Cabot Top Ten Trader Issue: April 22, 2024

Intermediate-Term Trend Turns Down

With weeks of churning action and complacent sentiment, the market was flirting with trouble for a while, and now it’s hit the intermediate-term tripwire, with the major indexes all sinking below their 50-day lines (and down big for the month; Nasdaq off nearly 7% for April coming into today) and most stocks doing the same (including leaders like chips and AI outfits). Thus, we mostly advise defense here—after a big run-up and the aforementioned churning, the odds favor more short-term downside testing and/or pain ahead. That said, the odds also favor a resumption of the longer-term uptrend down the road, whether that comes sooner (possibly if earnings season, which is kicking into gear now, goes well) or later, so it’s best not to get too holed up in your bunker, either. Tonight, we’ll leave our Market Monitor at a level 6 and see how this bounce plays out—right now, the main message is to hold a good chunk of cash, honor stops and be very selective on the buy side until the market digests its prior gains and the buyers return.

This week’s list is another broad mix of stocks, with something for everyone in terms of stories, sectors and setups. Our Top Pick is Core & Main (CNM), which looks like a reliable grower in the infrastructure area that’s pulling back toward support. Given the market, keep new buys on the small side.

Stock 1

American Express (AXP)

Why the Strength
American Express is the second-biggest credit card issuer in the U.S. by purchase volume (nearly $550 billion last year), and it also offers a wide range of services including payment and expense management, banking and non-card financing products. The company’s growth trajectory is largely predicated on the increase in digital payments, as customers both here and overseas expand their card usage—particularly among those in the higher income bracket, which Amex is traditionally geared towards. Indeed, due to the company’s reputation as a premium card issuer (with highly rated travel rewards, customer service and other perks), it has the financially healthiest customers of all major card providers and continues to attract high-spending, high-credit-quality customers to its franchise (the key to the company’s success). In Q1, Amex acquired 3.4 million new card accounts, flat from a year ago but up an eye-opening 17% from Q4. Fee-based products (those with an annual fee) accounted for around 70% of the new account acquisitions, with the company seeing “strong demand” from Millennial and Gen Z consumers, who collectively accounted for 60% of new customer accounts globally. (These cohorts contribute a much bigger lifetime value for Amex than older cardholders.) Q1 revenue of $17.8 billion increased 13% year-on-year, driven mainly by higher net interest income and card member spending, while earnings of $3.33 beat estimates by 35 cents (the reason for the share price strength). Total network payment volume rose 5% for the quarter, and Amex finished with 141 million active cards (up 6%). Moving forward, the top brass pointed to the “ongoing momentum” across its business as a reason behind its forecast for full-year sales to increase around 10% in 2024, while earnings are expected to improve 15%, thanks largely to double-digit growth in spending from international consumers and large corporate customers.

Technical Analysis
AXP hit a peak in early 2022 and went on to hover between 130 and 200 for nearly two years, but that rest period came to an end in January, when shares decisively broke out on earnings—and while the stock didn’t set the world on fire, it rose steadily, hitting 230 before backing off into its 50-day line. But last Friday’s quarterly report brought in the buyers, with a big-volume bounce off the key support line; it’s probably not headed straight up due to the market, but we think it’s buyable here or on minor weakness with a tight stop under the recent low.

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Stock 2

Antero Resources (AR)

Why the Strength
Natural gas is known for having big, multi-month (or multi-year) swings, and there’s no question that right now things are in the basement, with the commodity continuing to trade below $2, not far above its lows in February. But more big investors are betting the next big move is up and is coming soon, and if prices do rally, Antero has all the makings of a winner, with many advantages over its peers: The company believes it has the largest low-cost drilling inventory in the sector thanks to huge efficiency improvements (24% drop in drilling time needed before production last year) and lucrative acreage (24% more output per well vs. peers during the past two years), which means it’ll be able to hold production flat this year while slashing maintenance capital spending by 26%, and thanks in part to more than half its output being liquids, Antero’s overall breakeven price is just $2.27 natural gas—again, best in class. (Also helping is that three-quarters of output goes to LNG terminals, including tier 1 LNG players, resulting in far better pricing than peers.) Of course, that doesn’t mean the low price environment has had no effect; Antero is likely to operate near free cash flow breakeven (maybe positive by 10 or 20 cents per share this year) in 2024. But if/when the cycle turns up, possibly thanks to demand for LNG and other exports (to Mexico), cash flows have enormous upside gush. The Q1 report is due this Wednesday, April 24.

Technical Analysis
AR’s chart looks like a long-term turnaround in the making: Shares collapsed 60% from its high in 2022 to its low in mid-2023, and after a rally into the fall, came back to retest those lows (near 20) in December of last year and again in February of this year. But the stock found big-volume support on each retest, and now AR has marched back toward resistance in recent weeks, even holding the 25-day line as the market sank. We wouldn’t bet the farm, but a nibble here or on dips and a tight stop under 27 looks like a decent risk/reward situation.

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Stock 3

Core & Main (CNM) ★ Top Pick ★

Why the Strength
Core & Main isn’t going to wow you with revolutionary products or triple-digit growth, but the firm has a very solid, steady infrastructure-related story that should play out for many years to come thanks to the numerous spending bills passed in Washington (and from individual states) as well as the sorry state of things like water infrastructure (the firm estimates water utilities suffer up to 16% loss of water thanks to old piping). Core & Main is one of two nationwide distributors of pipes, valves and fittings (which make up about two-thirds of revenue), storm drainage and fire protection products as well as water meters; about 80% of its revenue comes from non-commercial and municipal end markets. Core has about 17% market share in total, with its closest peer about the same, meaning two-thirds of the market is served by smaller regional or local outfits—which opens up further market share gains given Core’s stature, as well as through aggressive M&A. Indeed, the firm completed seven (mostly small) buyouts last year and four so far this year, with another couple pending, broadening its reach and product line in different parts of the country. While growth isn’t going to be rapid, sales and earnings growth are expected to begin accelerating in Q1 and, more important, the top brass believes the next few years will be very bullish, with revenues to grow 50% over the next five years while EBITDA lifts 65% and free cash flow soars, allowing for plenty more M&A ($200 million-ish dollars per year) and upwards of $500 million per year of share buybacks and dividends annually, too. (The Q4 share count was down a whopping 13% from a year ago!) It’s a very solid infrastructure-related story.

Technical Analysis
CNM came public in mid-2021, etched a huge post-IPO base for the next two years and broke out on the upside last November. And that led to a beautiful run, with just two down weeks (both in January) and ended with a superb earnings pop in March. Now CNM is pulling back in a controlled manner on very light trade as the 50-day line approaches—we’re OK buying some here or on further dips toward support with a reasonable stop.

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Stock 4

Gates Industrial (GTES)

Why the Strength
It’s not a sexy story, but Denver-based Gates Industrial makes the crucial parts that keep everyday conveniences we often take for granted—like automated supermarket doors and car engine components—up and running. The company is one of the world’s top providers of power transmissions and fluid power products, including V-belts, water pumps, hoses, sprockets and pulleys. Its offerings are used in a wide variety of heavy industries ranging from agriculture, construction, manufacturing and energy, as well as in consumer applications like power washers, vacuum cleaners and virtually all forms of transportation. Nearly two-thirds of Gates’ revenue comes from replacement applications (mainly industrial and automotive), which Gates says reduces the ups and downs in the overall business. To that end, management is focused on what it sees as multiple growth opportunities in the replacement market, which it thinks can deliver “meaningful” structural margin improvement over the next two years, with an annual adjusted EBITDA margin target of 24.5% by 2026 (versus 21% of 2023 sales). The company has also identified sub-markets it sees having “particularly strong” secular trends, including general manufacturing, warehousing automation and solutions for food and beverages, and is focusing much of its innovation efforts on these areas. Additionally, Gates is committing more resources to the infrastructural build-out and renewal trends in both domestic and emerging markets, and, while early, it has a data center cooling offering that could be popular as that sector booms. In Q4, revenue of $863 million was down 3% year-on-year, while earnings of 39 cents beat estimates by 11 cents and adjusted EBITDA rose 12%—all reasons for the stock’s strength—and at a March Investor Day, said all of the above should lead to a 54% earnings per share bump by 2026, with free cash flow also lifting (leading to some M&A and share buybacks). It’s a solid nuts-and-bolts story with a reasonable valuation. The Q1 report is due May 1.

Technical Analysis
GTES had a strong start to 2023, rising 25% in the first two months, but by March the sellers stepped in and took control for the next several months, with the stock fading back to the 11 area (not that far off its bear market low near 10) in October. The rally from there was just OK, with shares near 12.5 in February, but since then GTES has shown great power, surging to two-plus-year highs and, encouragingly, holding firm and tight even as the market has cracked. If you’re game, you can consider a small position on further dips.

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Stock 5

Martin Marietta (MLM)

Why the Strength
Spending on non-residential construction (such as commercial buildings and manufacturing plants) and heavy engineering (roads, bridges and utility lines) continues to outpace residential construction by a mile, thanks largely to recent state and federal infrastructure bills. As a result, private businesses are hiring more people to build factories, while governments are hiring more workers to repair roads and bridges. These developments have helped build momentum for North Carolina-based Martin Marietta, a top provider of the essential materials for construction and infrastructure projects, with operations spanning 30 states, Canada and the Caribbean. Its offerings include aggregates and downstream products such as mixed concrete and asphalt, as well as paving services for both the private and public sectors. In Q4, sales of $1.6 billion were up 9% year over year, with earnings of $4.63 beating estimates by 20%, a catalyst for the recent share price strength. The results were led by a 12% improvement in ready-mixed concrete revenue of $233 million and a 13% increase in asphalt and paving revenue of $228 million. Looking ahead, the company expects aggregates demand for infrastructure, large-scale energy and domestic manufacturing projects to strengthen in 2024, and while not as strong, the top brass also said it expects single-family residential construction to recover a bit as well, providing another tailwind. The firm’s M&A activity should also help, as it just completed a good-sized buyout ($2.05 billion) of Blue Water Industries, a pure aggregates operator in the Southeast U.S. that brings with it a couple billion dollars worth of cash flow; that will likely make the firm’s prior EBITDA estimate (up 13%) too conservative, with an update likely on the Q1 report on April 30. All told, it’s a solid story that should play out for many quarters to come.

Technical Analysis
MLM peaked around 460 last summer, then dropped 70 points during the market-wide correction in the fall. It bottomed at 390 in late October and abruptly reversed higher on earnings, with the share price gradually accelerating over the next few months and hitting a record high in early March. Shares stalled out for a few weeks at that point and then got caught up in the market’s slide the past couple of weeks. To us, it’s a potential “pullback resumption” setup—we think you can grab shares on a move back toward 600.

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Stock 6

Oscar Health (OSCR)

Why the Strength
Oscar Health is a health insurance provider in 20 states, with around half its 1.3 million members in Florida. The company believes its integrated focus on cloud-based technology allows it to operate more efficiently and appeal to self-employed individuals and small businesses that make up the bulk of its business. Oscar operates in states where ACA (Obamacare) marketplaces are in effect (the fastest growing area of health insurance), allowing it to tailor insurance plans that are more affordable, drawing in generally healthy people who make fewer medical claims. Put simply, it aims to take in more in premiums that it spends. When costs rise too fast for its tastes, it simply exits the business, as it has done the past year in retiring its Medicare Advantage plans and withdrawing from California. Management has done well on its vision, posting positive EBITDA for the first time in 2023 and cutting its net loss by more than half to $1.22 on $5.85 billion in revenue. Long term, Oscar Health sees its business growing in two ways: The first is that it believes Obamacare has reached a critical mass and will never be repealed, and it sees Republican resistance to it fading in states like Texas, which is considering its own healthcare marketplace. Growth will also come from using its integrated technology to create deeper datasets on expected health costs on various demographics and selling the information to other health care providers. This year, Oscar says it will generate around $8.35 billion in revenue, up a big 42%, with improving, positive EBITDA thanks to a healthier mix of policyholders and better federal reimbursement rates. Earnings are due May 7, and a month later, the firm will host an Investor Day, too.

Technical Analysis
OSCR went public in March 2021 and plummeted into 2022, but as business has improved, the stock has grown up—shares were sitting near 5 last October, but embarked on a big run from there, getting over 18 by February. The correction was sharp (28%) but not unreasonable given the move, and base-building efforts have been solid, with OSCR actually perking up of late even as the market stumbled. We’ll set our buy range up from here, thinking a strong move toward its recent highs will lead to good things; keep positions small ahead of the quarterly report.

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Stock 7

Sweetgreen (SG)

Why the Strength
Think of Sweetgreen as the Chipotle Mexican Grill of salads and more: A fast-casual chain that has made its mark with consumers by presenting itself as a healthier (but still tasty) option. For Sweetgreen, that means in addition to salads it offers popular items like warm bowls and, more recently, protein-centered dishes called Plates, which reportedly are off to a good start. The company has been on a winning streak after the pandemic roiled its core business district lunch sales (since few were in the office). For Q4 2023, management reported the firm’s 11^th straight quarter of 20%-plus revenue growth, posting sales of $153 million and a narrower net loss of 13 cents per share. A lot of the strength comes from having cracked the code to produce fresh, consistently goods salads on a large scale, though the danger is being seen as just salads by consumers. That’s why last fall it started rolling out Plates, featuring dishes like caramelized garlic marinated steak, herb-roasted chicken and miso-glazed salmon; Plates have boosted dinner orders significantly and have been seeing particularly strong reception in Texas and the southeast. For 2024, management says it sees sales between $655 and $670 million (up 14% at the midpoint), bolstered by a couple of dozen new store openings. (The cookie-cutter aspect here is real, with the store count likely to rise more than 10% this year, but that would still leave the firm with “only” around 250 locations.) For Q1, to be reported May 9, consensus is for $152 million sales and a per share net loss of $0.18, both an improvement over last year. Longer term, Sweetgreen expects Infinite Kitchen—its rebrand of the robotic fast food chain Spyce it bought last year—to excel in heavy-volume urban locations, where its robots can prepare 500 salads an hour and provide margins about 7% better than a Sweetgreen outlet.

Technical Analysis
SG was stuck in a wild, up-and-down bottoming area until the Q4 report vaulted the stock higher, with shares eventually tagging a 23-month high near 26 around the end of March. As the market has weakened, this stock hasn’t been immune, with a sharp 24%-ish retreat to its 50-day line—but that sets up a possible resumption buying opportunity. Yes, you could nibble here, but we’re going to place our buy range up from here, looking to start a position if the stock can power off this support area.

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Stock 8

TechnipFMC (FTI)

Why the Strength
Increasing energy security concerns are putting pressure on efforts by countries to increase oil and gas production, while at the same time, the offshore ultra-deepwater drilling industry is now experiencing a long-term upcycle, supported by supply constraints (lack of industry-wide investment here for many years) and resilient oil prices. Consequently, several nations (including most recently Mozambique and Bangladesh) are seeking partnerships with energy companies to increase offshore exploration and production, all of which bodes well for TechnipFMC. The company is known for its systems that are used to access energy resources both offshore and onshore—including what are regarded as the world’s most advanced exploration submarines. TechnipFMC is reporting increased spending in both its land and offshore markets and says the incremental production needed to support global energy growth will come mainly from international markets driven by the Middle East, Africa and offshore. On that score, TechnipFMC was just awarded a large contract (valued between $500 million and $1 billion) by an ExxonMobil affiliate in Guyana to supply subsea production systems for that country’s Whiptail project, which is expected to add approximately 250,000 barrels of crude oil in daily capacity by the end of 2027. The global exploration demand recovery was further underscored by Q4 results which featured revenue of $2.1 billion that soared 23% year-on-year, plus EPS of 14 cents that was miles ahead of last year’s Q4 per-share loss. Other metrics were equally upbeat, including total company backlog of $13 billion that increased 41%, a subsea order book through 2025 that rose 20% to $30 billion, plus annual free cash flow of $468 million (over $1 per share). Analysts see explosive earnings growth of 150% for 2024, and it’s likely Technip has many years of solid growth ahead of it beyond that.

Technical Analysis
FTI has been in a solid uptrend since late 2022, though it has had some multi-month corrections and consolidations along the way. The latest of those rests began last November when the stock pulled back 20% over a couple of months as the 40-week line caught up. Shares found support in February and began to rebound, breaking out with the oil sector in mid-March and lifting to 27 before exhaling a bit of late. The market environment is a wild card, but we’re OK taking a swing at FTI here with a stop just under the 50-day line.

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Stock 9

United Airlines (UAL)

Why the Strength
United Airlines needs no introduction, as it’s one of the big airlines that, due to big demand, relatively controlled costs, higher prices and more flights, has seen earnings and cash flow go bonkers during the past few quarters—and while many have been skeptical these figures would persist, United is seeing a lot of buying after its own Q1 report (as well as some good numbers from peers like Delta) suggests the good times will continue. In the quarter, United’s sales were up 10%, thanks mostly to more flights (9% increase in seat miles flown, just 1% from higher prices), while the loss per share of 15 cents was much better than expected despite the grounding of the 737Max (Q1 is usually the weakest quarter of the year, too), yet free cash flow came in around $4.50 per share. Meanwhile, the top brass is sticking to its bullish view for the year, which includes around $10 per share of earnings (including $4 in Q2) with 66 airliner deliveries this year and 100 per year between 2025 and 2027, meaningfully boosting capacity over time. To be fair, as with many airlines post-Covid, the balance sheet has been stressed—United has $22.5 billion of net debt (much higher than its market cap), with a few billion in operating leases, too, but with so much free cash flow it’s likely that those figures will come down. Obviously, a big slowdown in travel (here or overseas) or a big spike in fuel expenses could change the landscape, but with the economy resilient, it’s a good bet United should continue to see earnings through the roof for many quarters to come.

Technical Analysis
Despite huge earnings and cash flow, airlines have been the dog’s dinner for a long time now, and UAL hasn’t been an exception—after testing multi-year highs last summer, shares had a horrid 42% plunge into late October, and relative to the market, actually hit a new low in January. The stock did firm up a bit from there, and after one final shakeout, saw exceptional power after earnings last week, soaring to eight-month highs on its heaviest weekly volume since 2020! To be far, the uptrend here is still developing, but if you want in, a small position on dips of a couple of points is fine by us.

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Stock 10

Warrior Met Coal (HCC)

Why the Strength
After a sharp drop earlier this year, steel prices are rebounding on the back of improving global demand—the latest data reveals that steel exports from top producer China surged by over 25% year-on-year in March to the highest levels since 2016, which means that key inputs used in the steel-making process, including coal, are also in high demand. Warrior produces and exports non-thermal metallurgical (or “met”) coal for the steel industry, operating two active underground mines in Alabama. The company boasts some of the most extensive reserves of met coal assets in the U.S., with several coal grades that allow it to sell at premium prices on the export market—particularly in countries where demand for metal is booming due to essential infrastructure projects (primarily in Asia and South America). But a big part of the story here is the company’s Blue Creek Mine, which is under development and is scheduled to define its first development tons later this year, with the commencement of longwall operations (extraction) by 2026. With a promising total reserve base totaling nearly 120 short tons and a projected mine life of 50 years, analysts expect this mine to eventually generate upwards of $800 million a year in free cash flow (compared to Warrior’s tally of $176 million for all of last year)! To that end, a major Wall Street bank just upgraded Warrior shares based partly on the potential for Blue Creek to boost the potential for “very strong free cash flow yields” (a reason for the stock’s latest strength). Of course, the current environment is also strong: In Q4, Warrior posted revenue of $364 million, up 6% from a year ago, along with a 34% increase in sales volumes and a 21% jump in production volumes for the full year. Earnings of $2.49 per share missed estimates but improved 31%, and while analysts see earnings sloughing off this year and next, they remain elevated (and the valuation remains tame), with the Blue Creek bump lurking as a major positive catalyst beyond that.

Technical Analysis
HCC hit an all-time peak at 43 in March 2022, then spent the next 16 months bobbing and weaving in a lateral range, making no net progress. The breakout from that big range came last September and it launched a great move, with shares motoring higher into mid-January. The 26% pullback from there found support above the 40-week line, and HCC has moved back to within a few percent of all-time highs. We suggest aiming for dips of a couple of points to start a position.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on April 29, 2024.

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