April 13, 2023

The market is still like a jar of mixed nuts. Some good, some bad.

Earnings season begins this week as large-cap banks start delivering Q1 results. Across small-, mid- and large-cap stocks (all sectors) earnings estimates have been trending down for several quarters.

That’s not great. But what’s also interesting is that forward revenue expectations have not been coming down. The implication is that, broadly speaking, profit margins are going to take a hit in 2023. In other words, corporate revenue may be near record highs, but companies will make less per dollar of revenue than last year.

Rising costs and softening demand is not a great mix, especially when interest rates have been cranked up and recession odds are rising. Did I mention there’s still risk of financial contagion from small and regional banks?

It all sounds pretty dire. But the stock market tends to look forward about a year. And we could be in much better shape heading into the back of 2023, especially if the current rolling recession rolls on through without snowballing into a full-blown recession.

Let’s back up to earnings season.

In Q1 and Q2 of 2023 large-cap EPS is expected to fall by -7.7% and -6.6%, respectively. But, in Q3 and Q4 EPS is seen rising by 1.4% and 9.7%. Bad, to better.

Turning to small caps, Q1 and Q2 EPS is expected to fall by -11.9% and -17.1%. No doubt the relatively high weight of economically sensitive stocks (financials, industrials, materials, energy) in the small-cap index have taken an earnings expectation hit since SVB’s demise.

But getting into the back half of the year, in Q3 and Q4 expected EPS growth for small caps begins to improve, to -3.3% and +8.7%, respectively. Bad, to better.

This not-so-great-now-but-maybe-better-later expectation is part of why the P/E for the S&P 500 (18 as of Monday) is down from its range in the low 20s from the last couple of years, but not overly depressed.

Small caps are much more attractively valued, if you can look past the risks of a credit crunch (I know, I know). The S&P 600’s forward P/E of 12.9 is off the lows from a few months ago, but still well below the 16-19 range where it has spent much of the last two decades.

Last but not least, there have been some interesting developments in the yield curve since SVB blew up.

As you can see in the following chart from Yardeni Research the yield on both the 10-year (3.41%) and 2-year (3.95%) Treasury have fallen lately, even while the target Fed funds rate (4.88%) has gone up.

The message is that the market sees a higher chance of a mild recession and/or the Fed being just about done with rate hikes. Yesterday’s FOMC minutes support both scenarios. Current market odds are about 66% that it’s another 25-bps hike in May, then hold.

I’m far from being an economist, but I feel like I have a decent amount of common sense. And my question is – why would the Fed keep hiking rates if they project a “mild recession” (their words) due to an emerging banking crisis?!

That just seems silly, in my humble opinion. If they were to hike in June I may just lose my mind.

Add it all up and there’s no clear trend in the stock market. That makes it a challenging market to be a stock picker.

Yesterday’s CPI inflation print was better than expected, and this morning’s PPI was as well.

So the “bad to better” environment later this year isn’t a pipe dream. The takeaway message is that we should continue to tread carefully now, while positioning for better times ahead.

Recent Changes: None

Updates

Alphatec (ATEC) is our newest portfolio addition. It is a MedTech company with surgical solutions for spinal conditions. Whereas some companies offer a smattering of products for spine surgery Alphatec reorganized its business a few years ago so that it could offer a soup-to-nuts product lineup. The team has developed surgical procedures, body positioners, surgical tools/access systems, informational systems for pre-, intra-, and post-operative care, implants, fixation systems, and biologics. It’s an example of a company that embodies the spirit of a pure play – either it’s going to win in spine or … well, if it doesn’t win it will probably end up selling itself off to one of the more diversified MedTech companies. But right now, Alphatec is winning. The trends are very good.

Alphatec has posted average annual revenue growth of 41% since 2018. Revenue grew by 44% (to $351 million) in 2022 and was up by 43% in each of the last two quarters. Earnings are negative, but losses are getting smaller. EPS was -$1.50 in 2021 and -$1.47 in 2022. The company is expected to grow 2023 revenue by 25% (to $440 million) and 2024 revenue by 20% (to $530 million). EPS loss is expected to improve by 56% in 2023 (to -$0.64) and by another 42% (to -$0.37) in 2024. Earnings should be out in early May. Before then, we’ll hear from management at the Needham conference (April 17). Management will also speak at the Bank of America conference (May 9). BUY

Enovix (ENVX) pulled back a little last week after it hit the 5 level. But shares have popped back up this week after management announced more progress ordering equipment for production lines. It has completed the order for the high-volume Gen2 Autoline equipment (to be located in Penang, Malaysia) as well as for the Agility Line, a next-gen R&D line designed to increase the speed of the customer qualification process and get new products to market more rapidly. This line will be located in Fremont, CA. This is welcome news. Looking for shares of ENVX to break above 15. They haven’t been above that level since last October, just before the Q3 earnings release. HOLD
Earnings: Wednesday, April 26

Expensify (EXFY) enjoyed a pop this week (evaporated yesterday) on news that the company bought back another 83,376 shares (0.1% of total shares outstanding), bringing up the year-to-date total to $629,000. These repurchases are part of the May 2022 repurchase program, which is good for up to $50 million. So far, Expensify has repurchased around $12.73 million. Also in Q1 2023 employees purchased almost 150,000 shares of company stock. Shares of EXFY seem to have found a bottom (we hope) around 7 on March 13. The stock was flirting with breaking back above its 50-day line before the afternoon selloff yesterday. HOLD

Flywire (FLYW) continues to challenge the February 2 high of 29.3 but hasn’t broken out yet. We have an earnings date of May 9. Yesterday Goldman Sachs increased their price target on FLYW from 30 to 34. BUY
Earnings: Tuesday, May 9

Huron Consulting (HURN) was moved to hold a couple of weeks ago after shares came back from that dip into the low 70s and were just below overhead resistance around 83. We’re still just below that level now and waiting for a breakout to move back to buy. HOLD

Inspire Medical Systems (INSP) has come off the 224 low from a few weeks ago and is now right at that 238 level that acted as support up until March 10. We have an earnings date of May 2 and a price target increase from Stifel (290 to 300). HOLD TWO THIRDS
Earnings: Tuesday, May 2

Intapp (INTA) remains the star in our portfolio as shares continue to trade at an all-time high near 45. There is no news to report and we don’t have an earnings date just yet, though I suspect it will be in mid-May. HOLD

Rani Therapeutics (RANI) just gave a Q4 update a few weeks ago so there’s nothing new to report. In the coming quarters we’re looking for a Phase 2 trial for RT-102 in the second half of 2023 as well as three additional Phase 1 studies at some point this year. Those include RT-111 (partnered with Celltrion), a RaniPill Go capsule containing a biosimilar of STELARA (ustekinumab), RT-105 (adalimumab biosimilar) and RT-110 (PTH for hypo-parathyroidism). Management will speak at the Needham Healthcare Conference next Tuesday, April 18. HOLD

Repligen (RGEN) dipped to 158 last week but has strung together three decent days this week, putting it back in the middle of its recent trading range. Yesterday we found out Repligen has acquired FlexBiosys for an undisclosed amount of cash and equity. FlexBiosys makes a range of single-use bioprocessing bags and assemblies, which ties in nicely with the single-use portfolio of solutions Repligen has been building and acquiring. I suspect the financial impact will be limited, but it’s nice to see Repligen making another move for what will hopefully be a high-margin tuck-in acquisition. HOLD THREE QUARTERS

Sprout Social (SPT) was hit with a short report from Akram’s Razor last week which sent the stock to the low end of its trading range (around 50). Rather than address the report directly the company has put out a number of press releases focused on the healthy state of the business. The first was to announce earnings will be out on May 2, the second discusses new AI investments being added to the platform and the third details how customers reported a 233% return on investment. Sticking with Sprout. HOLD HALF
Earnings: Tuesday, May 2

Terex (TEX) continues to shape up a little after a quick trip into the lower 40s after the banking crisis unfolded. Key to the stock’s ongoing recovery will be an earnings report showing that the materials handling segment remains strong and that demand for rentals isn’t falling apart. I’m impressed TEX didn’t get caught up in the afternoon selling yesterday. BUY HALF

TransMedics Group (TMDX) is trading right around 70, where it’s found support since the Q4 earnings report in late February. No news to report. HOLD THREE QUARTERS

Please email me at tyler@cabotwealth.com with any questions or comments about any of our stocks, or anything else on your mind.