Cabot Early Opportunities Issue: July 19, 2023

Stocks in This Issue

Earnings Season Preview

With second-quarter earnings season upon us, I’m dedicating this month’s intro to quick notes on what is expected out of each of our current positions.

Datadog (DDOG) will report on Tuesday, August 8. We’re expecting revenue to be up about 24% to $502 million and for EPS to be up 17% to $0.28. Key to the stock’s reaction will be updated guidance. The hurdle is revenue of $2.09 billion (+25.3%) and EPS of $1.17 (+19.5%). We’re up 20% since we jumped in about a month ago. BUY HALF

e.l.f. Beauty (ELF) has a beautiful chart that has our position up 28% since April 19. Earnings are expected around August 1 and we’re looking for revenue of $183.9 million (+50%) and EPS of $0.56 (+44%). Note that this report will be the first quarter of fiscal 2024 for ELF. Full-year consensus estimates call for revenue of $726 million (+25.4%) and EPS of $1.81 (+9.1%). The company enjoyed a huge burst of earnings power in the second half of last year so comparable quarters in fiscal 2024 are tough. Moving the stock to HOLD today.

Ferrari (RACE) continues to buy back shares and the stock continues to work. We’re up about 11% since mid-May. Earnings are expected around August 2. Revenue is seen coming in at $1.48 billion (+14.4%) and EPS around $1.72 (+26.8%). That would put the sportscar maker on track to grow revenue by 14.6% this year and EPS by almost 25% (EPS gets an added boost from share buybacks as earnings are distributed among fewer shares of stock). BUY

HubSpot (HUBS) leads in our portfolio with a current paper gain of 35%. Earnings come out August 2. Revenue better be up at least 20% to around $505 million and EPS needs to be $1.00 or more (+126%). The full-year guidance hurdle is 20.7% revenue growth to $2.09 billion and EPS of $4.84 (+74%). BUY HALF

Microsoft (MSFT) is just one percentage point behind HUBS as of yesterday’s close (i.e., +34% for us). Earnings are on July 25. Too many headlines about AI here to list but the bottom line is the company is moving fast and rolling out products, features and partnerships that help it monetize (i.e., charge) for its AI solutions. Pretty exciting if you’re a shareholder. This will be MSFT’s Q4 of fiscal 2023 and revenue is seen up 6.9% to $55.4 billion, and EPS is seen up 14.4% to $2.55. Guidance for fiscal 2024 is key. Management should hint toward revenue of a gazillion dollars ($236.2 billion if you want to be more precise, which is +11.7%) and EPS of $11.02 (+14.5%). BUY

Pulmonx (LUNG) reports on August 2. This has been a sneaky climber for us, having climbed 19% higher since mid-March with hardly any attention-grabbing daily moves. Revenue is seen up 13.7% to $15.9 million in the quarter with EPS of around -$0.44. Full-year revenue expectations of $64.7 million imply 20.7% growth while EPS is seen at around -$1.72. LUNG is still a recovery story after the pandemic crushed the business. We’re looking for significant improvement in the underlying trends. BUY HALF

Rivian (RIVN) will be a closely watched stock when it reports around August 8. We doubled down on May 22^nd and that move has helped us get back in the black (+10% as of yesterday’s close) after being down more than I care to admit. Looking for revenue of $986 million (+171%) and EPS of -$1.42. Full-year revenue guidance should top $4.1 billion (+147%). Clearly, this is a big growth story as next year’s expected revenue growth is 87%. BUY

Shopify (SHOP) will deliver the goods on August 2 and there’s still not a huge bunch of fans among analysts. It is a “show me” story at this point. We need revenue to be around $1.62 billion (+25.4%), EPS near $0.07 and full-year revenue guidance for about $6.73 billion (+20%) and EPS guidance of $0.34. Beyond the numbers, investors will surely want to hear about how the logistics business is going and what steps management is taking to incorporate AI into the platform. BUY HALF

Snowflake (SNOW) should be out with its report around the end of August, so after our next Issue. Revenue is seen up 33% to $663 million and EPS of $0.10 would mark an improvement from just a penny in the year-ago quarter. Full-year revenue should grow over 33%, and about the same in 2024 (guidance on that would be great, but not expected). Analysts haven’t been psyched with SNOW’s commentary on recent conference calls so hopefully management can paint a story that helps outline all the good things they are doing. We’re up about 20% thanks to doubling down in March so I’m not complaining. BUY

What to Do Now

The bull market appears alive and well as we head deeper into the second-quarter earnings season.

To say complacency is creeping in would be an understatement. But we have inflation coming down (CPI just 3%), recession risks easing (Goldman says just 20% now) and investors scrambling to get back into stocks.

Add it all up and there’s the chance of a market melt-up through the summer. But let’s not get ahead of ourselves.

We’ve leaned cautiously optimistic for some time now and our portfolio shows the results. All of our positions are in the black. And all but Shopify (SHOP) are showing a double-digit gain.

Continue to manage portfolio creep (i.e., don’t own 1,000 stocks) by trimming laggards and adding exposure to what’s working by averaging in (i.e., buying a set dollar amount at intervals to spread out the risk).

And buckle up for earnings season.

STOCKS

Arhaus (ARHS)

I’ve been kicking the tires on Arhaus (ARHS) for a while, but the stock hasn’t made it into our portfolio yet. It’s sliding onto our Watch List today.

Bank of America aggregated credit card data from June shows consumer spending at furniture retailers accelerated through the second quarter. Web traffic data shows positive momentum too.

If you’re not familiar with the story, Arhaus is an omnichannel retailer of premium home furnishings (83% retail, 17% e-commerce). The company was founded in 1986 by John Reed and his father, Jack Reed, in Cleveland, Ohio.

Arhaus stands out because of the heirloom quality of its products and its commitment to work with artisans around the world that use sustainably sourced, reclaimed and recycled materials whenever possible.

The company has more than 80 showrooms and design center locations in the U.S. In 2021 it expanded domestic manufacturing and distribution with a 500,000-square-foot facility in North Carolina. It’s growing.

When management reported Q1 results back in May, revenue came in at $304.6 million (+23.7%), about as expected. But EPS of $0.25 (+108%) was a nickel ahead of expectations as costs for storage and for opening new stores were lower than planned.

Customer demand trends were far from off-the-charts great. But management maintained full-year revenue guidance of $1.24 - $1.3 billion (+1% to +5.8%) at the time. And the credit card and web traffic trends I mentioned earlier suggest a stronger consumer now (and possibly through the summer and into the fall) than was factored in back in May.

The company will report Q2 earnings on August 9. At the moment, consensus expectations suggest revenue of $327 million (+6.9%) and full-year growth of 2.8%. EPS is seen around $0.25 in Q2 and $0.77 for the full year.

I’ll put ARHS on our Watch List and we’ll see if the upcoming report justifies adding the stock to our official portfolio in August.

The Stock

ARHS came public at 13 in November 2021, a rugged market to jump into. Shares sold off to around 7.6 right away, rallied to an all-time high of 15 by year-end, then fell apart. The low of 4.2 was struck early last July. The stock recovered and hit fresh all-time highs just above 15 in February. But ARHS was pulled down again in March when Q4 earnings underwhelmed. The trend has been much better since shares bottomed at 6.75 on June 1. ARHS has traded above 10 since June 27. WATCH

Comfort Systems (FIX)

Comfort Systems (FIX) is a Texas-based mechanical and electrical service provider. It has 35 operating companies and over 170 locations across the U.S. The bulk of locations are east of the Mississippi.

It’s clearly a play on construction in the U.S. But it’s not just about new builds.

Comfort is focused on the non-residential market. It generates revenue from new construction (39%), renovations & expansions (26%), modular construction (15%), and a mix of service projects, maintenance and monitoring (20%).

By end market, Comfort has significant industrial exposure (50% of revenue from manufacturing and technology markets), commercial (21% from offices, retail, etc.) and almost 29% from institutions (healthcare, education and government).

The trends are all very positive as demand for manufacturing space, data centers, life sciences, and EV/battery plants in the U.S. increases and customers demand higher interior air quality.

Just over three-quarters of business is for mechanical work while the remainder is for electrical-related work.

The base of service work is growing steadily and now tops $165 million. Construction backlog surged from $2.3 billion in 2023 to just over $4 billion last year and is currently around $4.5 billion.

Comfort Systems has generated positive free cash flow for 24 consecutive years. The company is an acquirer of smaller businesses (spends about 75% of available cash on acquisitions), periodically buys back its own shares and pays a small dividend (roughly 0.5% yield).

In the first quarter of 2023, revenue of $1.17 billion represented nearly 33% growth while EPS of $1.51 was up almost 66%. The company is on track to grow revenue by almost 19% to $4.9 billion this year and EPS should be up around 31% to $6.92.

When the Q2 earnings date rolls around toward the end of the month (July 27 is the estimated date) analysts see revenue up 20% to $1.2 billion and EPS up 33% to $1.56.

I like the trends and think that, while the stock has done very well lately, there’s still more room to run. We’ll jump in with a half-sized position today.

The Stock

FIX came public at 13 in 1997 so there’s a whole lot of history here. But it’s the last decade where things have gotten interesting. Since shares traded down to 27.5 in 2020 FIX has made a series of higher lows and higher highs on the weekly chart. Somewhat consistent consolidation phases tend to last a few months. The last of these began in late February and ran through the end of May, during which FIX mostly traded in the 127-155 range. Shares broke higher on June 6 and have moved up to 170 since. Let’s jump in with a half and see if we can capture a run into and out of earnings. BUY HALF

GitLab (GTLB)

I added GitLab (GTLB) to our Watch List last month, and with the stock continuing to act well, we’ll make it an official position today.

The big picture hasn’t changed. GitLab still does what it did a month ago, namely provide a source code management (SCM) platform with a host of collaboration, sharing and tracking tools for software developers.

The buzz on the Street is that analysts are becoming more confident that GitLab can gain share in the DevOps market.

I talked last month about how GitLab’s platform already has some AI capabilities built into nine different offerings, including Suggested Reviewers and Code Suggestions.

More are currently in beta mode. And GitLab is working on its own proprietary models using Google Vertex AI. Central to this strategy is the idea of protecting code and providing privacy tools.

Bigger picture, and what investors will be keen to hear more about on the Q2 earnings call (expected around September 6), GitLab is working to convert free users to paid, increasing prices for the higher tier solutions, launching Duo AI (variety of AI-powered workflows) and getting large customers onto its single-tenant SaaS solution, Dedicated.

If that all sounds like Greek to you the bottom line is that analyst estimates are creeping up and the Street is now looking for full-year 2023 revenue of $543 million (+28%), up a couple million from a month ago.

EPS is still seen negative this year (-$0.15 expected) but could turn the corner and be positive in 2024 ($0.04 currently expected).

We’ll take a swing with a half-sized position today.

The Stock

GTLB came public at 77 in October 2021 and traded as high as 143 during the pandemic. It gave it all back, and then some. Shares bottomed just weeks ago, at 26.2, on May 4. Some excitement came back to the stock after the June 5 earnings report, which sent GTLB from 35 to 46.4 the next day. It’s up a little more since but has yet to break convincingly through 54. If that can happen the next hurdle is 59 (last struck on February 2, 2023) then 71 (last struck in August 2022). BUY HALF

IonQ (IONQ) ★ Top Pick ★

Quantum computing technology leverages quantum mechanics to address challenges too complex for traditional computers, and even supercomputers.

As IBM describes it, the real world runs on quantum physics. Standard computers just can’t keep up. They can’t figure out things like subtle patterns of fraud in financial transactions. Or simulate the behavior of individual atoms in a molecule.

But quantum computers can.

They’re about the size of a car and have a bunch of cooling equipment to keep them just above absolute zero so electrons can move through materials without resistance. That’s how they earn the superconductor badge.

To invest in quantum computing you can buy stock in diversified large and mega caps like Microsoft (MSFT) and IBM (IBM).

But if you want a pure-play quantum stock you’re looking for IonQ (IONQ).

IonQ was founded by quantum computing pioneers Chris Monroe (U Maryland) and Jungsang Kim (Duke).

Both are on the White House’s National Quantum Initiative Advisory Committee. There is a bit of a tech race heating up as the U.S. tries to open up the lead it has over China. Select European countries are hard at it too.

IonQ has rights to intellectual property (exclusive, no royalties due) from both the University of Maryland and Duke, who have equity positions in the company.

The ultra-high-level pitch for IonQ is that the company approaches building quantum computers using the trapped ion approach. This means trapping an ion in a vacuum (glass boxes work well) then using lasers to manipulate the ions. Don’t try it at home!

IonQ’s computers have quantum capacity of 32 qubits and operate roughly 20 algorithmic qubits. Hard to wrap your mind around those specs but the bottom line is that it’s competitive performance. And a 64-qubit system is in development.

Sales are limited right now but growing briskly. Revenue of $2.1 million in 2021 grew by 430% to $11.1 million last year and should be up around 80% to $20 million this year. That said, a few deals can move the needle so any estimates should be taken with a grain of salt here.

In terms of how IonQ makes money, right now the bulk of revenue comes from working with clients to develop quantum solutions and laying the groundwork to use that technology in their organizations in the near future.

IonQ also hosts its own Quantum Cloud platform so users can pay to access that. And it has partnered with the public cloud providers who provide Quantum Computing-as-a-Service (QCaaS), much like they do with other software and computing resources.

Lastly, IonQ charges for direct access to quantum computing resources for clients that don’t want to wait in the queue to access them via public cloud. Over time this revenue source will likely fade once the QCaaS capacity takes off.

A few partners/customers include Fidelity, Accenture (ACN), Goldman Sachs (GS), Volkswagen (VLKAY) and Softbank.

And in late June IonQ disclosed that QuantumBasel (Switzerland quantum hub) signed a deal to establish and manage a European quantum data center, complete with two advanced IonQ quantum computers.

That latest deal drove management to increase its 2023 bookings estimate by 25%, to a range of $45 million to $55 million.

Stepping back, IonQ has the potential to become a tech force. What that potential translates into in terms of market cap size over the coming quarters and years is highly uncertain. This is a speculative stock.

Shares could be up a few hundred percent or more by the end of this year, cut in half, or do absolutely nothing.

Whatever the future holds, I think it’s an interesting story and opportunity today, so we’ll jump in with a half-sized position and see what happens. Buying a half leaves us the option to average down if IONQ takes a dive, but the story remains intact.

The Stock

IONQ came public in November 2020 via SPAC merger and traded around 10 for almost the next year. Then shares rocketed 350% to hit an all-time intra-day high of 36 in November 2021. There was a lot of speculation going on, and as the market bubble burst, IONQ came down, hard. Shares moved below 5 last May and bottomed at 3 on December 29, 2022. The trend has been much better since. IONQ was back to 5 in February, ran above 10 in May after the Q1 earnings report then broke above 13 on June 28. Momentum is building and shares jumped above 15 yesterday. Again, this is a speculative name and share price movement will be very unpredictable, both to the upside and downside. BUY HALF

Zillow Group (ZG)

After an incredible run during the pandemic, home sales have come way down, partly due to higher prices and mortgage rates, and partly due to lack of supply.

The correction has been rough on companies that rely on transaction volume to fuel their businesses. And while it’s very unlikely there’s going to be a massive surge in home sales in the near future, it’s very possible that the worst is behind us.

Zillow (ZG) represents a way to play rebounding home sales transaction growth in 2024. There’s also a compelling self-help story as Zillow is taking steps to capture more of the transaction market.

Stepping back, Zillow is undoubtedly the top dog in the online real estate advertising market.

The company owns the most visited real estate web property in the country, Zillow.com, through which home buyers can search for homes to buy or rent, get connected with agents and brokers, and secure financing. It owns other brands as well (Zillow Rentals, Trulia, StreetEasy, Zillow Closing Services, HotPads and Out East)

Zillow also offers a variety of marketing and technology tools for the real estate industry (Mortech, dotloop, Bridge Interactive, New Home Feed and ShowingTime).

Putting all the pieces together, Zillow’s platform helps streamline transactions related to buying, selling, financing, renting, etc. These transactions total around $300 billion every year.

Back in 2021, Zillow captured around $4,000 when it got a buyer referral. Management thinks it can capture closer to $5,200 per deal over the coming years by working on the financing, seller services and closing services parts of a deal.

The company just put out Listing Showcase, a subscription product for agents that falls under its ShowingTime+ solution. Showcase will help agents boost their listings and brand and features high-res images, room photo organization and better visibility for home shoppers. Early reports say there are over 8,000 agents currently waitlisted.

With home sales expected to be around 4.2 million in 2023, there’s no doubt it’s a soft market. But it will recover, and Zillow has a lot of leverage, so shares will move quickly on any positive (or negative) news.

Expectations are currently low. Analysts see revenue of about $1.9 billion this year, a whopping 69% decrease as compared to 2022. But 2024 looks better with 13.5% revenue growth expected.

EPS this year is seen at around $1.03, down 35% as compared to last year. But EPS should improve next year when analysts see EPS of $1.58 (+54%).

Zillow isn’t a sure bet. But it’s an interesting recovery story. Let’s put it on our Watch List and see how the stock acts around earnings (estimated for August 2).

The Stock

ZG came public in 2011 at (split adjusted) 6.2 and, like the housing market, is prone to big runs and good-sized pullbacks. Shares peaked at 51.4 in mid-2014, 65.4 in mid-2018 and 212.4 in early 2021. The 21-22 correction was as painful as they get. ZG landed at 26.2 last October, a roughly 87% correction. Shares have acted much better this year. The stock broke above 40 in early January and, aside from a little wobble in March, has been grinding higher. Shares moved above 50 last Tuesday. WATCH

Previously Recommended Stocks

On June 27 we exited the final 1/3 of our position in Xponential Fitness (XPOF) after the stock came under attack from a short seller. Our loss of 12% on this sale offset gains of 28% and 39%, respectively, on our first two sales, meaning an average gain of 18.3%. We also exited Airbnb (ABNB), a little prematurely it appears, for a loss of 10%. This week, on Monday, July 17 we sold Timken (TKR) and Si-Bone (SIBN) for gains of 6%.

On Monday we cut ShockWave (SWAV) from our Watch List.

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 August 16, 2023.