February 16, 2022

In the February Issue of Cabot Early Opportunities we take a quick look at the big-picture events influencing the current market then dive into five names that keep jumping onto my radar.
This month we take another spin with two names that served us well in 2021 and add a software company that has the potential to be a massive player in the digital economy. We also take half a stake in a watch list name and refresh that list with an exciting IoT company.

Enjoy!

Market Overview

Stock Name	Market Cap	Price	Investment Type
Cactus Inc. (WHD)	$3.80 billion	50.2	Rapid Growth – Oil Services
Concentrix (CNXC) - Trade	$10.7 billion	204	Growth + Value – CX Software
GitLab (GTLB)	$11.0 billion	75.5	Rapid Growth – DevOps Software
Portillo’s (PTLO)*	$1.0 billion	27.9	Rapid Growth – Restaurant
Samsara (IOT) - Watch	$11.4 billion	22.4	Rapid Growth – IoT Networking

Current Market Outlook

* Watch List Addition

Plenty of Buying, but Plenty of Crosscurrents Too
Recent data from Bank of America shows all of the bank’s clients, except for hedge funds, have been buying stocks in recent weeks. Retail buyers have been stepping up to the plate for six straight weeks while institutional buyers have been buying over the last three weeks.
What are they buying?

Small caps and mid-caps (i.e., SMID caps, which is simultaneously the best and worst acronym in the investing world).

As it turns out inflows to SMID caps have been near record levels. This is likely due to clients taking heed of the bank’s notes on how smaller company stocks are trading at a near-record discount to large caps in terms of valuation.

On the one hand this creates an intriguing setup for stock pickers who, like us, tend to primarily focus on small and mid-cap stocks.

On the other hand, there are still a lot of questions out there. And they might not be answered any time soon.

At the top of the list right now is the situation between Ukraine and Russia.

If we believe Dr. Evelyn Farkas (who served as Deputy Assistant Secretary of Defense for Russia/Ukraine/Eurasia and Senior Advisor for Public/Private Partnership, Supreme Allied Commander NATO/Commander, U.S. European Command) Russia, along with China, is trying to challenge the global order. Putin wants to make sure there are no examples of democracy bordering Russia or the former Soviet Union.

To advance his interests Putin is also trying to keep himself in power and thinks that if he can reattach the states that escaped when the Soviet Union collapsed (he doesn’t need all of Ukraine, just part of it) his dented popularity in Russia will improve.

I’m about as far as you can get from being an authority on this topic. But even I know that shaking up the world order is a pretty big deal. Hence the market’s intense focus on the Russia/Ukraine situation.

Closer to home we have the Fed preparing to hike rates for the first time in years. This week Goldman joined Bank of America in saying it sees seven hikes in 2022 to contain inflation. That’s no joke, and rumors of a 50-basis-point hike in March have raised eyebrows among those that closely follow all things Fed-related.

The irony of the rate hike concern is that, historically, stocks have tended to do quite well once rate hikes begin. It’s just in the period leading up to the hikes that stock returns are challenged.

Oh, and let’s not forget about this pandemic that we’ve been living with for the last two years. At the moment, things are looking pretty good as Omicron recedes and mask mandates start to be lifted. That’s helped going out stocks like restaurants, hotel operators and fitness chains.

But, it’s still cold and flu season in much of the country and there are a lot of areas around the world where vaccination rates need to improve dramatically before things can get back to some semblance of normal.

Bottom line, while the action in the stocks we follow has improved significantly since the January Issue of Cabot Early Opportunities, we are still facing a myriad of big-picture situations that could go either way.

As we try to navigate through all these crosscurrents it’s important to maintain something of a split personality, with one part keeping tabs on the big-picture stuff, and the other part focused on pursuing opportunities in individual stocks.

What to Do Now
Continue to tread carefully, take smaller positions, focus on diversification, and keep plenty of cash available. While we’ve seen some improvement in higher-growth and recent IPO names the market is still moving around significantly on macro factors, which are difficult to predict and often overshadow company-specific factors.

In short, the best big-picture advice is the same as last month – think more about playing the long game and taking a stab at a few opportunities along the way. But don’t overcommit to this market.

Stock Summaries

Cactus (WHD)
We made a little money on Cactus (WHD) last year and with the ongoing strength in the energy market we’ll take another crack at it now.

The backstory is that Cactus is a small-cap, pure-play wellhead and pressure control equipment provider that serves the U.S. onshore oil drilling market. The company designs, makes and sells wellheads and pressure control equipment (roughly 60% of revenue). It also rents equipment and provides mission-critical field services to clients (roughly 20% of revenue from each category).

The company’s main products are Cactus SafeDrill wellhead systems, frac stacks, zipper manifolds and production trees.

Cactus is a major player in the wellhead market, owning roughly 40% market share. It has benefited from the growth of privately held exploration and production (E&P) companies, which operated just 20% of rigs a few years ago but now operate over a third of them.

Based on recent management commentary, the company sees rig count growing by 10% from Q3 into Q4 (report expected February 28) and by about the same amount into Q1 2022.

Looking deeper into 2022, there is potential that public E&P companies could do more business with Cactus given the ongoing strength in commodity prices. While we don’t want to get super bullish (costs and supply-chain issues continue) there is certainly potential that Cactus could enjoy a very strong 2022 if both private and public E&P companies try to cash in on the strong oil price.

As a final note, Cactus has a manufacturing facility in Louisiana, and it plays in a specific little market (wellheads). Those factors might help the company increase prices in 2022 (following price increases in early 2021).

Current consensus is for Cactus to grow Q4 revenue by 81% to $123 million and to deliver adjusted EPS of $0.20 (up 150%). That implies 2021 revenue growth of 23%. This year (2022) should be even better as revenue is seen growing by 40% to $600 million and adjusted EPS is expected to nearly double, to $1.33.

This is a cyclical stock, and it is not one to tuck away and forget about for the next decade. But if the recovery plays out roughly as expected, Cactus could deliver the goods.

The Stock
WHD came public in February 2018 at 19 and got off to a strong start. For the last twelve months or so the stock has been making a series of higher highs and higher lows on a weekly chart, though, the dips have been material (in the range of 13% to 30%). Most recently WHD declined from 47 (October 25, 2021) to 35 (early December), a 26% retreat. But it roared back and broke out to new highs on January 25. We’ll take another crack at WHD here near 50 and see if we can’t grab another 10% to 20% gain.

Concentrix (CNXC)
Concentrix (CNXC) is a pure-play customer experience (CX) company that was spun out of SYNNEX Corporation (SNX) on December 1, 2020. CX has become a strategic imperative for companies as they seek to build customer relationships around the emotional connection and sense of authenticity that customers feel toward a company.

Concentrix is primarily focused on customer lifecycle management, consumer/user experience strategy and design, digital transformation, voice of the consumer and analytics. Primary modes of communication are voice, chat, email, social media, and asynchronous messaging.

The company has over 750 clients from across a spectrum of industries. Many (125) are new-economy clients (combined market cap near $7 trillion) and over 100 are Fortune 500 companies.

Concentrix has over 250,000 employees and provides services in more than 40 countries and 70 languages across North and South America, Asia-Pacific, Europe and the Middle East. It has a significant presence in emerging markets.

The company stands out from the pack because it is a global player that’s well-recognized among big companies, has a wide variety of solutions, a top-notch management team, and a history of well-integrated acquisitions.

On that front, on December 27 the company closed on the acquisition of ProKarma Holdings (PK). The $1.6 billion purchase (roughly 2.5-times PK estimated 2023 revenue) was funded with new debt. PK operates in the digital IT services part of the market, which is the fastest growing area. PK brings a lot of intellectual property and CX technology that should help drive deeper client relationships, especially among the high-growth clients that Concentrix servs.

At a recent investor day, management talked about the types of growth drivers the company is seeing in the CX market. They flagged the metaverse (AR/VR, networking, edge computing, digital economy), Web3 (Blockchain, crypto, NFT, security) and Ethical-AI (privacy, anti-bias, transparency, non-discrimination) as being major drivers in the space.

The company just reported Q4 2021 results in January that met analyst expectations (revenue up 13% to $1.47 billion, EPS up 44% to 2.99), and fiscal 2022 guidance was also in line. In a market growing by around 4%, Concentrix is expected to grow closer to 6% to 8%. However, factoring in acquisitions, 2022 revenue should be up around 17% to $6.5 billion while adjusted EPS should be up 19% to $12.10.

Despite the growth, CNXC tends to trade at a discount to peers (ACN, TASK, TIXT, etc.). Analysts think this is because it hasn’t been public for all that long and that, as management executes on the growth plan, the stock will earn a higher valuation. In the meantime, investors can buy into a growth stock with defensive characteristics (0.5% dividend, high EPS, etc.).

The Stock
CNXC started trading as a stand-alone company on December 1, 2020, when it closed at 105. By April the stock was approaching 150 and for the greater part of the summer CNXC traded in the 140 – 165 range. The stock moved above 170 in late August and despite a couple wobbles climbed to 191 by mid-November. December and January were rough as CNXC fell by as much as 18%. But the stock was far more solid than many other conservative growth names, and following the Q4 earnings report on January 18, CNXC began to recover and ultimately broke out to new highs above 191 on January 31. For the last two weeks the stock has been hanging out near the 200 level.

GitLab (GTLB)

As the digital economy grows and businesses prioritize digital transformation, teams of developers are constantly creating and tweaking software applications. This is done through a process called DevOps. And at the center of DevOps is creating, reviewing and deploying code.

To keep all this work organized, software developers need a myriad of tools to collaborate, share, track changes and resolve code conflicts. In short, they need a source code management (SCM) platform.

That’s where GitLab (GTLB) comes in.

GitLab provides an end-to-end DevOps platform that functions as a system of records for source code. The platform has tools that software developers across all industries can use to develop and deploy applications quickly, efficiently and at scale.

Over time, GitLab’s strategic importance to its users is growing. This is happening for a few reasons. For starters, as developers create and manage more code on GitLab’s platform their reliance on the company grows and their incentive to use disparate solutions from other providers decreases. It’s far easier to use one platform that does everything they need.

Moreover, as the market evolves, GitLab is creating more DevOps tools to meet the needs of its growing user base.

This is the same type of trend that evolved in the early days of other software categories. We saw it in CRM where Salesforce (CRM) emerged as the winner (market cap has expanded from $1.1 billion to $203 billion since 2004) and with HCM and ERP markets where Workday (WDAY) has risen to the top (market cap of $7.7 billion has expanded to $58 billion since 2012).

In the SCM market the stakes are high. The quality and stability of an organization’s/application’s source code is everything in the digital economy. No application exists without source code. And having a platform that permits near-instantaneous changes can mean success or failure for users that rely on that application.

While there are other solutions out there, including GitHub from Microsoft (MSFT) and BitBucket from Atlassian (TEAM), GitLab is seen as being led by a visionary management team, having a great culture and having the best platform in the SCM industry, which is growing toward $50 billion by 2025.

In short, while it is in the early days, GitHub has the potential to be the “winner” in this market.

Revenue is expected to grow by 52% to $70.3 million in Q4 fiscal 2022 (no date set yet) while EPS is seen around -$0.25. That result would mean fiscal 2022 revenue growth of 64% ($250 million) and EPS of -$1.40.

In fiscal 2023 revenue is seen up 36% to $340 million while EPS is seen improving 26% to -$0.04.

The Stock
GTLB came public at 77 on October 14, 2021, and jumped 35% the first day. Shares advanced as high as 137 by November 9 before going on a multiweek slide that ended at 70 in mid-December. After a brief relief rally that carried GTLB back to 98 shares retreated again, ultimately landing at 53 on January 24. Over the last three weeks GTLB has walked higher, trading as high as 80 last week. With arguably one of the more attractive long-term growth stories in the mid-cap software space, we’ll jump in here in the mid-70s.

Portillo’s (PTLO)
Portillo’s (PTLO) was added to the Watch List last month and we’ll jump in today with a half-sized position.

As a refresher, the company is a fast-casual restaurant chain that began in 1963 when Dick Portillo opened the first Portillo’s hot dog stand in Villa Park, IL. He invested $1,100 in the stand, which he called “The Dog House.”
Over the years, Portillo’s has become a well-known restaurant brand in the Chicago area. Success has led the company to expand into nearly 70 locations across nine states and to take the company public (IPO was in October). Most locations are in the upper Midwest, with a few scattered across Florida, Arizona and California.

The restaurant is knowns for famous Chicago-style hot dogs, Italian beef sandwiches, chopped salad, cheese fries, homemade chocolate cake and chocolate cake shakes. I’ve never been to one but have heard great things from friends that have.

The average per-person spend at Portillo’s is less than $10. That’s much lower than other, high-volume, fast-casual restaurants. But this is a very efficient business with diners coming in across weekends, different times of the days and through both drive-in and lobby locations. The average works out to roughly 50-50 lunch/dinner.

Average daily guests per restaurant surpasses 2,500. That’s more than McDonalds (MCD), which pulls in around 1,600 a day!

Investments in technology are part of the reason Portillo’s can keep costs down and customer turnover quick. The company has drive-thrus (53% of revenue), delivery (6% of revenue) and dine-in (41% of revenue), all supported by online ordering and mobile app capabilities. Around 20% of orders come through digital channels.

Food costs are higher than is typical in fast casual, while labor costs are lower. All in, Portillo’s unit-level returns hover around 30%, which is higher than the industry average.

This is the type of business that could explode over the next decade. It’s been in business for over 50 years, so that brand recognition and story is authentic and time-tested, should consumers want to embrace it. It’s also in the fastest growing area of the restaurant industry. And Portillo’s has an aggressive expansion strategy to grow to 600 locations by 2039, implying average annual growth of 13%.
While stores around the Chicago area tend to have higher sales volume (up to $9 million versus $6 million outside of that area), there is room for those locations to turn up the dial as brand awareness and restaurant density spreads. Expect management to focus on growing store count in current geographic areas before it spreads out to new states.

In 2022 we should see seven new stores open. That should mean revenue grows by around 10%, to $590 million. That’s somewhat slower than the 19% growth rate expected when 2021 is in the books. But there’s likely some upside room to consensus estimates. As a final sweetener, Portillo’s is expected to turn profitable this year and deliver adjusted EPS of $0.32. We don’t yet have a Q4 2021 earnings date, but I expect the event to occur around the beginning of March. BUY HALF

The Stock
PTLO came public at 20 on December 21 and jumped 46% the first day. Shares kept climbing all the way to an intra-day high of 57.8 on November 18. Following the November earnings report it became clear the stock was stretched and over the coming weeks PTLO slid by 48%. A brief rally began in the back half of December which carried PTLO back to 40, but another slide pulled shares down into the low 20s by the end of January. PTLO firmed up and was trading near 28 at yesterday’s close.

Samsara (IOT)
The idea of tracking vehicle fleets and other physical assets with a combination of devices, cameras and software is not new. But it’s taken some time for technology to get to the point where doing so is easy enough and generates clean enough data that it’s worth the effort and expense.

Much of the credit for advancing the Internet of Things (IoT) market goes to Sanjit Biswas and John Bicket, who have been on a mission to increase the safety, efficiency and sustainability of the operations that power our economy.

The company they founded to help them achieve this goal is Samsara (IOT), which came public in December 2021 and is growing like a weed.

Samsara uses a combination of in-vehicle devices, gateway sensors, video-based AI and a cloud platform (Samsara Connected Operations Cloud) to monitor and manage commercial vehicles and their drivers, worksites, manufacturing equipment, heavy equipment and more.

Customers come from a wide variety of industries, including wholesale, retail, construction, shipping, logistics, utilities, field services and manufacturing. They all have one thing in common – the need to oversee thousands of employees and pieces of equipment and coordinate the production and transportation of goods so that the right items arrive at the right place, safely and on time.

Given how quickly things move these days and how often things change, it’s simply not realistic to repeatedly pull this off with phone calls, text messages, etc.

While the company initially began by focusing on the connected fleet market (i.e., vehicle telematics) the more recent expansion into equipment and worksites added more than $20 billion to its addressable market, which is now approaching $55 billion.

Samsara’s Connected Operations Cloud combines vehicle telematics, video-based safety and apps & driver workflows with connected equipment and connected physical sites; the platform not only helps things get where they need to go but it can also reduce CO2 emissions and limit accidents, lawsuits, workplace injuries and equipment damage.

Samsara’s best-selling solution continues to be Vehicle Telematics, which provides GPS tracking, fuel efficiency monitoring, etc. But Video Solutions (both forward and driver-facing cameras) is catching on quickly. And the Site Visibility Solution is also doing very well.

The market isn’t devoid of competition. Depending on the application, Samsara may bump into solutions from Microsoft (MSFT), PTC (PTC), IBM (IBM), Amazon (AMZN) and Salesforce.com (CRM).

But with a focus on delivering out-of-the-box applications that work well with its cloud platform, Samsara has, and should continue to have, tremendous success. Revenue in 2021 grew by 109% to $250 million and is seen rising by 67% in 2022, to $417 million. Looking out through 2025, annual revenue growth should top 30%. Samsara won’t generate a profit for a while.

This is an exciting company and a high-potential stock. That said, in the current environment, and given it has been public less than two months, it’s one we’re going to add to the Watch List today. The next earnings report will come out on March 2 and give us the first official look under the hood since the IPO. WATCH

The Stock
IOT came public at 23 on December 15 and rose 7% the first day. Shares traded up to an intra-day high of 31.4 in the quiet market that persisted through the holidays, then IOT retreated into the low teens in January, ultimately bouncing off the 14.5 – 15 range a couple of times before working its way back above 20, where IOT has been for the last week. The stock is simply too young to say there’s any sort of trend, so we’ll add IOT to the watch list for now.

Previously Recommended Stocks

Soon after the January Issue of Cabot Early Opportunities we let go of Coinbase (COIN), the second half of our position in Global-E (GLBE), our remaining three-quarter stake in Kornit Digital (KRNT) and our final quarter position in Upstart (UPST). On February 11 we sold another quarter position in Cloudflare (NET).

With new recommendations today we’re going to continue to trim a few weak positions.

First up is Sea Limited (SE). This week we learned that India has banned the Free Fire game. Given the importance of Sea’s gaming division as a way to pull users into Sea’s platform and fuel growth in the e-commerce and fintech businesses this is a potential risk to what should be a major growth initiative (i.e., expansion into India). While the reasons behind the ban (India is concerned about games with ties to China) are a little iffy (Sea Limited is not a Chinese company) and there’s potential for the decision to be reversed, the reality is SE has been a challenged stock for some time now. Let’s bite the bullet and move on. SELL

We will also say goodbye to DLocal (DLO) today. The payments company offers solutions that help global merchants make and receive online payments in emerging markets across Latin America, Middle East, Africa and Asia. Payments companies have been challenged in the current environment – see PayPal (PYPL) and Block (SQ), among others – and while there are certainly differences among various players the bottom line is DLO hasn’t done its job for us. I’ll keep an eye on it, but as of today it’s a sell. SELL

We are also dropping Matterport (MTTR) from the Watch List due to poor performance.

We are moving ZoomInfo (ZI) to HOLD following yesterday’s Q4 earnings report. This decision is based on market performance, not fundamentals as the report illustrates that ZoomInfo’s growth trajectory is very much intact. It’s not likely that the company enjoyed a big pandemic boost that will soon fade. If anything, the business continues to fire on all cylinders. That said, growth stocks remain in an up-down trading pattern following earnings reports that aren’t out-of-this-world great, so we’ll be conservative until a more sustained uptrend emerges. HOLD

Finally, we are moving Allbirds (BIRD) to HOLD as the stock is bouncing around what looks like support around 10.8. However, should BIRD take another leg down we will likely cut the name. 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.

The next issue of Cabot Early Opportunities will be published on March 16, 2022.