Cabot Top Ten Trader Issue: April 24, 2023

Here Comes Earning Seasons

Last week was quiet, which keeps the overall evidence mostly unchanged—the indexes are hanging in there despite a rash of worrisome news, and we’re seeing lots of setups among individual stocks that have mostly taken the past two to three months to etch more proper bases. That said, there remain plenty of potholes and news- (and rumor-) driven action, including continued selling on strength when stocks approach their old highs. As earnings season picks up, the question is whether Q1 reports will bring buyers out of their slumber and launch of bunch of fresh leaders higher. If so (given the hugely bearish sentiment out there), there could be tons of opportunities—but until it happens, it’s best to remain cautious, with a few lines in the water but plenty of cash, too. Once again we’ll leave our Market Monitor at a level 5.

This week’s list has does have a couple of recent earnings winners, as well as plenty that are set up well ahead of their reports in the next couple of weeks. For our Top Pick, we’ll go with big-cap D.R. Horton (DHI), which gapped to new highs on earnings last week and is attempting to lead a group-wide breakout in homebuilders.

Stock 1

Arista Networks (ANET)

Why the Strength
Cloud titans Microsoft and Meta (along with plenty of other cloud players) are transitioning into 400-gig optical transceivers, as the high-density devices can provide a four-fold increase in maximum data transfer speeds. This is good news for Arista (covered in the March 13 issue), which designs and sells multilayer network switches for cloud data centers and other computing environments. Meta and Microsoft accounted for over 40% of Arista’s sales last year, and the company expects growth this year to be driven by ongoing infrastructure investments from these, and other, cloud giants which widely utilize Arista’s next-generation 100, 200 and 400G products. The company’s offerings are divided across three main segments, with core Cloud and Data Center Products (including stackable switches) accounting for nearly 70% of 2022 total revenue, thanks to strong cloud and enterprise spending. The second is Network Adjacencies (including campus routers), which saw a doubling of corporate campus orders to $400 million last year, putting Arista on track to realize its goal of $750 million in campus revenue by 2025 if not sooner. Subscription-based Network and Software services are the third category and make up 18% of the company’s current product line. Arista’s multi-domain management platform, CloudVision, is a leader in this category with over 2,000 cumulative customers (up 33% from a year ago) that pay (sometimes huge amounts) each month. For 2023, the company expects earnings and revenue to grow by approximately 25%, driven by a strong backlog and “continued healthy demand” across all its key markets. When Arista releases Q1 results on May 1 after the close, Wall Street foresees top- and bottom-line growth of 49% and 60%, respectively.

Technical Analysis
We missed getting into ANET when we covered it last month, as the stock got away from us during its late-March rally. However, the upward move hit a peak at 170 five weeks ago and shares have pulled back last week on modest volume, nearing the 50-day line. You could nibble here, but we’re going to set our buy range up a bit, thinking a rally could signal the end to this pullback—though we’d keep any new buying small ahead of next week’s report.

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Stock 2

Crocs (CROX)

Why the Strength
Crocs’ molded foam, brightly colored clogs were once known as the shoe of choice for people who stood on their feet all day—notably chefs, healthcare workers and even kids. But the demographic appeal (and product line) of Crocs has drastically expanded in recent years to include both young and old alike across a broad socioeconomic stratum, including some big-name entertainers. Indeed, the company’s use of celebrities like Justin Bieber and Bad Bunny in its advertising efforts, plus its partnerships with high-end fashion firms like Balenciaga, have broadened the appeal of the ubiquitous clogs (which accounted for nearly 60% of Crocs’ total sales last year). And while it’s true that footwear tends to be a fickle fashion, Crocs has taken pains in recent years to expand its product offerings to include boots, sneakers, sandals and shoe charms. Importantly, the company’s acquisition of casual footwear brand HeyDude (completed last February) will also be a driver, as it’s a big brand that’s growing faster than Crocs and is expected to contribute over $1 billion to the top line this year. However, Crocs itself is still seeing some noteworthy growth of its own—especially in its main market of North America—while boasting eight consecutive quarters of double-digit sales growth overseas. This was on display in the Q4 report, which revealed a stunning 61% year-over-year sales increase (bolstered in part by the HeyDude buyout) to $945 million, with per-share earnings of $2.65 beating estimates by 29 cents. Going forward, the company plans to extend its reach in the $30-billion (but relatively fragmented) global sandal market, in which it believes it has a competitive advantage, while seeing lots of growth room for clogs internationally. After a step-function higher in earnings, analysts see the bottom line inching higher this year and growing double digits in 2024. The Q1 report is due out Thursday morning (April 27).

Technical Analysis
CROX had a massive bull run during the quarantine years of 2020/2021 when millions of Americans found the firm’s footwear perfect for lounging at home or working in the garden. Then came a huge decline, with shares falling from 180 to 45—but, with earnings still in good shape, CROX began to rebound quickly. Shares marched all the way back to 140 or so in February and then built a reasonable eight-week base that it started to leave behind last week. With earnings coming this week, we’d keep it small and aim for dips.

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Stock 3

D.R. Horton (DHI) ★ Top Pick ★

Why the Strength
In the real world, the housing decline is on, with higher mortgage rates and so-so real incomes (due to inflation) crimping demand and prices. But in the market, which looks ahead, investors are seeing a not-as-bad-as-feared downturn, especially as homebuilders didn’t overextend themselves (speculative building, etc.), which should keep earnings very elevated compared to years past, and set to grow in the near future. D.R. Horton is the granddaddy and largest of all U.S. builders (it recently closed the sale of its one-millionth home in its history), and the just-reported fiscal Q2 report confirmed what many have been thinking—yes, earnings of $2.73 per share were down 32% from a year ago, but that easily topped estimates of $1.90 or so while overall revenues were actually flat. Moreover, the forward-looking measures weren’t bad at all: While the backlog was down a big 44% from a year ago due to some weakness in the second half of last year, new orders in Q1 were down just 5% in units (11% in value) from a year ago, the cancellation rate was up just two percentage points and sales prices were essentially flat. And management said some soothing words, too, including that tight supply and favorable demographics are essentially pushing back against higher rates and iffy wages. Don’t get us wrong—business here will still fall off a good amount in coming quarters, but Wall Street now sees earnings falling to “only” $11 per share this fiscal year (ending in September), which is miles above the pre-pandemic peak of $5 to $6 per share. A modest dividend (0.9% yield) and active share buyback program (share count was down 3.1% from the prior year) also help the cause.

Technical Analysis
DHI topped out during much of 2021, fell as much as 45% into its June 2022 low and etched out a bottom for the next few months. Shares began to show real relative strength last October, rallying to within a few points of their all-time highs in early February. Then came a new launching pad that was shallow and tight, showed accumulation off the lows and ended with a big-volume breakout on earnings last week. Breakouts have been very tricky in this market, but we’re OK with a nibble here or on dips.

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Stock 4

DraftKings (DKNG)

Why the Strength
Sports gambling has become a multi-billion-dollar growth industry in recent years, and DraftKings (covered in the March 13 issue) is making big waves in this space. The company is one of 40 approved online sports betting platforms in the U.S. and serves more than 20 states, giving it a leading position in the industry. Mobile sports wagering has been approved in only about 60% of the country, but as more states legalize it, DraftKings is well-positioned to increase its market share. Additionally, betting volumes continue to rise even in well-established markets as new products (such as in-game betting, where the odds change after every play!) become commonplace. Already this year, DraftKings has launched sportsbooks in Ohio and Massachusetts as both states legalized sports betting in January. While revenue growth remains rapid, possibly more important is that the top brass here is tightening its belt (more than $100 million being cut last year even as it expanded; marketing spend per customer is coming down, showing that initial acquisition costs come down in a big way) and yet is still seeing take-rates increase. The net effect should be that EBITDA should leap into the black by the end of this year (and surge afterward), a fact that has several major Wall Street institutions upping their share guidance. Obviously, this is a big growth industry; some believe 70% of adult men could be gamblers when the U.S. market is mature, and nearer-term, the average amount wagered in a year by an average bettor is forecast to exceed $6,000 by 2025, providing the company with plenty of runway. When DraftKings reports Q1 earnings on May 4, analysts see sales rising 66%, with a 34% increase expected for the full year (likely conservative).

Technical Analysis
DKNG bottomed in the 10 to 12 area last May, June, July, September and October, so when shares began to perk up this year, it had a solid footing underneath it. Like most names, the stock hit a wall near resistance (at its highs from last summer) a couple of months ago, but instead of cascading, DKNG built a very reasonable, 21% deep base, with support near the 50-day line—and then buyers piled on, pushing the stock back to its old highs. Today’s selling is par for the course in this environment; a bit more weakness could be buyable, but keep it small ahead of earnings.

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Stock 5

Gold Fields (GFI)

Why the Strength
Lingering fears of a banking contagion and some nascent political fears are key factors pushing gold toward its highest-ever price level. South Africa-based Gold Fields is one of the world’s largest gold miners with attributable gold-equivalent mineral reserves of nearly 50 million ounces, providing the firm with plenty of exposure to rising prices. Last year was a tough one for gold miners, in part due to rising costs, but Gold Fields still managed to exceed its production and cost-per-ounce guidance. Full-year revenue of $4.3 billion was 2% above the prior year total, while per-share earnings of $1.18 increased 19%. Attributable gold production in 2022, meanwhile, grew 3%, to 2.4 million ounces, led by strength in the company’s Australian operations. Higher mining costs are expected to persist in 2023, as Gold Fields expects all-in sustaining costs (AISC, a key metric in this industry) of around $1,320 per ounce—up 19% from last year—and sees gold production of around 2.3 million ounces (down 4% if realized). However, the company’s 100% owned Salares Norte high-grade gold/silver project in Chile is expected to see its first gold pour by Q4, with commercial production anticipated next year. This will have a material impact on the firm’s output down the road, with up to half-a-million gold equivalent ounces expected to be mined in 2024 with production rising to 600,000 ounces in 2025, all of which will help expand Gold Fields’ Latin American footprint. (The mine is also expected to help lower AISC costs below $1,200 in the next two years.) On its African front, Gold Fields sees the completion of a proposed joint venture with AngloGold Ashanti on their mines in Ghana by early 2024, with Gold Fields having a 60% stake in the project. Analysts see a 8% sales bump this year, with revenue jumping 15% in 2024 as the new projects come into play.

Technical Analysis
GFI soared to a multi-year high at 17 last March on the back of gold’s strength, but the market finally got to gold and the stock, dropping it by more than half by September. There was a great rally soon after which, after another selling wave, led to a higher low in February—but since then GFI has looked like a homesick angel, powering ahead six weeks in a row back in the range of its old highs. A shakeout of a point or so (possibly toward the 25-day line, now at 14 and rising quickly) would be tempting.

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Stock 6

Inspire Medical (INSP)

Why the Strength
Inspire Medical has had a great story throughout the last couple of years, and after a big decline, rally back and fresh setup (see more below), the time might be close to when the stock can begin a sustained advance. The company is all about its sleep apnea solution, which is looking to revolutionize the industry—as opposed to CPAP machines (which work pretty well but have a giant non-compliance rate) or invasive surgical solutions (which have wildly varying success rates), Inspire’s minimally-invasive implant is safe (very low re-admittance rate) and actually has better results in many studies than CPAP offerings, too, with dramatic reductions in events per hour overall (70% according to one huge study, 12 months after implant). The system allows patients with moderate to severe apnea to “turn on” (via remote) the device at night, providing mild electrical impulses to keep the airways open, and those who have had the procedure (about 36,000 through the end of 2022) love it, with more than 90% saying they prefer it to CPAP. Plus, the battery lasts 11 years and the system is now full-body MRI compliant, which removes some big hesitations about getting the implant; it also just got approval for use in down syndrome patients and thinks it could get an expanded label (more apnea patients eligible), too. The firm has been making rapid and steady penetration into the U.S. market (sales have been growing at consistent 70%-plus rates the past few quarters), and Inspire is diving headfirst into international opportunities (first reimbursed cases in France, Belgium and Hong Kong in Q4). Analysts do see revenue growth slowing to “only” 40% this year, though that will probably prove conservative—and the bottom line should approach break even next year. The next big event is the Q1 report, which is due May 2.

Technical Analysis
We’re seeing more and more stocks that have taken the last three-ish months (since the market’s early-February top) to round out shallower, more proper base-building efforts following last year’s wild downs and ups. INSP is a good example—shares cracked last spring and hit a higher low in September, then rallied all the way back toward its highs earlier this year before running into a wall. But the last nine weeks have shown a reasonable (21%) dip that found support at the 40-week line and a sharp (albeit lower volume) snapback. There’s still overhead and earnings to get through, so we advise looking to enter on weakness.

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Stock 7

Intra-Cellular Technologies (ITCI)

Why the Strength
The combination of a pickup of M&A activity in the biotech group (many big pharmas have lots of cash while the broad S&P Biotech Fund (XBI) has made no net progress since 2015!) and some enticing medical breakthroughs has many names picking up steam, and Intra-Cellular Technologies is one of our favorite fundamental stories in the group. As with many smaller outfits, the story here is about one drug, but it looks like a blockbuster: Called Caplyta, it gained approval for adult schizophrenia back in 2020, which got sales off to a nice start, with 1,750 patients or so within a couple of years and quarterly revenues rising to $25 million or so. But then came approval for bipolar depression, which changed the game—in fact, Caplyta is the only drug to be approved for treatment of both Bipolar I and II, both in conjunction with certain medications or on its own. And that’s been a huge driver, pushing quarterly sales up to around $88 million in Q4 of last year! Both of these indications combined have millions of potential patients, and with great clinical results, Intra-Cellular should see years of growth on these alone … but there could be even more good news coming soon. In recent Phase III trial results, Caplyta met primary endpoints for patients with either bipolar depression or major depressive disorder (MDD for short), with results showing declines in both the number of and severity of symptoms. Interestingly, no precedent exists for approval for so-called mixed features depression (having two or more disorders), who tend to more severe and difficult to treat, which explains the optimism surrounding the trial results. To be fair, analysts are still watching other of the firm’s MDD trials underway, and there could be some patent concerns after 2024; thus, there’s risk here, but it certainly seems like Intra-Cellular’s Caplyta is a one-of-a-kind treatment. Analysts see sales ramping from $250 million last year to $444 million this year and north of $650 million in 2024. The Q1 report is due May 10.

Technical Analysis
ITCI refused to buckle during the first few months of the bear market and even snapped back after an initial decline last summer, but shares eventually sagged from a peak near 66 to lows in the 42 area. That bottom area was retested in early March, but the stock began to bounce after—and then changed character completely after the recent Phase III trial results came out, driving ITCI all the way back toward its old highs. We like the action, but given the environment, aim for dips if you want in.

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Stock 8

Intuitive Surgical (ISRG)

Why the Strength
Robotic surgery is increasingly common today, as the thin robotic arms used in such procedures have a much wider range of motion than the human hand, while also being far less invasive and involving fewer risks with faster recovery times. Intuitive Surgical provides robotic systems, software and instruments designed to improve clinical outcomes of surgery patients. The company is known for its da Vinci Surgical System, which covers a wide variety of medical procedures and has been used in over seven million surgeries worldwide. Intuitive is the dominant player in the surgical robotics market; the da Vinci System costs around $2 million (with full installation), though the big money comes via recurring orders for the reusable equipment that goes on the “arms” of the robot. In Q1, Intuitive placed 312 systems (compared with 311 a year ago) and grew its clinical installed base to nearly 7,800 systems, up 12%. Worldwide da Vinci procedures increased 26% in Q1, despite Covid-related disruptions in China earlier in the quarter. Total sales increased 14% to $1.7 billion, while per-share earnings of $1.23 beat estimates by three cents. Intuitive said sales trends in China are recovering now that the country’s harsh lockdown is over, and patients in several major countries are returning to seek surgical procedures post-pandemic, with pipelines in some countries running above pre-pandemic levels after several years of lagging. System placements have been healthiest in the U.S., the U.K. and India, a trend the company expects to continue. The top brass also noted the systems are being used more hours per operating day while customers are increasing the mix of shorter duration procedures, which it sees as “good long-term indicators” for business. Wall Street sees the top and bottom lines both climbing around 15% this year.

Technical Analysis
ISRG peaked at 370 at the end of 2021 and came careening back to earth last year, reaching a nadir of 180 in mid-October. The stock launched a sharp recovery after that thanks to Q3 earnings, rallying to 285 before meeting resistance in December. Like so many other stocks, ISRG then spent the past few months building a more proper launching pad (not as deep and with plenty of tight areas), with last week’s Q1 report kicking shares to their highest levels in a year. We’ll set our buy range down a smidge from here, thinking the 300 area could offer some resistance.

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Stock 9

Mobileye (MBLY)

Why the Strength
Mobileye is a fast-growing manufacturer of advanced driver assistance systems (ADAS), such as camera- and lidar-based sensors that improve vehicle safety and driver awareness. The company reports Q1 2023 earnings before the market opens Thursday (April 27), which will obviously be a big event. That said, management cautions the quarter could look weak compared to Q4’s 59% revenue growth, but only because automaker order patterns mean the lion’s share of revenue comes in the back half of each year. Nevertheless, Mobileye says the first half of 2023 should see about $917 million of the year’s $2.23 billion anticipated annual sales, which would be up from $854 million in the first half of last year. Since the business just held its IPO in October, the numbers from last year are a bit subjective, but what counts is the future anyway; Wall Street consensus is for 12 cents of EPS with sales around $457 million in Q1. Mobileye originally developed its technology for autonomous driving and saw high-end car makers first embrace those features for their vehicles. The business benefits from the downstream migration of its tech into more affordable cars. Some 800 models from about 50 manufacturers use one or more of Mobileye’s products today. Its fastest-growing offering is SuperVision, its most autonomous-like driving system based, in part, on extensive video mapping of roads by Mobileye. Geely’s luxury EV marque Zeeker was first to deploy SuperVision last year, sparking enough interest from automakers worldwide to double orders. And that’s really the biggest part of the story—last year alone, bookings for its various systems should account $6.7 billion in revenue through 2030, bringing its backlog of sorts (through 2030) up to $17 billion. Order updates from Q1 will be key.

Technical Analysis
MBLY was spun off by Intel in late October, with its IPO priced at 21. Shares never tested that level, instead rising to a high of 48 early this year. Since February, shares have been in a range with support at 37 to 39 (near the 50-day line) and a top at 45 to 47. If you’re aggressive, you can nibble here—or look to see if MBLY can stage a decisive show of strength following earnings. Either way, use a loose leash given the stock’s volatility.

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Stock 10

Samsara (IOT)

Why the Strength
Samsara is using the Internet of Things (IoT) to connect vehicle fleets and improve corporate operations, such as using vehicle data to pre-preemptively identify repair needs (before something starts squeaking), monitor driver safety (which can cut on insurance costs) and save fuel by reducing idling times. The company focuses on large fleet operators such as truck transport, construction, field servicers and agriculture outfits, not to mention huge city- or state-based transportation departments. Samsara has 1,200 customers paying more than $100,000 annually for its services, and 50 paying over $1 million, which are charged via subscription. In March the company posted its fiscal 2023 results for the year ending January, which showed annual recurring revenue (ARR) – its sales run rate – up 42% to $795 million, while actual revenue was up 48% to $187 million in the fiscal fourth quarter, with a bullish narrowing of its non-GAAP loss per share to two cents. The potentially worsening macroeconomic environment has the company conservatively projecting this quarter will see sales growth of 30% to 35%, to about $191 million, with a per-share loss of five to six cents. The growth even in a weaker market shows the embrace of advanced cloud systems by the old-school industries Samsara serves. Originally a GPS service that tracked equipment, Samsara increasingly sells AI-powered services to help businesses better estimate things like carbon emissions, predict future maintenance needs and improve route efficiency. In this way, it’s become more like a software business – the trillions of data points it collects from its customers each year create a positive feedback loop that improves its offerings. Analysts see the top line up 30% this year and 28% next, and long term, the potential here is huge as it inks more big clients and expands its product line-up.

Technical Analysis
IOT went public in December 2021 at an IPO price of 23, topped near 32 and then collapsed into the single digits during the bear market. It was still languishing near 11 when the calendar flipped and the stock changed character—IOT soared eight weeks in a row, including a huge gap on 13x volume (a bullish breadcrumb). The six-week rest after that didn’t even touch the 10-week line and now shares have moved to 14-month highs. As with most names, if you want in, we suggest looking for dips and keeping it small.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on May 1, 2023.