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Small-Cap Confidential
Undiscovered stocks that can make you rich

Cabot Small-Cap Confidential Weekly Update

The market looks a lot better less than three weeks into 2019.


The market looks a lot better less than three weeks into 2019.

Granted, it looked downright awful in late 2018 and at times seemed it couldn’t get much worse. But over the last 18 days the index has climbed up to 918, which is more than an 8% gain year-to-date (see two-year chart below).


I still wouldn’t say it is time to wave the all-clear flag. To my knowledge, nothing material has happened with the U.S.-China trade war (talk is cheap, actions matter). Washington remains in gridlock in the midst of the longest government shutdown in history. And while bank earnings have helped this earnings season get off on the right foot, we don’t have a full picture of how companies did in the October, November and December quarter, when the market was falling apart.

Plus, after this earnings season ends the benefit of the tax cuts that went into effect at the beginning of 2018 will no longer provide the boost they did last year. Comparisons will be tougher, and rising wages may cut into profit margins.

On the other hand, stocks remain cheap, especially if forward revenue and earnings expectations are accurate. There is ample room for progress in Washington, D.C., and with respect to trade. The Fed seems flexible. And most economists and analysts aren’t calling for the recession (in the near term) that many market observers began contemplating as the market pulled back at the end of 2018.

In other words, it’s going to be an interesting 2019!

We’ll keep trying to thread the needle to maximize our chances of making money and reducing risks with small-cap stocks that are doing things right and participating in secular growth trends.

There are no major ratings changes today. Keep averaging into those stocks rated as buy. And take note of the announced and estimated earnings dates for each position you own, or plan to buy.

Changes this week


AppFolio (APPF) has had a quiet week after last week’s announcement that it acquired Dynasty Marketplace, which develops artificial intelligence (AI) software solutions for the real estate market. The stock is essentially unchanged since last week’s update. Revenue growth projections are still good (32% in 2018 and 26% in 2019) and estimated EPS growth, with profitability, is impressive (121%, to $0.62 in 2018 and 58%, to $0.98 in 2019). But my sense is that the market is wondering what the next big thing for AppFolio will be. Is it going to make a big push to move upmarket to bigger property management customers? Is it possible to efficiently scale the legal business to make it a bigger part of the pie? Is there a new business vertical that makes sense to enter? The company has the blocking and tackling down and over the long term that makes it an attractive stock to own. But big investors like to know what the future holds, and more of the same doesn’t get them too excited when talking about high-growth software names. Keep Holding. HOLD.
Estimated Earnings Date: February 25

Arena Pharmaceuticals (ARNA) is essentially flat over the last week, when there has not been any new news. Recall last week that management announced more good data for etrasimod for treatment of moderate to severely active ulcerative colitis (etrasimod is also being evaluate for Crohn’s and atopic dematitis). The oral drug candidate showed long-term safety and efficacy in the open-label extension of the Phase 2 OASIS trial. Etrasimod addresses a potential market opportunity of $4 billion to $8 billion, but Arena also has valuable assets in ralinepag (out-licensed to United Therapeutics) and, potentially, early-stage assets APD418 (decompensated HF) and olorinab (IBS/IBD pain). The company is cash rich with around $1.3 billion on its balance sheet, but it will be a few years before any treatments hit the market (assuming approval). Phase 3 data for etrasimod is likely a 2021 event. Upside is significant for those that can be patient while downside should be limited. Keeping at Buy. BUY.
Estimated Earnings Date: March 12

Bottomline Technologies (EPAY) had yet another quiet week, though the stock is looking a heck of a lot better than it did a month ago. We’re about 30% off the stock’s September high and I think a year from now we’ll be looking back at this as a terrific buying opportunity in a high-quality asset. Earnings (Q2 fiscal 2019) should be out in a few weeks, which should give the stock a boost. In terms of what to expect, analysts are calling for 9% revenue growth in both fiscal 2019 (ends in June) and 2020, with EPS growth of 13% and 17%, respectively. It’s not massive growth, but it should be steady. BUY.
Estimated Earnings Date: January 30

CareDx (CDNA) is acting true to form, meaning the stock is a little wild on a daily chart. But on a weekly chart action is more subdued. Shares of the company, which specializes in diagnostic testing and surveillance solutions for heart and kidney transplants, raced higher after I recommended it two weeks ago, then pulled back last Friday and Monday. Over the last three sessions they’ve been climbing. As I said in my report, average in and don’t get too caught up in the day-to-day gyrations. The stock hasn’t broken through any support, never really tanked in November and December (when most other stocks did) and has been trading in a 10-point range (20 to 30) since it broke out last August. BUY.
Estimated Earnings Date: March 22

Codexis (CDXS) is a protein engineering company that I added to the portfolio at the beginning of December when the stock had just broken out (not great timing, in hindsight). But we only added a half position then, and added the other half on December 31 after shares had come in. With shares up over 6% since we filled the second half, and 9% over the past week, we’re now roughly 8% in the red. Technically, this looks like a consolidation phase, similar to the one from last summer, and a good time to buy. With a recent thumbs up from the FDA that Codexis can continue with its clinical trial protocol of CDX-6114 (detailed in my report, and last week’s update) and a decision from Nestlé expected before February 17, it’s easy to see why investors would be snapping up shares now. The company isn’t expected to report quarterly earnings until March 8, which means we should have a decision by Nestlé first (although an extension is possible). This is an exciting story that’s evolving quickly. Analysts see revenue growth of 20% in 2018 and 17% in 2019, with EPS improving from -$0.24 (2018) to -$0.13. BUY.
Estimated Earnings Date: March 8

Chefs’ Warehouse (CHEF) distributes roughly 50,000 units of specialty foods, ingredients and staples to around 30,000 independent restaurants, specialty stores, country clubs and other foody-type establishments in the U.S. This past week management announced preliminary 2019 guidance, calling for sales between $1.52 billion and $1.57 billion (up around 8%), and gross profit between $390 million and $400 million. That has analysts looking for EPS of around $1.00 in 2019, or up 28% over 2018 (when EPS should have risen 77%, to $0.78). The company’s founder CEO Christopher Pappas said the company will continue to focus on what it’s been doing, namely being a high-touch and flexible food distributor for independent restaurants, drive organic growth, push its e-commerce platform and mobile app, and drive operating efficiencies throughout the business. BUY.
Estimated Earnings Date: February 18

Everbridge (EVBG) is one of those stocks that continues to surprise, in a good way. You’d think a secondary stock offering in the current environment would hurt. But it didn’t (at least not yet). This week Everbridge announced it would raise around $120 million by selling 2.3 million shares (plus 345,000 if underwriters desire) at 55.25. J.P. Morgan, BofA Merrill Lynch and Credit Suisse are joint book-running managers, while Stifel, KeyBanc, Canaccord Genuity, Needham & Company, Raymond James, SunTrust Robinson Humphrey, William Blair and Northland Capital Markets are all co-managers. In other words, there are a ton of investment banks in on the action. Along with a share price that barely dipped (the stock is only down 3% from last Thursday’s close) this suggests very high demand. The proceeds will be used for the regular boilerplate reasons, but I suspect another acquisition, a big ramp up in R&D, or retirement of some or all of the roughly $93 million in senior convertible notes on the balance sheet (at 1.5%) due in 2022, is on the horizon. That said, I’m not sure why the company would choose to pay off such low-interest debt. It had $103 million in cash on the books at the end of September, so the pro-forma cash balance is now around $260 million. I still like it. BUY.
Estimated Earnings Date: February 19

Goosehead Insurance (GSHD) sells personal lines insurance (mostly homeowner and/or auto policies) and is disrupting the market by deploying a cloud-based sales and support platform coupled with a hybrid corporate and franchise distribution model. We’re looking at around 40% revenue growth this year and 30%+ in 2019, with potential for that forward forecast to jump quite a bit. Plus, Goosehead is profitable (expected EPS of $0.25 in 2018 and $0.42 in 2019). If you chop off the two spikes to 38 in September and November and lop off the dip below 22 in November, you see a stock that’s mostly been rangebound between 24 and 29. We’re in that range now. I like this one a lot and think there’s ample room for the stock to rise as the currently unknown story gets out. There’s also potential for a special dividend by March, which could help raise awareness. With earnings expected relatively soon we could have a near-term catalyst. Keeping averaging in. BUY.
Estimated Earnings Date: January 28

Q2 Holdings (QTWO) sells cloud-based virtual banking software to regional and community financial institutions. We have an earnings date out (Feb. 13) and based on reported bank earnings so far it appears that Q2’s target market is seeing better net interest margins, which should be a tailwind for Q2’s business. Last week I stated that analysts see Q2 delivering revenue growth of 24% in 2018 and 27% in 2019, but I mistakenly said that expected EPS of $0.11 in 2018 should jump to $0.28 in 2019. Those numbers were outdated (or changed dramatically in the last week, which I think I would have noticed). The current consensus estimate is for EPS of $0.14 in 2018 and $0.13 in 2019. That lack of expected earnings growth in the current year is one potential headwind for the stock. If Q2 can show margin improvement/leverage in the business then the stock should do very well. Still, at its current price I think it’s a reasonable value. This week’s solid bank earnings reports could be the catalyst to push Q2 through the 55 level that would signal higher prices in the near term. BUY.
Announced Earnings Date: Wednesday, Feb. 13. Conference call: 8:30 AM EST Thursday, Feb. 14

Rapid7 (RPD) is one of the most compelling names in small-cap security software since it has evolved from a provider of vulnerability management (VM), a good, but somewhat limited market, into a provider of a broader portfolio of security operations management (sec ops) solutions, including VM, security incident and event management (SIEM), IT Ops, and incident detection and response. That pushes its addressable market up to around $7 billion. And with Rapid7’s transition to a cloud-based/subscription model largely behind it, which should grease the wheels to make it easier to land new clients and upsell to existing ones, the future looks bright. Look for growth in recurring revenue to bring big investors to the stock, but also for near-term concerns around cash flow (due to the transition to subscription and higher spending) to keep Rapid7’s stock from achieving its full potential right away. In my mind, this all makes it a good long-term buy-and-hold position. More analysts are starting to agree with that position. BTIG upgraded to buy this week. BUY.
Announced Earnings Date: Thursday, Feb. 7. Conference call to follow at 4:30 PM EST

Repligen (RGEN) presented at the J.P. Morgan Healthcare conference last week and I updated you on news from that event, so there’s nothing new to say this week. That is, other than that shares were up 3% this week, and by adding the second half of our position on December 31 (the stock’s up 9% since) we’re now almost back to break-even on our position (RGEN is still 20% off its high). Repligen is also back to where it was just before it broke out at the end of October. It looks like a particularly compelling buy when you look at the one-year chart and factor in that the decline in December likely had nothing whatsoever to do with the fundamentals!


To refresh your memory, Repligen is a pure-play supplier of bioprocessing technologies that make it more efficient to manufacture biologic drugs. At the recent conference management said momentum continues and that it’s on track to meet its long-term revenue goal of $400 million to $500 million by 2023, implying 10% to 15% annual revenue growth (organic). Repligen’s acquisition of Spectrum is tracking as expected and is on target to achieve $15 million to $20 million in synergies (60% from cross-selling) by 2020 (with roughly $3 million achieved through the first nine months of 2018). Management is also planning on expanding its product portfolio (it has a history of innovation in specialty markets), beefing up its IP portfolio and integrating global operations to drive efficiencies. It also has around $190 million in cash so has capital to keep the M&A engine purring. I like this story a lot. BUY.
Estimated Earnings Date: February 20

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