Cabot Top Ten Trader Issue: April 1, 2024

Trends Remain Up, but Plenty of Crosscurrents

It seemed like the post-Fed action from two weeks ago may have paved the way for another leg up in the leadership, but while that’s not off the table, we’re continuing to see a lot of crosscurrents out there—growth stocks have been stagnating again, which led to a little rotation into the broad market last week before seeing broader selling today, as money sloshes around. What does it mean? Not much yet, as the major evidence remains positive, but it’s best to play things by the book: For current holdings, continue to raise and honor your stops and take the occasional partial profit on the way up, while for new buying, make sure you’re focusing on names that are generally earlier in their moves and/or have shown outsized buying power of late. We’ll leave our Market Monitor at a level 8, but more than ever, it really depends where you look, with more and more extended growth stocks losing strength while some older world and fresher titles find buyers.

This week’s list has many names that are either just coming into favor or have tightened up nicely after prior runs. For our Top Pick, we’ll go back to the commodity theme—CNX Resources (CNX) is toying with new highs despite the fact that natural gas is still at very low levels. We’re OK starting small here and adding if the buying continues.

Stock 1

Atkore (ATKR)

Why the Strength
Major public electrical contractors are reporting record backlogs, thanks to rapid growth in key end markets like data centers, manufacturing, healthcare and non-residential and multi-family housing. Atkore plays a big role in each of these industries and many others; its offerings include electrical and mechanical products (conduits, cables and tubing), as well as safety solutions such as metal framing and perimeter security. However, 90% of Atkore’s product portfolio is geared toward supporting electrical infrastructure, which is a key reason for Wall Street’s optimism given the acceleration in electricity demand underlying the energy transition and related long-term federal programs. In fiscal Q1 (ended December), Atkore’s revenue of almost $800 million was 4% lower year-on-year while adjusted EBITDA declined by 19%, mainly due to decreased average selling prices across the firm’s products. The post-pandemic surge in pricing is still gradually correcting—however, it’s fading far slower than expected, as earnings of $4.12 beat estimates by 51 cents, while organic volume growth surged by 13% across all key product areas, particularly in the pipe and conduit categories and led by “solid growth” in Atkore’s PVC products. Moreover, management said the year is off to a “strong start” and that the spring and summer months should see increased construction activity, adding that Atkore is “well-positioned” to benefit from the strong electrical trends. The company maintained its previous guidance of achieving low double-digit percentage volume growth for fiscal 2024, and to that end, recently initiated a dividend for the first time (current yield 0.7%) and continues to buy back shares (share count down 1% year on year). Earnings should remain elevated and possibly return to growth later this year, while the valuation remains very tame (10x earnings).

Technical Analysis
ATKR essentially hit a major peak just over a year ago near 155—while it nosed to new highs a couple of times after that, it never could really break free, with three corrections (25%, 27% and 16%) during that time and with no net progress for a full year. But late February saw the stock leap to new highs on a nice volume cluster, and ATKR has kited higher from there. We’re not chasing it up here, but we think this fresh breakout should work; aim to enter on minor weakness.

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Stock 2

Beacon Roofing Supply (BECN)

Why the Strength
Beacon Roofing is one of many housing and construction outfits in favor right now, thriving because of resilient demand, solid execution and plenty of moves that have been boosting efficiencies (and margins) in recent years. As its name suggests, the firm is mostly about roofing—in fact, it’s the largest publicly traded distributor of roofing and related building products in the U.S. and Canada. About half of business is for residential purposes (including storm/disaster demand, which makes up about 30% of the total in this segment), with non-residential 27% of sales and the rest for complementary offerings (waterproofing, siding, etc.). And, simply put, business is solid, both organically and thanks to some M&A activity—in Q4, sales rose 17% (about 4% of that came from acquisitions), with each of the three segments up double digits, bolstered by a price hike that took effect last August, mid-teens volume growth in non-residential activity and generally stable prices. Meanwhile, EBITDA was up 21% in the quarter as margins expanded (2023 was the third straight year of double-digit EBITDA margins). That’s not to say the firm isn’t investing (it has been modernizing its fleet and facilities, as well as completing nine buyouts), but the top brass sees sales up mid-single digits this year and another year of solid cash flow, too—part of which it’s using to buy back shares (Q4 share count down 2.5% from a year ago). There’s nothing magic here, just a well-managed company that’s the leader in its field and should benefit from a rebounding housing market and strong non-residential demand.

Technical Analysis
BECN had a very strong spring of 2023, bursting to all-time highs, but the rally petered out around 85 and the stock retreated 22% before it tested its 40-week line. That led to a rebound for a while, but more important to us, then resulted in a very tight range for the first 10 weeks or so of the New Year—usually a sign of accumulation. And now BECN has lifted to new highs, with volume picking up the past couple of trading days. Shares are testing the century mark, so we’ll set our buy range down a bit, thinking a normal exhale is coming.

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Stock 3

CNX Resources (CNX) ★ Top Pick ★

Why the Strength
With natural gas prices remaining in the basement, you’d think that most gas-heavy producers would be circling the drain—but thanks to cost controls, hedges and operational flexibility, CNX Resources is doing just fine, and it also has a unique side business that’s contributing to good results. The company is a smaller Appalachian, gas-heavy outfit (market cap of $3.6 billion), and thanks to hedges (nearly $2 billion of gains on derivatives last year!), it’s been cranking out solid numbers: Last year, production came in a bit above guidance, with hedge gains helping free cash flow for the full year to come in above $300 million (around $2 per share), and it’s using that to shareholders’ benefit, paying off debt (no maturities until 2026) and buying back shares (Q4 share count down nearly 10% from the year before). Interestingly, $34 million of last year’s cash flow came from the firm’s “New Tech” division, formed in 2021, which focuses on innovations to lessen carbon intensity; right now, capturing waste methane from industrial activity is big and is being rewarded via some government incentives (including one program in Pennsylvania), all of which could produce $75 million of free cash flow this year! (The company says incentives aren’t large enough to expand the methane operation at this point, but it’s still a good business.) Back to the core natural gas operation, low prices are having an effect—CNX recently delayed completion activity on three Marcellus pads—but it also reduced its expected CapEx this year by $50 million alongside that move. All told, the firm should still be solidly free cash flow positive for the year (more than 80% of gas output is hedged), and if/when gas prices do pick up (supply/demand for gas is improving), expect production and future cash flow to do the same.

Technical Analysis
Following a deep correction, CNX picked up steam last spring and summer, challenging its all-time high near 24 before again pulling back—but this time, it did so much more mildly, falling 19% and holding its 40-week line despite very depressed natural gas prices. Like most peers, CNX has changed character since mid-February, with a modest bounce into March and a rally back followed by a strong surge to 24 on good volume in recent days. We’re OK starting small here or on minor dips.

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Stock 4

DexCom (DXCM)

Why the Strength
In the U.S., at least one in ten Americans have some form of diabetes, 25% of U.S. healthcare dollars are spent on diabetes patients and by some estimates, as many as one in every three (!) people suffer from pre-diabetes. That leaves a massive market opportunity for San Diego-based DexCom, which is a leading provider of continuous glucose monitoring (CGM) systems—a big advancement over traditional intermittent monitoring—which help intensive insulin and type 2 diabetics more efficiently manage their blood sugar levels. There is competition from Abbott and others, but DexCom has been a leader in this field for years and has succeeded in launching new and better CGMs over time—the latest is its G7 monitor, which began rolling out two years ago and, according to the top brass, is “the most accurate CGM ever launched.” And now it’s announced the upcoming launch of Stelo, the first CGM specifically designed for type 2 diabetes patients who aren’t on insulin. The company sees Stelo driving “greater health and economic outcomes” for all people with diabetes and just won FDA approval in early March, being the first glucose sensor that doesn’t require a prescription! (Sales will begin online this summer.) Management noted in the latest earnings call that Medicare coverage went live for type 2 patients last year using basal insulin only, as well as certain non-insulin-using patients with hypoglycemia risk, which effectively doubled DexCom’s reimbursed population in the U.S. while expanding its prescriber base by almost 40% in 2023. Consequently, a major investment bank just initiated coverage of DexCom with an “outperform” rating based on the firm’s growing addressable market. On the financial front, the company posted revenue of just over $1 billion in Q4—up 27% from a year ago—and per-share earnings of 50 cents that beat estimates by seven cents. Wall Street sees sales up 15% to 20% annually for 2024 through 2026 while earnings generally follow along.

Technical Analysis
DXCM has a history of staging big, long advances but then falling into big, long corrections and consolidations. Not surprisingly, the last major peak was in late 2021, with shares getting clobbered in 2022 and it wasn’t far off its lows at last year’s October bottom. But the stock righted itself from there, rallying back near resistance at 140, and after a controlled dip to the 40-week line, DXCM has shown some strength on the Stelo approval. There’s still resistance to chew through, but we’re OK starting small here and adding on further strength.

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Stock 5

Marathon Petroleum (MPC)

Why the Strength
U.S. oil refinery utilization has fallen 11% since the start of this year, recently hitting a five-year low of around 80% and putting upward pressure on gasoline and diesel prices. Marathon Petroleum operates one of the nation’s largest refining systems (13 in total across 12 states), with a capacity of nearly three million barrels of oil per day (as well as processing a variety of light and heavy crude oils and other natural gas liquids). In Q4, Marathon’s 13 refineries helped fill the nationwide refining gap, running at a 91% utilization rate and processing about 2.7 million barrels of crude per day. And while revenue of $37 billion was 8% lower year-on-year, it exceeded estimates, as did earnings of $3.98 a share (by a whopping 80%, one reason for the stock’s strength). Like most refiners, a big part of Marathon’s money is made on crack spreads, or the difference between oil and gasoline prices, and while the company saw its per-barrel margins lower across all regions on a sequential basis in Q4 (driven by lower crack spreads), those spreads have been steadily rising over the past six months. On a related note, a major consultancy just released a report that predicted more than 20% of the world’s total refining capacity is at some risk of closure by 2030 due to economic headwinds—particularly in Europe and China—as well as increasing restrictions on carbon emissions. Overall, while business is still normalizing after the pandemic boom, these developments mean earnings and cash flow should settle out at more than double pre-pandemic levels—which in turn will allow Marathon to continue buying back tons of stock (share count in Q4 was down 19% from the year before!) and paying a decent dividend (1.6%). Wall Street has set a low bar for 2024, but widening crack spreads could easily upend those expectations. Either way, earnings should remain elevated.

Technical Analysis
MPC has been in a relatively steady upward trend with shares continuing to reach higher ground over time. The most recent shakeout was almost a year ago when the stock corrected 30 points (down 22%) in April and briefly penetrated the 40-week line, then resumed its stride in July. After hitting a new high in September, it took a five-month rest, but MPC broke free of the holding pattern after the calendar flipped and has been hitting new highs regularly over the past month. A dip back to (or slightly below) the 200 area would be tempting.

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Stock 6

Medpace Holdings (MEDP)

Why the Strength
Before new drugs can be commercialized, they must undergo extensive clinical testing and regulatory review, which tends to be extraordinarily expensive, not to mention increasingly complicated. (It has been estimated that the total cost of achieving regulatory approval averages a whopping $2.5 billion, with an average development time of around 10 years!) This is where Cincinnati-based Medpace comes into play. It’s a leading contract research organization (CRO) that provides clinical research (Phases 1 through 4) for the development of drugs and medical devices across several major therapeutic areas, as well as providing regulatory, bioanalytical and central lab assistance, all of which help drug and medical device makers reduce their costs by outsourcing time-consuming research trials and related tasks. While there was a drop in trial spending in Covid’s wake during the last couple of years, a recent survey of 130 biotech executives found that 60% of them plan to increase research and development spend this year. These findings were backed by mostly solid fourth-quarter earnings reports from several publicly-traded CROs (including Medpace), with many companies noting higher optimism among pharmaceutical and biotech clients for 2024 and beyond. For Q4, Medpace saw sales just shy of $500 million increase 26% year-on-year, with earnings of $2.46 a share beating estimates by 11% and EBITDA rising 19%. For the full year, net new business awards of $2.4 billion jumped 29% and ending backlog was $2.8 billion (up 20%), continuing a multi-year rising trend in backlog growth and essentially locking in solid growth for the next many quarters. Indeed, the top brass expects 2024 revenue of around $2.2 billion (up 17% if realized) and EBITDA of $415 million (up 14%). Wall Street, meanwhile, sees the bottom line growing 20% this year. It’s not changing the world, but it’s a solid and reliable growth story.

Technical Analysis
MEDP had made good progress over time, though it’s usually choppy, with many rests and shakeouts along the way. The last dip came in September/October, bringing the stock down to its 40-week line (and marking no net progress for the past year), but Q3 earnings got things moving on the upside, and after a tight six-week consolidation, MEDP exploded higher on its Q4 report and, again, has tightened up. We’re OK starting a position around here with a stop just under the 50-day line.

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Stock 7

Natera (NTRA)

Why the Strength
Natera is extending its lead in women’s health screening with the recent acquisition of certain assets of Invitae, which has one foot in the grave. The deal basically takes competing tests off the market—Natera is switching Invitae’s clients to its own offerings, including its Signatera test, which uses cell-free DNA fragments from a simple blood draw to find markers of breast, colorectal and some organ cancers, as well as its Panorama test for prenatal screening. The acquisition, plus the continued organic growth of its two offerings, has management saying 2024 sales will rise at least 22% to $1.34 billion, as its leadership in less-invasive blood tests continues to gather steam. While Panorama is the biggest source of business, commands half the market and is still expanding as it takes share from older, riskier methods (a new syndrome could be approved and added to the test panel in the months ahead, which would also help the cause), Signatera looks like the main growth engine—rolled out in 2019, the test was used by one-third of oncologists in the U.S. in Q4 and has been gaining steam as a solid breast cancer tumor screen. Medicare approved coverage of Signatera for breast cancer testing in 2022, a boon to the business since federal coverage accounts for the majority of revenue. A similar cell-free DNA test called Prospera tests for whether a patient is likely to reject a kidney transplant (with trials underway to expand its indications to heart transplants). Investors have been pleasantly surprised by Natera over the past year, with management consistently beating guidance, and while earnings are in the red, the company sees itself getting to cash flow breakeven by the third quarter. It’s not a household name, but the firm has the makings of an emerging blue chip in the medical testing field.

Technical Analysis
NTRA looked sick at the market’s October 2023 bottom, with shares not too far off a new weekly low. But it’s been all up since then, with the 25-day line basically containing the entire advance. More recently, the stock gapped up beautifully after the Q4 report, and it’s held firm despite lots of market ups and downs of late, with the 25-day line catching up. If you don’t own any, we’re OK taking a stab at it around here or (preferably) on dips, with a stop just south of 80.

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Stock 8

Novo Nordisk (NVO)

Why the Strength
The weight-loss revolution sparked by semaglutide has Novo Nordisk thriving. Sales of its market-leading weight-loss and diabetes treatments Wegovy and Ozempic (the same drug with different names depending on use) were up more than 200% in North America and 154% overall last year. That comes even as the company has been throttling the availability of the starting doses of Wegovy to ensure its supply chain can meet demands of the large base of people who use higher doses once they are ramped up on the drug (it also needed to keep supply for diabetics taking Ozempic), though management says it will be increasing the availability of Wegovy starter kits throughout the year. The company is also closing on a purchase of contract manufacturer Catalent, which will allow it to expand Wegovy supplies even more. Overall, shedding weight is a great way to add sales: Novo Nordisk says it expects revenue to rise 18% to 24% in 2024, on a constant currency basis, though it should be noted that the firm has a history of lowballing and exceeding their outlook. Analysts see earnings rising at the high end of that range as well, but the main attraction here is the long-term potential—many see Wegovy and Lilly’s competing Zepbound as possibly being the biggest-selling drugs in history and which could affect many other areas of society (like health issues that come from obesity). Meanwhile, the top brass is forging ahead with another possible treatment, for peripheral arterial disease, which afflicts about a quarter of all cardiac disease patients. Novo Nordisk believes that combined with a hormone amylin, semaglutide can be a significant treatment. All in all, this remains a humongous story.

Technical Analysis
NVO actually broke out to new highs back in late 2022, so the stock certainly isn’t in the first inning of its run, but the buyers remain in control. Shares tightened up nicely near the end of January and leapt higher from there, nearly reaching 140 before some selling finally set in—but we like the well-controlled pullback on mostly light volume as the 25-day line has caught up. We wouldn’t argue with a nibble here, but we’ll set our buy range up from here, looking to enter on a resumption of the overall upmove.

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Stock 9

Procore Technologies (PCOR)

Why the Strength
Procore Technologies has always had a business that just made a lot of sense: It’s a cloud software operation that’s tailor-made for the construction industry, bringing meaningful efficiencies in a variety of areas for large projects. The software connects the endless web of contributing parties (from owners to financiers to suppliers to contractors and subcontractors) on one platform, offering help with everything from bid management, estimating, project management, quality control, workforce planning, financials, invoices and much more. The firm has always avoided per-user fees, thus encouraging adoption, and growth has been steady for years as it takes market share—but the firm isn’t resting on its laurels, moving ahead with ancillary products like Procore Pay, which management is very high on (launched September 2023, it consolidates all the payment apps from different projects, making life for general contractors much easier), as well as insurance services on projects (being a broker and, occasionally, as an underwriter) and even providing working capital (things like material financing and even early pay) here and there. All told, the potential is huge, though to be fair, while Procore’s clients are usually engaged in huge, long-lasting projects, the iffy environment is likely to slow growth a bit going ahead—the top brass sees revenues up around 20% this year, but (a) that’s likely conservative, and (b) operating margins should surge from 2% to 7.5% as free cash flow and earnings take off as well. It’s a great story, and we’re not surprised to see sponsorship pick up in a big way (535 funds at year’s end, up from 400 nine months before), including some top-notch performers.

Technical Analysis
PCOR technically bottomed in mid-2022, but it really never could get a head of steam going during the next 15 months—in fact, shares were blasted after the Q3 report in November of last year, leaving them well within their bottoming range. But it’s been all up since then, with every modest dip (including an intraday wobble after the Q4 report in February) finding support near the 25-day line. The last two weeks have seen PCOR move to their highest levels since late 2021 (good), though volume has been tepid. We like the overall look of the chart, but we’ll set our entry range down a bit from here.

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Stock 10

Steel Dynamics (STLD)

Why the Strength
After a tough last couple of years, the steel industry is heating up again, led by accelerating demand from U.S. non-residential construction as well as resilient ordering in the oil and gas industries. Steel Dynamics is America’s third-largest producer of carbon steel used in buildings, bridges, rails and other infrastructure; it’s also one of the most profitable steel companies in terms of profit margins and operating profit per ton. The company’s core products include sheet steel, structural steel and steel tubes and pipes used by the oil and gas industry. Non-res construction and energy market strength was a big reason for the records Steel Dynamics set last year, including steel shipments of 13 million tons (up 5% from 2022), the second-best annual cash flow and the second-highest annual revenue of its history, at $19 billion. The company attributed the strength to a “solid” backlog for steel joists and decks used for industrial buildings, plus “strong” energy sector activity that drove pipe orders used for oil and gas extraction. Also contributing to the stellar 2023 results were strong steel demand for solar energy applications and a respectable showing for the firm’s metals recycling operations (in spite of declining scrap prices through much of the year). The company said customer order rates was excellent, with January showing one of the strongest order entry environments ever, especially for value-added products. To be fair, elevated pandemic-era pricing is still coming back down to Earth, but management recently provided guidance for Q1 earnings that was well received by Wall Street, expecting EPS of about $3.53—down from around $4 per share a year ago but above estimates of $3.32. Moreover, the firm’s backlog extends through the first half of 2024, and management is very shareholder-friendly, recently bumping the dividend (1.2% yield) and buying back lots of stock (share count down 8% in Q4 vs. a year ago). It’s a solid commodity story.

Technical Analysis
STLD plowed ahead to all-time highs in late 2022 and early 2023 before finally hitting a wall in March and shedding about one-third of its value during the next three months. But shares essentially went straight sideways for months after that (keeping close to the century mark), and after a late-year pop and one last sag to 110 in January, STLD finally entered a sustained upmove, with shares returning to their prior highs by late February and, after a test of the 25-day line, they’ve zoomed to virgin turf in recent days. A bit of weakness should provide a solid entry point.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on April 8, 2024.

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