Cabot Stock of the Week Issue: November 7, 2022

The Federal Reserve managed to throw cold water on any budding investor optimism following a promising October, though the damage has been relatively minimal, with the S&P 500 down about 2.5% since we last wrote, though the Nasdaq suffered much steeper losses, down 5%. Still, all three major indexes remain north of their September/October lows, and the real test may come this week with Tuesday’s midterm elections and Thursday’s inflation data release.

Historically, the midterm elections spark a rally through year’s end (and beyond) as months of uncertainty finally give way to clarity; that could especially be the case this year as tight races abound, and control of Congress is totally up in the air (the Senate is a virtual toss-up). But, if the consumer price index (CPI) comes in higher than expected again on Thursday (economists are expecting 7.9% inflation in October), then it could limit any post-midterm market bump. Regardless, things could change drastically between this issue and next – again.

In the meantime, we’re holding firm with our 14 existing positions, most of which outperformed the market in the past week. Also, we’re adding one of the rare growth titles that’s held up well of late and has been a favorite of Cabot Growth Investor Chief Analyst Mike Cintolo for quite some time. Here are his latest thoughts on it.

Wingstop (WING)

So, let’s say you’re an institutional, growth-oriented money manager right now, with a mandate to remain nearly fully invested. Where do you turn? You could go for super-liquid growth stocks, the mega-caps of the world—but those might be the weakest names out there right now (Amazon, Microsoft, Google, etc.) as most other big investors unwind positions. And then there are the aggressive names like cybersecurity, cloud software and the like, which are also being unwound. You probably have a handful of “safe” growth names (healthcare, etc.), but need more.

More than likely, you’re going to be looking for stocks that (a) already went through the wringer to some extent to kick out the weak hands, but also (b) have come back strongly as business, which had taken a hit, had come back strongly and promises good things no matter what tremors hit the economy.

That leads us to Wingstop (WING), which has always had a solid story, but it saw business convulse a bit during the pandemic, first surging when digital ordering took over (the firm has always had a great online platform and still gets north of 60% of its orders that way) and then sag after (as the world turned right side up and as chicken wing prices spiked). In essence, the pandemic ended up being a bit of a distraction that got things off course.

But this powerful cookie-cutter story is back on track, which is attracting lots of the aforementioned big fish’s attention. There’s a lot to like: The menu is relatively simple, with wings in a dozen or so seasonings and flavors, and it’s been moving into non-bone products like chicken sandwiches, too. The company ended Q3 with 1,898 restaurants (1,631 in the U.S., nearly all franchised, and 225 overseas), which was up around 13.5% from a year ago, with the long-term plan of growing the store base by around 10% per year.

Indeed, management has a goal of 4,000 domestic locations and 3,000 international (the overseas count was up 25% from last year), with a goal of becoming a top 10 global restaurant brand—so you know the top brass is thinking big.

Beyond just opening new restaurants, sales at existing restaurants are picking back up after the pandemic-induced spike produced tough comparisons of late; in Q3, domestic same-store sales were up 6.9%, which is very solid and up from a 3.3% decrease (Q2) and a 1.2% increase (Q1) the prior couple of quarters. And this is happening while wing prices have fallen back to pre-pandemic levels, which is obviously helping drive down costs. (The move into more non-bone chicken offerings should help long-term margins, too.)

Yet perhaps more important is what that resumption of growth means for the underlying economics of the business: Wingstop’s average location brings in about $1.6 million, but it only costs about $415,000 to open a restaurant, which leads to a 70% payback of the initial investment in the first year! And the firm believes it has a clear path to raising the average revenue figure to $2 million, which would only boost the attractiveness to franchisees—indeed, Wingstop’s store pipeline is stronger now than a year ago, with management seeing nothing stopping another big store opening year in 2023.

There will always be some ups and downs in the details, but it certainly looks like the firm’s steady, reliable growth path is back on track, with years of upside ahead. In Q3, revenue growth lifted 41% and earnings were up 55% (EBITDA, which is probably a better profitability measure for the firm, grew 33%), with analysts seeing 20%-ish bottom-line growth likely for the foreseeable future.

As for the stock, it topped out for more than a year and then skidded with everything else earlier this year, sinking as low as 68 in May. But then shares saw a huge-volume rally back (helped by the Q2 report) above its 40-week line and many choppy weeks as the market dipped back toward its lows. And two weeks ago, WING popped again after the Q3 report. There is some resistance in this area from the middle of last year, but with the path of least resistance pointed up, we’re going to take advantage of the stock’s brief rest to grab a position. BUY

Current Recommendations

Changes Since Last Week’s Update
None

For the second straight week, we have no changes. The addition of Wingstop (WING) bumps our portfolio to 15 stocks – making it 75% full, in essence. This feels like the calm before the storm: Five of our companies report earnings this week, so it would be surprising if we have a third straight week of no rating changes, either up or down. Sprinkle in the midterm elections and the latest inflation data, and this is shaping up to be one of the more pivotal weeks of 2022.

Before the chaos ensues, here’s what’s happening with each of our existing positions.

Updates

Arcos Dorados (ARCO), originally recommended by Bruce Kaser in Cabot Undervalued Stocks Advisor, didn’t budge this week, which qualifies as a victory. Earnings are due out next week (November 16), which should get the shares going one way or another. In his latest update, Bruce wrote, “Macro issues have a sizeable impact on the shares’ trading, including local inflation and the Brazilian currency. Since early 2020, the currency has generally stabilized in the 1.00 real = $0.20 range – a remarkably favorable trait given the sharp declines in other currencies around the world. As the company reports in U.S. dollars, any strength in the local currency would help ARCO shares.

“In the October 30 presidential election in Brazil, former president Lula won 50.9% of the votes, compared to 49.1% for current president Bolsonaro, in the closest race in the country’s history. While we are not political experts, this outcome seems favorable to Arcos as it could bring incrementally more spending stimulus yet will likely result in little major spending changes due to the narrowness of the victory margin. One risk among many is that, since the current president has not conceded, Bolsonaro’s supporters may rally/riot with allegations of voting fraud. This disruption would likely hurt sentiment toward the Brazilian stock market and currency. So far, the Brazilian stock market has had a mildly positive reaction to the election results.

“ARCO shares … have 13% upside to our 8.50 price target.” BUY

Brookfield Infrastructure Partners (BIP), originally recommended by Tom Hutchinson in Cabot Dividend Investor for his Dividend Growth Tier, is down slightly since reporting third-quarter earnings last Wednesday, despite a very solid quarter. In his latest update, Tom wrote, “The infrastructure partnership reported terrific earnings this morning. It soundly beat expectations with funds from operations (FFOs) growth of 24% for the quarter. That’s impressive considering BIP has fallen more than 20% from the high over the past couple of months. Rising interest rates soured investors as fixed-rate alternatives became more attractive. There was also some concern about the strong dollar and negative exchange rate effect. But this is a terrific company with reliable earnings in a recession that should be performing better.” HOLD

Centrus Energy (LEU), originally recommended by Carl Delfeld in Cabot Explorer, reports earnings before the bell tomorrow (Tuesday, November 8). The stock was down this week along with most other renewable energy names, giving back some of the gains from the previous two weeks. Still, at 45 as of this writing, LEU remains one of our biggest winners. We’ll see how it responds to earnings tomorrow. HOLD

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Undervalued Stocks Advisor, was essentially flat in its first week in the portfolio on the heels of a recent Q3 earnings report, which was mostly good. Bruce elaborated on that report in his latest update: “On Thursday, October 27, Comcast reported a decent quarter that was consistent with our thesis. Revenues slipped 2%, but this was entirely due to the one-time boost last year from the NBC coverage of the Tokyo Olympics. Even so, profits expanded by 6%, which included record-high profits at the cable segment and the U.S. operations of Universal theme parks. Small losses in the number of cable subscribers were nearly offset by an increase in wireless subscribers. Comcast repurchased $3.5 billion of shares in the quarter. Overall, Comcast is making incremental progress with its incremental initiatives to defend its franchises and is returning sizeable amounts of cash to shareholders.

“Revenues fell 2% from a year ago but were in line with estimates. Adjusted earnings of $0.96/share rose 10% and were 7% above estimates. Adjusted EBITDA of $9.5 billion rose 6% and were 3% above estimates.

“Total revenues fell about $450 million. Advertising revenues fell $1.2 billion (-26%), contributing more than all of the revenue decline. However, ad revenues from a year ago were boosted by $1.8 billion from the NBC coverage of the Tokyo Olympics – excluding this boost, total revenues would have increased by 5%. Cable operations revenues rose a dull but solid 3%, while within NBCUniversal, revenues from theme parks, content licensing and theatrical all rebounded sharply from pandemic-weakened results a year ago. The Sky operations were uninspiring, as revenues were flat excluding the effects of the weak British pound but fell 15% on a reported basis. Sky’s customer base showed incremental growth.

“Even with the weaker ad revenues, Comcast’s profits increased by 6% as measured by adjusted EBITDA. The company kept its expenses restrained (falling 5%), helping increase the profit margin to a healthy 32% from 30% a year ago. Cable profits were a record, and profits at NBCUniversal rose 25%. Sky profits fell 16% adjusted for the weak British pound, reflecting ongoing cost increases as well as upfront programming costs for the 2022 FIFA World Cup.

“Debt net of cash on the balance sheet rose an incremental $1.3 billion from a year ago, but the leverage ratio declined incrementally due to higher profits. Comcast used its healthy free cash flow of $3.4 billion (+5% from a year ago) to repurchase $3.5 billion of shares and also paid its $1.2 billion in quarterly dividends.

“Our price target for Comcast shares is 42, based on 6.5x EV/EBITDA using a conservative estimate for 2024 results.

“Comcast shares were flat for the past week and have about 32% upside to our 42 price target. The shares offer an attractive 3.4% dividend yield.” BUY

Enphase Energy (ENPH), originally recommended by Mike Cintolo in Cabot Top Ten Trader, coughed up much of its gains from the previous couple weeks, plummeting from a high of 308 to 270. Still, the stock is well ahead of its October lows (237) and our buy price (198), and the company is still coming off a strong earnings report. In Q3, sales were up 81% year over year, while earnings per share improved 108%(!), both of which handily topped estimates. But after a 20% run-up in a matter of days following that report, some consolidation was to be expected, especially given last week’s Fed-induced market weakness. So, we kept it at Hold despite the run-up, and will continue to keep it there until ENPH settles into a more predictable pattern. HOLD

Green Thumb Industries (GTBIF), originally recommended by Tim Lutts and then Michael Brush in the Sector Xpress Cannabis Advisor, is up slightly since we last wrote thanks to a decent earnings report on November 2. Revenue improved 12% year over year and is now up 17% through the first nine months of the year, while EBITDA increased 32% over the third quarter a year ago. The market seemed to like the results enough, pushing shares up about 5% since they came out. Even better, the stock is now up 50% from its early-July lows, and yet still trades well below its late-August and early-October highs in the upper 13s. This looks like a great entry point if you haven’t already bought. BUY

Kinross Gold (KGC), originally recommended by Clif Droke in his Sector Xpress Gold & Metals Advisor, was up about 6% in the last week ahead of the gold mining company’s third-quarter earnings report this Wednesday, November 9. Kinross Gold is a senior mining firm that acquires, explores and develops gold properties in the U.S., Canada, Brazil, Chile, and Mauritania. Both revenue and earnings are expected to be down in Q3, but perhaps the low bar will lend itself to a surprise – and perhaps another bump in the shares. We’ll see. BUY

Montauk Renewables (MNTK), originally recommended by Brendan Coffey in his Sector Xpress Greentech Advisor, continued to bleed lower, falling from 15 to just below 14 this morning. The recent closing low is 14.14, so if the stock closes below that level today, it will be a new low since early August. With earnings due out this Wednesday, November 9, let’s hang on, for now, to see if a beat can spark a turnaround. A miss and additional weakness in the stock will surely have us selling shares of this renewable energy upstart in next week’s issue, if not earlier. HOLD

Ormat Technologies Inc. (ORA), originally recommended by Brendan Coffey in his Sector Xpress Greentech Advisor, is why it’s worth hanging onto companies – particularly relative upstarts – through earnings: ORA shares are up about 12.5% since reporting earnings on November 2! Q3 results beat both revenue and earnings estimates. While EPS was up just a penny (to 33 cents from 32 cents) from the same quarter a year ago, it blew past the 25 cents per share analysts were anticipating. Meanwhile, revenues ($175.9 million) narrowly topped estimates but were up 10.7% from the same quarter a year ago. Furthermore, the geothermal energy company’s CEO said Ormat is “on track with the commercial operation of most of our geothermal projects” and that the company “continues to see strong global tailwinds for renewables.” That all sounds positive, which is why investors pushed the stock up to new 52-week highs above 99. For the year, ORA shares are now up more than 25% – quite the contrast with the rest of the market. Like Enphase Energy, Ormat could pull back this week following such a big run-up. But we’ll keep it at Buy. BUY

Rivian (RIVN), originally recommended by Tyler Laundon in Cabot Early Opportunities, retreated right back to 31 a week after rising to 34, likely in sympathy with the market. Where it goes next will depend on the Q3 earnings report due out this Wednesday, November 9. Analysts are expecting huge revenue growth but a big earnings drop-off for this fast-rising maker of electric SUVs. Stay tuned. BUY

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, remains the standard Rivian and every other EV upstart is chasing. But the stock has had a rough go in the last six weeks or so, dipping to new 2022 lows after sinking 4.5% this morning. TSLA’s latest nosedive comes on the heels of a big run-up the week prior. Why another retreat? Nothing specific, as earnings are well in the rear-view mirror at this point. Elon Musk’s new high-profile role as Twitter chief has some in the industry concerned his divided attention will hurt Tesla, which is part of the reason for the selling. But a lot of it was market-driven, as many of the mega-cap tech names (AMZN, AAPL, MSFT) that occupy the same rarified air as Tesla have collapsed this earnings season. Coming off a quarter in which sales improved 41.6% and profits nearly doubled, I continue to think TSLA shares won’t stay down long – and that the latest retreat is yet another prime buying opportunity. BUY

Ulta Beauty (ULTA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, pulled back a tad after adding 19% the previous week but is still well above its moving averages. Despite a dizzying number of ups and downs, the overall trajectory looks good, with shares of this beauty retailer up more than 17% since May and 9% since it was added to the Stock of the Week portfolio. HOLD

WisdomTree Emerging Markets High Dividend Fund (DEM), originally recommended by Carl Delfeld in his Cabot Explorer advisory, had a nice week, rising from the low 32s to the upper 33s, though it remains mired in the tight 31-34 range in which it’s been stuck since late September. In his latest update, Carl wrote, “WisdomTree Emerging Markets High Dividend Fund (DEM) offers us a smart asset allocation play with both a high dividend yield and some of the highest quality emerging market stocks in the world with an average price-to-earnings ratio of around 5. This ETF covers 17 different emerging markets and gives broad exposure to large caps, mid-caps and small caps in these countries with an emphasis on income and value. The stocks in its basket tend to be conservative, defensive companies with low valuations and high dividends.” BUY

Xponential Fitness (XPOF), originally recommended by Tyler Laundon in his Cabot Early Opportunities advisory, is down about 11% in the last two weeks ahead of earnings this Thursday, November 10. In fact, the stock broke below its months-long trading range between 17.8 and 21, albeit narrowly. Still, not a great sign. Let’s see how the company’s earnings go before changing the rating, which remains a Buy. The company is the largest franchisor of boutique fitness brands in the U.S., with roughly 2,000 studios across 48 states. It also has over 175 studios open in 11 foreign markets and even has studios on cruise ships crossing the world’s oceans. BUY

The next Cabot Stock of the Week issue will be published on November 14, 2022.