Cabot Early Opportunities Issue: November 15, 2023

Stocks in This Issue

Will IPOs Come Back In 2024?

There have been a lot of bear markets over the last two years but one of the hardest hit has to be the IPO market.

While we’ve had hundreds of “new” stocks to consider over the last year given the IPO bull market in 2020 and 2021, and the steep pullback in recent IPO share prices in 2022 and 2023, it’s safe to say that most early-stage investors are feeling like it’s time for some fresh names to hit the market.

Take a look at the following chart, courtesy of Renaissance Capital.

As you can see, 2023 has been a dismal year for IPOs with just 100 names hitting the exchanges so far. Granted, that’s better than just 71 last year! But still, even if we add up the last two years we only get to 171, which is lower than the annual average from 2014 – 2021.

One of the underlying issues behind the dearth of new offerings is simply lack of confidence from new investors that they’ll make a good investment. That concern hits home especially hard after seeing the performance of a few of this year’s biggest offerings, which include Arm Holdings (ARM), Klaviyo (KVYO) and Birkenstock (BIRK). Only ARM is above its IPO price, and just barely.

There also isn’t a ton of capital out there, especially when interest rates are high enough to provide alternative, safe opportunities. The following chart, also from Renaissance Capital, shows how little the $19.3 billion raised so far in 2023 is relative to history. It’s pitiful.

The question is, how long will this last and when will we begin to jump into new IPO opportunities?

My best guess is probably not until later in 2024.

History shows that IPO markets warm up slowly, not all at once. Just reference the charts above and that becomes pretty clear.

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) given that the stock market is forward looking about six months.

On interest rates, some are saying the Fed will start to cut the Federal Funds Rate (FFR) as early as March 2024. I think that’s a bit aggressive. But if we go with the market odds that suggest June 2024 that’s probably early enough that bankers will start to test the IPO waters this coming spring. And things could warm up heading into the summer and fall.

For us, that means we’re not likely to pounce on any super-fresh IPOs soon. That remains a strategy we’ll leave in 2020 and 2021, for now.

As a practical matter, we still have a lot of potential opportunities in the 600+ companies that came public over those two years.

Still, I look forward to a time when jumping into an IPO is a viable option again.

What to Do Now

With the market acting well on the back of renewed peak interest rate speculation (in the latest BofA Global Fund Manager Survey, 76% say the hiking cycle is over), diminished geopolitical risks (for now), reduced odds of a government shutdown later this week (thanks, Mike Johnson) and even some analysts suggesting the first rate cuts could come as early as March 2024 (let’s not get ahead of ourselves despite yesterday’s CPI surprise) it’s still time to lean bullish.

That said, any of the above tailwinds could flip around into a headwind overnight. So best not to get too cozy under that new bull market blanket. We’ll continue to take a measured approach, picking up a few names that look good right now while also considering where there are opportunities to book profits.

STOCKS

BellRing Brands (BRBR)

BellRing Brands (BRBR) is a protein-focused packaged food company that was spun out from the cereal company Post Brand (POST), maker of Raisin Bran, Honey Bunches of Oats, Grape-Nuts, Pebbles, etc., in October 2020.

The company’s products fit into the convenient nutrition category so the stock is basically a play on people trying to lead active, healthier lives and eating foods and shakes that help their bodies recover from exercise. It’s also a play on nutritious meal replacement.

Given that focus, it’s not surprising that as excitement for the new class of GLP-1 weight loss drugs has grown so too has interest in healthy food companies, including BellRing. Anybody that’s ever tried to lose weight, or has lost weight, knows that having an easy, healthy, packaged and/or quick-to-make meal is a huge part of the battle.

The company sells three main groups of products: ready-to-drink (RTD) protein shakes under the Premier Protein brand (79% of 2022 revenue), protein powders under the Dymatize brand (18% of revenue), and nutrition bars under the PowerBar brand (3% of revenue).

The business is concentrated within club channels, including Costco, Walmart, and Sam’s Club (collectively about 64% of revenue), with the remaining portion of sales coming from online, specialty, and convenience stores.

BellRing grew revenue by 10% to $1.37 billion in fiscal 2022 (fiscal year ended in September) and by 18%, 22% and 20% in the first three quarters of fiscal 2023, respectively. Sales should grow by about 21% this year.

Revenue benefited from a lift in prices this year, but volumes have also grown nicely as distribution gains (with more upside potential) and an assortment of new/reintroduced shake flavors have hit the shelves.

BellRing is also profitable. EPS was $1.16 last year and is on pace to grow 12% to $1.30 this year and upwards of 20% in 2024.

With production capacity increasing, along with promotions and advertising, there is ample potential for BellRing to surpass expectations in the year ahead. That’s not to say there’s no competition – there certainly is. But on balance things seem to be working in BellRing’s favor.

The Stock
BRBR came public at 14 in October 2020 and climbed to 24 before falling back and trading as low as 13.6 during the 2020 market crash. The stock made new highs near 34 in 2021 then spent much of 2022 in the low-to-mid 20s. Momentum picked up at the beginning of 2023 and, while there have been some consolidation phases over the last 11 months, the trend is undeniably up and to the right. BRBR’s last pause was in September (39 – 42 range), then there was a little dip a couple of weeks ago. Shares made another new all-time high this week. We’ll put BRBR on our Watch List given earnings are due next week. WATCH

Construction Partners (ROAD)

It’s not that often you come across a small-cap infrastructure company that’s positioned to post double-digit revenue and EPS growth for the next three years. But that looks to be the setup for Construction Partners (ROAD) right now.

Construction Partners is a vertically integrated (i.e. supplies its own materials) pure-play roadway construction and maintenance company operating in the southeast U.S. The company is currently focused on the five states of North Carolina, South Carolina, Georgia, Alabama and Florida.

Construction Partners works on both public (60% of revenue) and private (40% of revenue) infrastructure projects, including highways, roads, bridges, airports and commercial and residential developments.

It also sells construction materials to third-party customers, including hot mix asphalt (HMA), aggregates, liquid asphalt and ready-mix concrete.

The company’s high exposure to Southeast recurring paving and public sector road work is a significant attraction. Over the last three years funding for pavement-related projects in its states has grown by 47% to $81 billion. Additional, unspent highway funds of $1.2 billion have also been directed to these states by the Federal Highway Administration, yet another signal that Sun Belt states will see several more years of roadwork.

With Construction Partners’ focus on shorter duration projects (six to nine months) and a backlog of $1.6 billion (a new record) as of the end of Q3 the company should turn 75% to 85% of backlog into revenue over the next 12 months.

That backlog provides revenue visibility. And shorter-duration projects help fuel operating cash flow, which in turn helps fund the company’s acquisition strategy (leans on cash rather than debt).

The company has completed 19 acquisitions since its 2018 IPO. Given the fragmented nature of the market, management sees roughly 200 potential asphalt production targets and 2,000 other opportunities (guard rail, earth work, trucking, traffic control, etc.).

The bottom line is that revenue grew by 11% to $422 million in Q3 fiscal 2023 (reported August 2) and in early October the company pre-announced preliminary full-year growth numbers and fiscal 2024 guidance ahead of consensus.

The official report will come on November 29. Reported revenue for 2023 should be at least $1.55 billion (+19.3%) and EPS should be $0.86 (+111%).

Looking out to next year we’re expecting revenue of around $1.75 - $1.83 billion (13% to +18%) and EPS of $1.26 (+47%).

The Stock
ROAD came public at 12 in May 2018 and followed the typical IPO pattern of starting strong, then fading soon after. But the stock enjoyed a multi-year run that began in 2019 and carried it to an all-time high near 45 in late 2021. The next year (2022) was a tough one as ROAD retreated into the low-teens by mid-year, though an early-summer rally pushed shares back into the 24 to 32 range. That’s where ROAD stayed until June 2023 when the stock stepped up to 34.4. A quick pullback to 28 set shares up for a rally to fresh highs after the August 2 Q2 earnings report. The stock has made a series of higher highs and higher lows on its way to 40 in the weeks since, with the most recent dip to the 200-day line at 36.7 drawing in buyers. Yesterday’s 7% rally has put ROAD just barely out of reach so let’s watch closely for the next buyable dip. WATCH

Stride (LRN)

Stride (LRN) is an educational technology company primarily serving K-12 schools and with a small business geared toward career advancement for adults.

Its software and support services cover curriculum, systems, instruction and support for virtual and blended learning environments, which are becoming the norm since the pandemic.

Stride has been around since 2000 and has grown to be a leader in the online education market. Products are designed to help clients attract, enroll, educate and support students and to help learners reach their potential through inspired teaching and personalized learning.

The company’s solutions target two markets: General Education (62% of revenue) and Career Learning (38% of revenue).

General Education includes services for K-12 public and private schools, school districts and charter boards. As you’d expect, content covers core subject matters (math, English, science, history, etc.) as well as additional solutions for safety concerns, academic support, advanced learnings and more.

Career Learning solutions are targeted at middle and high school students (83% of segment revenue) and adults (remaining 17%) looking to build their skills and experience or advance their careers in high-growth, high-demand industries, such as tech, healthcare and business. These products are sold to government agencies, employers and consumers.

Not surprisingly, interest in the company’s solutions (and investor interest in the stock) has risen since the pandemic.

In 2021, revenue in the General Education segment grew by 37% as schools all scrambled to go online. However, that made for tough comparisons. Revenue in this segment was flat in 2022 and down 11% in fiscal 2023 (ended in June).

However, the Career Learning business has picked up the slack, and then some. Segment revenue was up 140% in 2021, 61% in 2022 and 71% in fiscal 2023.

No doubt it’s been a wild few years. Looking forward, things seem a little more stable. Total revenue is seen up about 10% in fiscal 2024, with both General Education and Career Learning segments growing at about the same clip.

EPS, which grew by 18% to $2.97 in fiscal 2023, is seen up 32% to $3.91 in fiscal 2024.

The Career Learnings segment’s growth has surprised to the upside. Also, funding from states came in slightly better than expected for the start of the current academic year.

Taken together these inputs could mean Stride’s all-in “normal” growth rate could easily stay in the mid-to-high single digits. And with a good chunk of revenue falling to the bottom line EPS growth could stay in the double digits for years.

The Stock
LRN came public at 18 in 2007 and for many years the stock didn’t do anything impressive. The pandemic changed that and LRN hit new all-time highs in July and August of 2020. Unfortunately, the stock was cut in half later in the year. When you zoom out to a weekly chart the trend since 2021 has been good. In fact, LRN’s recent move has pushed the stock above the 2020 high and it’s been hitting fresh all-time highs most days over the last two weeks. That said, upon closer inspection on the daily chart one sees that there have been some long flat spots and some serious quick dips over the last two years. So while I’m intrigued by the name we’ll put on our Watch List for now. WATCH

TriNet Group (TNET)

TriNet Group (TNET) is a $5.7 billion market cap company offering outsourced Human Capital Management (HCM) solutions to the fragmented small- and mid-sized businesses market.

This is an interesting trade opportunity in a little-known stock that’s doing well even though revenue is likely to be down both this year and next (EPS should grow this year).

What’s the story? Well, it’s a strong employment market in some areas, but not tech, which is where TriNet has a good amount of exposure.

Still, with high post-pandemic regulatory complexity and dispersed workforces employers are continuously tasked with pressure to provide competitive salaries and benefits to attract and retain talent. That’s not always easy for smaller players, which is why many turn to services like QuickBooks from Intuit (INTU).

TriNet offers a compelling alternative.

Solutions are sold under the professional employer organization (PEO) model, which means TriNet acts as the employer of record for admin and regulatory purposes for worksite employees.

This co-employment model means businesses get a high-touch employee benefit provider that operates at scale, handles day-to-day HR functions and has competitive employee benefits, while also sharing employment risk liability.

For its part, TriNet is careful about the risk profile of clients that it takes on given that it has an at-risk insurance model. It focuses on high growth markets that include tech, financial services, life science, non-profit and professional services.

The company reports in two segments with insurance services (workers comp, actuarial expertise, health insurance) generating the bulk of revenue (85% in 2022) and professional services generating the remaining 15%.

The company’s main competitor is ADP (ADP). Not surprisingly, both flagged lower tech hiring in Q3 and shares of ADP were whacked while TNET was flat, probably because the company did well in health care.

On the conference call TriNet management was upbeat and suggested that Q4 trends were OK and that insurance risk has been very well managed (i.e. low claims payouts).

It seems like salespeople are doing a bang up job, even in soft tech market, and while there’s no tech hiring boom on the immediate horizon decent win rates, a $1 billion share repurchase and a discounted valuation have investors snapping up shares of TNET.

It’s not a stock I want to get into a long-term relationship with right now. But it looks like an interesting momentum play. We’ll take a swing.

The Stock
TNET came public at 16 in 2014 has had its fair share of ups and downs, but the long-term trend is up and to the right. Until recently the post-pandemic high was around 110 (November 2021) and the most recent low was around 60 (November 2022). Currently, TNET is trading less than 10% from a new all-time high. That high water mark (121.6) was struck just weeks ago, on October 16. After that day the stock went into a two-week tailspin that finally turned around at 100. Shares are up about 12% since, meaning we can jump in mid-rally and try to sneak out a relatively quick albeit modest gain if the stock can rally back to its recent high. BUY

Varonis (VRNS) ★ Top Pick ★

Varonis jumped on our Watch List last month and after a solid Q3 earnings report and continued momentum in the stock we’ll add a half position today.

The big-picture story hasn’t changed over the last four weeks. But to refresh your memory, Varonis (VRNS) sells security software that’s used to protect enterprise data, from sensitive files and emails to confidential customer and patient records, financial data, strategic and product development plans and so much more.

The company is benefiting from a successful transition to the SaaS business model and there’s a potential AI boost to consider as well.

On the latter note, one of the biggest challenges for large companies looking to develop generative AI capabilities is how they protect their data. They need a very clear data governance framework that stops large language models (LLM) from leaking all the info they try so hard to protect.

That spells opportunity for Varonis, who specializes in setting data security and governance standards.

As Morgan Stanley says, Varonis could become a “key enabler of Generative AI adoption within the enterprise.” When management reported Q3 results a couple weeks ago management called AI a “game changer,” saying the technology should continue to boost growth as data governance becomes increasingly important.

Turning back to the SaaS transition, Varonis is blasting by its early goals to move to the cloud. When it first laid out its transition plans a few years ago management called for 15% of new bookings to be SaaS revenue in 2023. In the recently reported third quarter of 2023 59% of new business was under the SaaS model, well above expectations for 45%. SaaS now accounts for 15% of annualized revenue.

With just one quarter left in the year analysts now see Varonis growing revenue by about 5% this year, to $496.7 million. Keep in mind that revenue grew north of 21% last year, and is expected to reaccelerate to nearly 10% in 2024.

On the profitability front EPS should be up around 78% to $0.32 this year, then analysts are penciling in just 10% EPS growth next year. I think that number is low, and actual EPS growth in 2024 will be more in the 30% to 60% range.

The Stock
VRNS went public in February 2014 at 22 and reached a pandemic-era high near 75. Things then fell apart and VRNS hit a bear market low near 16 in November of 2022. After that washout VRNS began to gain altitude again, reaching 30 in February of this year. That was the top for a while, but VRNS was back to the 30 level after the Q2 earnings release in August. Shares mostly traded in the 30 to 32.5 range from August – October, then the stock stepped out after the Q3 report (October 30) and has continued to inch higher over the last two weeks. We’ll step in with a half position just north of 35. BUY HALF

Previously Recommended Stocks

On November 6 we booked a quick profit of 15% on ATI (ATI) and on November 9 we locked in a modest gain of 5% on HubSpot (HUBS). On October 31 we elected to cut our losses on IonQ (IONQ) at a 39% loss and we took a more modest loss of 8% on Avantor (AVTR) on October 25.

From our Watch List we have dropped coverage of Array Technologies (ARRY), Freshworks (FRSH) and LSI Industries (LYTS) since the October issue.

Today Cellebrite (CLBT) moves to HOLD. This comes after the company reported a better-than-expected Q3 and raised forward guidance. The majore takeaways is that the company is landing bigger deals and growing profit margins. With the stock bumping up against overhead resistance we’ll be a tad cautious and move to hold, for now. HOLD

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 December 20, 2023.