The market has been jumping around lately as it digests the Fed’s announcement last week that it expects to hold interest rates steady until 2020 (and just one hike in that year) and would stop shrinking its balance sheet later in 2019.
Then we have the whole yield-curve inversion thing going on, the end of earnings season, the trend of forward earnings estimates coming down, ramp up in speculation about which party will be in the White House in 2021, talk of big investors selling leading stocks to free up money for new IPOs (Airbnb, Lyft, Uber, Pinterest, etc.) and the re-emergence of short reports (this past week it was one suggesting Medicare reimbursement will be slashed for medical device makers iRhythm (IRTC) starting in 2021—a baseless attack, IMO).
In other words, the “raging bull” market that I referenced in last week’s update just came to an end, at least for the time being.
Given the strength in the first two and half months of 2019 some sort of pullback wasn’t surprising. In fact, I had been anticipating it, which is why many of our rallying stocks are rated hold and not buy right now.
At the same time spring is in the air and interest rates have fallen, so we could easily see those green shoots of growth re-emerge soon.
We’ll continue to maintain a balanced perspective on the market and on our stocks. On the one hand we want to maintain (and even add) exposure to the strongest stocks out there. On the other hand, we want to do so in a way that makes sense.
This means be selective in what you buy right now. Focus on those stocks that aren’t looking too overbought. And sit tight with those that are.
With the exception of one small partial position sale, this week’s update has no ratings changes, so just keep executing on the stock-specific strategies that we had in place last Friday. Also, since stock-specific news flow has slowed to a trickle, I’ve included a high-level overview of what each of our stocks does.
Changes this week
CareDx (CDNA) moved to SELL A QUARTER
Updates
AppFolio (APPF) was formed in 2006 to provide cloud-based software solutions for small businesses in the property management industry. Its property management solution was first offered in 2008, then in 2009 AppFolio began offering value-added services for property management clients (website hosting, automatic payments, etc.). It then expanded into the legal market in 2012 and has begun offering value-added services for legal customers in the years since. It is a customer-centric enterprise. Management doesn’t take the same approach to communicating with investors, however, so news flow is pretty sparse. That said, it’s an efficiently-run business. Revenue is expected to be up 33% this year (to $252.5 million) and 24% next. And adjusted EPS should be up around 45% this year (to $0.81) and 36% in 2020 to $1.10). BUY.
Arena Pharmaceuticals (ARNA) is a biopharmaceutical company that develops novel, small-molecule drugs with optimized receptor pharmacology designed to work across a wide range of therapeutic areas. It believes this approach will allow its drug candidates to address diseases more effectively, while limiting negative side effects. The pipeline includes potential treatments for pulmonary arterial hypertension (PAH), ulcerative colitis (UC), pyoderma gangrenosum (PG), primary biliary cholangitis (PBC) and pain associated with Crohn’s disease. The pathway to commercialization is long (potentially 2021), but Arena is well-funded so patient investors should just sit tight. HOLD.
Avalara (AVLR) is a cloud-based provider of sales and indirect tax compliance software. To achieve its vision of being part of every transaction in the world the company has developed solutions that help customers become more efficient and accurate with respect to sales tax calculations, returns filing and remittance. Over 20,000 customers currently use Avalara, including big names like Pinterest, Thule, Adidas, Superfeet, Smartsheet (SMAR), Marketo, Life Is Good and Crocs (CROX). But its core market is the small business to mid-market segment (20 to 500 full-time employees), where management sees 270,000 potential customers. Analysts expect revenue to grow by 22% (to $333 million) this year and for EPS to improve by $0.17, to -$0.50. BUY.
Bottomline Technologies (EPAY) is a $2 billion market cap company that is wholly focused on helping businesses pay and get paid. It operates in an extremely complex market where business-to-business (B2B) payment networks literally go every which way but straight. In the face of this complexity, Bottomline is designing simple and secure payment paths that leverage the benefits of cloud-based software and infrastructure. I moved the stock back to buy last week anticipating that more investors would tune in to the story since it’s one of the few quality stocks that hasn’t made a big year-to-date move. Look for a move above 52.5 to really get things going in the right direction. Revenue growth should be a modest 7% this year than 8.6% in 2020, while adjusted EPS should be around $1.33 (up 5%) in 2018 and $1.56 (up 17%) in 2020. BUY.
CareDx (CDNA) is applying the latest advancements in genomics and bioinformatics technology to improve the lives of organ transplant patients. It specializes in noninvasive diagnostics solutions for heart and kidney transplants. The big news this week was the filing of a patent infringement suit against Natera (NTRA), a $1.2 billion market cap diagnostics company that mainly sells preconception and prenatal genetic testing services. However, Natera is also working on a kidney transplant rejection test and is trying to secure Medicare reimbursement by the end of 2019. Natera management is also working to validate the accuracy of the test and planning a commercial rollout, which is expected to be done with a direct sales force as well as through partnership with Thermo-Fischer Scientific (TMO) subsidiary One Lambda, which has commercial infrastructure across U.S. transplant centers.
The CareDx suit alleges that Natera infringes on U.S. Patent Nos. 9,845,497 and 8,703,652 (exclusively licensed to CareDx from Stanford University) through its marketing and performance of a test to analyze cell-free DNA from a transplant patient to inform rejection. I’ve reviewed the materials I can get my hands on. Without inside knowledge I can’t make a determination as to where the chips will fall, and Natera has remained quiet on the matter (so far). Based on previous experience, I suspect this isn’t going to go away quietly, or quickly. So it could weigh on shares in the near term. In terms of what to do, the most pragmatic approach is to simply take partial profits so we don’t risk losing our recent paper gain (well over 30% since January) but also maintain exposure for if/when this passes. Therefore, let’s sell a quarter of our position today. SELL A QUARTER.
Chefs’ Warehouse (CHEF) is a Connecticut-based specialty food distributor that has been supplying artisan and high-quality food products to chefs across the U.S. for over three decades. Chefs’ stated goal is to support the needs of all its chefs through distinctive and hard-to-find specialty and center-of-the-plate food products. Its primary focus is on menu-driven family-owned and independent restaurants, of which there are roughly 350,000 across the U.S. Chefs’ serves over 30,000 of them. This isn’t a business for the faint of heart. Management is candid that it is a complex, dynamic and often undesirable business to be in (i.e. high barriers to entry). But Chefs’ likes these challenges and has figured out ways to make them work to its advantage. The company has enviable margins, but there still isn’t a lot of meat on the bone here. That’s why Chefs’ has been investing in technology to make operations flow as efficiently as possible. These investments are showing up in relatively rapid EPS growth. Analysts see 2019 revenue rising by 8.4% to $1.57 billion and EPS of $0.98 (up 25.6%). In 2020, the growth trend continues with revenue growth estimated at 7.4% and EPS growth at 19.4%. I’ve had at Buy since I think the next move is up. BUY.
Codexis (CDXS) is an industrial biotechnology company that has developed a proprietary technology platform, CodeEvolver, that uses artificial intelligence and machine learning to create new proteins for use in customer products, manufacturing processes, and other commercial dimensions. Historically, naturally occurring proteins have been used to produce or add desirable characteristics to many products people use on a daily basis. But in their natural form proteins come up against inherent barriers that limit their commercial potential. Codexis engineers novel proteins that overcome those inherent limitations. When it started in 2002 the company first targeted the pharmaceuticals industry. It has since expanded into food and nutrition, molecular diagnostics, biotherapeutics, agriculture and other industries. Its protein catalysts help customers manufacture products at a lower cost and with lower fixed capital investment. They also reduce the cost of development of complex chemical synthesis processes and can even eliminate entire steps from chemical production. And they allow for the manufacture of purer end-products with lower levels of impurities. Look for 17% revenue growth (to $71 million) and adjusted EPS of -$0.23 in 2019. BUY.
Everbridge (EVBG) was founded in 2002, shortly after the 9/11 attacks, to provide fast, automated communications services during life threatening situations and mission-critical business events. The software platform powers apps that help organizations and government entities keep people safe, and business running. Customers buy the software to lower the risks to human life and the cost of business downtime due to terrorist attacks, active shooter situations, severe weather events, IT outages and cyber-attacks. The company started with one product, a mass notification solution that it tweaked and expanded for the first ten years of the company’s existence. It now offers a Critical Event Management (CEM) platform and a number of solutions, and that’s helped Everbridge grow its customer base to over 4,400, reaching over 500 million people across 200 countries and territories. Look for 33% revenue growth (to $196 million) and adjusted EPS of -$0.28 (up from -$0.54 in 2018) this year. HOLD.
Goosehead Insurance (GSHD) is attempting to shake up the insurance brokerage market by building an independent personal lines insurance sales and support platform and deploying it at a national scale, through a hybrid corporate and franchise distribution model. It’s the only publicly-traded insurance broker of its kind out there. Its focus on auto, homeowners’ and other personal lines (boat, umbrella, etc.) gives it access to a sticky market with high renewal rates. Goosehead is based in Texas, is run by its founder, and does not underwrite any policies, so it has zero underwriting risk. There are only a handful of analysts following the stock and estimates vary by around 10%. But the consensus is that 2019 revenue will be up 42% to $85.4 million and adjusted EPS will be up 90%, to $0.38. There has been some concern that a slowing housing market (Goosehead gets a lot of new policies from new homebuyers) will dent growth, however, with interest rates slipping toward 4% and the busy spring/summer market just over the hill, those concerns could soon fade. Keep averaging in. BUY.
Q2 Holdings (QTWO) is a pure-play provider of digital banking solutions to the highly personalized community banking and credit union market. It offers a purpose-built platform that brings small banks and credit unions up to speed with solutions for deposits, money movement, lending, security and fraud, giving them the power to compete with the mega banks for depositor accounts. In 2019 analysts are expecting revenue growth of 21% (to $308 million) and adjusted EPS of $0.14. Keeping at Buy. BUY.
Rapid7 (RPD) is a $2.4 billion market cap software company that helps protect an organization’s best interests in an increasingly complex, chaotic and interconnected digital world. Customers use its cloud-based and on-premise software solutions to better understand, prioritize and address the threats facing their physical, virtual and cloud assets. With a growing set of solutions to sell as part of its entry into the emerging SecOps movement, which brings together security and IT operations (all hosted on the Insights Platform, which launched in 2015), and a transition to an easy-to-deploy Software-as-a-Service (SaaS) pricing model (largely behind it), Rapid7 is landing larger deals, more multi-product deals, and more customers. In 2019 analysts see revenue up 26% to $308.5 million and adjusted EPS improving to $0.05 from a loss of -$0.41 in 2018. HOLD.
Repligen (RGEN) is in the business of selling bioprocessing supplies to life sciences and biopharmaceutical companies around the world. It plays in a highly specialized field, and with the trends pointing toward more personalized medicine and small batch drug production this company’s equipment is more critical to its customers’ long-term success than ever. Most of the best-selling drugs on the market are now biologics, including Humira (AbbVie), Rituxan (Roche), Enbrel (Pfizer/Amgen), Herceptin (Roche) and Avastin (Roche). Their effectiveness is making biologics one of the fastest growing areas of the pharmaceutical market with estimated global sales of $200 billion in 2018 jumping to $250 billion by 2020. The only catch is that biologics are not easy to make. This is where Repligen comes in, and it is one of the few small-cap pure-play bioprocessing stocks out there. Analysts see both revenue and EPS growing by 14% this year, with revenue of $221 million and EPS of $0.83 expected. Keeping at Buy. BUY.
Upland Software (UPLD) is a $900 million market cap company that provides cloud-based Enterprise Work Management (EWM) software to companies where collaboration and teamwork are critical to their operations. Over the last month consensus estimates for revenue growth in 2019 have risen from 27% to 31% (to $197 million), while adjusted EPS estimates have increased from $1.98 to $2.11. Keeping at Buy, just be sure to average in. BUY.
