The market continues to look good as stocks are grinding higher with a few normal-looking down days mixed in (like yesterday) to keep investors honest.
The S&P 600 Small Cap Index is now back in the 900 to 1,000 trading range that seemed like a logical place for the index to pause and consolidate at the end of 2018. However, as we all know the market isn’t always logical (or our expectations of logical action aren’t fair!), and stocks plummeted in December.
It’s probably a little dramatic to say that what happens now will dictate how stocks do until spring (and Q1 earnings season) comes around.
But at the same time, you don’t need to be a technical analysis wizard to draw a straight line across a chart and see that we’re now in a range where small-cap stocks have traded on several occasions before making big moves to both the upside and downside.
We’ll keep an eye on this trading range in the weeks ahead as a move above or below it should be respected.
Let’s not forget that December did happen. That huge pullback set up a furious rally as investors scrambled to pick up beaten down names. We’re now in the midst of Q4 earnings season, which means we’re also getting a lot of information about how companies expect 2019 to pan out. This has all reduced uncertainty, which is usually a good thing for stocks.
That’s not to say it’s all sunshine and roses out there and that uncertainty has evaporated. There are stocks that are getting hammered every day. And it’s hard not to feel like we’re getting played by the constant barrage of increasingly fluffy-sounding tweets and headlines related to issues that tripped up the market last quarter, mainly U.S.-China trade tensions.
I hate feeling like the market makes big moves based on what one, or a few, people decide to put out in the public domain, but which lacks much substance. If you feel the same way, don’t make any big financial decisions based on such things.
But on a more bullish note, there are plenty of stocks jumping higher, including several in our portfolio. And I see a nice selection of small-cap growth stocks on my watch list that I’d like to add to our portfolio.
For those with a glass-half-full perspective it’s still time to be invested in small caps. Just be a little cautious out there and pare back new buying.
I’m not planning any big change to our strategy, which has thus far relied on relatively steady buying, across time, with a focus on high-potential pure-play opportunities in the software and medtech arenas, with a little exposure to other off-the-radar growth trends mixed in.
Average in, spread out your buys across different stocks, and take note of the current trading range and where support, and overhead resistance, appear to be. We’re going to watch these levels closely for the next several weeks.
Action is starting to pick up in our portfolio, with a few companies having reported this week and a number on tap for next week too.
Here’s what’s new.
Changes this week
Arena Pharmaceuticals (ARNA) moved to HOLD
Rapid7 (RPD) moved to HOLD
Updates
AppFolio (APPF) sells software solutions for the property management and legal industries. There hasn’t been any news lately, other than that we now have an earnings date of February 28. Current consensus is that revenue grew by 32% in 2018 while EPS should have jumped 121% to $0.62. In 2019, analysts see revenue growing by 26% while EPS should go up 58% to $0.98. With the Q4 2018 pullback in shares the stock is now trading with an EV/Forward Revenue multiple of 7.3, well off its peak multiple of 12 from mid-2018. Based solely on that it’s starting to look more attractive, and the leverage in the business is driving very nice EPS growth. Technically, if we can get a move above the 68.5 area the stock stands a much better chance of a sustained run to its previous all-time high of 91.49. For now, keep holding. HOLD.
Announced Earnings Date: February 28
Arena Pharmaceuticals (ARNA) has made a really nice move in the month of February after rallying off a double bottom in the low-30 range (first in August, then in November). Early this week it traded up to a multi-year high near 50 (which it also did in June and early October). We didn’t get the big breakout to fresh highs just yet, but this is encouraging action, and improving sentiment in the biotech sector (IBB crossed back above its 50-day line in January) could help Arena break out to a new high. That all said, with the stock trading near overhead resistance it’s equally possible shares could retreat in the near term. If you’re in the stock it’s a good hold here, but I’d like to either see a breakout, or a lower entry point, for those looking to buy shares. Therefore, I’m moving Arena to hold, for now. HOLD.
Estimated Earnings Date: March 12
Avalara (AVLR) was last Friday’s new addition to our portfolio and marks our first new stock in the cloud-based software space in several months. It’s a company I’ve had my eye on since it went public in 2018 since the big-picture idea – the company is a cloud-based provider of sales and indirect tax compliance software – makes a lot of sense and seems like it would be a very sticky product, especially as tax compliance becomes more complicated. Avalara’s software helps automate what is currently a labor-intensive manual process for many companies. And its deep content base of tax info isn’t something competitors can just go out and get – it has to be developed the hard way, by people entering the info into Avalara’s database and/or by acquiring companies that have already acquired content in niche markets.
On that front Avalara just announced this week that it has acquired Indix’s AI technology and expertise, with comprehensive product descriptions for over one billion products that are sold and shipped around the globe. This technology will be integrated into Avalara’s platform and help it extend its leadership position of accurate, current and deep tax and product content. The technology should also help Avalara become more efficient when it comes to gathering and maintaining content in its database. Financial terms weren’t disclosed. This is an interesting technology acquisition and I’m looking forward to hearing more about if/how Indix can drive market share gains and/or reduce R&D for Avalara in the future. BUY.
Announced Earnings Date: February 12
Bottomline Technologies (EPAY) dropped back its December 2018 low after reporting Q2 fiscal 2019 results last Friday. I’ve been looking forward to digging into the additional details usually disclosed in a 10Q filing but that hasn’t come out yet, so I’ll go over the numbers from the press release and 8K filing today.
In short, the numbers in the quarter were fine. Revenue of $104.9 million was up 10% and beat by $1.5 million. On a constant currency basis revenue was up 11%. Adjusted EPS of $0.35 was in line with expectations, and up 13%.
Breaking the revenue mix down, subscription and transaction revenue (the main driver of growth at 68% of total revenue) of $71.3 million was up 13%. Currency fluctuations trimmed 1% off the growth rate (Bottomline gets around 25% of revenue from the U.K.), but growth in Digital Banking solutions (which is just starting to be recognized now) is helping to offset that some.
Bottomline landed 29 institutions on its Paymode-X solution, seven for its cloud-based legal spend management solution, two for its banking solution, and a handful for other solutions, including Financial Messaging. All in, new subscription and transaction bookings was $22.5 million, bringing total booking for this line item to $85 million over last four quarters.
Management attributes these wins to a relentless focus on R&D so that Bottomline has a product technology edge over the competition. On that note the company has been, and will continue to, invest in machine learning and analytics technologies, which are used to help automate Paymode-X vendor enrollment and fraud protection. These capabilities are being rolled out to automate the legal spend bill review process as well, and are being expanded to the U.K. market.
The downside of technology investments is that Bottomline has been spending more on sales, marketing and development. The company purchased a new U.K. headquarters for $20.7 million just after the end of the quarter. Management said that, yes, Brexit is an unknown, but that the U.K. is leading the Open Banking market and that’s creating tons of change and opportunity, which is terrific for Bottomline.
In terms of guidance, this is the source of the stock’s weakness.
Fluctuations in the British pound are expected to have a negative impact throughout the rest of fiscal 2019. That trimmed around $1.5 million in Q2 and is expected to trim around $3.8 million through the second half of the fiscal year.
That puts full-year guidance at around $415 million to $420 million, versus prior consensus at $425.7 million. In terms of EPS, new guidance is at $1.27 to $1.32, versus consensus of $1.44. On the conference analysts kept going back to the reduction in guidance and asking why the EPS cut is larger (in percentage terms) than the revenue guidance reduction, especially because Bottomline has unrealized Digital Banking revenue that’s just starting to be recognized and that should ramp up in the final two quarters of fiscal 2019 (then be in the 15% to 20% growth range in fiscal 2020).
I think the answer is that management is being extremely conservative in terms of foreign currency fluctuations, tax changes and spending on investments. The quarter ending December 31, 2018 was a crazy quarter, and there is a good deal of uncertainty around Brexit. There’s no reason for management to stick their neck out. It’s better to be conservative, even though that can lead to questions about how well the business is likely to do.
Analysts on the call also asked about the competitive environment, and referenced the B2B payment initiatives being pursued by MasterCard, Visa and NACHA (a nonprofit working to facilitate electronic payments networks and financial data exchanges). Bottomline management discussed how they are partnered with both Visa and MasterCard and could participate in any newly developed business directory, but that it’s confident in the value its current business model gives customers.
I think the punchline here is that Bottomline remains a good business that’s dealing with some perfectly manageable challenges that are having a short-term impact, but aren’t going to hurt the company long term. While the stock fell after the report, it’s good to see it held at its prior low. And at this level there is certainly potential for a buyback given that Bottomline has excess cash.
That said, the stock’s not acting strong. I’m going to keep it at hold and we’ll take it week by week. Be patient, stick with it, and I expect we’ll be upgrading back to buy before too long. HOLD.
Earnings: Done
CareDx (CDNA) is trading right near the middle of the 22 to 30 range that has mostly held up for the past five months. We’ve already received preliminary Q4 and FY 2018 results so there’s not a lot to look forward to in the near term with respect to high-level operations. We will, however, dig into the details when official results come (estimated around March 22). Q4 revenue is expected to be up 85% to 88%, to around $23.4 million, and up 58%, to around $76.4 million, in 2018. I came across an SEC filing this week that extended confidential treatment of information related to a previous acquisition, but that’s about all there is for news. Management will speak at the BTIG Annual Medical Technology, Life Science Tools, and Diagnostics Conference on February 27 and 28. BUY.
Estimated Earnings Date: March 22
Codexis (CDXS) is a protein engineering company and it has been one of our most energetic stocks this week. The stock started rising last week on higher trading volume then jumped again on Monday on news it inked a multi-year extension/upgrade with Merck (MRK) to provide that company with its CodeEvolver protein technology. The original deal was stamped in 2015 and this extension signals that Merck continues to see the value of using the CodeEvolver platform to develop novel enzymes for use in the manufacture of pharmaceutical products. Then on Wednesday Codexis announced a multi-year supply agreement with KYORIN Pharmaceutical for the supply of a proprietary enzyme used in the manufacture of a key ingredient in Beova Tablets, a once-daily treatment for overactive bladder. Beova was launched in November 2018. We are also waiting on a decision from Nestlé to see if it’s going to exercise its option with CDX-6114. Assuming no extension, we should know by February 17, which is the Sunday before President’s Day. With the recent run in the share price it’s best to stick to buying smaller blocks of the stock here. But it’s still a buy. Earnings are due out in early March. Analysts see revenue growth of 20% in 2018 and 17% in 2019. BUY.
Estimated Earnings Date: March 8
Chefs’ Warehouse (CHEF) announced preliminary 2019 guidance a couple of weeks ago, 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 stock hasn’t reacted either positively or negatively, rather is still trading in the middle of its rather wide five-month trading range of 30 to 39. We’ll hear how the last quarter in 2018 went next Wednesday. BUY.
Announced Earnings Date: February 13
Everbridge (EVBG) broke out to an all-time high last Friday when it traded up to 64.79 intraday. It’s pulled back a few points since, but clearly demand is high for shares. JP Morgan picked up coverage this week as well, and that exposure should pull incremental buyers into the name and help keep the stock trending in the right direction. We’re looking at an earnings date of Tuesday, February 19, which will be the first day the market is open after a long President’s Day weekend. It’s still a buy, just in smaller quantities. BUY.
Announced Earnings Date: February 19
Goosehead Insurance (GSHD) continues to trade in an established range and has repeatedly bumped up against the 29 level in 2019. A couple of weeks ago our data feed suggested earnings would be out in late January. That appears to be a data feed error as other platforms are saying earnings aren’t expected until around March 13. We’re looking for around 40% revenue growth this year and 30%+ in 2019, with potential for that forward forecast to jump quite a bit. Goosehead is profitable (expected EPS of $0.25 in 2018 and $0.42 in 2019). Management will speak at the Bank of America Merrill Lynch Insurance Conference next Thursday. BUY.
Estimated Earnings Date: March 13
Q2 Holdings (QTWO) sells cloud-based virtual banking software to regional and community financial institutions. Earnings are out next week and analysts are looking for revenue growth to accelerate from 24% in 2018 to 29% in 2019 as new clients go live and the positive impact of the Cloud Lending acquisition and release of Q2 Open add exposure to credit card and bill payments. The EPS growth rate could decline from around 365% in 2018 (expected EPS of $0.14) to flat in 2019, though that could easily change once we get a better idea of the go live cadence and impact of the aforementioned initiatives. The stock has benefited from a number of analyst upgrades in early 2019 and a solid quarter and forward outlook has the potential to send Q2 rallying to fresh highs. On the flip side we’ll want to be mindful of the ever-present threats represented by bank & credit union consolidation and competition from established transaction processing players. It’s a buy, but in smaller quantities than a few weeks ago. BUY
Announced Earnings Date: Wednesday, Feb. 13. Conference call 8:30 AM EST Thursday, Feb. 14
Rapid7 (RPD) reported yesterday after the closing bell and the results were absolutely terrific. The stock’s been acting great lately and broke out to a new high above 39 last week. Last night’s report should mean the stock is strong today.
The results (using the new ASC 606 accounting standards): Revenue was up 19% to $68.8 million while adjusted EPS of -$0.05 beat by $0.04. North American revenue was 85% of the total, while the closely watched annualized recurring revenue (ARR) line (a measure of how much of the revenue base is on recurring subscriptions) was up 53% to $252 million and now sits at 83% of total revenue. Impressively, ARR growth accelerated from 46% in Q3 and is now up six quarters in a row. The company’s renewal rate for Q4 was 120%, showing that it is upselling and cross-selling additional products to current customers.
For the full-year 2018, revenue was up 21.5% to $242 million while adjusted EPS came in at -$0.41. Customer count at year end was 7,800, up 11% over the end of 2017. Management also issued guidance for 2019, when it expects revenue to grow by 25% to 28% ($304 million to $312 million) and deliver adjusted EPS of $0.00 to $0.05.
The big-picture trends here look great. Revenue growth is accelerating even with the transition to the subscription business model. The core vulnerability management (VM) market is strong and customers are buying more solutions, including InsightConnect, Rapid7’s fourth Insight module. Over half of the customer base is now on the platform, versus just 37% at the end of last year. And customer count increased by a modest 1%, even on a larger customer base. Also impressive is that the company delivered an operating margin of –3.9% in Q4 versus expectations of around –7.0%, and expects to deliver first profits in 2019. Spending will go up (and dent cash flow) due to a new global headquarters (costing around $25 million) but that’s been reflected in consensus estimates for a while.
We’ve seen what happens when small companies really gain traction and enjoy accelerating revenue growth on a larger (and more loyal) customer base, and then start delivering profits. Stock prices usually go up! Rapid7 isn’t the “deal” it was when we got into the stock (we’re up over 50%) but despite a valuation that’s closer to in-line with peers I suspect we’ll see higher prices over the course of 2019.
That all said, the stock is now breaking out and trading at all-time highs and that means we’re in uncharted territory. If you want to nibble on a few shares to start a new position, or add a few more to an existing position, that’s just fine. But I don’t see this as a time to load up with a big, new position. Therefore, I’m moving Rapid7 back to hold today until we see how shares act after a few more trading days. HOLD
Earnings: Done
Repligen (RGEN) is still recovering from a horrid December and has moved back above its 50-day line, though that accomplishment could be reversed with one down day. I suspect the December decline made investors wary of the stock but that the positive growth drivers that pushed it above 70 in November will come back into focus when Q4 results come out around February 20. From a technical perspective the first hurdle to get over is the 59 level that was the high last fall. I like the stock here and recommend adding to your position. BUY
Estimated Earnings Date: February 20
