Cabot Early Opportunities Issue: December 21, 2022

Stocks in This Issue

Stock Name	Market Cap	Price	Investment Type	Current Rating
Catalyst Pharma (CPRX)	$1.94 billion	18.6	High Growth – Biopharma	Buy 1/2
Chewy (CHWY)	$16.8 billion	39.6	Growth – Online Pet Supplies	Buy 1/2
Halozyme (HALO)	$7.67 million	56.7	High Growth – Biotech	Buy 1/2
Sight Sciences (SGHT)	$599 million	12.5	High Growth – MedTech	Watch
SolarEdge (SEDG)	$17.3 billion	310	High Growth – Solar	Watch

Santa Claus Rally Looking Unlikely This Year

Heading into the final days of a pitiful year, stocks are looking suspect once again.

Blame the Fed.

While the Federal Reserve’s actions at last week’s FOMC meeting and Jerome Powell’s comments during the press conference largely lined up with analyst expectations, the market’s interpretation is that a hard landing (i.e. deeper recession) is now more likely in the first half of 2023.

What stuck out to me was that, just a week earlier while speaking at the Brookings Institution, Powell’s commentary painted a much more upbeat picture of what the U.S. economy could look like in 2023.

He was a lot more hawkish last Wednesday.

Data shows inflation is coming down – headline PCE inflation is expected to drop from 5.6% this year to 3.1% in 2023 – and we are within a couple hikes of the median FOMC member Federal Funds rate forecast of 5.1% (current target rate is 4.25% to 4.5%). Still, the Fed is hell-bent on managing expectations, which means not showing any weakness in its resolve to crush inflation before it becomes baked into the psyche of U.S. consumers.

The silver lining is that Fed member projections see the Fed Funds rate dropping to 4.1% in 2024 and 3.1% in 2025.

One issue right now is that services inflation remains too high, and likely won’t come down until the labor market cools off. That’s not an easy “problem” to fix as there may be structural shifts within labor markets (demographics, post-pandemic reluctance to cut staff, etc.) that aren’t yet incorporated in Fed models.

The Fed has made it clear it is willing to tolerate higher unemployment and slower growth to achieve its inflation goals. An updated Summary of Economic Projections (SEP) last week showed the Fed now sees 2023 unemployment of 4.6%, up from 3.7% this year.

The Fed’s new 2023 GDP forecast is a range of -0.5% to 1.0%, down from September’s forecast range of -0.3% to 1.9%

The net effect of expectations for higher interest rates, higher unemployment and lower GDP growth is crushing any hopes of an end-of-year rally in the stock market.

Analysts have already been cutting their forward earnings estimates for the S&P 500 in Q4 2022. The average of consensus estimates now show just 0.4% EPS growth, which would work out to earnings of about $220 for the full year 2022.

If we look out at 2023, current earnings estimates are around $230. That’s higher than this year, but just barely. In a recession scenario, 2023 earnings would likely drop closer to $200.

That’s the bad news.

The good news, such that it exists, is that if a recession does come it will be the most widely expected recession in history. That raises the question of how much of all this is already baked into current stock prices.

Investor sentiment, which continues to be in the gutter, suggests the market is already discounting a lot of bad news.

Given that the market tends to look forward by about 12 months, to a time when inflation, the Fed Funds rate and earnings trends should be moving in more market-friendly directions, there are reasons to be optimistic for the back half of 2023.

The bigger question is what happens in the next three to six months.

My best guess – and this isn’t a trading plan but just a “what I think on December 20” type comment – is that in the near term the market will continue to act much as it has over the last six months, rising and falling as economic data comes out and as the Fed updates us on its plans and projections. We need more data showing that inflation is heading solidly lower before the broad market can make any significant progress.

We’ll get one batch this Friday when November’s personal income report comes out. If this data – the PCED report – confirms that consumers continue to spend and that inflation is moderating, then a modest Santa Clause rally may just have a chance.

We’ll heed the data and the market’s action when it comes to our investment decisions.

The next FOMC meeting is on February 1, which seems far off, until you consider Q4 earnings season starts in mid-January.

Bottom line, the Fed should be nearing the end of its hiking cycle and the data should continue to show inflation moving in the right direction. But we need more evidence that a soft landing scenario is still possible for the broad market to make any near-term progress.

What to Do Now

Continue to tread carefully and keep plenty of cash available. The key to being able to sleep soundly during a bear market is knowing that you have the capital available to act when the trends improve.

That said, there are fierce rallies during bear markets, as we’ve seen. And not all stocks are disasters. I see plenty of charts that look good (including those of stocks in this Issue), and a lot of companies with terrific business models, rising revenues, earnings and cash flow.

We will continue to prioritize taking partial positions in a few names to try and capture upside, but also leave the door open to cut bait on smaller position sizes, or average down in stocks we like if they falter but are still attractive.

Catalyst Pharmaceuticals (CPRX) *TOP PICK*

Catalyst Pharmaceuticals (CPRX) is a small-cap biopharma company focused on in-licensing, developing and commercializing novel medicines to treat rare diseases. It has a market cap around $2 billion.

While the company came public in 2006, the company’s current success is more closely aligned with a collaboration it struck with BioMarin (BMRN) in 2012 when Catalyst obtained the North American rights to amifampridine.

At the time amifampridine was being developed to treat Lambert-Eaton Myasthenic Syndrome (LEMS), a neuromuscular disorder that often causes severe and progressive muscle weakness and fatigue.

LEMS occurs when the immune system disrupts communication between nerves and muscles and disrupts the release of an important chemical called acetylcholine (ACh). Lacking proper release of ACh muscles don’t fully function. LEMS impacts about 3,000 people in the U.S. and many more worldwide.

In 2018, Catalyst obtained FDA approval for amifampridine tablets (commercial name is Firdapse) for adults with LEMS. Commercial launch was early 2019 and is now available for adults. A pediatric label expansion is now in a Phase 3 trial. Canada has approved the treatment for adults and expansion efforts in Japan are underway.

Catalyst is also on the prowl for assets to spur more growth. In 2021, the company began evaluating drug candidates beyond neuromuscular diseases in an effort to diversify its revenue base. Management has said it will seek to acquire companies and acquire or in-license drug products in development.

On that note, in July 2022 Catalyst acquired the rights to Ruzurgi from Jacobus Pharma. This acquisition settled an ongoing patent dispute and helped remove an overhang from CPRX stock.

Then this week Catalyst announced the acquisition of the rights to FYCOMPA from Eisai. This drug is approved for epilepsy, should generate $136 million in the 12 months ending March 31, 2023 and should add to Catalyst’s earnings. The $160 million acquisition also includes an option to evaluate and potentially acquire an additional epilepsy drug from Eisai.

Clearly, Catalyst management is thinking of building a bigger company.

In Q3, the company added $35 million to its balance sheet to end the quarter with $256 million in cash. Revenue grew by 59% to $57.2 million. EPS was $0.26 (+86%).

Analysts expect revenue growth of around 49% ($210 million) this year and growth of 20% ($250 million) in 2023. Expected EPS is $0.73 (+33%) this year and $0.88 (+19%) in 2023.

The Stock

CPRX was up and down for a number of years but the stock began to do well this past summer when it broke out to multi-year highs above 8. It continued to rise through the Jacobus asset acquisition in July and reached a September high of 17.2. Shares pulled back as low at 11.7 late in September but soon stabilized and began making a series of higher highs and higher lows again. That pattern persisted through mid-November when CPRX moved above 16. For the last four weeks the stock has been trading in the 16 to 19 range. CPRX enjoyed a boost from the acquisition news on Tuesday and is on the verge of breaking out. BUY HALF

Chewy (CHWY)

Chewy (CHWY) is a pure-play U.S. online retailer for pet supplies. The company has a market cap of $18 billion and just reported a better-than-expected Q3 fiscal 2023 (which ends in January) two weeks ago.

There are no guarantees for any stock in a weakening economy. But pet supply retailers are among the last to see spending cuts. Like grocery stores, these businesses sell products that customers need, in addition to some that they just want.

Chewy management says that 83% of net sales come from non-discretionary categories, pet food and healthcare.

The company has 20.5 million active customers (up 1% over the last year and 9% over the last two years) and sells more than 100,000 products spanning pet products (branded and private label), prescription Rx food and Rx medication products.

In recent quarters Chewy has benefited from more stable supply chains, investments in logistics, fulfillment center automation (two going now, three more coming soon and retrofit of existing centers underway), careful inventory management, and reduced pricing in some categories.

The company has also expanded its CarePlus suite of insurance and wellness offerings, launched Vibeful, a private brand of non-prescription supplements, and begun testing sponsored ads on Chewy.com.

Combined with continued growth of its Autoship program (+19% to reach 73% of total sales in Q3 fiscal 2023), which allows customers to subscribe to regular orders of the same products, these initiatives are driving higher investor interest in CHWY stock.

In Q3, net sales per active customer (NSPAC) rose by 14% to $477. Revenue rose 14% to $2.53 billion while EPS of $0.01 improved from a loss of -$0.08 in the year-ago quarter. Analysts see full-year fiscal 2023 (ends in January) revenue up 13% to just over $10 billion and EPS of -$0.01.

In fiscal 2024 revenue is seen rising 10% to $11 billion and EPS is seen up 10-fold to $0.10.

With the stock looking good but holiday sales still an unknown we’ll start with a half-sized position.

The Stock

CHWY went public at 22 in June 2019 and shot up 59% in its first day. The bull market during the pandemic, especially among online specialists, helped CHWY surge to an all-time high of 120 in February 2021. The road to the 2022 low of 22.2, struck in May, was similar for CHWY as it was for many other high-growth pandemic favorites. There were pockets of strength here and there but, big picture, it was a drawn-out slide characterized by lower highs and lower lows. CHWY came off the May low and enjoyed a run to 52 by mid-August. Another drawdown pulled shares down to 30 a few weeks later. But CHWY’s chart has begun to look a lot more constructive since October and, with the stock trading in the low 40s now, we’ll jump in with a partial position. BUY HALF

Halozyme Therapeutics (HALO)

Halozyme Therapeutics (HALO) is a biotechnology company that has developed a drug delivery platform called ENHANZE that is used to deliver injected drugs and fluids. It has a market cap of $7.9 billion.

The key part of ENHANZE is Halozyme’s proprietary recombinant human hyaluronidase enzyme, rHuPH20. This enzyme works by breaking down a naturally occurring carbohydrate in the extracellular matrix in tissues (such as skin and cartilage) to improve the absorption and dispersion of injectable biologics, small molecules and fluids.

This means drugs that were required to be delivered via IV can now be delivered just under the skin (subcutaneous injection) with ENHANZE. The technology can cut delivery time by hours, reduce adverse reactions, simplify dosing requirements and allow more flexible treatment options, such as dosing at home by nurses, or even the patient.

Halozyme makes money by licensing its technology to biopharmaceutical companies and collaborating with them to develop products that combine ENHANZE with their own compounds.

This gives the company a much lower risk profile than many other small- and mid-cap biotech companies because its revenue streams are diversified.

I won’t get into all the treatments Halozyme has licensed ENHANZE out for. But suffice it to say with agreements with Roche, Baxalta, Pfizer, Janssen, AbbVie, Lilly, Bristol-Myers Squibb, Alexion, Argenx, and Horizon Therapeutics, among others, there are a lot of irons in the fire.

Halozyme has also recently completed the acquisition of Anteres Pharma, which brought in an autoinjector technology with a 5 mL autoinjector currently in development. This product appears to be well suited for patients that want to self-administer treatments.

Halozyme’s revenue is a mix of product sales, collaboration revenue and license revenue. In aggregate, the trend is strong.

Halozyme grew revenue by 66% to $443 million in 2021. Q3 2022 revenue was up 80% to $209 million and is seen up 53% this year and another 31% in 2023. Halozyme is expected to deliver EPS of $1.35 this year (-33%) and $2.63 in 2023 (up 95%).

With HALO bucking the broad market trend we’ll take a small swing today with a half position but keep a close eye on it and be ready to step back if the stock falters.

The Stock

HALO started trading in 2004 but didn’t do much for a long time. Then revenue and profits improved in 2020, the company began buying back stock, and in the middle of the year HALO moved through its previous all-time high of 25. Shares kept rallying through the end of the year and made new closing highs near 50 early in February 2021. The trend turned and HALO had a long drawdown that sent shares as low as 31 by early 2022. The stock rallied back to 53 by this past July, retreated to 38 in September, then took off and enjoyed a three-month rally that has carried it to new highs just below 60. BUY HALF

Sight Sciences (SGHT)

Sight Sciences (SGHT) is a small MedTech company specializing in eyecare solutions for patients with glaucoma (OMNI and SION devices) and dry eye disease (TearCare). These are two of the largest markets in eyecare and the standard of care, pharmaceutical eyedrops, falls well short of achieving desirable results.

The OMNI surgical system is a minimally invasive glaucoma surgery (MIGS) device indicated for adult patients with primary open-angle glaucoma (POAG). POAG accounts for 90% of all glaucoma cases and is the leading cause of irreversible blindness.

OMNI is an implant-free device that surgeons use to lower interocular pressure (IOP) by targeting any of the three primary points of blockage or resistance. It looks a bit like an electric toothbrush, with a much more intimidating tip that resembles a curved needle.

SION is a manually operated surgical instrument used in goniotomy procedures. Goniotomy is a surgery for glaucoma patients that’s intended to lower eye pressure. With SION, surgeons have a bladeless tool that allows them to remove diseased tissue around Schlemm’s canal. The device was just launched in August 2021.

TearCare is the company’s treatment for dry eye disease due to meibomian gland dysfunction (MGD). It uses both wearable and smart technology to deliver localized heat therapy.

The device is comprised of SmartLids, which stick to the skin above and below the eye and are connected to a SmartHub, a small device that manages heat and time to the SmartLids on each eye.

In Q3 2022 revenue grew by 43% to $18.7 million. Glaucoma (OMNI and SION) grew by 37% to $17.1 million (91% of total revenue) while dry eye (TearCare) grew by 145% to $1.6 million. Results were ahead of expectations, especially for TearCare.

For the full year 2022, management guided for revenue of $70 - $72 million, or roughly 45%. Estimated revenue growth in 2023 is 30%. The company is not profitable. Estimated 2023 EPS is -$1.36.

Shares of Sight Sciences have significant upside if physician adoption trends continue and if positive reimbursement decisions come through (especially for TearCare). The biggest risk is that competition (think stents) keeps the company from achieving expected growth.

The Stock

SGHT came public in July 2021 at 24. The stock jumped 40% the first day then kept climbing until it peaked a few weeks later at an intra-day high of 42.6. After that SGHT trended down until it hit 6.3 in late April of this year. Shares traded as high as 11.8 over the next three months then trended down again, ultimately bottoming at 5.35 on October 11. SGHT has mostly been trending higher since. The stock enjoyed a 35% pop after the Q3 report on November 10 and has recently traded at an eight-month high above 14. That said, given the recent pullback below 12, we’ll put SGHT on the Watch List now and see where shares stabilize. WATCH

SolarEdge Technologies (SEDG)

SolarEdge (SEDG) makes power optimizers, solar photovoltaic (PV) inverters and home batteries for the rooftop and distributed solar power markets. Every solar array needs an inverter to convert the direct current (DC) into alternating current (AC). This allows the power to be distributed, stored and used to power lights, appliances, etc.

SolarEdge stands out in the industry because it invented an intelligent inverter solution that changed how power is harvested and managed in residential and commercial solar PV systems.

In a nutshell, the SolarEdge DC optimizer inverter system maximizes power generation from each PV module while also lowering the cost of energy produced by the entire solar PV system.

Because each PV module is connected independently, one module can get dirty, covered with snow or messed up in another way and not throw off the entire system.

Think of it like a system that lets any given bulb in a Christmas light strand break, without affecting how any of the other lights perform.

SolarEdge’s string inverter system is more expensive than simpler string-array systems, but more cost-effective than a microinverter system which requires an inverter for every PV module.

This is essentially a volume game. As demand for installed solar panels goes up, so too does demand for inverters, including those from SolarEdge. The company is poised for growth now because rooftop and distributed solar demand is growing quickly as solar becomes more cost-competitive in both developed and emerging economies.

In Q3 the company beat on the top line, in part due to strength in Europe (60% of Q3 revenue), easing of supply chain disruptions, and as new manufacturing capacity comes online. We could see the company’s first U.S. plant begin production in 2023, depending on how things shake out with the U.S. Treasury and Inflation Reduction Act.

Q3 revenue grew by 59% to $837 million. EPS was $0.91, lower than expected due to a higher-than-forecast tax rate.

Analysts currently see full-year 2022 revenue climbing 57% to $3.09 billion then growing another 30% in 2023, to $4 billion. U.S. production would likely add to that. Estimated 2022 EPS of $4.37 is seen jumping by 87% to $8.16 in 2023.

With a bright future and pending Inflation Act boost, but a volatile share price and an iffy market, I’ll add SEDG to our Watch List today.

The Stock

SEDG went public in 2015 at 18 and did well over the years. But shares really began climbing in 2019 and reached 143 before the pandemic hit and cut the price in half. SEDG was back to new highs by the middle of 2020 and in January 2021 hit an intraday high of 377. Since then the stock has been swinging in a wide range between 190 and 390. The latest surge was this past July when SEDG peaked at 376. But by mid-October the stock was back at 190. Since then it has rallied back to 320, helped by a surge in interest after the Q3 earnings report on November 7. WATCH LIST

Previously Recommended Stocks

We’re not making any changes to ratings in our current portfolio or our Watch List stocks today.

While there are a few Watch List stocks acting well (like ARHS) and a few current positions that have pulled back to levels where averaging down could make sense (like NRDS) we have a new batch of portfolio additions today and we’ll maintain our current focus on those.

An updated table of all stocks rated BUY, HOLD and WATCH as well as recent stocks SOLD, is included below.

Please note that stocks rated BUY are suitable for purchasing now. In all cases, and especially recent IPOs, I suggest averaging into every stock to spread out your cost basis.

For stocks rated BUY A HALF, you should average into a position size that’s roughly half the dollar value of your typical position. We may do this when stocks have little trading history (for instance, IPOs), when there is more uncertainty in the market or with a stock than normal, or if a stock has recently jumped higher.

Those rated HOLD are stocks that still look good and are recommended to be kept in a long-term oriented portfolio. Or they’ve pulled back a little and are under consideration for being dropped.

Stocks rated SOLD didn’t pan out, or the uptrend has run its course for the time being. They should be sold if you own them. SOLD stocks are listed in one monthly Issue, then they fall off the SOLD list.

Please use this list to keep up with my latest thinking, and don’t hesitate to email with any questions.

Recently Sold Positions

The next issue of Cabot Early Opportunities will be published on January 18, 2023.