Weekly Update - The Meltdown
First things first, I hope you have a wonderful Holiday and a great New Year!
Next week will be one of the few weeks of the year when we won’t publish a Weekly Update. That said, I’ll be following the market and sneaking in some work on the January Issue, which comes out two weeks from today. If there’s anything that needs to be said I won’t hesitate to send a quick note.
In other news, my laptop chose yesterday morning to gasp its last breath.
I was working on this update, trying not to get too distracted by the deteriorating market when the fan started going crazy and my applications started acting quirky. I figured it was time to shut it down and take a break. It’s like the computer felt what was going on in the market and just said, “To hell with it, I’m out!”
We’ve all been there so I won’t go into detail on the range of emotions. Though, I will say I was surprisingly calm. I’ll attempt to administer life support later today when I’m sure I’ll receive the very best care Lenovo tech support and/or the local computer repair guys will give. After all, they’ll be super-engaged on the Friday before Christmas, right?!
There is a part of me that wonders if this is just the computer gods’ way of saying it is time to step back and take a break. More likely, it’s just a fried motherboard. Computers, like stock market returns, come and go. Sometimes they work for you. Sometimes they work against you.
Fortunately, I have a temporary solution in my wife’s Mac. And I’m a fairly organized guy with most of my files stored in the cloud and access to most research platforms still available, though I can’t update my more sophisticated Excel templates.
I’m not looking forward to the cash outlay of a new computer (or the research to figure out what I need). But I am looking forward to getting back to a normal research and writing process.
Back to the market.
One big picture thing worth mentioning: We’ve all seen various data points about just how bad this market is and how it’s “the worst” in this dimension or that. All of this stuff is just saying what we know—the market stinks and is breaking a bunch of undesirable records.
On the flip side the economy still appears to be doing OK, even if revised Q3 GDP data and estimates for Q4 shows some slowing. New York Fed President John Williams came out on CNBC this morning and tried to let us all know the Fed doesn’t have the blinders on. If they need to adjust policy, they will.
This might help a little in the short term. But just like stocks tend to go up too much in a bull market they go down too much in a bear market.
It hurts to see stocks you own go down. And it’s hard to buy on the way down. But buying stocks when valuations are lower does increase expected future returns. If your time horizon can be pushed out a little these are the times to be looking for those incredible deals that will ultimately put a huge smile on your face.
When I started at Cabot in late 2015 I had just left a different job and closed out a portfolio of huge winners, and I came here and started a new portfolio. We were in the middle of a horrible market, and while every stock I recommended didn’t go up, that period laid the groundwork for many of the big winners that we were able to close out in 2017 and 2018.
I think the beginning of 2019 is going to prove to be a similar time. I see a lot of stocks I want to buy. I don’t want to buy full positions just yet. But quarter positions, or half positions? You bet.
We’ll get into more details on what to buy in the first week of January. This is what’s going on with the stocks we own now.
Changes this week
Chefs’ Warehouse (CHEF) Moved to BUY
(From Tuesday’s Special Bulletin)
IntriCon (IIN) Moved From Hold a Quarter, To Sell Last Quarter
Axogen (AXGN) Moved From Hold A Quarter, To Sell Last Quarter
Updates
Altair Engineering (ALTR) has moved sideways over the last week so there’s not much new to say here. The backstory is that the company sells simulation software and is a play on the digital twin theme. Demand for simulation software is on the rise and Altair’s solver business is well-positioned to grow. However, concerns about global trade and exposure to the economically sensitive automotive market haven’t helped the stock. That said, on the last conference call management said the ramp-up in activity from non-conventional players (electric, autonomous, etc.) has been so significant that it’s not seeing any slowdown. We’ve been holding half a position and it’s on a very, very short leash. Given the sideways action over the past week we can stick around, for now. HOLD HALF.
AppFolio (APPF) took a little hit this week but is still above its October and November lows and looks to be building a base around this level. We’ve taken partial profits so we can give our remaining position a little room. If you’re new to the name, AppFolio sells cloud-based software tailored to two industry verticals: property management and small legal businesses. It has an efficient business model characterized by relatively low customer acquisition costs and high revenue/profit per customer. It’s also an expensive stock. It sold off with most software stocks but has a history of going on intense runs higher. It could be an attractive acquisition target, or a potential purchaser of another business that would give it a third vertical to play in. HOLD HALF.
Arena Pharmaceuticals (ARNA) lost some ground this week but it’s not a stock I’m particularly concerned about. That’s mainly because it’s really not economically sensitive. Other than a small amount of revenue generated through partnerships with legacy products Arena’s value is derived from its pipeline. And first revenue, assuming successful Phase 3 trials, won’t be for several years. On the one hand that means you have to be patient to realize the big value in the stock. On the other, there’s really no revenue risk in the near term! As you know if you’ve been following along, Arena recently out-licensed its ralinepag asset to United Therapeutics (UTHR) for up to $1.2 billion in exchange for an $800 million upfront payment, a $400 milestone payment, and tiered low double-digit royalties on global sales. That cash will help Arena move etrasimod, olorinab and other early-stage assets through the pipeline. It also jolted the stock back to life (though some has drained out lately) as investors were reminded about why the stock’s attractive. BUY.
AxoGen (AXGN) is a medical device stock that sells nerve repair solutions. We’ve been reducing our position for several months and this past week we liquified the final quarter (I sent a Special Bulletin) after a shoddy hit piece was published in Seeking Alpha. Shares have sold off hard since, which could set the stock up for a fierce rally. But in this market there will need to be something convincingly bullish—not just a deep value-play thesis—to drive shares significantly higher. That could be increased guidance from management or even takeover speculation, which frankly wouldn’t surprise me. But we don’t invest on pure speculation. I’ll keep a close eye on AxoGen since it treated us so well for a long time. If the stock gets its act together, we can add it back to the portfolio. SELL LAST QUARTER.
Bottomline Technologies (EPAY) is still a stock I like even though the trend is down at the moment. It’s a play on digital business-to-business payments with a little digital banking exposure mixed in. Revenue should be up around 8% this year and 10% in 2019, while EPS should expand from $1.45 this year (up 14.2%) to $1.69 next (up 16.6%). I think the stock was unfairly punished in November. But it’s clearly going to take some time for the bull case to come back into focus. I won’t keep at buy much longer as at a certain point we need to heed the trend (if it continues). But here, and a little lower, Bottomline is a buy in my book. BUY.
Chefs’ Warehouse (CHEF) has pulled back from being right near a 52-week high a couple weeks ago. I moved to hold two weeks ago given that the stock had been so strong. With this little pullback Chefs’ goes back on the buy list. The company supplies independent restaurants with food and other supplies. It’s a very difficult business model to emulate and while there are larger competitors (like Sysco and U.S. Foods), Chefs’ plays in a segment of the market where most customers have well under 50 locations. BUY.
Codexis (CDXS) is our most recent addition. I recommended starting with a half-sized position and while we’re down on our initial position I’m not looking at this as a loser. Rather, I’m trying to figure out how we thread the needle and fill the other half at a super-opportunistic price. I don’t know what that strategy looks like just yet. It might mean we fill the other half all at once, we fill a quarter, or we just sit still.
The company does very interesting work. You should pull up the full report, but if you want the 10-second version Codexis is a protein engineering company that specializes in the discovery, development and commercialization of novel proteins. These engineered proteins (also known as biocatalysts and/or enzymes) are used in a wide range of industries to make manufacturing processes faster, cleaner and more efficient. Codexis’ CodeEvolver platform helps it engineer novel proteins that are better than naturally occurring ones, and it’s finding success in drug development, novel biotherapeutics, food and nutrition, and molecular diagnostic markets. One example of how its technology is being applied is in the creation of a better-tasting stevia sweetener. If you’re not up to a half-sized position yet you can keep nibbling, but don’t over-do it. BUY A HALF.
Everbridge (EVBG) is still moving sideways and given the action in the broad market the stock looks terrific to me. Keep purchases small since the stock could easily pull back. The backstory is that Everbridge sells critical event management software. BUY.
Goosehead Insurance (GSHD) is off a few points this week but the stock hasn’t been all that volatile lately and I’m still keeping at buy. If you’re new to the name, Goosehead sells personal lines insurance and is disrupting the market by deploying a cloud-based sales and support platform coupled with a hybrid corporate and franchise distribution model. Most policies are either homeowner or auto policies, both of which are relatively sticky products. Goosehead represents over 80 carriers (Progressive, Travelers, Safeco, MetLife, etc.) so it’s able to offer clients the best policy for their situation. It’s also growing at a blistering pace; revenue should be up over 40% this year and next and has potential to accelerate as Goosehead scales the business up. It’s also profitable, with EPS expected to hit $0.27 in 2018 and $0.35 in 2019. Keep averaging in. BUY.
IntriCon (IIN) hasn’t been looking good lately and I sent out a Special Bulletin earlier in the week suggesting you sell your final one-quarter position. It’s a stock that I think still holds a lot of promise, but there’s no reason to hold it when it’s broken. I’ll keep a close eye on IntriCon and look to add back if things improve. The company makes components for Medtronic’s (MDT) blood glucose monitors, among other small medical device parts. It also has a hearing aid manufacturing business through which it sells to major brands, to companies selling direct-to-consumer (DTC) and through its own DTC channel, Hearing Health Express. SELL LAST QUARTER.
Q2 Holdings (QTWO) was moved back to buy last week since the risk-versus-reward potential looks attractive at the moment. The stock promptly fell after I upgraded it, but I’m sticking with a buy rating for now. Q2 is a digital banking software stock that’s enjoying strong end-market dynamics as financial institutions are enjoying improving net interest margins. Revenue is expected to accelerate from 24% in 2018 to over 27% in 2019 as it goes live with larger installations. This should also help margins and drive EPS up from $0.11 this year to $0.28 in 2019. BUY.
Rapid7 (RPD) is a security software stock and it’s been doing just fine in this crazy market. Shares have come down a little over the past week but are still well within their last six months’ trading range. Security is one of those areas of software that’s a must-have, which makes it somewhat defensive. Rapid7 has been doing well and 20% revenue growth this year and next, along with an estimated $0.45 EPS improvement in 2019, mean it should be at about a $300 million annual revenue run rate and break-even profitability a year from now. That’s not a bad profile. BUY.
Repligen (RGEN) has sold off dramatically over the past two weeks and has now not only given up its post-earnings gains from November but also a good chunk of the gains from August and September. This is another stock we started off by taking just a half position in so we’re not over-extended. The game plan has been to average down on weakness, and we’re certainly seeing that now! Let’s not try to catch the proverbial falling knife, though. A better strategy is to wait for signs of stabilization and/or even a little strength, then fill our other half. If you haven’t filled your first half position yet, keep picking away at it.
Repligen is a pure-play supplier of bioprocessing technologies that make it more efficient to manufacture biologic drugs, while ensuring high quality and safety standards. It is a leader in areas such as filtration, pre-packed chromatography columns and Protein A ligand manufacturing. These solutions help customers overcome capacity, cost, quality and time pressures. It’s been doing very well due to innovation and growth in single-use technologies, which reduce capital spending for customers. BUY A HALF.
