Cabot Early Opportunities Issue: October 18, 2023

Stocks in This Issue

Teasing Out Relevant Whisper Numbers for Q3

With earnings season underway I wanted to look quickly at what the whisper numbers are for our companies and see what analysts are thinking results for the current fiscal year will look like. I’ve excluded details on companies featured in this month’s Issue since those are included in the company-specific write-ups.

Let’s dive in.

AppLovin’ (APP) is expected to report Q3 results on November 8. Revenue in the quarter is seen up 11.7% to $796.7 million while EPS is expected to come in at $0.27, a huge increase from $0.06 in the year-ago quarter. Looking out to full-year results, revenue is seen up 9.8% to $3.09 billion while EPS is seen at $0.78, much better than a loss of -$0.52 last year. Both revenue and EPS growth is expected to accelerate in 2024 (13% and 75% growth, respectively). The stock is trading near our entry point. BUY

Badger Meter (BMI) reports tomorrow, October 19. Revenue in Q3 is expected to be up 21% to $179.1 million while EPS growth of 32.5% to $0.81 should keep this year’s profit growth trend solidly above 30%. Full-year revenue expectations of $691 million implies 22.2% growth, while EPS expectations of $3.01 implies 33.4% growth. Next year is a little fuzzy. Consensus estimates have inched down over the last month and now imply revenue will only grow 6.8% (to $738 million) while EPS will grow 9% to $3.29. It wasn’t long ago that revenue growth of 8% and EPS growth of 11% was consensus. The stock has pulled back lately along with a lot of other industrial and building material types. And I’m a little concerned that the trends in the building and infrastructure market are turning. But on the other hand, Badger Meter does a lot of work with utilities to install smart water meters and monitoring solutions and there’s a lot of policy support (efficiency) and risk mitigation support for this market. To balance things out right ahead of earnings I’m moving BMI to hold today. We’ll evaluate after the report comes out. HOLD

Cellebrite (CLBT) was one of last month’s new additions and Q3 earnings (scheduled for November 14) expectations have barely budged. Revenue in the quarter is seen up 14.6% to $82 million while EPS is seen around $0.03. On the Q2 earnings call management gave full-year revenue growth guidance (increased) of 15% to 18%, and consensus of $316.2 million is right in that range (+16.8% growth implied). There are some adjustments to GAAP earnings this year that create some noise (acquisition expenses, etc.) but the adjusted EPS number should show an improvement over 2023. It’s worth noting that Cellebrite is headquarters in Israel, though that hasn’t hurt the stock lately. BUY

GitLab (GTLB) has been with us since July and over the last three months growth estimates have trended higher while the stock has just gone sideways, in the 41 to 54 range. The company’s third quarter doesn’t close until the end of October (fiscal year ends in January) so Q3 results probably won’t be out until December. But the trend is good. Back in July it looked like Gitlab would deliver full-year fiscal 2024 revenue growth of 28% ($543 million) and EPS of -$0.15. But we’re now looking for 31.6% revenue growth ($558.4 million) and EPS of -$0.06 (a $0.09 improvement over just a few months). Imbedded in these estimates is the assumption that Q3 revenue grows about 25.5% to $141.6 million and EPS is right around break even (-$0.01 is consensus). It’s worth mentioning that the expected revenue growth rate in fiscal 2025 is still hovering near 30% (i.e. no material deceleration from this year) and GitLab is expected to swing to profitability (EPS of $0.16). BUY HALF

HubSpot (HUBS) joined our team in April of this year, when analysts expected 2023 revenue would rise 19% to $2.06 billion and EPS would be $2.48. Fast forward six months and, after two more earnings reports, estimates have gone up significantly, especially on the bottom line. Revenue is now seen up 22.5% to $2.12 billion while EPS is seen near $5.29. Those numbers imply Q3 results (projected to be on November 8) will include revenue growth of 20.3% to $534 million and EPS growth of 80% to $1.24. Both those figures are at the high end of management guidance. HOLD HALF

IonQ (IONQ) is a quantum computing company that’s reached commercial scale and sales are growing quickly but are still relatively limited. The company has three revenue streams. Most comes from working with clients to develop quantum solutions and prepare their organization to apply the tech in the near future. IonQ also hosts its own Quantum Cloud platform and has partnered with the public cloud providers who provide Quantum Computing-as-a-Service (QCaaS). Until this QCaaS revenue stream takes off IonQ is also charging direct access to quantum computing resources for clients that don’t want to wait in the queue to access them via public cloud. Revenue was $2.1 million in 2021, grew by 430% to $11.1 million in 2022 and is seen up around 72% to $19.1 million this year. That’s actually about 8% slower growth than we expected back in July, but remember that a few deals, and timing, can move the needle a lot here. So any estimates should be taken with a grain of salt. The projected Q3 earnings date is November 13. BUY HALF

Krystal Biotech (KRYS) hasn’t nailed its earnings date yet but it should be around November 8. The biotech is just transitioning to commercial stage with Vyjuvek (gene therapy treatment for dermatological disease DEB) in Q3 so estimates are sort of a best guess at this point. With that caveat, Q3 revenue is seen around $6.4 million then $23.4 million in Q4, for implied full-year sales of $32 million. That jacks up to roughly $184 million in 2024 (475% growth). There will be a lot of details to digest on the call around infusion, handled by Option Care Health (OPCH) and Amedisys, as well as other shots on goal that haven’t gone in (yet). BUY

Microsoft (MSFT) reports Q1 fiscal 2024 results next Tuesday and the market is looking for revenue of $54.5 billion (+8.8%) and EPS of $2.65 (+12.9%). Azure revenue growth is always a big item, and that’s seen up 26.2%. Naturally, we’d like to see results come in a little better than expected, as has been the trend in six of the last seven quarters. And analyst estimates have inched ever so slightly higher over the last month. For the full fiscal year we’d like to see signs that revenue can grow by at least 11.2% to $236 billion. And of course we want to hear good things about ChatGPT, the Activision acquisition and so much more. Take note, in fiscal 2025 revenue and EPS growth are expected to accelerate to 13.4% and 15.2%, respectively, so there’s plenty of gas left in the tank here. BUY

Rivian (RIVN) will report on November 7. In Q3 the company is expected to report around 15,000 deliveries, including 3,600 R1Ts, 8,100 R1S’, and 3,400 RCVs. That’s expected to translate into $1.3 billion in revenue (+145%) and EPS of -$1.34, an improvement of $0.23 over Q3 last year. Looking out further Rivian is seen growing revenue by 163% to $4.36 billion this year then by another 58.5% in 2024. One of the big topics of discussion here, aside from demand, deliveries and timing of the new models, is the profit trend (or more accurately, the loss trend). Management has talked at length about simplifying components, but not “dumbing down” the vehicles, and along with greater scale that’s expected to help drive a 30% improvement in EPS loss in 2024 (to -$3.55). That’s still a long ways from break even, so any details that accelerate or push back that expected milestone will be very important for the stock’s performance. BUY

Shopify (SHOP) will report Q3 results on November 2 (the day after the Fed rate decision) and the EPS expectation trend is fantastic. That’s largely because the company bailed on plans to build out its own fulfillment network. In Q3, EPS is expected to be $0.14, a $0.16 improvement over Q3 last year. And for the full-year 2023 and 2024 EPS is expected to be $0.52 (vs. $0.04 in 2022) and $0.79 (+52%), respectively. Turning to revenue, Q3 should be up 22% to $1.67 billion while full-year 2023 should be up 24% to $6.94 billion and 2024 should grow by another 19% or so. SHOP has come back to trade in the low 50s after reaching a high of 71.4 back in July. With shares right on the 200-day line and a lot of attention on retail sales and the health of the consumer heading into the holiday season, not to mention company-specific growth/headwind drivers, this will be an important report. BUY HALF

What to Do Now

We’re continuing to take a very measured approach to this market given the continuous push and pull between the bears and the bulls.

On the bearish side we have rising geopolitical risks (Gaza), some upward pressure on rates from select economic data (good news is sometimes bad news still) and risks out of China (semiconductors).

On the bullish side, we’ve heard a lot of Fed officials hinting toward holding in November and this being the peak of the rate hike cycle (data dependent, of course), a dip in investor sentiment (contrarian indicator) and a good start to earnings season (resilient economy).

The bottom line is there isn’t really a powerful, bullish trend (in fact breadth has been pretty bad) so we’re just not ready to get excited yet. The Fed begins the next meeting on October 31 and we’ll get a rate decision two weeks from today.

That decision, combined with earnings reports over the next two weeks should help give us a better idea of which direction the market wants to go in the last two months of the year.

STOCKS

Avantor (AVTR)

Avantor (AVTR) is a mash up of two advanced materials and life science businesses that came together about six years ago to create a higher growth company with more stable revenue and greater profitability. It currently has a market cap of $14.6 billion.

The company makes advanced materials and distributes chemicals, reagents, lab products and equipment. It also offers specialty procurement and other value-added lab services to help companies with their R&D and manufacturing.

The biggest customer base is the biopharmaceutical industry (roughly 50% of revenue), followed by advanced technology and applied materials, healthcare, education and government.

Over the last year or so the headwinds from COVID-19 destocking have affected just about every market Avantor plays in, and a slowdown in China has been an added challenge. So has a generally slow biotech market, where funding has dried up (thanks high interest rates).

Revenue, which had grown by 15.5% in 2021, grew just under 2% last year and is on pace to shrink by almost 8% (to $6.94 billion) in 2023. EPS is also expected to be down this year, by about 24% to $1.07.

Things are expected to be a little better in 2024 when consensus estimates call for revenue to be up 3.6% to $7.19 billion and EPS to grow 13% to $1.21. But there’s still a good deal of uncertainty.

So why even consider the stock now?

For starters, the AVTR stock is trading at a discounted valuation relative to history. But that’s not the only reason – we’re not deep value investors here.

More important is that the bioprocessing market has potential to bottom out in Q4 (i.e. the current quarter) and begin to recover next year, with the second half being much stronger. Any indications from industry participants (DHR, TMO, RGEN, AVTR, etc.) could light a fire under the group when they begin to report earnings next week.

Specific to Avantor, there’s also potential opportunity within the GLP-1 class of weight loss drugs. Management is being tight lipped given the evolving landscape around reimbursement, approvals, pills vs. injection formulations, etc. But it’s definitely there.

And there’s potential for Avantor’s semiconductor/advanced materials-related business to improve as that market works through finished goods inventory (Q2 was seen as the bottom, hoping to confirm on the Q3 report).

Lastly, there’s always the potential Avantor will sell itself.

In short, there’s a decent chance that the trough of this slowdown is behind Avantor and a slow burn is about to begin. If and how that develops will determine how the stock does, of course.

With earnings coming up next Friday and shares gaining showing a little momentum we’ll jump in with a half-sized position today.

The Stock
AVTR came public at 14 in May 2019 and was reasonably strong until the pandemic market crash cut the stock in half. Then the bioprocessing market took off during the pandemic and pulled AVTR with it. Shares hit 44 in September 2021. That was the top. The stock then dribbled lower until finding support in the 18 – 20 range in late-2022. A little rally to 25 was cut short in March 2023. Since then AVTR has mostly hovered around the 20 level again, with a few dips into the 18’s and a few rallies just north of 22. Over the last ten sessions shares have been inching higher. BUY HALF

Dynatrace (DT) ★ Top Pick ★

Dynatrace (DT) can be a tough company to understand if you’re not very tech savvy. But at a very high level, it’s a software company with solutions that help very large organizations monitor their ever expanding IT environments.

On a slightly more granular level, Dynatrace helps organizations monitor all the infrastructure and applications they rely on. And it mixes in a good deal of automation and AI to boot.

It’s used by a lot of different departments within a large company, including sales, marketing, IT application support, IT infrastructure support, DevOps and more.

If you’re looking for a short list of companies with toes in the same sandbox we’re talking Datadog (DDOG), Splunk (SPLK) and New Relic (NEWR). It’s worth mentioning that Splunk is being acquired by Cisco (CSCO) while New Relic is set to be acquired by private-equity firms Francisco Partners and TPG.

Back in August Dynatrace management struck a conservative tone on the Q1 fiscal 2024 earnings call, even though there appeared to be a lot of fresh interest (new logo growth +15%) and the pipeline was filling up nicely.

On the product front, the company talked up a new AI solution, Davis CoPilot, which is expected to engage more clients while improving ROI. And it also acquired Rookout, a troubleshooting tool for cloud0-native applications.

Since then, I’ve read more than a couple analyst notes about customers moving to Dynatrace for some of their workloads due to aggressive price hikes from other industry players.

It’s a bit early to say the floodgates are opening, but there’s definitely a lot going on in this market, both in terms of customers evaluating their options and significant M&A deals.

Analysts see Dynatrace growing revenue by 21.7% ($1.4 billion) this year then by almost 19% in fiscal 2025. EPS should be up about 8% to $1.05 this year.

The Q2 earnings date is November 2. Revenue is seen up 23.4% to $344.6 million and EPS is seen up 21% to around $0.27.

The Stock
Like a lot of companies that went public shortly before the pandemic DT had a great start, crashed, then came roaring back ... before falling prey to the post-pandemic bear market of 2021-22. In DT’s case the high was around 80 (October 2021) and the low was around 30 (May 2022). The stock entered 2023 trading in the 35 – 40 range and enjoyed a lift after earnings reports in the first half of the year, then bumped up against the 55 level for most of July. Shares sold off after the August 2 earnings report but never slipped below 45. And for the last two months DT has been pretty darn stable in the 45 – 50 range. BUY

Elastic (ESTC)

Elastic (ESTC) is a Dutch-American company that was founded in 2012 with the name Elasticsearch, an open source project that the founders started as an enterprise search engine.

It has since evolved into an entire ecosystem and open source community. At the core Elastic remains a search company that develops SaaS solutions for enterprise search, logging, security, observability, monitoring, and analytics use cases.

The company is often referred to as Google for large companies. That’s a pretty good description. At a very high level, users turn to Elastic to do things quickly, accurately and securely.

The company’s solutions are packaged as the Elastic Stack (ELK Stack), which combines Elasticsearch, Kibana, Beats and Logstash into one platform that allows users to take data from any source and in any format, and apply search, analytics and visualization tools.

Given the importance of big data to enterprises this is a competitive space. And the rise of generative artificial intelligence (AI) has only made it more so.

Elastic’s market overlaps with that of Dynatrace (DT), Splunk (SPLK) and New Relic (NEWR). It’s not out of the realm of possibilities that buyers have been knocking on the door, just as they did at SPLK and NEWR.

Interest has increased since Elastic reported Q1 fiscal 2024 results on September 1. At the time management talked about the rise in customer activity around its ElasticSearch Relevance Engine (ESRE), a platform for building Generative AI applications and Vector Search capabilities.

Even though it’s a relatively new solution the company already reports hundreds of paying customers. And is seeing more customers consolidate their workloads with Elastic as they more closely manage their spend.

Interest remained high in late-September when Elastic hosted its ElasticON AI event in San Francisco, CA, prompting Bank Of America to flag the company has a “strategic generative AI tach stack disruptor” and rise their price target on shares to 90 (shares trading around 80 now).

Turning to the numbers, in the current fiscal year (2024, ends in April) revenue is seen up 17% (to $1.25 billion). The profit spigot is expected to open, driving EPS to $1.08 this from $0.25 last fiscal year.

That all said, analysts are being cautiously optimistic about the ESRE potential. There could be some upside, depending on how things shake out.

The Stock
ESTC came public at 36 in October 2018 and its pre-pandemic high of about 104 was hit in mid-2019. Shares were crushed during the pandemic but ultimately hit a new all-time high near 190 late in 2021. The stock followed the general tech stock pattern in 2022, selling off, enjoying a summer rally then fading to make new lows near year’s end. Since bottoming at 46.2 on January 6, 2023 ESTC’s chart is one of peaks and valleys, first in the 50 to 67 range (through May) then in the 57 to 75 range through August. The big change of character came after the September 1 earnings release when shares jumped 20% to close at the highest levels of the year (near 74). For the last seven weeks ESTC has been solid in the 75 to 83 range. We’ll jump in with half a position here. BUY HALF

LSI Industries (LYTS)

LSI Industries (LYTS) has been on my radar for a while, and that interest prompted me to write it up for a Cabot Walth Daily article last week. After listening to the most recent quarterly earnings call again and seeing that earnings will be out in a couple of weeks I wanted to get it on your radar by adding to our Watch List today.

The backstory is that LSI is a small industrial company that makes and installs integrated lighting and display solutions for big commercial and industrial applications.

We’re talking about massive sports complexes, gas stations, burger chains and other quick service restaurants, car dealerships, parking garages, retail and grocery outlets, warehouses and things like that.

Since I’ve been aware of the company I’ve taken more notice of the lighting and signage in these locations. It’s both impressive and surprising when you notice the size of some of these installations. And there are rather obvious energy efficiency considerations that are becoming increasingly important.

There are too many new products in LSI’s portfolio to get into details. After all, the company has been launching more than 40 new products every year. And those innovations are driving around 30% of sales.

But one of the new products coming to market soon is worth mentioning. It’s a new refrigeration display solution that uses no ozone depleting chemicals. It looks like LSI will make it in Maine and start taking orders any day.

One of the blockbuster products is a digital menu board, which was introduced a few years ago and was responsible for landing a $100 million, multi-year project.

One of the pros (and potential cons) of the company is that a few sizeable contracts can make a big difference. There are some fluctuations quarter to quarter, and management doesn’t shy away from that.

If I’m being perfectly honest that’s one of the reasons I’m putting LYTS on our Watch List now, and not in our portfolio. I’d like to see how new projects are stacking up with cooler months coming.

In fiscal 2023, which ended in June, revenue was up 9.2% to $497 million. With operational improvements and debt payments LSI enjoyed massive profit growth. EPS rose 55% to $0.99.

Looking into fiscal 2024 (the first quarter of the fiscal year just ended in September) management has called for a flattish first half, then stronger growth in the second half.

The bottom line is that fiscal 2024 revenue growth should net out to 4% to 5%, with EPS growth of around 12% (to $1.19). The stock pays a dividend equal to a yield of 1.2%. We’ll get an update in a few weeks and go from there.

The Stock
LYTS has been public for a long time so the stock has been through all types of markets. Shares were doing terrific leading into the pandemic and after a short and painful crash resumed their upward trajectory, ultimately topping out near 11.2 in January, 2021. The trend over the next seven months was down, then LYTS found support near 6 last August and turned up again. Shares hit a fresh high of 16 in March, corrected and consolidated in the 11.4 to 14 range until August 16, then jumped right back to around 16 after the Q4 fiscal 2023 report on August 17. LYTS has acted well since. With Q1 fiscal 2024 results so important given the seasonality we’ll start by putting LYTS on our Watch List. WATCH

Varonis (VRNS)

We’re going to piggyback on a recent upgrade out of Morgan Stanley (MS), who called security company Varonis (VRNS) their “top SMID-cap security idea.”

Varonis is a company I covered back in 2020 so this isn’t an entirely new story. In fact, several of the trends that were enticing back then, including a successful transition to the SaaS business model, are playing out now. The stock is also more attractively valued, and there’s a potential AI boost to discuss.

The deal is that Varonis’s security software is 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.

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”.

That could lead to a lot of upside to current growth forecasts, and is why the stock has acted so well this week.

Turning 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 Q2 2023 new business was around 50% SaaS.

That translates into better economics for both Varonis and customers. And implies the business will enjoy higher margins, shorter sales cycles and greater efficiencies for years to come.

To be clear, growth has cooled since the go-go days of the pandemic. In 2021 revenue soared 33%, then was up 21% in 2022. This year, analysts see revenue up just 5.6%, to $500 million.

But profitability arrived during the pandemic (EPS was $0.18 last year and should be around $0.22 this year). And revenue is expected to reaccelerate in 2024, to around 10%.

With all the tailwinds of the SaaS transition, underappreciated Generative AI upside and a stock that’s trading at a discount to peers, with M&A in the space, Varonis is definitely worth keeping an eye on.

The Stock
VRNS went public in February 2014 at 22 and reached a pandemic-era high near 75. The bear market over the last two years took a bite out of the stock, which fell into the mid-teens back in November of 2022. After that washout VRNS began to gain altitude again, basically doubling in value by February of this year. That was the top for a while as shares slid back into the low-20s before shooting back to the 30 level after the Q2 earnings release in August. Over the last two and half months VRNS has mostly traded in the 30 to 32.5 range. But shares have moved solidly above 33 this week following Morgan Stanley’s bullish note. With earnings just under two weeks and the stock having just rallied to a 15-month high we’ll put on the Watch List today. WATCH

Previously Recommended Stocks

Today, Badger Meter (BMI) moves to HOLD.

We cut our losses on Academy Sports (ASO) on September 20 (-15%) and Zillow (ZG) on October 3 (-18%), and also stepped aside from our half stake in both Datadog (DDOG) and Comfort Systems (FIX) at about break-even on September 20 and October 13, respectively. On the plus side we locked in a gain of 17% on our remaining shares of e.l.f. Beauty (ELF) on September 20.

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 November 15, 2023.