In the June issue of Cabot Early Opportunities we add a conservative stock from our Watch List that’s acted well over the last month and also take a partial position in an emerging player in the energy space. We also refresh the Watch List with a pure-play beverage stock, a biotech stock with a big date in November and another emerging energy name.
Enjoy!

Cabot Early Opportunities Issue: June 15, 2022

Stocks in This Issue

Stock Name	Market Cap	Price	Investment Type	Current Rating
Aris Water Solutions (ARIS)	$1.02 billion	19.1	Rapid Growth – O&G Water Services	Buy Half
Dutch Bros (BROS)	$5.50 billion	33.4	Rapid Growth – Coffee Shop	Watch
Grocery Outlet (GO)	$3.68 billion	38.1	Growth – Discount Stores	Buy
PBF Energy (PBF)	$4.68 billion	38.9	Growth + Value – O&G Refining	Watch
Travere Therapeutics (TVTX)	$1.49 billion	23.5	Development/Growth – Biotech	Watch

Is It Worth It?
Those of us that follow the market are always finding analogies between stocks and everyday aspects of life.

For me the most recent was inspired by watching a reality TV show. It has to do with when it’s worth taking the risk of buying a stock, and when it’s not.

Here’s the story.

I’ve recently been watching Season 9 of Alone on the History Channel. My reason for watching is that a friend from college made the cut this year. I don’t yet know how it all works out, but my money is on him 1,000%.

The show follows ten participants that are dropped into the remote wilderness of Labrador, Canada, with just ten items of their choosing (beyond clothes, cameras and some other things).

Their objective is to outlast their fellow castmates to claim a $500,000 prize. They’ll probably be out there for several months.

While Labrador is beautiful, it’s also a pretty rough environment. They need to hunt and forage for food, deal with wet and cold conditions and be aware of potentially dangerous big game, including black bears and Polar bears.

Also, as the name implies, each participant is completely alone. So they need to deal with that.

Sound kind of like investing in stocks right now?!!

What really got me thinking about this was a segment from episode two where a guy sees a grouse (a wild bird), a potential meal. Each participant has a bow and nine arrows.

He takes a shot at the bird while it is close to the ground and misses. Not a huge deal but he’ll have to look for that arrow later as the bird flies high up into a tree.

Debating whether or not to take another shot, knowing that his arrow could fly off to God knows where, he ultimately pulls back and lets the arrow fly.

He misses and arrow number two goes sailing into the great beyond. Seems doubtful he’ll ever see it again.

Now down to seven arrows he questions whether that shot was worth it or not.

This segment really resonated with me given my focus on “hunting” individual stocks in this market.

As a viewer with the benefit of hindsight the obvious answer to “was the shot worth it or not” is no, it definitely was not. The risk of missing a bird way up in a tree and losing one of nine arrows forever is just too high.

With $500,000 on the line and probably months to go in the wilderness, alone, every arrow counts. You have to make sure you have a good chance of getting your arrow back if you miss dude!

To complete the analogy, growth investors are stuck in bear territory in Labrador.

In this environment we need to be relatively conservative with the shots we take. Taking big risks just isn’t worth it until the odds are more in our favor.

This will change at some point. And I’m not saying we shouldn’t invest in any stocks at all. But for now, we’ll continue to hold more arrows than we shoot and look for opportunities where, if we miss, we still have enough capital (arrows) and fortitude to remain in the game.

What to Do Now

It’s hard to see the broad market making much upside progress until there’s some relief in sight from rising interest rates and inflation (maybe later in the year). That’s likely to make it hard to generate significant gains in individual stocks across a large portfolio, so we’ll continue to keep ours relatively small.
For now, continue to keep new buying on the low end (just one and a half positions this month) and take smaller positions, while trimming here and there if positions just aren’t working.

Things will turn up at some point; so, don’t tune out of the market entirely. Rather, put your energy into reading up on ideas that could work down the road and managing that Watch List.

Aris Water Solutions (ARIS)
The list of top-performing recent IPOs has dwindled to a handful, but holding strong is Aris Water Solutions (ARIS), a Houston, Texas-based company providing water infrastructure and recycling solutions to oil and gas operators in the Permian Basin.

Aris helps the industry slash use of fresh and non-potable water by blending technology, integrated infrastructure and logistics. Aris also helps customers achieve ESG (Environmental, Social and Governance) compliance.

Aris’ growing footprint helps it aggregate large volumes of produced water from several operators and treat and redeliver recycled volumes back to its customers. Produced water that is not recycled is safely disposed in saltwater disposal wells.

The biggest customers are ConocoPhillips (COP), Chevron (CVX), Exxon (XOM), Occidental Petroleum (OXY) and Marathon Oil (MRO), which collectively drive around 70% of revenue.

While this customer concentration does pose some risks, there is upside as well. Especially since, despite what some reports say, these producers are moving toward production increases. In just the last few months, Chevron increased Permian growth expectations and ConocoPhillips talked about an uptick in Permian activity.

In Q1 2022, (reported in early May) Aris modestly surpassed expectations with total water volumes handled or sold rising 45% to 1.17 mbwpd (million barrels water per day) and recycled water volumes up 290% to 273,000 bwpd. Revenue per barrel water sold was $0.68, up $0.04 from the year-ago quarter.

Rising volumes and stronger pricing drove Q1 revenue up 54% to $71 million. Adjusted EBITDA rose 54% to $35.9 million while adjusted EPS came in at $0.46.

Management also announced a long-term water management deal with Chevron that expands produced water handling and (especially) recycling across an additional 50,000 Northern Delaware acres.

For the full-year 2022 analysts now see total revenue growing around 40% to $320 million. Management has guided for adjusted EBITDA of $165 - $175 million.

The company will need to invest to support the Chevron agreement (and others) but with $268 million in liquidity ($68 million cash, $200 million revolving credit line) the $0.09 quarterly dividend (1.7% yield) appears very solid.

Given that this is a relatively new IPO and will tend to trade in sympathy with crude oil prices (which we’d really like to see come down) we’ll start with a half position.

The Stock
ARIS came public in October 2021 at 13 and rose 10% the first day. Over the next four months the stock traded mostly in the 10 - 15 range, then broke above 15 following the Q4 2021 earnings report on February 28. Shares briefly traded above 19 in March and April then fell back to 15 in the weeks after lockup expiration (April 20). ARIS turned north again after the Q1 2022 earnings report on May 9 and walked up to an all time high of 22 by May 31. Shares held above 20 through last Thursday then fell back with the market to trade in the high teens. BUY HALF

Dutch Bros (BROS) Dutch Bros (BROS) is a rapid-growth, drive-through coffee chain based in Oregon that focuses on fun, fast and excellent service.

The company was started in 1992 by Dane and Travis Boersma who got a pushcart and started slinging espressos. The business grew and the first franchise opened in 2000 then spread across the northwest.

The company now has over 535 company-owned and franchised units across 12 states, with the biggest presence still in the northwest and California but also stretching across Arizona, Utah, Colorado, Texas and as far east as Tennessee.

The heart of the business is still serving espresso-based beverages. But Dutch Bros has grown its menu (especially the “secret” menu) to offer a huge variety (over 9,000 combinations) of unique, customizable cold and hot beverages including smoothies, lemonades, teas, sodas and more.

Fun is a key part of the story. Employees report high job satisfaction while customers appear to love it too, even if they’re just going through the drive-through. With high engagement, Dutch Bros has a successful rewards program (Dutch Rewards), which captures roughly 60% of transactions.

Dutch Bros skews toward a younger crowd. More than half of customers are under 25 years old (roughly 65% are female). Most sales tend to come in the afternoon, though morning beverage sales have increased lately.

While growth is very rapid (revenue +52% in 2021), Dutch Bros is facing some challenges in the current environment.

The company has been growing locations quickly (98 units opened in 2021) and has plans to open at least 130 in 2022 (32 were opened in Q1). This pace of growth comes with costs (building, staffing, etc.) so ramping up volumes at new locations is critical.

Rising gas prices may also be pressuring consumers. On the Q1 call, management said as soon as gas prices jumped in March, daily sales were impacted. This led BROS (and analysts) to reduce 2022 same-store-sales growth from around 4%-5% to flat.

Ingredient costs are also up with dairy (almost 30% of ingredient costs) up 25% in Q1 and syrup and coffee prices higher too. While a 3% price hike this spring offsets these costs somewhat, there is a point at which consumers won’t absorb both gas and price increases just to have a beverage treat.

Still, adding it all up, this is a stock big investors are likely to want to own. Should some of the inflation trends moderate, even just a little, BROS stock could take off.

Look for revenue growth of 43% this year ($710 million) and continued growth above 30% for years as BROS ultimately is tracking toward several thousand stores across the country. Adjusted EPS this year may be about half of what it was in 2021 ($0.15 estimated) as the aforementioned costs curb, but don’t kill, profitability.

Given the inflation trends we’ll put BROS on the Watch List for now.

The Stock
BROS came public at 23 on September 15, 2021, and jumped 59.5% the first day. Shares traded as high as 81.4 a month and a half later. Not surprisingly BROS then pulled back but held firm in the 40 – 66 range through May 11. Then the stock plunged 65% over a couple days after the Q1 earnings report, which coincided with the broad market’s steep declines. By the beginning of last week BROS had doubled from its intraday low of 20 in May. Shares have come down into 33 area this week. WATCH

Grocery Outlet (GO)

I added Grocery Outlet (GO) to our Watch List last month and the stock has been solid since, while the broad market has headed in the other direction. Given the relative performance and appeal of the stock in this environment, I’m adding to the portfolio today.

Not much has changed over the last month. Grocery Outlet is still the type of stock that can do well when the economy doesn’t. It is an extreme-value retailer from the 1940s that has 418 stores in seven states, mostly along the West Coast.

The company’s ownership model, called Independent Operator (IO), means store owner-operators have an equity stake in their stores and considerable autonomy over hiring, merchandising, marketing and more.

Over 50% of products are sourced at a deep discount through an opportunistic sourcing model. Buyers scour the world looking for deals on brand name groceries, either through packaging changes, surplus inventory or product overruns.

Those deep discounts are passed on to consumers. Yet Grocery Outlet maintains very predictable profit margins.

The stock is trading at around 33-times estimated 2023 EPS of $1.15. With food price inflation that EPS number could easily go up. GO has traded with a forward PE of over 50.

In Q1 2022 revenue was up 10.5% to $831.4 million, beating by $21 million. Adjusted EPS of $0.22 beat by $0.02.

Full-year guidance was raised modestly, to around $3.4 billion. Same-store sales are seen rising 5.5% to 6.5% (versus 4.0% to 5.0% previously) and adjusted EPS is now seen in the range of $0.94 to $0.99, up from a range of $0.92 to $0.97 previously.

The main fly in the ointment I saw with GO a month ago was the volatility in both Walmart (WMT) and Target (TGT) as they purchased too much inventory for their customer bases. But GO has held up well and, as I said in May, this business is much more targeted with fewer categories of products than WMT and TGT.

The only new news lately is that Grocery Outlet and Uber (UBER) have teamed up on a pilot program across CA, OR and WA to pilot on-demand and scheduled grocery delivery.

The StockGO came public at 22 in June 2019 and finished the year near 33. While 2020 was a strange one, GO did well, eventually peaking at 44 in November. The stock had a tough 2021. Shares eventually found bottom at 21 last October. The stock was able to get back near 29 toward the end of the year, then after weakness in January, GO walked up to 36.6 in early April. A choppy five-week period followed during which GO slipped to 30.6, but the stock popped right back up near 36 following the May 10 earnings report. Shares have traded between 37 and 39.5 over the last three weeks. BUY

PBF Energy (PBF)
PBF Energy (PBF) is an independent refiner that produces gasoline, diesel heating oil, lubricants, etc. The company owns and operates six domestic oil refineries (CA, LA, OH, DE, NJ) with a combined processing capacity of over 1 million barrels per day (bpd).

During the pandemic the refining industry took on debt to get through a very weak period where demand imploded (remember when crude oil prices went negative?). Now, crude prices are back near 120 and there is not enough refining capacity out there.

While a relatively small player, PBF’s operations are diversified across the country and it has two refineries in California, a market that is set to lose its second refinery in three years in 2023.

This diversification, combined with the rise in oil prices, sets PBF up to generate a ton of cash this year and next. That cash is likely to be used to pay down the considerable debt PBF had to take on to get through the pandemic. Part of that hole was dug when PBF acquired the Martinez refinery (CA) from Shell in February 2020 (oops).

Granted, the cash flow boost from higher oil prices won’t last forever. Still, in the coming months PBF should be able to pay down a significant amount of high-interest debt. That will set the company up with a much stronger balance sheet to navigate whatever comes in 2023 and beyond.

This trend is already very much under way.

At the end of 2021 PBF had roughly $3 billion in net debt ($4.3 billion in long-term debt and $1.3 billion in cash and equivalents). With $30 million in senior notes repurchased in Q1 2022 and cash added, net debt went down to around $2.3 billion.

Then last week the company sent a notice of redemption to holders of 9.25% Senior Secured debt. Redeeming this $1.31 billion in debt (probably done with cash) means standalone debt will drop to around $2.4 billion.

With expected free cash flow (expected to be roughly $2 billion in 2022) PBF could end the year with net debt well below $500 million, a huge improvement from the roughly $3 billion at the end of 2021.

Of note, PBF holds a 48% ownership interest in PBF Logistics LP (PBFX), which is also taking steps to repair its balance sheet (and pays a 7.4% dividend).

The Stock
PBF traded near 30 at the end of 2019 then the pandemic killed the stock. It traded as low as 4.0 in October 2020. Shares had a bumpy 2021 as well, trading just above 18 in March and June but also trading as low as 7.2 in August. The stock ended the year near 13. In 2022 PBF has been off to the races, making a series of higher highs and higher lows. Shares broke above 20 in March then rallied through 30 in May. Last week the stock traded as high as 43.7 before pulling back to around 40 later in the week. Given the recent rally we’ll put PBF on the Watch List for now and look for a better entry point. WATCH

Travere Therapeutics (TVTX)
We made 26% on Travere Therapeutics (TVTX) last year, and with the stock trading below where we first bought it, but the pipeline further advanced, we’ll put the stock back on our Watch List today.

The backstory is that Travere is a biopharma company developing therapies for rare diseases. It currently has three approved drugs that bring in steady revenue, including Chenodal (gallstones), Cholbam (bile acid synthesis disorders) and Thiola/Thiola EC (prevention of kidney stones).

Revenue grew by 13% in 2020 and by 15% in 2022 (to $228 million).

Much of the story here is about the pipeline of potential treatments for progressive kidney disease. Sparsentan is the most advanced pipeline asset and is being evaluated for two diseases. Commercialization could be right around the corner, pending FDA approval.

The first is for treatment of a rare kidney disease, focal segmental glomerulosclerosis (FSGS), which is a leading cause of end-stage renal disease. The second is for treatment of immunoglobulin A nephropathy (IgAN), the most common primary glomerular disease. Data on both has been good so far.

Sparsentan has the potential to help younger patients, typically in their 40s and 50s, that are at high risk of death from both FSGS and IgAN, which have no approved treatments in either the U.S. or EU.

On May 16 management announced the FDA has accepted Sparsentan for priority review (with no advisory committee) for IgAN, with an action date of November 17, 2022. The company’s launch plan targets 30,000 to 50,000 patients in the U.S. and 2,000 to 6,000 nephrologists. The assumption now is that this program will reach commercial status following approval in November.

Travere is also about to file an NDA for Sparsentan for FSGS any day now, and priority review could be on the table there as well.

In the event Sparsentan is approved for both indications, TVTX should be worth roughly twice what the stock trades at today.

With Sparsentan appearing on track, investors are digging a little deeper, which brings us to Pegtibatinase. This asset is being evaluated in a Phase 1/2 study (COMPOSE) to treat classical homocystinuria (HCU), which is characterized by high levels of homocysteine that can lead to vision, skeletal, circulatory and central nervous system issues. Revenue contribution could be $400 - $500 million (in the U.S.) once up and running.

Altogether, the Travere could generate $282 million in revenue in 2022 (+24%), $350 million in 2023 (+24%) and $570 million in 2023 (+64%). Those numbers will go up or down upon eventual approval/failure of Sparsentan.

As always, small-cap biotech stocks are risky, and shares will rise and/or fall upon trial results and/or FDA approvals/failures. With the November FDA announcement still a little way off we’ll add to our Watch List today.

The Stock
TVTX has been public since 2012 and has had many ups and downs along the way. The stock was crushed in spring 2021 (traded as low as 12.8 in July) upon news of a delay in the accelerated approval process for FSGS. But TVTX walked back up to 15 by mid-August then gapped up to 18 on positive IgAN data/potential FSGS approval. Since then shares have mostly traded in the 20 – 30 range and are currently near the lower end of that range. WATCH

Previously Recommended Stocks
Since the May issue we sold Endava (DAVA), Petco Health & Wellness (WOOF), our remaining one-quarter stake in Cloudflare (NET) and ZoomInfo (ZI).

Today we are stepping aside from Portillo’s (PTLO) due to continued poor performance. SELL. We are also moving GitLab (GTLB) to hold. HOLD.

Despite the recent volatility we’ll keep Caribou Biosciences (CRBU) on the Watch List. ANTLER Phase 1 trial results for CB-010 in relapsed or refractory B cell non-Hodgkin lymphoma (r/r B-NHL) initially showed a complete response (albeit in small sample size of six) that faded for four of the six patients after six months. While far from perfect this performance is better than many previously approved therapies and Caribou is now moving on to a higher dose, which may have longer durability.

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.

^ Average of high and low price if published intraday, or closing price if published after 4 PM ET

^Average of high and low price if published intraday, or closing price if published after 4 PM ET

The next issue of Cabot Early Opportunities will be published on July 20, 2022.

About the Analyst

Tyler Laundon

Tyler Laundon is chief analyst of the limited-subscription advisory, Cabot Small-Cap Confidential and grand slam advisory Cabot Early Opportunities. He has spent his entire career managing, consulting and analyzing start-up and small-cap companies. His hands-on experience has taught Tyler that the development of a superior business model is the biggest factor in determining a company’s long-term success. Accordingly, his research focuses on assessing the viability of management’s growth strategies, trends in addressable markets and achievement of major developmental milestones.

Tyler’s small-cap portfolios favor a high allocation to stable, high growth companies, upon which he layers strategic purchases of higher risk, event-driven investments. He first began publishing his analysis of small-cap opportunities in 2009. Since 2012, he has led his subscribers into 10 doubles. Between 2012 and September, 2015 his small-cap recommendations generated cumulative returns of over 2,300%, including both winners and losers, and outperformed the Russell 2000 Index by an average of 28% per year.

Prior to joining Cabot, Tyler founded and operated a small business for 15 years. He then worked as a consultant for start-up technology companies, as well as Vermont’s largest health care institution. From 2009 to 2015, he was the chief analyst of growth stocks at Wyatt Investment Research, where his research spanned the full spectrum of the growth stock universe, from micro-cap start-ups to multi-national mega-caps.

Tyler holds a B.S. and MBA from The University of Vermont, where he graduated Valedictorian. He has been a long-time contributor to the Wall Street’s Best Investments, has been quoted by U.S. News & World Report, and has presented investing ideas and strategies for The Money Show and Bloomberg Markets LiveINSIGHTS.