It’s nice to feel bullish again.
Below is the chart I showed last week, when I said that the S&P 600 Index should have found support in the 900 to 1,000 trading range when it corrected late last year. And that, now that we’re back in this range, it feels like a natural place for some consolidation.
The consolidation isn’t happening just yet.
Rather, small caps keep grinding higher. And many of the stocks in our portfolio are trading at, or near, all-time highs.
Still, keep an eye on this trading range. I suspect we’ll see the small cap index pause before moving back above 1,000. While the index has a very different composition than our portfolio, it’s still wise to keep abreast of the trends in our asset class since they feed into thinking (and actions) of portfolio managers, who do a lot more buying and selling than our group.
The most exciting thing going on isn’t that small caps are approaching a technical resistance level, but that it is earnings season. This—the fourth quarter—is a particularly interesting time because most companies are wrapping up 2018 results and issuing guidance/comments for 2019.
Most of the commentary I’ve heard from the management teams behind our portfolio stocks has been good.
I can’t recall one mention of China trade tensions or U.S. government shutdown impacts. There was a little disruption in Bottomline Technologies (EPAY) because of what’s going on in the U.K., but that’s a stock-specific issue.
We’ll probably hear Everbridge (EVBG) comment on the U.S. shutdown next week because they do business with areas of the U.S. government. And Repligen (RGEN) has historically generated over 50% of revenue from abroad, so we’ll want to keep an eye out there.
But for the most part things seem to be going along pretty well, so continue to lean bullish, just a little less so than a couple of weeks ago.
This week I moved one stock that has recently rallied back to hold, while upgrading one that could be on the verge of a run back to buy. All other stocks stay the same.
Changes this week
AppFolio (APPF) moved to BUY
Q2 Holdings (QTWO) moved to HOLD
Updates
AppFolio (APPF) is looking better to me and I like how the stock is grinding slowly higher without much volatility. There’s no news, and I’m not specifically calling for an insanely good Q4 report (due out on February 28). But with the backdrop for cloud software stocks looking good and AppFolio trading well off its peak valuation it feels like there’s an opportunity here. Shares should stay strong ahead of earnings, then react either positively or negatively based on the result. It’s a bit of a crapshoot, but let’s move back to Buy today. Don’t go in huge. But it’s fine to add to an existing position or start working on a new one. 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. BUY.
Announced Earnings Date: February 28
Arena Pharmaceuticals (ARNA) made a nice move to multi-year highs last week and is still hanging out in the vicinity, eyeing a breakout to fresh highs. Wouldn’t that be nice! We’ve essentially been rangebound between 35 and 50 since the beginning of 2018, with a few spikes a couple points lower here and there. It would be a welcome change to move up into a new range and establish 50 as a “floor.” We’ll see. I moved the stock to Hold last week since the risk-versus-reward profile of loading up at this very moment isn’t particularly attractive. Long term, Arena looks great. HOLD.
Estimated Earnings Date: March 12
Avalara (AVLR) just reported and I detailed the high-level results in yesterday’s Special Bulletin. Shares kept climbing yesterday, putting our current gain just north of 35%.
From yesterday: Revenue of $76.9 million was up 32.5% and beat by $5.7 million while the adjusted EPS loss of -$0.28 was as expected. It’s clear that the Supreme Court’s South Dakota vs. Wayfair decision is driving a lot of activity as states (and BIG states, like California and New York) pass legislation requiring online businesses to collect and remit sales tax. Since that decision roughly 30 states have passed economic nexus laws. I think the floodgates are beginning to open and Avalara’s sales staff is going to be extremely busy for a number of years (which will drive up costs). I see analysts moving their price targets way up. We could see some insiders/early investors selling some shares to take advantage of the strength, and never rule out a secondary offering to raise cash for acquisitions. However, given the growth trajectory I would think a wider shareholder base and accretive acquisitions would be viewed as a good thing. Keeping at Buy.
Additional comments: Should the floodgates for Avalara indeed be opening it’s worth mentioning the dynamics of the business model. On the front end many businesses are looking for sales tax automation solutions, and that should translate into bookings. After new customers are on the platform Avalara should be able to enjoy years of accelerating growth as transaction volume picks up. This dynamic is going to mean higher costs in terms of sales people and investments in building out the sales tax content base, as well as capital needs to fund acquisitions (sales people are paid on commissions based on bookings). In Q4 sales and marketing expense grew by 33% YOY to 61.5% of revenue. This is one of those investments you want to make because, while customer acquisition costs are front-loaded and will crimp profits near term, those costs roll off as customers stay with Avalara and renew (and as their transaction volume grows). Core customer count grew by 580 in Q4 2018 (vs. 410 in the prior quarter and 238 in Q4 2017).
The bottom line here is this is an exciting time for this company and it feels like a massive opportunity lies in front of them. Let’s hope management continues to execute. BUY.
Earnings: Done
Bottomline Technologies (EPAY) presents a bit of a conundrum. On the one hand, the chart looks like garbage and I really hate to see the big step-downs that the stock has taken (November and end of January). On the other hand, I don’t think this business is fundamentally flawed. It does seem that overall growth is good and that digital banking revenues should kick in and help offset some of the negative impact from foreign currency conversions. While Brexit poses a risk, one would think that mess will get sorted out eventually and that digital banking/payments will continue to be a growth market there, as well as the rest of Europe. In short, my thinking on Bottomline is that we should be patient. We’re down around 15%, which is quite disappointing given where the stock was in September. But in addition to the likelihood that this is just a bump in the road, there’s also lurking potential that Bottomline could offer itself up for sale, at what I would expect would be a nice premium to the current share price. Keep Holding. HOLD.
Earnings: Done
CareDx (CDNA) pulled back over the last week but remains in the 22-to-30 range that has mostly held up for the past five months. As I’ve stated a few times already we’ve received preliminary Q4 and FY 2018 results. 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. It’s still a Buy. BUY.
Announced Earnings Date: March 6
Codexis (CDXS) management has been busy lately. Last week it announced a multi-year extension/upgrade with Merck (MRK) to provide that company with its CodeEvolver protein technology. And it 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 (launched in November 2018), a once-daily treatment for overactive bladder. Then yesterday it announced that Nestlé Health Science has exercised its option to obtain an exclusive license for the global development and commercialization of Codexis’ novel, orally delivered enzyme CDX-6114 for the management of phenylketonuria (PKU), an orphan metabolic disorder. This event triggers a $3 million milestone payment, and means Nestlé assumes all responsibility for future clinical development and commercialization of the compound. Codexis is also eligible to receive up to $86 million in development and approval milestones, up to $250 million of sales-based milestones if sales surpass $1 billion in a single year, and tiered royalties (based on net product sales) ranging from middle single digits to low double digits. Surprisingly, there was little impact on shares yesterday, despite the good news. That might be because the $3 million payment isn’t a huge deal and we don’t yet know if a marketed treatment will come out of this. I expect management will give us a good update in early March when earnings are due out. Analysts see revenue growth of 20% in 2018 and 17% in 2019. The stock is still a buy, but be aware we’re trading near resistance just below the December high of 23, so best to buy smaller positions. BUY.
Estimated Earnings Date: March 8
Chefs’ Warehouse (CHEF) reported Wednesday night and I detailed the results in yesterday’s Special Bulletin.
From yesterday: Chefs’ announced preliminary 2019 guidance a few 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 had analysts looking for EPS of around $1.00 in 2019, or up 28% over 2018 (when EPS should have risen 77%, to $0.78). Management reported official Q4 2018 results last night with revenue up 10.4% to $394 million (beating by $6.8 million) and adjusted EPS of $0.32 (in line). Management reiterated 2019 revenue guidance and also issued 2019 EPS guidance, which works out to a range of $0.91 to $1.01, the midpoint of which is below consensus. In short, the business is tracking about as expected. The stock hasn’t been able to break out above prior highs yet and I expect will probably continue to trade in the 30-to-40 range for a bit. It’s still a good place to add to a position. I know Chef’s doesn’t seem like the biggest growth stock out there. But I’d be remiss not to point out that since we added it in July 2018 the stock is up by 18% versus an 8.7% decline in the S&P 600 Index. That absolute performance, and 26.7% relative performance, track record is pretty darn good in my mind. BUY.
Earnings: Done
Everbridge (EVBG) is an easy stock to like since it’s doing all the right things. We have another new high this week, and a big earnings event coming up next Tuesday. I’ve kept at Buy and while it’s always a little risky to take new positions just ahead of earnings I think you can still pick up a few shares around this price. Just keep things reasonable. BUY.
Announced Earnings Date: February 19
Goosehead Insurance (GSHD) management spoke at the Bank of America Merrill Lynch Insurance Conference yesterday and some new significant shareholder positions were filed with the SEC. I didn’t get a chance to hear the BAC presentation but shares were up 9% yesterday so there seems to be some bump in interest! We don’t have a firm earnings report date yet. 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). BUY.
Estimated Earnings Date: March 13
Q2 Holdings (QTWO) reported Wednesday and held a conference call yesterday morning.
From my Special Bulletin on Thursday: Q2 reported a quarter that came in largely as expected with revenue accelerating by 30% (vs. 20.8% in Q3 2018) and adjusted EPS of $0.08, up from $0.05 in Q4 2017. Management’s initial 2019 guidance was good at $305 million to $309 million but a touch below the most bullish street estimates, while EBITDA guidance was quite a bit lighter, most likely due to the Cloud Lending (comprehensive lending and leasing platform) and Gro (digital sales and onboarding solution). Overall, it seems like a good quarter that supports the bull thesis but this morning’s call will be important to let management give us more info around margins. Given where the stock is trading now (just below resistance/all-time high) and that the forward guidance wasn’t wildly bullish, I’m not expecting a big jump to all-time highs today (though nothing is off the table). Moving to Hold until the stock digests the recent rally and the earnings report and we see if it can break out. HOLD.
Earnings: Done
Rapid7 (RPD) reported last week and the stock has been off to the races since. I moved the stock to hold just because I didn’t want anybody chasing the stock in what’s starting to feel like a bit of a euphoric market. That said, Rapid7 hasn’t traded at a premium to peers until now so we might be seeing a “new normal” here. I think you can keep pecking away at a few shares here and there (preferably on weakness), but for bigger positions I’d like to see some consolidation, or mellowing out of the uptrend, just to reduce the risk of being underwater soon after taking the position. We’ve been in Rapid7 for just under a year now and it’s nice to see that the bull thesis I put forth in my report (smooth transition to cloud, expanding solutions, cross sells, etc.) is playing out. Keep Holding. HOLD.
Earnings: Done
Repligen (RGEN) isn’t much changed from last week and is still recovering from a tough December. As I suggested last Friday, I think 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 on February 21. Shares did manage to break above 59 to hit 60 ever so briefly on Tuesday before dropping back a little on Wednesday. Just a couple more days until earnings come out. It’s still a Buy. BUY.
Announced Earnings Date: February 21
