Cabot Stock of the Week Issue: March 13, 2023

Well that sure escalated quickly!

A week ago, the Wall Street waters were mostly calm on the heels of a nice bounce-back week and with not a ton of noise outside of the latest Fed speak. Three bank capsizings later, and we’re back firmly in bear territory, with the major indexes falling below their 200-day moving averages for the first time since late January. Ugh.

Will more banks join Silicon Valley Bank, Silvergate and Signature Bank and suddenly turn belly-up? It’s too early to tell. At the very least, there’s surely plenty of exposure out there among public companies – Roku (ROKU) had 26% of its cash held by SVB; online gaming firm Roblox (RBLX) had 5%; Stitch Fix (SFIX) had a $40 million credit line with SVB, to name a few – and regional bank stocks have been getting pummeled since the news broke, down 22% in the last three trading sessions. Yuck.

The good news is the market is holding mostly firm today, which is no small thing two trading days removed from the second-largest bank failure in U.S. history. The federal government’s Sunday evening vow to back SVB’s deposits beyond the federally insured ceiling of $250,000 has surely helped matters, as has President Biden calling the U.S. banking sector “safe.” Nevertheless, volatility and uncertainty are back, and not in the “what will the Fed say this week?” kind of way that we’ve grown accustomed to.

What do now? We’re selling two of our weaker performers, including our one bank stock. But we’re also adding a retail stock that’s likely immune to the banking carnage. It’s a long-held favorite of Cabot Growth Investor Chief Analyst Mike Cintolo, and here are Mike’s latest thoughts on it.

Wingstop (WING)

When it comes to market leadership, we’ll never complain if technology is in the lead—give us a cloud software, networking, or chip name with a unique offering that’s growing fast and we’re all over it. Indeed, if the market kicks into gear, there are some names in these groups (especially chip stocks) that could have great runs.

That said, a group we’ve always loved just as much as some revolutionary technology stocks is retail—while not as explosive, if you have a new-ish retail concept that can expand around the globe (particularly if growth is mostly a matter of opening new locations), then the firm is capable of not just rapid growth, but also very reliable growth with a long runway of upside for many years. It’s the combination of those factors (rapid, reliable, long runway) that gets big investors excited and entices them to build big positions.

That’s a big reason we like Wingstop (WING), which is aiming very high: Management has said for years that it wants to become a top 10 global restaurant brand, and it’s making steady progress toward that front every year.

Like most good retail stories, Wingstop’s is a simple one: The firm’s restaurants offer wings in 16 flavors, along with fries, dips, shakes and desserts—the standard feel-good grub. About the only drawback of that menu was that the firm was reliant on ever-volatile bone-in wing prices, which can move a surprising amount. That’s still the case, but recent launches of chicken sandwiches and tenders are seeing good uptake and should lessen the cost issue somewhat for investors.

The model is simple, and importantly for a cookie-cutter story, the store economics are terrific. Wingstop’s average restaurant brings in $1.6 million of revenue (up from $1.1 million in 2015), and encouragingly, new openings are seeing higher sales than prior cohorts (those opened in 2020 had around $1.3 million in their first year, compared to just $1 million or so for 2018’s cohort). That, along with a few other factors (more data-driven marketing and advertising, etc.) is why the top brass sees the average location bringing in $2 million annually in the years ahead. All of that leads to excellent returns, with about a 70% return per store.

And with those figures in hand, the top brass has been busy flooding the U.S. with new locations: The restaurant count has risen from 1,133 in 2018 to 1,959 at the end of 2022, an 11.5% average increase, and management sees another 240 openings in 2023 (up 12.2%). To this point, the vast majority of those (88%) are in the U.S., and it still thinks it can more than double its count here over time. But an even bigger opportunity is international, where Wingstop had 238 franchised locations at year-end but thinks it can eventually get to 3,000 locations. In the near term, expect many more in Canada, the U.K. and Mexico (its biggest international market right now).

All in all, the firm sees 10%-plus annual restaurant growth combined with mid-single-digit same-store sales growth, which should lead to mid-teens revenue growth and faster earnings and cash flow expansion. And business right now is much stronger than that: In Q4, system-wide sales rose 29%, thanks to an 8.7% same-store sales increase (that figure is now up 19 years in a row!) at U.S. locations and a 13.1% hike in the store count, while EBITDA lifted 72%. Growth is likely to slow some this year, but Wingstop reiterated the overall outlook.

As for the stock, WING topped out for much of 2020 and 2021 and was then crushed during the early stages of the bear market, falling from 180 to 70 or so. However, falling wing prices and continued execution helped to change perception, with shares ripping back to 140 and rallying back to 170 in mid-November. Since then, WING has built a new launching pad; it tried to get going after Q4 earnings, but the market pulled it back in. Even so, the uptrend is intact and there should be plenty of support in this area, even in an iffy market. We think it’s buyable right here.

Current Recommendations

Changes Since Last Week:
Centrus Energy (LEU) Moves from BUY to HOLD
Citigroup (C) Moves from BUY to SELL
Polestar (PSNY) Moves from BUY to SELL
Uber (UBER) Moves from BUY to HOLD

Three weeks ago, we had reached our 20-stock capacity in the portfolio and were running into the desirable problem of having to jettison a perfectly good stock to make room. But the market has changed drastically since, and today we have two more sells (and two other downgrades), leaving us with a mere 16 stocks. Citigroup (C) was the no-brainer, as it got caught up in the tidal wave of bank stock selling and needed to go. Polestar (PSNY) isn’t a bank stock, but it’s an unprofitable, still-maturing EV stock, and it’s a tough environment for those types of growth stocks. So that’s gone too.

As for the rest, it’s a mixed bag, though most of our stocks have proven to be resilient, which is what we hired many of them to be in times like this.

Here’s what’s happening with all of them.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, dipped below the 8-9 range it had been in since the start of the year and is currently hitting 2023 lows. The dip was likely market-related, but it’s also possible investors know something ahead of earnings this Wednesday (March 15). With the stock still trading above its 200-day average, I’ll keep it at Buy and see whether the earnings report can reverse the recent drop-off. BUY

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, was down sharply, dipping below 39 support and now threatening to bump up against mid-January lows around 34. There was no news, but growth stocks have taken it on the chin since the market collapsed last week – especially growth stocks with meat on the bone like LEU, which is still up more than 10% year to date. This is the latest in a series of fits and starts for this nuclear energy stock, which is still up double digits since we added it last summer. But with the stock having broken below its 200-day line, let’s downgrade to Hold. MOVE FROM BUY TO HOLD

Chewy (CHWY), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, held up pretty well this past week, dipping only slightly despite the carnage around it. That bodes well for when the selling stops. Q4 earnings (due out March 22) are another potential catalyst on the immediate horizon. BUY

Cisco Systems (CSCO), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, remains in the same 48-49 range that it’s been in for the past three weeks. The stock still has 37% upside to Bruce’s 66 price target. It’s a quiet stock, and right now quiet is good. BUY

Citigroup (C), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, is our one bank stock, and it showed. After threatening to break above resistance at 52 a week ago, the stock is getting hammered since the SVB/Silvergate craterings, falling to 45 this morning. Citigroup may well be a strong long-term value play (especially now), but I don’t want any part of the financial sector at the moment. It’s time to sell before our relatively modest loss (10%-ish, depending on the minute) balloons any further. MOVE FROM BUY TO SELL

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, dipped from 37 to 35 this past week. There was no big news – the dip is likely market-related. Shares now have 18% upside to Bruce’s 42 price target. We’re still sitting on a profit, so let’s see how CMCSA performs if the market can get its act back together. BUY

Gates Industrial Corp. (GTES), originally recommended by Bruce Kaser in the Buy Low Opportunities Portfolio of his Cabot Undervalued Stocks Advisor, is down about 6% since hitting new 52-week highs a little over a week ago. Still, the stock is up 18% year to date and well above its 200-day line. In his latest update, Bruce wrote, “Gates is a specialized producer of industrial drive belts and tubing. While this niche might sound unimpressive, Gates has become a leading global manufacturer by producing premium and innovative products. Its customers depend on heavy-duty vehicles, robots, production and warehouse machines and other equipment to operate without fail, so the belts and hydraulic tubing that power these must be exceptionally reliable. Few buyers would balk at a reasonable price premium on a small-priced part from Gates if it means their million-dollar equipment keeps running. Even in automobiles, which comprise roughly 43% of its revenues, Gates’ belts are nearly industry-standard for their reliability and value. Helping provide revenue stability, over 60% of its sales are for replacements. Gates is well-positioned to prosper in an electric vehicle world, as its average content per EV, which require water pumps and other thermal management components for the battery and inverters, is likely to be considerably higher than its average content per gas-powered vehicle.

“The company produces wide EBITDA margins, has a reasonable debt balance and generates considerable free cash flow. The management is high-quality. In 2014, private equity firm Blackstone acquired Gates and significantly improved its product line-up and quality, operating efficiency, culture and financial performance. Gates completed its IPO in 2018, with Blackstone retaining a 63% stake today.

“On February 9, Gates reported an encouraging fourth quarter and provided reasonably strong guidance for 2023 that implied steady-to-rising revenues and profits rather than a recessionary decline. Fourth-quarter free cash flow rose 55% as profits rose and inventory was sold down. Total debt fell about 3%. Leverage remains reasonable at 2.8x EBITDA, although it ticked up due to lower EBITDA. Gates continues to follow a common strategy of companies owned/controlled by reputable private equity firms: generating wide profit margins and high free cash flow conversion (free cash flow relative to adjusted net income). We strongly agree with this strategy.

“There was no significant company-specific news in the past week.

“GTES shares … have 18% upside to our new 16 price target. We recently raised our price target from 14 to 16 due to the company’s capable management, strong franchise within its market, still-improving fundamentals and reasonable valuation.” BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was similar to GTES in that it retreated to 56 after hitting the 52-week high above 60 a little over a week ago. In his latest update, Mike wrote, “The recovery in Macau is going as planned, and that’s keeping the path of least resistance in LVS pointed clearly up, despite the market’s wobbles. Gross gaming revenue in China’s gambling conclave rose 33% from the year before, and through February, revenues were up a strong 55% compared to 2022’s tally. One analyst sees the area’s revenue rising to north of 90% of 2019 levels (pre-pandemic) by the end of 2023, which would obviously be a big boon to Sands’ cash flow. As we’ve said a couple of times now, we’d like to fill out our position in LVS, and the stock itself looks fine, but we’re going to wait until we see some real firmness in the market (or at least a strong couple of days of support) before layering more on. We do, however, think the dip in recent days offers a good entry point to start a position if you don’t own any.” BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, was actually up slightly in its first week in the portfolio despite a rough week for the market – a very good sign. The stock’s recent strength has a lot to do with artificial intelligence, a major buzzword on Wall Street these days. As Tyler wrote last week, “Microsoft has been laying the groundwork in AI for years. It invested in OpenAI in July 2019 and has been investing in AI within Azure, GitHub Co-pilot and Microsoft Designer, among other solutions, since.

“Management says Search is the largest software category in the world and that the digital ad market is worth roughly $500 billion and growing at about 18% a year.

“It only holds about 3% market share. That translated into just $18 billion in 2022 ad revenue (9% of total revenue).

“The number is so small because the big tree in this market is Google (GOOG), which holds roughly 85% market share.

“That said, Microsoft has been gaining share for seven consecutive quarters. And each percentage point of share gain equates to about $2 billion of Bing revenue. If the company captured an additional 10% market share that’s $20 billion in revenue, enough to add roughly 10% to 2022 revenue.

“Beyond Bing, Microsoft is also bringing ChatGPT/AI technology to other solutions. It recently announced premium editions of its Teams solution for $10 per user per month. The new technology will help with note-taking and meeting scheduling.

“Rough math suggests the cost to run all Bing search queries through ChatGPT technology will be about $600 million to $1 billion per year, assuming no major changes to market share. That works out to about 0.4% of estimated 2023 revenue, which seems reasonable given the monetization opportunities of better-targeted ads and new subscription tiers across other products.” BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, pulled back normally after hitting new all-time highs. This pharmaceutical giant develops and markets therapies for diabetes and obesity. According to Carl in his latest update, “Novo plans to increase production of the weight loss drug Wegovy to meet high demand which should translate into higher revenue growth and profits.” BUY

Polestar (PSNY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, has done nothing but fall for the past five weeks – the five weeks since we added shares to the portfolio. This was a miss – it happens – so let’s cut our losses and move on. Probably not the best market in which to own an electric vehicle startup, no matter how promising. Time to sell. MOVE FROM BUY TO SELL

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, dipped from 64 to 62 this past week, though it’s recovering nicely today. In his latest update, Tom wrote, “In a rudderless and directionless market, income is king. And this legendary income REIT is the king of income stocks. It has paid 632 consecutive monthly dividends and increased the dividend payment 119 times since its IPO in the 1990s. And the REIT has been growing stronger through acquisitions of late. Earnings grew at 9.2% for 2022, which is above the historical average, and it did it in a challenging year. O has been trending slowly higher since the middle of October and should continue to be an investor favorite in this tough market.” The latest dip could be a buying opportunity for this monthly income payer. So, we’ll keep at Buy for now and see how it behaves in the coming week. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, is in retreat mode again on the heels of its underwhelming Investor Day on February 28. The backpedaling prompted at least one analyst downgrade (from Rod Lache of Wolfe Research, to a target of 185), but nothing has really changed with the company itself. Revenues are expected to grow more than 26%. I still think this will be a strong bounce-back year for TSLA – the stock is still up 39% year to date even after the recent pullback – but let’s wait for momentum to return before we even think about upgrading to Buy. HOLD

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, had a bad week, falling from 34 to just under 31. That prompted Mike to sell it last Friday. Here was his rationale: “We’re going to cut our loss in Uber (UBER), a stock that looked totally normal two days ago but has plunged the past couple of days. We definitely still think the company is on the right track and the stock can have a good run in the next bull phase, but UBER is obviously getting hit hard as fears mount that the Fed has gone too far and the economy could see reverberations.

“We’ll keep a distant eye on Uber to see if it’s ready to go when the market shapes up, but even though it’s a quick turnaround, we think it’s best to sell and hold the cash as the market weakens.”

Because we got in much later and our losses are more modest, we’ll hang on to it for now. But let’s downgrade to Hold. MOVE FROM BUY TO HOLD

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, reported earnings last Thursday, which were quite good. Earnings per share of $6.68 improved 23% from a year ago and handily beat $5.69 estimates. Revenues increased 18% year over year, as demand for beauty products remains resilient even as inflation continues to take a toll on other segments of the economy. The stock is up 10% year to date, so the gains appeared to already be built into the stock, which has dipped slightly since earnings. This remains a very strong stock in a solid niche of the retail sector. BUY

Visa Inc. (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor, slid sharply from 226 to 216 in sympathy with the market – and on the heels of a strong week the week before. Those happen to be the two weeks since we added the stock. Let’s see how V behaves if/when the market normalizes somewhat. BUY

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, is a rock. It keeps holding in the 37 to 39 range, unaffected by all the volatility and turbulence virtually everywhere else in the market. Our lone ETF offers a high dividend yield and some of the highest-quality emerging market stocks. The fund gives broad exposure with an emphasis on income and value. BUY

Xponential Fitness (XPOF), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, gave back some of its earnings gains from the week before, but not many, dipping from 29 to 27. That’s still higher than it was pre-earnings (25). The earnings brought nothing but good news, with revenues up 44% year over year and EPS more than tripling estimates as people continue to return to gyms in a post-Covid world. This remains one of our top-performing stocks. BUY

The next Cabot Stock of the Week issue will be published on March 20, 2023.