Cabot Early Opportunities Issue: February 21, 2024

Stocks in This Issue

Checking In On The IPO Market

Back in November, I gave an update on the state of the IPO market, the gist of which was that 2022 and 2023 were terrible years given just 71 and 108 new listings, respectively.

That’s way below the range of 160 to 397 (gulp) between 2017 and 2021.

Lack of new IPOs is not great given that we’d prefer a steady supply of new companies to consider investing in and that we’d like to give newly listed issues time to “marinate” before seriously considering a position (as is the case with the 2021 IPO I’m adding to our portfolio today).

While it’s still early in the year we’ve seen encouraging signs out of the IPO market through late February.

There have been 19 IPOs priced thus far in 2024. That’s up 19% from the same time last year. Total proceeds raised YTD is $5.8 billion, up 224%.

Looking at where the action is, healthcare is the clear winner with about half of the new listings.

Now, I’m not claiming the IPO market is off to a screaming start. A lot of these companies are quite small and “up from last” year isn’t saying a heck of a lot.

But as I said in November, “History shows that IPO markets warm up slowly, not all at once ... For things to truly begin to thaw out we’ll likely need to see interest rates come down and something of a real bull market take shape in the stock market. The latter could be happening now (not a prediction, just an observation) ...”

Interest rates haven’t come down yet (though expectations imply they’ll begin to this spring/summer), but the IPO data shows the thaw has begun.

That suggests as we get deeper into the year more (and bigger) names will come to market. That supply is exactly what we want to supplement the shopping list of opportunities that are already maturing on the public exchanges.

What to Do Now

Until last week the stock market had been on a tear as tech stocks marched higher and higher. The only downside is, if we go by analyst estimates, the S&P 500 has already made the bulk of expected upside progress for the year. And it’s not even the end of February!

That doesn’t mean there are no opportunities out there. In fact, with a relatively small number of stocks driving the bulk of the market’s gains in 2024, and the big-picture market tailwinds still intact, an argument can be made that opportunities abound.

Taking it all in, it’s a good time to be cautious with the most high-profile year-to-date winners. I’d rather allocate new money to a mix of steady growers and lesser-followed small and mid-cap names that have yet to draw too much attention.

STOCKS

Cadre Holdings (CDRE) ★ Top Pick ★

Cadre Holdings (CDRE) is a relatively new (2021 IPO) small-cap growth and value stock offering exposure to the fragmented safety and survivability products & services market.

The company is growing both organically and through acquisitions. Management has a history of success with this strategy (Armor Holdings, sold to BAE Systems), suggesting that at some point Cadre will be sold to a larger defense company.

In the meantime, the company continues to grow its core products business, mainly body armor, explosive ordinance disposal (EOD), duty gear, etc. (drives bulk of revenue and profit) while looking for niche M&A targets that have leading market positions, strong brands, recurring revenue and little to no competition.

Even though police departments remain understaffed, Cadre has done well as spend per officer is going up. And there remains significant potential from overseas conflicts (Ukraine, Gaza) that could drive demand for explosive ordinance disposal (EOD) and tactical gear once things calm down a little.

To put things in perspective, one EOD suit costs around $30K while one de-mining suit costs around $5K.

The most recently completed acquisition, Alpha Safety ($107 million) was just announced yesterday. Alpha Safety has been around for over 40 years and focuses on products and services across radioactive material handling, advanced manufacturing and integrated project services.

Back in January, the company closed the acquisition of ICOR Technology, a leading maker of EOD robots and specialized protective security equipment.

Looking back at Q3 results (reported in November), Cadre surpassed expectations as revenue grew 12.2% to $121 million and EPS jumped 123% to $0.29. Crowd control products drove growth while high volumes and cost containment efforts drove profit margin expansion.

When Q4 2023 results come out around March 7 we should hear that total 2023 revenue growth was around 4.8% ($480 million) and EPS was around $0.95 (+500%).

Looking into 2024, revenue should grow well above 7% (Alpha Safety not included yet) while EPS should be up around 20%. Cadre also pays a dividend, equal to about a 1% yield.

It’s a neat, undiscovered steady-growth business that we can jump on now and, with a little luck, ride to a sizeable gain as the story becomes better known.

The Stock
CDRE came public at 13 in November 2021 and, unlike a lot of other IPOs, held on to its early gains for a while. The first sizeable drawdown (from north of 28) came in June 2022, but by November the stock had made new highs over 30. It didn’t last long. In late 2022 CDRE fell back near 20 and shares were up and down mostly in the 19 to 23 range through July. The stock’s action changed after Q2 earnings on August 8. Since then, CDRE has traded in a tight pattern as it marched relatively steadily up to 35, where it sits today. BUY

Intuitive Surgical (ISRG)

Just over two decades ago Intuitive Surgical (ISRG) disrupted the surgery market by introducing the first generation of its robotic surgery platform, the Da Vinci system.

When the FDA first approved it in 2000 the Da Vinci system allowed surgeons to complete relatively complicated procedures with far greater precision.

In the years since, the company has pushed the innovation envelope further and grown into one of the most successful MedTech companies in history, now sporting a market cap of over $130 billion.

So, what’s new to discover here?

A few weeks ago, the company confirmed the August 2023 filing of its next-gen multi-port platform, Da Vinci 5, with the FDA (“multi-port” means multiple small incisions).

This is among the biggest stories in surgery, and analysts are musing about Da Vinci 5’s potential to slingshot robotic surgery forward (Bank of America theorizes it could get robotic surgery to “industrial scale”).

In other words, ISRG is potentially on the doorstep of a multi-year run higher. While it seems like one of the more obvious large-cap MedTech opportunities out there, sometimes these things sail right by investors who are hell-bent on making life (and investing) more difficult than it needs to be.

While specific launch timing, features, pricing and indication details remain a little elusive, educated guesses suggest a late-2024 FDA approval and processing power of roughly 10,000x the previous generation.

This is a new platform with some instruments and accessories from prior generations still compatible. But there’s no doubt that upgraded add-ons and consumables will be available at launch and new accessories, imaging, etc. options will become available over time that are exclusive to Da Vinci 5 (and priced at a premium).

As far as growth estimates and timing for buying the stock, consensus currently calls for revenue growth of 12.3% ($8 billion) in 2024 (no Da Vinci 5 contribution) and accelerating to 15.6% in 2025. EPS is seen rising from $6.26 (+9.5%) this year to $7.29 in 2025 (+16.5%) and probably near $9.00 in 2026 (+23.5%).

As for the stock, ISRG is currently pulling back after a big run to all-time highs into earnings. We’ll let things settle down just a little with the expectation of adding in the near future.

The Stock
ISRG came public at 9 on June 13, 2000, and after a few stock splits is up a cool 18,000% since (average annual return of almost 25%). Buy and hold anybody? More relevant to today, shares just hit an all-time high of 392 two weeks ago after a steady rally from 255 at the beginning of November. That rally came after a 100-point, multi-month drawdown that began last summer. I’m not expecting a massive retreat in ISRG soon given the upside potential/anticipation from Da Vinci 5, but even so, we’ll sit on our hands for a spell and look for an opportunistic entry point. WATCH

Joby Aviation (JOBY)

Joby Aviation (JOBY) is a transportation company developing an electric Vertical Take-off and Landing aircraft (eVTOL) that will operate as part of a fast, quiet, and convenient air taxi service.

Joby plans to make aircraft as well as operate as a passenger air carrier.

The company is a first mover in the Urban Air Mobility market, which Morgan Stanley estimates will have a total addressable market of $1 trillion by 2040 and $9 trillion by 2050.

Joby is advancing three business goals. First, certifying aircraft. Second, scaling manufacturing. And third, preparing for commercial operations.

Regarding certification, because this is such a new market, Joby (and other eVTOL manufacturers) need to be certified as “power lift” under 21.17b, a modified version of the FAA’s 21.17a certification rules that previously existed for small airplanes.

This means there is more uncertainty surrounding certification.

However, Joby is making significant progress. Just a few weeks ago, on February 9, management announced the FAA had accepted its certification plan for Joby’s propulsion system (all structural, mechanical, and electrical systems).

With the company nearing completion of the third of five phases, Joby is now focused on the fourth phase, detailed testing and analysis across the aircraft components and systems.

Turning to manufacturing, last September Joby selected Dayton, Ohio as the site for its first production facility. The 140-acre site is initially expected to support 2,000 jobs and deliveries of up to 500 aircraft per year. Expect construction to begin this year.

With respect to commercial operations, Joby expects to launch service in 2025. The company has already begun flight testing with pilots and has a number of partnerships and commercial agreements.

Last September Joby delivered its first aircraft to Edwards Air Force Base as part of its $131 million AFWERX Agility Prime contract with the U.S. Air Force (up to nine aircraft to the U.S. Air Force and other federal agencies).

On-base operations with Joby aircraft will be used to demonstrate a range of logistics missions, including cargo and passenger transportation, and will be operated by both Joby and U.S. Air Force personnel.

On February 11, the company announced an agreement with Dubai’s Road and Transport Authority (RTA) to launch air taxi services in the Emirate by early 2026, with initial operations beginning as early as 2025. The company also signed an agreement with Skyports to design, build and operate four initial vertiport sites across Dubai.

The next potential catalysts are, (1) continued progress towards FAA certification, (2) advancements towards executing on its agreement with the DoD and (3) earnings, which come out this afternoon.

In terms of the numbers, Joby ended Q3 2023 with about $1.1 billion in cash. The company will likely need to raise about $1 billion this year, with an announcement likely to come around the time certification is (hopefully) announced.

Limited revenue (maybe $500K) should be reported in this afternoon’s Q4 report. Revenue could be closer to $20 million in 2024 then ramp from there, potentially crossing the $1 billion threshold in 2028/2029.

That said, clearly there are a gazillion risks here and JOBY stock is likely to be extremely volatile over the coming years as things develop. Shares are relatively quiet now, but I’m not going to front-run earnings by a couple of hours so we’ll put JOBY on our Watch List and see how shares act after today’s report.

The Stock
JOBY came public in August 2020 at 10 when the stock market was strong. Shares held up for a while but began to fade later in 2021 and by the end of 2022, JOBY was trading in the low 3s. The stock began to build momentum last May and there was a fierce rally in late June that briefly pushed JOBY close to 12. But as things calmed down shares drifted lower again, ultimately closing 2023 just below 7. The stock has traded as low as 5.4 this year (as recently as early February) and seems to be building a little momentum now. With the company reporting this afternoon we’ll watch, for now. WATCH

Leonardo DRS (DRS)

I added Leonardo DRS (DRS) to our Watch List last month and nothing major has happened with the company since.

But with a few decent earnings reports from other specialized defense companies and a report coming from Leonardo next week, as well as a little bullish action in the stock, we’ll step in with a position today.

If you’re new to the name, Leonardo is a prime contractor and strategic subcontractor that provides technologies and services spanning land, air, sea, space and cyber arenas.

The Italian parent company Leonardo SpA (which is 30% owned by the Italian government) owns more than 70% of the stock, so the float is pretty small (27%).

Leonardo’s customer base includes all branches of the U.S. military (mainly Navy and Army) as well as other contractors and allied governments and militaries.

Its two segments/key areas of technology include Advanced Sensing & Computing (ASC) and Integrated Mission Systems (IMS), which includes electric power and propulsion.

The company’s legacy solutions, including sensing and hardware solutions for ground systems, tanks and armored vehicles, generate consistent, high-margin revenue and remain in high demand (the 2024 President’s Budget request included $13.9 billion for ground systems, a 10% increase over 2023).

Then there are newer projects, like electric power for the Columbia-class nuclear submarine made by General Dynamics Electric Boat. Leonardo makes the main propulsion magnet motor and drive component, among other parts. Contracts for the remaining six (of 12 total) ships are being repriced as they roll out of production.

Other IMS opportunities remain out there too, including work on electric propulsion and power conversion solutions for the South Korean stealth destroyer program.

As a defense company, growth isn’t insane, but expectations are rising. EPS growth is very strong and there’s ample opportunity for upside surprises to move shares. Revenue should be up about 7% (to $2.97 billion) this year while EPS should expand 17% to about $0.83.

We’ll know more when Q4 results and forward guidance come out next Tuesday, February 27.

The Stock
DRS corrected with the market in the first half of 2022 then spent the second half regrouping in the 9 – 12 range. Shares began to climb in December 2022 and continued their upward trajectory through 2023 (albeit with a few pauses here and there), ultimately closing out last year at around 20. The 20 to 21 price area has proven to be a zone of resistance since October, and DRS made another attempt to break out last week. With the potential for earnings to be the catalyst that sends DRS higher, but also some downside protection due to the conservative profile of the company, we’ll step in today. BUY

Netflix (NFLX)

Netflix (NFLX) is this month’s K.I.S.S. (Keep It Simple Stupid) candidate given a multitude of factors suggesting the company has earned – and will retain – the leadership position in content streaming.

Zooming out, the company has the scale, content and growth strategy in place to support several years of double-digit revenue growth, 25% to 30% EPS growth, and free cash flow (FCF) ramp from $6 billion in 2024 to $20 billion in 2026.

That potential already has a good number of analysts pounding the table on shares. The evolution of the story will likely pull in many more.

One of the big catalysts is the paid sharing initiative (current paid users add one shared user for $8/month), which has expanded the company’s addressable market by roughly 25% (from 400 million to 500 million households). It also helped bring in 13.1 million new users in Q4 (the largest Q4 in company history).

Next up is the new advertising business, which has yet to bear fruit but should become meaningful in 2025 and beyond given that 40% of new sign-ups in ad-supported markets are now on the ad tier.

Netflix also has the broadest content library in the business, partly because the company has so many users that it can pay more than competitors. In addition to its own shows/movies (more Oscar nominations than any other studio in January), recent licensing agreements showcase its power position.

Warner Bros., Paramount, NBC Universal and Disney have all inked deals recently. There’s also the nearly global deal with WWE, good for 10 years (with a five-year out).

Lastly, there’s the gaming content, which is new to the platform. It’s not for me, but the kids like to play video games. Netflix is growing its library of content there too.

There is, of course, risk that all of the above makes Netflix a stable, but not particularly exciting, growth story for the next five years or so. But there’s also a compelling argument that the next stage of growth is right in front of the market leader and that a good swath of investors have yet to recognize the opportunity.

The Stock
NFLX came public in May 2002 at 15 and has split shares twice so the current price is a fraction of what it would be unadjusted. The stock has delivered annualized returns of almost 33% since its IPO. The all-time high (692) was struck during the pandemic (November 2021), and in the six months afterward shares suffered a massive drawdown of over 75%. From the May – June 2022 lows (near 163) NFLX has put together a fine stretch of mostly higher highs and higher lows. The biggest exception is the 100+ point drawdown from 453 from last September and October. But that retreat set up the current rally, which began when Q3 2023 results (October 18) came out and got another boost after Q4 results (January 23) sent NFLX up 10% and into the mid-500 range. Shares have hung out in the 580 – 600 range over the last month. With a few wobbles in large-cap tech lately offsetting some bullishness, we’ll start with a half-sized position. BUY HALF

Previously Recommended Stocks

On February 5, we sold Alight (ALIT) and Construction Partners (ROAD) for gains of 8% and 7%, respectively.

Today, I’m moving GitLab (GTLB) to hold until we get through earnings (March 4). Pinterest (PINS) also moves to hold given mediocre price action since the February 8 report.

On February 6, Varonis (VRNS) moved to hold.

From our Watch List, today I’m dropping Stride (LRN) due to the stock’s erratic action after reporting earnings.

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.

Active Positions

Recently Sold Positions

The next issue of Cabot Early Opportunities will be published on March 20, 2024.

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