing organ viability prior to transplant, boosting organ utilization and slashing transplant costs.

“This is good for patients (better access to life-saving transplants and quicker recoveries), hospitals (higher transplant volumes, better procedure economics) and for insurance payers (more cost-effective treatment for end-stage organ failure and lower post-transplant complication costs).

“The OCS is also the foundation of TransMedics’ National OCS Program (NOP), a turnkey solution for transplant centers that provides outsourced organ retrieval and OCS organ management.

“The goal of the NOP is to streamline delivery of donor organs from anywhere in the U.S. to a transplant center.

“The OCS—a proprietary, portable organ perfusion, optimization and monitoring system that preserves human organs in a near-physiologic condition—replicates aspects of the organ’s natural living and functioning environment outside of the human body.

“It is the first and only multi-organ platform to leverage the same proprietary technology across several organs.

“The OCS is designed to perfuse donor organs with warm, oxygenated, nutrient-enriched blood and maintain the organs in a living, functioning state. That means lungs are breathing, hearts are beating, and livers are producing bile.

“The end result is that, as verified through clinical trials, OCS dramatically cuts injurious ischemic time on donor organs and increases donor organ utilization as compared to cold storage.

“TransMedics management believes the platform—in concert with the National OCS Program (NOP)—can dramatically increase the number of organ transplants and improve post-transplant outcomes.

“So far, TransMedics has developed three OCS products; OCS Lung, OCS Heart and OCS Liver.

“All three have been approved by the FDA for organs donated after brain death (DBD organs) and organs donated after circulatory death (DCD). OCS Lung and OCS Heart are also approved in Europe.

“The National OCS Program (NOP) is an organ retrieval and management program developed by TransMedics for transplant programs, so they have an efficient process to source donor organs with the OCS. Management believes it will dramatically accelerate adoption of the OCS while boosting the company’s profile among transplant centers and payers.

“The key benefit of the NOP is that it allows transplant centers to outsource the retrieval and organ management process to TransMedics and avoid the capital and resource investments to support higher transplant volumes and long-distance organ retrievals. TransMedics currently has 14 dedicated NOP launch points across the U.S., with more to come. (Nancy’s note: currently, there are 16 NOP launch points).

“OCS products for additional organs, including kidneys, are currently in development with clinical trials for Kidney likely to start in 2023.”

The company’s fourth-quarter revenue jumped 225% year over year, and sales for the full year were up 209%, to $93.5 million.

As an early stage company, TransMedics is not yet earning any money. But its revenue growth has been astounding. And for 2023, TransMedics’ management sees that continuing, albeit at a slower rate. However, the team expects total revenue to climb between 48% and 55% in 2023.

With the passage of The Uniform Anatomical Gift Act (UAGA) in 1968, organ donation options began appearing on driver’s licenses. I signed up as soon as I could. More than 170 million Americans have done so.

Last year, 14,903 people became organ donors. And just 3,818 were heart transplants. A clinical trial showed that 89% of OCS-treated hearts were utilized.

But TransMedics is not a one-trick pony. It is the only company with a single system approved by the FDA to handle multiple organs. And its next big market entrance is in transplanted kidneys. Right now, more than 90,000 Americans are waiting for a new kidney, but last year, less than 25,000 transplants were performed.

TransMedic’s shares have been on a tear. But if the kidney initiative works as planned, the upside could be stratospherical. Of course, being a small-cap company, the downside risk is also substantial. Consequently, please don’t load up on the stock; it should be designated for that speculative part of your portfolio.

I would suggest that you buy in cautiously, and add on any temporary downturns.

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About the Analyst: Tyler Laundon, Chief Analyst, Cabot Early Opportunities and Cabot Small-Cap Confidential

Tyler’s small-cap portfolios favor a high allocation to stable, high-growth companies, upon which he layers strategic purchases of higher-risk, event-driven investments.

He first began publishing his analysis of small-cap opportunities in 2009. Since 2012, he has led his subscribers into more than two dozen doubles. Between 2012 and September 2015 his small-cap recommendations generated cumulative returns of over 2,300%, including both winners and losers, and outperformed the Russell 2000 Index by an average of 28% per year.

I’ve known and followed Tyler’s recommendations for many years—even before he joined us at Cabot. In the small-cap world, he is one of the few analysts in this arena who has thrived in both bullish and challenging markets.

With the volatility of the markets, as well as the upheaval in the regional bank sector, I was interested in finding out Tyler’s thoughts on recent events. Here’s our interview:

Nancy: In your March edition of Cabot Early Opportunities, you discussed your thoughts and concerns re: the banking industry, specifically the recent collapse of Silicon Valley Bank. Since then, Signature Bank was closed, and Credit Suisse was acquired by UBS. Is this the beginning of a larger crisis in the banking industry? What is your opinion of the deposit guarantees for Silicon Valley’s uninsured account holders?

Tyler: It was good to see the Fed step in just a couple days after SVB’s blowup to provide liquidity to banks through the new bank Term Funding Program (BTFP). I think guaranteeing uninsured account holders was the only move. If one argues SVB shouldn’t have been in this position in the first place, then the response is that their high quality assets wouldn’t have been underwater if the Fed hadn’t gone on a historic interest rate hike program. The “they shouldn’t be in this position” argument goes nowhere since so many other banks have underwater assets for the same reasons. The only path to avoid a financial crisis was to backstop the banks. The quick response, and the targeted mechanism to provide liquidity, has significantly reduced the risks of a credit crunch. It’s too early to say a banking crisis has been avoided since there could be other shoes to drop. But for now, it appears the Fed, Treasury and FDIC are on top of things, which is good.

Nancy: You also mentioned that perhaps the Fed would relax its rate hike policy. However, the Fed raised rates again just a week later. Has your thinking changed on that? Would you please share your reasoning?

Tyler: The only way the Fed could hike after the SVB failure was if they stabilized the banking system, which they did (at least in the short-term). In some ways, the rate hike showed their confidence in the economy and the banking system, which was short-term good for the market. My thinking is that the Fed has just one more hike to go, in May, before they pause. I’m just going with the market odds at this point, which reflects the most recent economic data.

Nancy: Your portfolio is peppered with many tech stocks. And technology equities have been rebounding this year, up almost 20% on average. I know, of course, that you focus on smaller-cap companies (and very successfully!). But for the average investor who would like to diversify into larger-cap tech companies, which might you recommend? And would you be a FAANG investor?

Tyler: I do like many of the mega-cap tech stocks. Microsoft (MSFT) is my favorite in that group, and I also like Apple (APPL) and Netflix (NFLX). I think the average investor would do well to own some of those three.

Nancy: Which tech sectors are you currently favoring, and which don’t you like?

Tyler: It’s very hard to make a sector call in this environment because stock performance, especially at the small end of the market cap curve, has been more about company specifics than sector-wide trends lately. That said, I think there are some interesting opportunities in fintech, medical technology and software, though that last category is so full of stocks that look horrible it’s hard to have faith in the few that look OK.

Nancy: Your portfolio has included several biotech companies. Are you still attracted to them?

Tyler: Yes, but biotech is such a fickle area of the market. It’s really hard to be successful picking a couple of these stocks here and there unless you can be really patient and willing to see a stock go down a lot. I think most investors would be better off gaining biotech exposure through an ETF like the IBB. It has plenty of upside, offers diversification, but removes the risk of a single stock blowing up overnight on a bad trial result.

Nancy: There have been several biotech acquisitions recently, particularly in the pharmaceutical arena. What do you think the M&A prospects of that industry are for 2023?

Tyler: I think M&A potential in biotech is good. But again, it’s so difficult to pick the winners in such a big market - especially if you’re only buying a few biotech stocks.

Nancy: Are there any sectors or sub-sectors that you currently see as oversold?

Tyler: Oversold, yes. Attractive buys? Not so sure. Big picture, as an asset class, small-cap stocks have definitely been impacted by the sell-off in the small-cap financials sector. Financials make up almost 16.4% of the S&P 600 Small Cap Index versus just under 13% of the large -ap index. And with some financial system instability, there is more financial tightening among smaller players, which has hurt small-cap industrial stocks as well as small-cap energy. These stocks are also feeling the impact of an economic slowdown. While they are “oversold,” I’m not convinced they are attractive buys just yet, other than for relatively nimble investors who may be looking for trading opportunities.

Nancy: What are the 3-5 most critical challenges to growth of the stocks in your portfolio right now?

Tyler: First is the ever-present pressure of the Fed’s interest rate hiking agenda. That’s the dark cloud over the entire market. And while it should be in the ninth inning, it has led to the second biggest challenge, which is a slowing economy and/or recession risk. Both of those challenges apply constant downward pressure on stocks and valuation and aren’t easy risks to eliminate. The third challenge is that there is now a viable alternative to stocks in the form of fixed income offerings given that yields of 4-5% are easy to come by, at least for short-term assets. That, along with subdued investor confidence means stocks – especially higher risk stocks – aren’t as attractive in general as they’ve been in recent years. I think all of these macro challenges permeate through even the best stock-specific stories and mean that an individual company has to have a really, really terrific story in order to gain the trust of larger investors.

Portfolio Updates

Not much news on M/I Homes (MHO). However, while media gurus bemoan the housing market, February stats showed that housing starts actually increased by 9.8%, helped by a small decline in prices and mortgage rates. The company will announce quarterly earnings on April 26. Current estimates call for EPS of $2.36 on revenues of $787.87 million.

If you have not yet purchased shares of M/I Homes, you could add a few here. For subscribers who are already owners, Continue to Hold for now.

Tom Hutchinson, Chief Analyst of Cabot Dividend Investor, recently updated his thoughts on Qualcomm (QCOM), saying, “This is a great longer-term stock of a company with a huge share of mobile 5G chips and strong exposure to some of the fastest growing areas in technology. Meanwhile, it sells at a very cheap valuation by historical standards. QCOM has been pushed around by the sector since it’s been under pressure, but there has been new life lately. Inflation is coming down and interest rates are falling, and technology is the best performing sector YTD with the group up over 20%. At some point this year, the market should start sniffing out the recovery, if one hasn’t already begun. And QCOM can make up for lost time fast when it moves.”

Qualcomm’s average brokerage recommendation is 1.87, on a scale of 1 to 5 (Strong Buys to Strong Sell). Of the 19 analysts recommending the company, 11 rate it a Strong Buy.

Industry experts are predicting a rally in the smartphone and mobile device market, due to upgrades to the 5G mobile network and the surge in AI applications. And with Qualcomm’s inventory on hand, that could bring a boost to the company’s stock.

MLCommons, an engineering consortium, just reported that in recent testing, Qualcomm’s AI 100 beat Nvidia’s flagship H100 chip at classifying images, based on how many data center server queries each chip can carry out per watt.

Let’s continue to Hold.

Insiders have been adding Devon Energy (DVN) shares to their portfolio. In the last year, they’ve purchased 47.21k shares worth $2.4 million. The company is expected to report earnings on May 1. Analysts are expecting EPS of $1.48 on revenues of $4.05 billion.

With OPEC’s recent cuts, oil prices have edged up, and so has Devon’s stock. Let’s continue to Hold for now.

Bruce Kaser, Chief Analyst of the Cabot Turnaround Letter and Cabot Undervalued Stocks Advisor, recently updated his Citigroup (C) recommendation, saying: “The bank’s CET1 capital ratio of 13.0% is healthy and a full percentage point above the new minimum of 12.0%. While its capital ratio could perhaps slip to 11% if it were to be required to take a 10% mark-to-market hit to its held-to-maturity bond holdings, we see such a requirement as unlikely. We see little to no chance of a capital raise or dividend cut, although share buybacks won’t likely resume for another year or two. Citi’s profitability appears relatively resilient. The shares currently trade at a very low 53% of tangible book value and 7.5x estimated 2023 earnings per share, and offer a likely sustainable 4.7% dividend yield. Citi is highly unlikely to experience a bank run, as depositors should know that they will almost certainly be fully protected given Citi’s status as a systemically important financial institution.”

Bridgewater Associates, founded by Ray Dalio, just bought more than $58 million of Citi’s stock. At the end of the year, 81 hedge funds owned about $7.5 billion of Citi stock.

The shares of Citi are severely undervalued. In fact, Investor Place recently commented, “The valuation has also gotten silly. Shares are going for just half of book value.” I agree. Buy.

Michael Brush, Chief Analyst of Cabot Cannabis Investor, shared his recent thoughts on Curaleaf (CURLF), commenting, “Curaleaf announced it will delay its fourth-quarter earnings release to April. Earnings were originally scheduled for March 28. Curaleaf said this is because of the complexities of converting financials to comply with U.S. accounting rules, from Canadian rules, and ‘the review of the treatment of various accounting matters.’”

The company just announced the completion of its previously announced acquisition of Deseret Wellness, the largest cannabis retail operator in Utah. That makes four dispensaries in Utah and 150 nationwide for CURLF.

These shares are for the long-term; buy for the speculative section of your portfolio.

Tyler Laundon also updated his take on Huron Consulting (HURN): “Huron has put together a nice string of days that has the stock sitting just a hair below multi-year highs. With roughly 10% revenue growth and 18% EPS growth expected over each of the next two years the stock ‘should’ do fine. It probably helped that mega-consulting group Accenture reported a better-than-expected quarter last week. That said, with the stock near a recent top (and barely above our entry price in December) I’d like confirmation of a breakout before buying more right here. Moving to hold until we get that confirmation. HOLD.” I agree. Hold.

Carl Delfeld, Chief Analyst of Cabot Explorer, had this to say about Kraken Robotics (KRKNF): “Shares almost broke 0.40 this week and finished at 0.38. The company designs and manufactures software-centric sensors, batteries, and underwater robotic systems for unmanned underwater vehicles used in military and commercial applications. This small maritime and defense company needs to get its story on the radar screen of more investors. It remains a buy for aggressive investors. Buy a Half.”

In an analyst report I recently read, estimates for a fair value for KRKNF were $1.02 per share. I like it! Buy for the speculative portion of your portfolio.

Our newest recommendation, Shift4 (FOUR), was recently updated by Mike Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader, commenting, “FOUR looked as good as could be a week ago, but this week’s rotation out of growth stocks and increased fears of a recession (many economic reports have been weak in recent days, even as Fed officials continue to jawbone for higher rates) has brought some selling—not cracking the uptrend, per se, but quickly pulling shares back into their March trading range.

“As we wrote about recently, a modest recession (if one comes) wouldn’t be good for a payment operator, but Shift4’s move into new industries should cushion any blow, as it did just a couple of years ago—even though restaurant and hospitality are its core clients, the firm actually grew during 2020, and obviously, those sectors are far healthier today while new clients should goose growth. Thus, the story remains excellent, though we’ll be watching the stock’s action: A decisive dip below the 65 area would be a yellow flag and at least have us going back to hold, but at this point the dip is sharp but acceptable, so if you don’t own any, we’re OK starting a position here. BUY.”

FOUR was a recent Stock of the Day at IBD, with analysts commenting that the “stock is well-positioned” in light of the recent regional bank crisis. Continue to Buy.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

ETF Strategies

Let’s unload iShares Core US Treasury Bond (GOVT) from our ETF portfolio this month. Recession fears seem to be reducing daily, and I think we no longer need this fund.

Currently, First Trust Water ETF (FIW), iShares US Energy (IYE), and AGF U.S. Market Neutral Anti-Beta Fund (BTAL) remain positive, as do newer recommendations US Healthcare Ishares ETF (IYH) and Communication Services Select Sector SPDR Fund (XLC).

I’m looking at some new technology funds, and am just waiting for a signal to jump in.

*Aggressive (A), Moderate (M), Conservative (C)

Transplant Needs are a Global Phenomena

In 2022, the global transplantation market size was valued at $14.37 billion, but it’s predicted to grow to $27.18 billion by 2029, a CAGR of 9.5%, due to demand for novel tissue transplantation products and the rise in organ failure, caused by serious trauma, loss of blood, poisoning, drug abuse, leukemia, sepsis, and other acute diseases. COVID-19 reduced transplantation numbers, as transplantation weakens the immune system, which was further compromised by the pandemic. But unhealthy diets, alcohol consumption, lack of exercise, and drug abuse are leading to increased worldwide demand for tissue and organ transplantation, mainly kidney, heart, liver, and lungs.

Demand for organs far outweighs supply.

Advances in the technology and development within the medical sector, such as developing techniques for vascular anastomoses, managing the immune response (chemical immunosuppressants), and devising preservation solutions (such as TransMedics’) has made it possible to transplant organs such as heart, kidney, liver, lungs, and various other organs.

The U.S. has more than 108,000 candidates waiting for organ donations, the majority of which require a kidney transplantation. But, as you can see from the following graph, the need is worldwide.

Global Organ Transplantation Market

And that creates a very attractive marketplace for TransMedics.

The next Cabot Money Club Stock of the Month issue will be published on May 11, 2023.