The undercurrents we felt in the market last week bubbled to the surface this week as value-oriented sectors opened a modest performance gap as compared to growth-oriented sectors. The general direction of stocks was mostly the same in both the large and small cap asset classes and, in aggregate, large caps outperformed by almost a full percentage point.
In our portfolio the three themes that jumped out were that software was weak (other than Bottomline Technologies (EPAY), all our software stocks were down), consumers were strong (Chefs’ Warehouse (CHEF) was up 8%) and health care and biotech were both much improved over last week (IntriCon (IIN) rebounded 8%, Arena (ARNA) was up 6% and AxoGen (AXGN) was flat).
On the software front, there’s little doubt a pause, if not a decent pullback, would be entirely normal. Software stocks are up roughly 50% year-to-date and many have been trading at premium valuations for an extended time. On the other hand, with strong secular tailwinds, robust top-line growth and many small cap software stocks becoming increasingly profitable, it’s not hard to see why these stocks continue to draw attention. It’s also worth noting that over 80% of software stocks beat revenue expectations in Q2, so while expectations are high many companies continue to exceed them.
From my perspective it makes sense to dial back our buying just a little more and narrow our focus on the stocks that appear less extended. With that in mind, I’m moving Chefs’ Warehouse to Hold given that shares have rallied 14% and 8%, respectively, over each of the last two weeks. Rapid7 (RPD) remains a Hold, as do IntriCon and AxoGen, though the action in the last two has markedly improved over the last five sessions (IntriCon was up 8% this week).
This leaves us with seven stocks on the buy list, including Goosehead Insurance (GSHD) and Bottomline Technologies, the two most recent additions and the two stocks that would be at the top of my buy list.
Changes this week:
Chefs’ Warehouse (CHEF) moved to HOLD
Updates
AppFolio (APPF) erased last week’s gain over the past five sessions and is now trading where it was at the end of August. In the grand scheme of things this modest pullback looks perfectly normal and shares are still trading above their July-August breakout level and above the stock’s 50-day moving average line. I’ve been maintaining at Hold since shares are expensive relative to peers, but as I stated last week this may be one of those stocks that just breaks the rules. In any event, it’s a good one to own, but I’m still not a buyer at these levels.
On the business development front, AppFolio recently announced a new tier of its AppFolio Property Manager service, called AppFolio Property Manager Plus. This service expands on the basic service by adding new performance-related dashboards, the ability to automate and configure processes within the software, new revenue management and optimization tools, and a new one-way data export API feature. This product suite is aimed at larger organizations, which makes sense given AppFolio’s move upmarket in recent quarters. The price is $3/month per unit, with a minimum $1,200 per month. Simple math implies customers with 400 units or more would be over that minimum level. HOLD.
Apptio (APTI) pulled back a few points this week but like most of our stronger software stocks APTI is still trading above summer highs and comfortably above its 50-day moving average line. The stock is strong because demand for Apptio’s software, which helps companies manage their technology spending, is strong and new product launches are beginning to bear fruit. The best evidence of this is a return to 20%-plus billings and revenue growth, largely due to the momentum in the new IT Financial Management Foundation (ITFMF) solutions (a lower-cost version designed for customers with under $20 billion in annual tech spend). There’s no new news this week. BUY.
Arena Pharmaceuticals (ARNA) is now up five weeks in a row and a very welcome 20% from its low of 36 in mid-August. As I’ve been saying lately the strength is likely due to four factors: bullish comments from management at conferences (it has two more, Cantor and Leerink Partners, on October 2); news that an extended-release (XR) tablet formulation of ralinepag was shown in two Phase 1 clinical trials to have improved pharmacokinetic (PK) performance over Actelion/Johnson & Jonson’s Uptravi for the treatment of pulmonary arterial hypertension (PAH); upcoming data release (by end of September) from Phase 2 results on Olorinab (non-opioid candidate intended for the treatment of visceral pain, specifically pain associated with Crohn’s disease); and an upcoming R&D/Analyst day on October 4. Collectively, these events are helping to raise Arena’s profile again. With the stock beaten down over the second half of the summer there’s still time to accumulate shares before it gets overextended. BUY.
AxoGen (AXGN) was dragged through the mud in late July and August, then again over the first half of September. I’ve been saying all along that I think the market has grossly overreacted to the Q2 miss, but until Q3 results are released and can confirm that all is back to normal (i.e. over 40% growth) the stock isn’t likely to really take off again. Last week I summarized management’s comments at the Morgan Stanley conference, which were quite bullish in my opinion and suggest that AxoGen is indeed on pace to hit its 2018 guidance of 40% growth or better. Early this past week we heard from Cantor Fitzgerald analyst Craig Bijou, who seems to have a similar opinion on the stock (he reiterated an Overweight rating). I’ve had to move to hold because we can’t ignore that the stock has acted very weak lately. But that said, for risk-tolerant investors a few shares added here could work out very well indeed, provided AxoGen delivers. For now, I’ll keep at Hold. HOLD.
Bottomline Technologies (EPAY) is our play on business-to-business digital payments and the stock’s uptrend looks rock solid. This week the company announced that TD Bank is collaborating with Bottomline to offer Paymode-X with Visa Payables Solutions to U.S. business banking customers. The solution will allow TD Bank business customers to make card, ACH and check payments to vendors in a single process, which increases automation and reduces costs, while offering significant convenience. It’s always an incremental positive when a large client is landed, and with customer relationships typically lasting a decade (or more) these are the types of deals that contribute to Bottomline’s steady-growth profile. BUY.
Chefs’ Warehouse (CHEF) is a specialty food distribution company and one of the outliers in our portfolio because it’s not a software or a medical device stock. It was one of my “undiscovered” Cabot Small-Cap Confidential stocks at this year’s Summit, and the past two weeks have shown why. The stock flatlined at 29 in August, then rallied out of the gate in September and is now up 25% over the past three weeks. I still like it and see it going higher over the coming year, but after two weeks of relentless buying it is time for a pause. Moving to Hold to let it cool off. HOLD.
Everbridge (EVBG) sells software solutions that keep people safe and businesses running. One example of how the software works was last week’s gas line explosions outside of Boston, Mass. Everbridge says its software was used by 75 organizations to send around 145,000 messages to employees as gas explosions and fires broke out in Andover, North Andover and Lawrence. It also sent out roughly 3 million messages in the lead-up to Hurricane Florence. The stock’s been chopping around in the 58 to 63 price zone for just over a month and will likely continue to do so for a little longer. You can still buy it, but preferably on the dips. BUY.
Goosehead Insurance (GSHD) was added two weeks ago and after a quick start the stock is now pausing to digest the recent rally. The company has developed a new business model for selling personal lines insurance that revolves around cloud-based technologies and a blended distribution channel of corporate sales offices and franchises. It’s looking to disrupt the industry and spread nationwide. The evidence to date suggests it’s on the right path. We’re looking for average annual revenue and EPS growth of around 40% and 60%, respectively, through 2021. BUY.
Instructure (INST) has been a hard stock to love lately since it hasn’t been able to gather any real momentum. Shares looked ready to break out above their 50- and 200-day moving average lines a couple weeks ago but this week they broke back below both. The potential is certainly there, but the market will likely need another quarterly earnings report to see how the most recent billings trend is tracking (it was a little soft last quarter). Despite the lack of momentum, the stock seems to be offering a good entry point here and, thus, remains a Buy. BUY.
IntriCon (IIN) was moved to hold recently and I’ll maintain that rating for now even though the stock has behaved much better over the last four sessions than it did last week. Shares just found support at 55, which is a level that also held during a dip in August, and over the last four sessions have retaken their 50-day moving average line. The company is a key supplier of continuous glucose monitors (CGM) for Medtronic. It also has a hearing aid division, through which it is working to sell direct-to-consumer (DTC). HOLD.
Q2 Holdings (QTWO) is our digital banking stock and it pulled back to its 50-day line this week in what looks like a normal dip. There’s no new news to report, and the stock remains on the buy list. BUY.
Rapid7 (RPD) is our cybersecurity stock and was moved to hold last week as it looked like upside was limited in the near-term. Shares ended up pulling back this week but have held above their 50-day moving average line. Yesterday the company announced it would soon release InsightConnect, a security orchestration and automation solution that helps teams reduce manual workloads and work more efficiently and effectively with IT and development teams. The company’s InsightVM (vulnerability management) and InsightIDR (incident detection and response) solutions will also include pre-built automation functionality (I imagine this is being offered to help grease the upsell wheels). Security automation is a major trend, and this is a positive development in my opinion. Still, I’ll keep at Hold for the time being. HOLD.
