Cabot Stock of the Week Issue: May 15, 2023

If it feels like stocks have been running in place for the past year, that’s because they have. A year ago on this date (actually May 16; May 15 was a Sunday), the S&P 500 closed at 4,008. As of this writing, it’s at 4,126 – a 2.9% “jump.” The S&P is no higher now than it was last August, this February or the beginning of April. The index peaked at 4,179 in early February, and since a big up-and-down from mid-February through the end of March, the index has neither eclipsed its February high nor closed below 4,055.

It’s hard to make money when the market is on such a seemingly never-ending hamster wheel. Eventually, however, a new bull market will arrive – it’s been about a year and a half since the last one ended, which isn’t nothing. Until it arrives, there will be opportunities to make money – 42% of the S&P’s strongest days in the last 20 years have occurred during bear markets, according to Hartford Funds. Another 34% of the index’s best days have come during the first two months of a bull market – before anyone realized a new bull market had arrived. In other words, three-quarters of the best days to invest over the last two decades have happened in environments like the one we’re in now or the one that could soon arrive at any moment. So, we need to be prepared for these big, usually unexpected upswings. And that’s why I currently have a full portfolio.

This week’s addition keeps us at our cap of 20 stocks – we had to sell our biggest underperformer to make room for it. Some, like NVO, UBER and XPOF, are already behaving like they’re in a bull market. Most others are holding their own, which is why our portfolio is full. And today, we add another growth stock that’s rebounding fast after a rotten 2022. It’s a new recommendation from Mike Cintolo in his Cabot Top Ten Trader advisory.

Here are Mike’s latest thoughts on it.

Spotify (SPOT)

Spotify came public in 2018, and as one of the leaders in global music streaming, we thought it had the potential to become a real liquid leader in the market—the type of stock that Fidelity, T. Rowe Price and dozens of other big investment houses would build into core positions. But, while the stock did have a nice run after the pandemic crash, it never really became a must-own stock for a couple of key reasons.

First and most obvious, competition (from Apple and others) was intense, leading to lots of promotional pricing and big marketing spend (high customer acquisition costs)—which, in turn, led to losses; Spotify has been in the red for years, with a 20 cent per share loss in 2021 its best showing. And then there’s the repeated butting of heads with music labels, which of course are always arguing for a larger cut of the pie since they own the content. Wall Street got tired of the act, and when combined with the bear market, SPOT’s stock sunk more than 80% from its highs and was just half of what it was soon after its IPO.

Despite all of that rough sledding, Spotify still had great potential—it’s the leading music streaming platform out there, with around one-third of the market, and it’s made huge gains in podcasts as well (they’re paying Joe Rogan a boatload to be on their platform, though there are dozens others to listen to as well). Thus, while costs were high (including acquisitions—it made four small ones last year), the firm has grown nicely, with subscribers nearly tripling during the past few years even as the stock has struggled. And the big idea here is that, with the business a bit more mature, management is focused on cash flow, and that has the stock in a turnaround phase.

Spotify announced some restructuring moves in January—like many tech peers, it’s reducing headcount and streamlining operations, with the CEO saying in its recent conference call that “opportunities to reduce spending in areas like marketing and content production and real estate should lead to steady progress of key [financial] metrics throughout the year.” (Spotify hasn’t raised prices in the U.S. for years and is still $1 per month cheaper than Apple or Amazon, so that’s a possibility going ahead.) With at least one activist investor onboard, it’s a good bet these cost cuts will come through.

On the business side of things, it’s worth noting that Spotify released a new, fairly dramatic upgrade of its app in March, making it far more personalized and heavier on imagery (think Tik Tok- or Instagram-like).

Overall, there’s a ton of monetization potential: At the end of Q1, the firm had a whopping 515 million total users, which was up 22% from the year before and 5% from the prior quarter. About two-thirds of those use the free, ad-supported version of the product, while 210 million were paid subscribers (up 15% from a year ago), helping revenues lift 14%. And the top brass forecasts more gains in Q2 (another 15 million total subs and seven million paid subs)—with a steady ramp in gross margins throughout 2023 as well as sequentially smaller losses.

All in all, Spotify looks like a good, old-fashioned turnaround situation: It’s a huge player in a huge industry, and if management makes the right moves, there’s no reason the bottom line and cash flow won’t continue to improve for a long time to come.

And the stock is clearly sniffing this out this year, with a quick, persistent ramp from 80 to 120 (round numbers) in late December and January—and while the market has wobbled since then, SPOT has held its own, respecting its 50-day line and, as of last Wednesday, closing at 13-month highs.

It’s a good place to start a position in a former leader that’s getting well again.

Current Recommendations

Changes Since Last Week: Sensata Technologies (ST) Moves from Hold to Sell

As I mentioned at the top, only one sell today – Sensata Technologies (ST), which has dropped like a rock since reporting strong earnings a few weeks ago, never a good sign. So, our portfolio remains at its 20-stock cap. Most are acting well, with a few of them at or near multi-month or even all-time highs. Earnings reports are largely behind us, with a couple exceptions. Thus, where they go next will depend on non-earnings-related catalysts, at least until the market can break out of its current rut.

Here’s what’s happening with our stocks…

Updates

BYD (BYDDY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, was up a couple points this week, at one point touching as high as 63 – a three-month high. China’s largest electric vehicle maker is getting even bigger by the day, coming off a quarter in which it sold a record 552,076 electric vehicles – a 92.8% year-over-year increase. That was on the heels of a 2022 in which revenues more than tripled, as the company sold more than 1.85 million electric cars last year, including hybrids. The company has tons of momentum, and the share price (+27% year to date, but well shy of its July 2022 peak above 82) is only now playing catch-up. BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Value Investor advisory, has held most of its gains since a big post-earnings gap up from 36 to 41 a few weeks ago. At 40, shares of the media conglomerate are shy of Bruce’s 42 price target – though Bruce noted in his latest update that he might possibly raise that target. In the meantime, we have a nice 25% gain on the stock. BUY

Eli Lilly and Company (LLY), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, has settled into the 427-435 range after a huge run-up in March and April. Considering the market has mostly pulled back lately, that’s a good thing – and Tom is impressed, as he wrote in his latest update: “WOW! LLY continues to kill it. It’s up over 38% since being upgraded to a buy in early March and just made another new all-time high. The stock got a huge bump after the earnings report when it reported very promising results from its obesity drug tirzepatide. Obesity is a massive problem, and this seemingly superior drug has mega-blockbuster potential. The following week, Lilly reported promising trial results for its Alzheimer’s drug, another potential blockbuster that could be approved within the year.” BUY

Gates Industrial Corp. (GTES), originally recommended by Bruce Kaser in the Buy Low Opportunities Portfolio of his Cabot Value Investor advisory, pulled back to pre-earnings levels this week, though is holding above May support. In his latest update, Bruce wrote, “On May 4, Gates reported an encouraging quarter even though adjusted earnings of $0.25/share fell short of the $0.26/share estimate. Investors looked through the higher-than-expected tax rate and costs of a cyberattack as operating results were strong. Gates maintained its full-year guidance and authorized a $250 million (about 6% of current market cap) share repurchase program.

“In the quarter, sales rose 0.5%, but rose 4% excluding currency and were fractionally below estimates. Adjusted EBITDA rose 12% and was 4% above estimates. The margin expanded to an impressive 19.4%. Important to note, however, is that a credit loss of $11 million due to a customer bankruptcy, $5 million of costs related to the cyberattack, $6 million of restructuring costs and $10 million of stock-based compensation expenses were removed from Adjusted EBITDA. We understand the reasons why these costs were excluded, but it would be hard to convincingly argue that they truly are one-off items or not a part of the costs in today’s economy. With these costs, Adjusted EBITDA would have been $124 million, up 15% from a year ago, producing a healthy but less-impressive 15.8% margin.

“Debt net of cash fell 15% from a year ago although only incrementally compared to year-end. Leverage ticked down to a reasonable 2.7x EBITDA, the share count fell 3%, and free cash flow improved with a 105% conversion (free cash flow to net income).

“GTES shares rose 3% in the past week and have 15% upside to our 16 price target.” BUY

Green Thumb Industries (GTBIF), originally recommended by Michael Brush in Cabot Cannabis Investor, had a rough first week in the portfolio, thanks mostly to apparent stagnation of momentum in the push for the SAFE Banking Act, which would make banking services available to cannabis companies. A Senate banking committee convened last Thursday to hear both sides, and while there were enough compelling arguments made in favor of cannabis banking, investors appear to have focused on those who spoke out against the bill – at least for now. So, the stock was down about 16%, along with most other cannabis stocks.

In his latest update, Michael wrote, “Green Thumb, the biggest position in our portfolio at about 24%, reported first-quarter revenue gains of 2.4% to $248.5 million on May 3. Same-store sales grew by a solid 6% versus the prior year on a base of 73 stores. That helped drive total retail sales growth of 9.4%. This offset wholesale sales declines of 14.7%.

“In retail, the metric same-store sales can be a useful gauge because it strips out the impact of store openings and closings. The same-store sales growth confirms the strength of Green Thumb’s Rise dispensaries, and its branded cannabis products like &Shine, Beboe, Dogwalkers, Doctor Solomon’s, Good Green, incredibles and RYTHM.

“The company reported net income of $9 million, or four cents a share. Green Thumb posted operating cash flow of $75 million for the quarter, and $185 million in cash. At a time when the sector remains wobbly because of negative pricing trends, this cash strength is important for two reasons. First, it suggests the company will be a winner in the current cannabis Hunger Games. Second, cash-rich companies have the power to build strength with opportunistic acquisitions or store openings to take share. Green Thumb plans to open 15 retail stores this year in Virginia, Pennsylvania, Minnesota, Nevada, and Florida.”

From a company perspective, there’s a lot to like here. Let’s see if that was just one bad week or the start of yet another cannabis sector downturn. BUY

Kimberly-Clark de México (KCDMY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, continues to hold in the low 11s, where it’s been for about a month. The company is the Mexican subsidiary of Kimberly-Clark (KMB) and produces and sells in Mexico and overseas a wide range of consumer paper products. It’s a play on Mexico’s manufacturing discount, which is drawing interest thanks to wages that are 25% lower than in China and the U.S. BUY

Las Vegas Sands (LVS), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has given back almost half its April gains, falling from a high of 64 to 60 in the last two weeks. In his latest update, Mike wrote, “LVS has chopped around a bit since re-emerging to new highs three weeks ago, with peer Wynn’s so-so reaction causing some hesitation. Even so, if shares can hold firm around here, they would be in great position to get moving should the market improve.” BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, keeps tacking on points to hit new 52-week highs! The latest catalyst is the European Union approving the company’s $69 billion acquisition of video game giant Activision Blizzard (ATVI). Approval from EU regulators is viewed as a major hurdle after U.K. regulators blocked the deal last month due to antitrust concerns. The deal isn’t done yet but seems more realistic now that Microsoft has offered remedies to assuage regulator fears that the deal could thwart competition in the console and cloud gaming market. Coming on the heels of a strong quarter in which revenue improved 7% and net income increased 10%, there’s a lot of momentum here, and the stock is now up 28% year to date. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in his Cabot Explorer advisory, was up slightly this past week in the wake of a strong first-quarter earnings report the previous week. The drugmaker saw sales of its obesity medications Wegovy and Ozempic rise 124% in Q1, helping overall revenues improve 27% year over year. The stock is now up 27% since we added it to the portfolio in late December. BUY

On Holding (ONON), originally recommended by Mike Cintolo in Cabot Growth Investor, has been holding mostly firm ahead of earnings tomorrow (Tuesday) morning before the bell. In his latest update, Mike wrote, “On Holding (ONON) continues to look fine, basically chopping sideways with a slight upward tilt, which is more or less what we’re seeing from a lot of ‘strong’ names. We do have our antennae up due to the market environment given that, if a stock acts well for a few weeks, a near-term trap door often appears. Still, at this point we’re OK waiting to see what earnings (due May 16) brings—if you don’t want to hold through the report, that’s your call, but we’ll follow the plan given our small profit, the prior blastoff and the outstanding growth outlook.” BUY

Realty Income (O), originally recommended by Tom Hutchinson in Cabot Dividend Investor, keeps holding in the 61-62 range, where it’s been for more than a month. In his latest update, Tom wrote, “In a highly uncertain environment like this, where the narrative can change on a dime, income is king. And this legendary income REIT is the king of income stocks. The returns haven’t been inspiring so far. But this stock has held its own in a bear market. As the economy slows and moves towards recession, investors will continue to demand safety and O is a highly desirable safe income stock. Although Realty Income is a retail REIT, it is far less volatile than most because of the diversification and remarkably stable clients that offer essential services that are recession resistant. Its largest clients include Walgreens, 7-eleven, Dollar General, FedEx, Walmart and CVS. Tenants have a historic median 98.2% occupancy rate.” HOLD

Sensata Technologies (ST), originally recommended by Bruce Kaser in the Buy Low Opportunities portfolio of his Cabot Value Investor, just keeps falling even after reporting strong earnings three weeks ago. With a loss that’s now crept into the teens, let’s say goodbye to ST despite its potential upside (about 80% to Bruce’s 75 price target), as it’s clearly been one of this now-full portfolio’s biggest laggards. MOVE FROM HOLD TO SELL

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, is down about 4% since we last wrote, but appears to have set up shop in the 160-172 range this month – still comfortably above the 153 bottom it touched in April. The latest blow to the company and share price came from George Soros, the billionaire investor who, it was reported last Friday, slashed his stake in TSLA in the first quarter. All of TSLA’s weekly losses have come in the two trading days since. But that’s a temporary concern, and one that probably won’t affect TSLA shares for more than a few days. What will truly determine where the stock goes from here is how the company’s many price cuts this year impacts sales, margins, and profits. With no news on that front this week, TSLA remains a Hold. HOLD

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, has held its gains after a big earnings gap from 29 to 37 in early May. In his latest update, Mike wrote, “UBER has come alive after earnings, and while a wobble isn’t out of the question (especially in this environment), we’re thinking the third time’s the charm, with this upmove coming after a tighter launching pad and, fundamentally, with cash flow estimates continuing to rise.” BUY

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has encountered some rare selling, falling 7.4% since bumping up against resistance at 551 in late April. No matter. There’s been no news, the stock remains well above its 200-day moving average, and we’re still up roughly 34% on it. Plus, earnings are due out next week, May 25, and those have been major catalysts for immediate pops in the share price of late. So, it’s not a bad time to buy the dip. BUY

UnitedHealth Group (UNH), originally recommended by Tom Hutchinson in Cabot Dividend Investor, has been in the 482-495 range for the past month. In his latest update, Tom wrote, “This recent portfolio addition has strong predictable revenues in a very defensive business ahead of a possible recession down the road. UNH has been a terrific stock to own in any market, as its three-, five- and 10-year returns attest. But it is also the epitome of a stock to own during an economic downturn. It pulled back since being added to the portfolio, but I expect the stock to be solidly higher in the months ahead.” BUY

Visa Inc. (V), originally recommended by Tom Hutchinson in Cabot Dividend Investor, has been mostly holding in a tight range between 231 and 234. In his latest update, Tom wrote, “V has been hanging very tough near the high point of the recent range. The payments processing company once again exceeded expectations on earnings. Visa grew earnings per share by 17% and revenues grew double digits versus last year’s quarter. And this is what the company does in a bear market with the economy slowing. It can really take off when the market recovers for good. V should be higher by the end of the year but there is a chance it pulls back somewhat after moving to recent highs.” BUY

Wingstop (WING), originally recommended by Mike Cintolo in Cabot Growth Investor, is mostly holding firm after a big earnings gap a couple weeks ago. In his latest update, Mike wrote, “Wingstop (WING) popped nicely on earnings before quickly giving up some ground—again, the sell-on-strength environment is affecting most everything out there—but the retreat wasn’t overly severe, and the stock is finding some support north of 200. We took partial profits here two weeks ago and are aiming to give the rest some room to maneuver, especially with business really powering ahead (three straight quarters of 40%-plus revenue growth) and the stock having punched out to all-time highs, surpassing its late 2021 summit.” We have a 22% gain on the stock in just two months. 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, keeps holding in the 28-29 range, where it seems to have found support following a post-earnings selloff. The earnings weren’t bad at all, with revenues up 40% and EPS losses narrowing to almost nothing (-$0.02). Management said they see full-year 2023 revenue higher than previously expected, in a range of $295 - $300 million (+20%), which straddles consensus of $295 million. They also see net new studio openings in the range of 540 to 560 (+8% over 2022). Adjusted EBITDA, a measure of profitability, is seen up 40% to a range of $102- $106 million. So, the growth story with this leader in the boutique fitness studio and fitness brand space remains very much intact. And with gains north of 60%, the stock remains our biggest recent winner. Bumping up against support, this looks like a solid entry point. BUY

The next Cabot Stock of the Week issue will be published on May 22, 2023.