Cabot Stock of the Week Issue: October 16, 2023

Stocks are having a nice bounce-back in October, with the S&P 500 up 1.75% and the Nasdaq advancing 2.25% through the first half of the month. It’s not much, especially when you consider that the market began the month by dipping to new post-summer lows. But there’s reason to believe that yet another October bottom has already been put in, and that – as my colleague Mike Cintolo is fond of saying – the next big move is likely to be up.

The just-underway third-quarter earnings season will help determine the market’s direction, and we have a few big earnings reports looming among our portfolio holdings, starting with Tesla (TSLA) this Wednesday. To temper some of the big swings we could see among our stocks in the coming month to six weeks, today I’ve decided to add a safer play in the form of a dividend-paying stock that’s benefiting from the resurgent global supply chain. It’s a name Tom Hutchinson just added to his Cabot Dividend Investor portfolio.

Here it is, with Tom’s latest thoughts.

McKesson Corporation (MCK)

The pandemic aftermath made us acutely aware of the importance of supply chains. The Oxford Dictionary defines a “supply chain” as the processes involved in the production and distribution of a commodity. It is how stuff gets from the producer into your hands. It involves the pickup and delivery with transportation, storage, distribution centers and networks in the middle.

The pandemic shutdown greatly disrupted these vital supply chains for a while. Many previously abundant products became in short supply. It was tougher to buy a car, get eggs, and many other things. Prices soared as a result. And the previously taken-for-granted supply chains became part of the national vocabulary.

Efficient distribution is what makes this whole consumer economy work. Producers and retailers are not distribution experts. This vital function is mostly done by companies that specialize. Maintaining supply chains is crucial to a functioning economy. In some cases, it is vital to maintaining people’s health and even surviving, such as with the delivery of vital medicines and pharmaceuticals.

McKesson Corporation (MCK) is a leading domestic wholesaler of branded, generic, and specialty pharmaceutical products. The company operates a supply chain that delivers products from 1,300 drug manufacturers to over 180,000 points of dispensation throughout the country. It has a solid base of over 40,000 customers and supplies about one-third of the U.S. drug distribution market. It’s a goliath with $284 billion in annual revenues.

McKesson buys drugs from manufacturers, delivers them, and resells them to retailers at a profit. Established in 1833, the company has been honing the process for nearly two centuries. It delivers from 1,300 producers to over 180,000 retailers by using 29 strategically located distribution centers throughout the country. Naturally, it has strategic partnerships with companies like CVS (CVS), Walmart (WMT), and Rite Aid (RAD).

The extensive distribution network and enormous scale provide tremendous bargaining leverage with suppliers and customers that can’t be easily duplicated by would-be competitors. That’s why the business is an oligopoly. McKesson, Cencora Inc. (COR) and Cardinal Health (CAH) account for 90% of the drug wholesale distribution market in the United States. There are very high switching costs among the providers, so they rarely lose business to the other two companies.

McKesson operates in four business segments: U.S. Pharmaceuticals, Prescription Technology Solutions, Medical-Surgical Solutions, and International. But the U.S. Pharmaceutical segment is by far the main event, accounting for 90% of revenue in fiscal 2023. This segment delivers the spectrum of branded, generic, specialty, biosimilar, and over-the-counter pharmaceuticals.

In this tough earnings environment, McKesson delivered revenue growth of 11% and adjusted earnings per share growth of 25% in the last reported quarter, which was the first fiscal quarter of 2024. The results were helped by solid volume growth in pharmaceuticals. It also raised the quarterly dividend 15% and raised guidance for the rest of fiscal 2024. The company expects earnings growth of 13% to 16% and revenue growth of 13% to 15% for the year.

The dividend is rather lame. It’s only $2.48 per share, which translates to a yield of 0.57% at the current price. The dividend is easily supported by over $4 billion in annual free cash flow and a payout ratio of just 8.05%. But it has grown the payout by an average of about 12% over the last three years. And companies that consistently grow the dividend tend to be the best-performing stocks on the market over time.

High performance has certainly been the case with this stock. Here’s how McKesson’s business has translated into stock total returns over the past several years compared to the overall market.

MCK has delivered more than four times the return of the S&P over the last five years and 6.5 times the return over the last three. But this isn’t a high-growth technology stock that’s been clobbering the market. This is a steady defensive stock with highly reliable earnings that has performed so well with far less risk and volatility than the overall market. MCK has a beta of just 0.59, which means the stock is only about 60% as volatile as the market.

While the past is no guarantee about the future, there are reasons to believe the stock can continue to deliver market-beating performance going forward. For one, the management is very shareholder-friendly. The company currently has an $8.9 billion share buyback program over the next few years. It plans to buy back $3.9 billion worth of those shares in fiscal 2024.

McKesson is also focusing on high-growth areas in oncology and biopharmaceutical services. In fact, its oncology network already serves 15% of new patients. Management knows the business and where the best opportunities are to deliver pharmaceuticals and services. The company also has plenty of free cash flow it can use to expand and make acquisitions.

That’s all well and good. It has a solid plan to proactively grow its business. But it doesn’t have to go crazy doing that because the main growth catalyst is the growth in existing markets.

Pharmaceutical demand continues to rise every year at a solid pace because of the aging population. It has a huge share of a business that will grow all by itself. That’s the advantage of a massive tailwind like the aging population megatrend.

The stock is selling near the high. But despite the recent performance, MCK sells at just 15.5 times forward earnings, which is well below the valuation of the overall market.

Current Recommendations

Changes Since Last Week: SI-Bone (SIBN) Moves from Buy to Sell

One more sell in this week’s issue, as small-cap MedTech SI-Bone (SIBN) has fallen apart along with most other stocks in the MedTech space of late. With the addition of McKesson (MCK), that again leaves us with 21 holdings in the portfolio. Fortunately, most of them are acting well – including several that are hitting either multi-year highs or all-time highs! That’s not something we’ve seen in a couple months, which could be an early harbinger of better things to come for the market. Regardless, we’ll take the “wins” when we can get them.

Here’s what’s happening with all our stocks.

Updates

AdvisorShares Pure U.S. Cannabis ETF (MSOS), originally recommended by Michael Brush in Cabot Cannabis Investor, is down slightly in the last week but is mostly holding near support around 7. There’s been no news for the cannabis sector of late, though as Michael noted both in his update last week and in my Street Check podcast chat with him on Friday, potential industry catalysts abound. Those include likely approval of rescheduling cannabis to a Schedule III drug by the Drug Enforcement Administration (DEA); progress in Congress for the SAFER Banking Act that would grant cannabis vendors banking access; ballot votes in Ohio and Florida, and more. Prior to August, it was easy to scoff at any “promising” catalysts for the sector after it had been beaten to a pulp for two and a half years, with very little reprieve. Then, the Food and Drug Administration (FDA) issued its rescheduling recommendation in late August, and this very ETF – a proxy for some of the best, most established, publicly traded U.S. cannabis companies – nearly doubled in a matter of two weeks. If and when the DEA approves rescheduling, which could happen before year’s end, this fund could double again. So, we’ll hang on through any gyrations (within reason) until then. If you haven’t yet bought, this is a good place to do so, with the fund appearing to be holding support for the last two weeks. BUY

Alibaba (BABA), originally recommended by Carl Delfeld in his Cabot Explorer advisory, held firm at 84 a share. One potential near-term catalyst, Carl wrote, is that Beijing is considering “increasing fiscal stimulus to boost consumer spending. Over the last 10 years, Alibaba grew revenue 36% per year on average, but post-pandemic Alibaba’s revenue slowed to an increase of just 2% year over year. The good news is that a recovery in consumer spending may be underway and shares trade at a cheap valuation of less than 10 times this year’s consensus earnings estimate.” That’s reason to buy now. BUY

Aviva plc (AVVIY), originally recommended by Bruce Kaser in Cabot Value Investor, held its gains from the previous week after gapping up from 9 to 10. Shares of this U.K.-based life insurance and investment management firm still have 38% upside to Bruce’s 14 price target. Also, as Bruce wrote in his latest update, “Based on management’s guidance for the 2023 dividend, which we believe is a sustainable base level, the shares offer a generous 8.0% yield. On a combined basis, the dividend and buybacks offer more than a 10% ‘shareholder yield’ to investors.” HOLD

Blackstone Inc. (BX), originally recommended by Mike Cintolo in Cabot Top Ten Trader, bounced off 103 support and is knocking on the door of 106 this morning. Earnings are due out this Thursday, October 19. Not much is expected after a down third quarter for the market: Analysts are looking for 0.5% revenue growth with a 3.8% EPS decline. The company has a habit of beating earnings estimates, however, having done so in each of the last four quarters. So we’ll see if Thursday’s numbers can clear a low bar. BUY

Broadcom Inc. (AVGO), originally recommended by Tom Hutchinson in Cabot Dividend Investor, had an excellent week, rising exactly 50 points, or nearly 6%, to top 900 a share for the first time since the last day of August. The catalyst behind the big move is news that Chinese regulators are close to green-lighting Broadcom’s proposed $61 billion acquisition of VMWare (VMW), which could close as early as this month. VMWare is a Chinese company that specializes in virtualization software, allowing users to replicate hardware functions through software-based virtual machines. If approved, the VMWare deal would greatly enhance Broadcom’s artificial intelligence profile – which is a big reason the stock is up 61% year to date. We now are back in the black on this stock, but there’s more upside ahead. BUY

BYD (BYDDY), originally recommended by Carl Delfeld in his Cabot Explorer advisory, bounced back nicely this week, adding 3%. In his latest update, Carl wrote, “BYD shares reached 62 this week as the company battles Tesla, which still leads BYD in EV sales globally. This could change in the fourth quarter as BYD ramps up exports and takes advantage of its greater range of EV offerings, ranging from $10,700 to $150,600.” Because of the growth, this remains my favorite long-term position in the portfolio. BUY

Comcast Corporation (CMCSA), originally recommended by Bruce Kaser in the Growth & Income Portfolio of his Cabot Value Investor advisory, is back up to 44 today but has been in the 43-45 range for more than a month. There was no major news, although Seaport Global did initiate a Buy rating on October 6. Earnings are due out October 26. BUY

CrowdStrike (CRWD), originally recommended by Mike Cintolo in Cabot Growth Investor, remains scorching, hitting new 52-week highs above 187 after rising another 3% since we last wrote. Mike likes what he sees, as he wrote in his latest update: “CrowdStrike (CRWD) is certainly acting like a leader should this market upturn morph into the real McCoy, with a straight-up move on solid volume beginning as soon as the pressure came off the market last Friday. (It also doesn’t hurt that peers like Zscaler (ZS) and Palo Alto Networks (PANW) have also been acting well.) Management’s hike of three-to-five-year targets a few weeks back was likely a perception changer, with solid top-line growth expected to result in much higher levels of free cash flow and earnings than previously thought. We’d obviously like to average up, but we’re not eager to push the envelope after the market’s bounced into some resistance. If you’re not yet in, try to start a position on dips of a few points.” Sounds like good advice. Buy now, even if you’ve missed out on the 15% gain in the six weeks since we added CRWD to the Stock of the Week portfolio. BUY

DraftKings (DNKG), originally recommended by Mike Cintolo in Cabot Growth Investor, has barely budged overall in the last week despite some ups and downs. In his latest update, Mike wrote, “DraftKings (DKNG) is sitting near the middle of its three-month range, with buyers and sellers taking turns pushing the stock around. We’re optimistic the next big move is up as the chart looks normal (the two big-volume up days in late September aren’t decisive, but are encouraging; the RP line isn’t far from new high ground) and the competition fears from ESPN seem to have died down.” BUY

Eli Lilly and Company (LLY), originally recommended by Tom Hutchinson in the Dividend Growth Tier of his Cabot Dividend Investor advisory, is on a tear again, pushing to new all-time highs! A new study showed that Lilly’s red-hot diabetes drug, Mounjaro, helped people who are obese or overweight lose at least a quarter of their body weight, or about 60 pounds on average. Mounjaro was approved for use in the U.S. in May 2022, and as Tom noted in his latest update, the company “has two potential mega-blockbuster drugs up for FDA approval this year as well as stellar earnings growth for the next several years.” With the stock trading at new highs, we now have an 86% gain on LLY in just seven months! Because it has plenty of momentum right now, I’ll keep my official rating at Buy. But if you got in early after we added it to the portfolio in mid-March and haven’t already done so, I would strongly suggest taking a few shares – anywhere from a quarter to a third of your initial position – off the table to book some well-earned profits. BUY

GitLab (GTLB), originally recommended by Tyler Laundon in Cabot Early Opportunities, is back up to 47 after dipping as low as 42 in late September. Its latest upmove has piqued Mike Cintolo’s interest, as he has added the software developer to his Cabot Growth Investor Watch List. Here’s what Mike had to say about it in his latest update: “GitLab has a unique DevOps platform that, in a nutshell, helps software developers test the code they wrote, merge it into existing code, push it out to users and make sure it’s working as expected. Revenues have been slowing but should crank ahead at 30% rates for at least the next couple of years, and the bottom line is just eking into the black—and the stock has set up a solid three-month pattern.” We’ll keep it at Hold for now, but a break above 48 could have us upgrading back to Buy. HOLD

Krystal Biotech (KRYS), originally recommended by Tyler Laundon in Cabot Early Opportunities, has been in a range between 110 and 118 for about the last month. There’s been no news, and the company won’t report earnings until next month, so it may continue in that range for a while unless the market rallies. But the intermediate-term picture is quite bright: Krystal Biotech is a biotech company with treatments for rare diseases that is transitioning from clinical- to commercial-stage with the upcoming launch of its first gene therapy, Vyjuvek. The pipeline is focused on treatments for inherited dermatological and respiratory diseases, with investigational therapies for oncology and ophthalmology as well. As a result, revenues are set to explode: from zero in Q2 to $8.7 million in Q3 as Vyjuvek hits shelves to $25.8 million in Q4. That implies 2023 revenue of $33.1 million, then $186.4 million in 2024 (+462%). BUY

Microsoft (MSFT), originally recommended by Tyler Laundon in Cabot Early Opportunities, is up about 1.5% since we last wrote and is approaching 338 resistance. A break above that level would be quite bullish. The company closed its record $69 billion buyout of gaming giant Activision Blizzard (ATVI), maker of the immensely popular Call of Duty online game. It’s the largest deal in the history of the gaming industry. U.K. regulators finally approved the deal late last week, sending MSFT shares up in early trading today. Activision Blizzard also makes Candy Crush and World of Warcraft, among other popular online games. In addition, Microsoft reports earnings on October 24, so the combination of earnings and the Activision Blizzard buyout finally gaining approval after a two-year battle could spur another rally in MSFT shares. Good time to buy the stock. BUY

Novo Nordisk (NVO), originally recommended by Carl Delfeld in Cabot Explorer, is, like Eli Lilly, hitting new all-time highs – and for essentially the same reason (its diabetes/weight-loss drugs)! Shares of NVO are up nearly 9% since our last issue, pushing above 100 for the first time ever after trial results showed that Ozempic, one of its two signature diabetes drugs along with Wegovy, is also effective at treating kidney failure. The company is ending the trial almost a year early due to the clarity of the results, which show that semaglutide – a key ingredient in Ozempic – delays the progression of chronic kidney disease and thus lowers the risk of death in those who are treated with it. The findings could greatly expand Ozempic’s total addressable market beyond just those who use it for diabetes treatment or weight-loss purposes. So, NVO shares have now reached new height, and we have a 50% gain on the stock. As with LLY, if you bought early after our recommendation late last December, I recommend booking profits on a few NVO shares. Otherwise, it’s a Buy. BUY

Nutanix (NTNX), originally recommended by Mike Cintolo in Cabot Top Ten Trader, had a fantastic first week in our portfolio, rising nearly 8% to reach new two-year highs above 38 a share. There was no company-specific news; instead, the surging cloud software company is likely getting a second wind after its September earnings report impressed, highlighted by a 30% increase in recurring revenue in Q2. Mike has flagged NTNX as a potential leader of the next major advance, adding in his latest update, “the combination of an in-demand product and a completed move to a subscription model should produce buoyant sales, earnings and free cash flow growth for many years.” BUY

ServiceNow (NOW), originally recommended by Mike Cintolo in his Cabot Top Ten Trader advisory, is one of the fewest stocks in our portfolio that actually fell this past week, down just over 2%. Still, the stock is well clear of multi-month support at 541, and there appears to be no nefarious reason behind the pullback. Perhaps third-quarter earnings – due out October 25 – can be the thing to wake this big-cap cloud-computing stock from its recent mini-slumber. BUY

SI-Bone (SIBN), originally recommended by Tyler Laundon in Cabot Early Opportunities, has fallen apart, and it’s time to bail. Shares dipped below 20 support last week and have continued to plummet, falling all the way to 17, all on no obvious news aside from the sudden sell-off in the MedTech space. With a sizable loss on the stock, let’s get out now before it mushrooms into an even bigger loss. MOVE FROM BUY TO SELL

Tesla (TSLA), originally recommended by Mike Cintolo in Cabot Top Ten Trader, was down about 4% ahead of earnings this Wednesday, October 18. Expectations are low for the quarter, with analysts forecasting 10% revenue growth but a 30% EPS decline. But what Wall Street will really have its eyes on are the margins, which are likely to drop again on the heels of more price cuts (as much as 6%) in Q3. Thanks to persistent inflation in the U.S. and surging competition from BYD in China (see above), Tesla has made a series of cuts to prices on some of its top-selling models. We’ll know more after Wednesday’s report, but the pullback in TSLA shares in recent days is likely telling us something. BUY

Tractor Supply Company (TSCO), originally recommended by Tom Hutchinson in the Dividend Growth Tier of Cabot Dividend Investor, fell sharply below its traditional 202-203 range – and has since spiked back to 206, near its October highs. There was no news for the farm and ranch supply retailer; earnings are due out October 26. We’ll hang in there until then unless there’s another deep retreat that lasts longer than just a few hours. HOLD

Uber (UBER), originally recommended by Mike Cintolo in Cabot Growth Investor, is back to its normal 44-46 range after briefly dipping to 43 last Friday. In his latest update, Mike wrote, “Uber (UBER) has perked up with the market and continues to have a series of slightly higher lows (unlike the major indexes), which bodes well. That said, similar to DKNG, it’s sort of in no-man’s land, just gyrating in the middle of the consolidation that began at the end of July. We think the juice is there for another uptrend if/when the market truly gets moving, but at this point we’re just sitting tight and giving the stock room to breathe. Earnings are due November 8.” With a 30% gain on the stock, we’ll keep it at Buy. BUY

Zillow Group (ZG), originally recommended by Tyler Laundon in Cabot Early Opportunities, keeps holding 41 support, so we will stick with it despite downgrading to Hold last week. None of the news for the housing market has been good of late – home sales are on track for their slowest year in more than a decade, due mostly to limited inventory and mortgage rates north of 7%. But, with the Fed likely to start cutting rates sometime next year, this position is essentially a future bet on better days for the housing market. Just so long as our losses (roughly 14% as of this writing) don’t become too deep. HOLD

If you have any questions, don’t hesitate to email me at chris@cabotwealth.com. You can also follow me on Twitter, @Cabot_Chris.

Here, too, is the latest episode of Cabot Street Check, the weekly podcast I host with my colleague Brad Simmerman.

The next Cabot Stock of the Week issue will be published on October 23, 2023.