Cabot Top Ten Trader Issue: April 8, 2024

Ping Pong

When it comes to the market and especially leading, Top Ten-type stocks, we’re increasingly seeing a game of ping pong occur—one day, the market and most stocks are up, often finding support at key levels (prior price lows, 50-day lines, etc.), but a day or two later will see selling, with many names that were perking up smacked right back down. What does it mean? We learned long ago not to anticipate things, as most of the time, what you might expect will never happen—right now, then, we continue to take things at face value, which means leaning bullish as most of the intermediate-term evidence is still positive, but also being selective as there’s no doubt that momentum has waned some and an increasing number of names are testing key support. We’ll move our Market Monitor back to a level 7, but the real key is to remain flexible and take things on a stock-by-stock basis—a strong move up or down from here could set the stage for the next intermediate-term move.

Meanwhile, while the market bobs and weaves, our screens continue to find strong situations, including some decent setups should the market get moving. Our Top Pick this week is another from the chip sector—Arm Holdings (ARM) erupted after earnings in February, but has spent two months calming down and is now standing just above support. A resumption of the rally from here would be tempting.

Stock 1

Air Lease (AL)

Why the Strength
More than half of all commercial aircraft globally are leased, a practice that offers big benefits to airlines—including aircraft availability, fleet flexibility and cost savings. Analysts, meanwhile, expect another strong year ahead for the industry as it marches closer to pre-covid leasing levels. Los Angeles-based Air Lease is a leader in this space, buying new commercial jet aircraft directly from manufacturers and leasing them to airline customers (119 airlines across 62 countries). Most of the company’s order book consists of Airbus narrowbody A220 and A320 aircraft, which is significant given that narrowbodies are the world’s most popular aircraft, accounting for nearly 60% of the current global fleet. In recent months, Air Lease has experienced notable growth in its own fleet, with “healthy gains” in sales activity and higher end-of-lease revenue contributing to a strong fourth quarter. The company reported revenue of $717 million in Q4, up 19% year-on-year, with earnings of $1.89 booming 56%. Air Lease also took delivery of 22 aircraft from its order book in the quarter, representing approximately $1.2 billion in aircraft investments, and finishing with 463 aircraft in its owned fleet (75% of which were narrowbodies and 25% widebodies), up 11% from a year ago. For 2023, the firm reported its fleet utilization rate was almost 100%, an indication of the ongoing strength in global air traffic, with management reporting “no signs on the horizon of volumes weakening.” Additionally, the company sees recent geopolitical risks to cargo ship traffic as a plus and likely resulting in higher air freight volumes going forward (bullish for widebody activity). Looking ahead, Air Lease has a backlog of $22 billion in deliveries pending through 2028, while Wall Street sees revenues growing 8%-ish this year and next. The strong earnings and cash flow plus a low valuation and tight industry supply should keep business pointed up.

Technical Analysis
AL was walloped during the pandemic as air demand ground to a halt, but even after rebounding it never could quite get going—in fact, the stock has had trouble near the 50 level going back to 2018! But we think a change in character may finally be at hand, with AL getting moving in early March (thanks in part to an index addition) and racing straight up to 52, with little selling coming into the stock since then even as it takes a breather. We’re OK buying some here or (preferably) on dips with a stop near 45.

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Stock 2

Arm Holdings (ARM) ★ Top Pick ★

Why the Strength
ARM designs semiconductor architecture and intellectual property that it licenses to chip manufacturing clients. It’s long been a blue-chip player in a few fields—the designs are used in nearly every mobile phone in the marketplace, for instance, making it one of the most relied-upon businesses in the tech market. Of course, that makes ARM heavily reliant on global mobile phone volumes, but management is shifting the business toward clients in the cloud and auto, from whom ARM commands higher royalty rates. That helped business blow past consensus in fiscal Q3, ended December, coming in 8% higher than expected at $824 million, with better-than-expected earnings per share of $0.29, and with management upping the outlook going ahead. The automotive business, especially in China, powered the quarter, along with continued strength in data center and tech infrastructure deals. In the current Q4, to be announced May 8, management says it should see sales of $875 million, nearly $100 million over its prior outlook (!) and up a third year over year. What’s especially exciting about ARM is that the emergence of AI will almost certainly benefit the business, with management saying ARM clients want to make all sorts of end-user devices AI-capable, like smartphones, smart speakers, laptops and more. ARM declined to give a fiscal 2025 outlook (which just began April 1), but noted AI plans keep evolving so quickly it is seeing an acceleration in sales of its highest-end chip designs. Wall Street projections see ARM sales doubling by fiscal 2028 to $6.54 billion with earnings pushing nicely higher. Earnings are likely out in early May.

Technical Analysis
ARM held its IPO in mid-September at 51 and didn’t see a lot of volatility (for a new issue) until its Q3 earnings report sparked a furious rally from 77 to an intraday high of 164 in just three days. That did mark a resistance area, with the stock unable to surpass 150 a few times and with some selling seen late last month—but now the stock has quieted down nicely, with some of its tightest ranges and lowest volume since before the earnings move. We’ll set our buy range up from here a bit, looking to start a fresh position on strength with a stop under the 50-day line.

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Stock 3

Crocs (CROX)

Why the Strength
Crocs needs no introduction, as its once funny-looking clogs that started out being popular with professionals who were always on their feet (think cooks and nurses) have become mainstays among the masses for comfort and ease of use. That said, the company has worked hard to expand its traditional product line, with sandals, flip-flops, slides and even boots and shoes, along with Jibbitz (little snap-ons that attach to a clog), while also teaming with some celebrities to increase the “hip” factor. And the 2023 acquisition of HeyDude expanded things further, getting its hands into more footwear cookie jars. Today, about three-quarters of business is Crocs with the rest HeyDude, while half is direct to consumer and 41% of sales are overseas. That said, growth has basically ground to a halt, with HeyDude revenue slipping in Q4 (the firm is rightsizing its account base, aiming to improve full-price selling and opening new outlet stores) and earnings actually contracted a bit, too. So why the strength? Partly because some imbalances have been corrected, with Crocs’ inventories down 15% at year-end, while debt has been cut following the HeyDude buyout (now 1.3x EBITDA, within the firm’s target range)—and partly because Wall Street sees the firm’s post-pandemic earnings boom (from $3.32 per share in 2020 to $12.03 last year!) sticking around, with the bottom line actually ticking higher from here, which doesn’t seem like something many investors were expecting (the stock is trading at just 11x trailing earnings). Throw in a modest share buyback program (share count was down 2.5% in Q4 from the prior year) and we think big investors are thinking the slowdown is priced in and any upside surprises will help the stock.

Technical Analysis
CROX has been cranking out solid results for a while, but the stock actually peaked back with the market near 180 in 2021—it fell below 40 in the bear market, rallied back to 150 in 2023 but hit a wall about a year ago and, as of the start of February of this year, was still hanging around the century mark. But perception may have finally changed character, with a five-week run toward its old highs before a sharp, low-volume dip last week. The action looks normal to us—if you want in, you can start small here with a stop near the 50-day line.

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Stock 4

Eldorado Gold (EGO)

Why the Strength
After reaching record prices in late 2020/early 2021, gold and other precious metals went through a long, tough stretch which saw investor interest for the sector wane while more glamorous assets took center stage. However, gold and silver have lately recovered their lost luster, with the yellow metal, in particular, roaring to new all-time highs in recent weeks, led by torrid central bank gold purchases and thoughts that inflation will prove stickier than initially expected. Vancouver-based Eldorado produces gold, silver and base metals (mainly lead and zinc) at several mine sites across Turkey, Canada and Greece. The company completed a number of projects last year and just reached its highest quarterly gold production level in over four years, and output is heading up in a big way in the years ahead. In Q4, gold production of over 143,000 ounces across all operations increased 11% from the year-ago quarter and rose 7% for the full year, reflecting improvements throughout its portfolio. Total revenue of $307 million in Q4 jumped 25%, while earnings of 24 cents a share beat estimates by 20%. Gold sales of 145,000 ounces in Q4 for Eldorado averaged a gold price of almost $2,000 per ounce sold, with all-in sustaining costs (AISC, a key metric) at $1,207 per ounce sold—obviously several hundred dollars below spot market prices. Going forward, the company’s growth engine is expected to be its Skouries mine, a high-grade copper-gold deposit in Greece which is scheduled to begin commercial production next year and which is predicted to increase Eldorado’s gold production by 45% through 2027. The addition of Skouries is also expected to boost copper output—a key metal in the worldwide energy transition—making it a bigger part of the firm’s overall production and revenue profile, with copper production pegged at ~20 million pounds next year. Wall Street sees both sales and earnings growth of around 20% this year, with more 20%-plus growth expected in the years after as the new mine comes online.

Technical Analysis
EGO has largely mirrored gold price movements during the past two years, hitting a major trough in late 2022 along with the metal and rebounding strongly in the first four months of 2023. However, the stock then began a very choppy up-and-down consolidation: EGO dropped to 8.5 by early October of last year, then rallied to new price highs above 13 in November before again turning tail and dropping to 10 in February. However, the buyers have clearly been in control since then, with shares up six weeks in a row and tagging their highest levels since 2017. We’ll set our buy range down a bit, but we’re not expecting a big retreat.

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Stock 5

Eli Lilly (LLY)

Why the Strength
The emergence of the weight-loss treatments has revived Lilly, which had been relying on a basket of 10 mostly long-in-the-tooth drugs for sales in recent years. Its core weight loss treatments, Mounjaro, for patients with diabetes, and Zepbound, the same drug with a different name marketed for the obese, are expected to push revenue growth this year up more than 20%, to $41 billion, while the healthy margins in weight-loss projects net income lifting to $12.45 a share this year. There’s a good chance results could be even better, given that Zepbound was only officially approved halfway through Q4 of 2023, a year which was already very strong for Lilly thanks to Mounjaro sales (demand for diabetes treatments were strong, but many were also prescribing it off-label for weight loss even before the FDA gave the go-ahead); the combination pushed Q4 revenue growth to 28%. For the full year, growth was 20%, as Jardiance, another diabetes-related drug for controlling blood sugar, also performed well. There’s plenty of demand for obesity treatments to go around for both Lilly and Novo Nordisk, the other weight-loss drug giant, but Lilly may have the long-term edge, since Zepbound is a dual-agonist drug, which means it acts on two hormone pathways to help patients feel full. There are early signs and trials that Zepbound may allow patients to lose more weight than Nordisk’s Wegovy, which is a single-agonist. Lilly is selling as much Mounjaro/Zepbound as it can produce, swelling margins as American patients clamor for the drugs. Longer term, Lilly is bullish on donanemab, a treatment for Alzheimer’s, which produced positive Phase 3 trial results showing that the drug significantly slowed cognitive and functional decline in people with early symptomatic Alzheimer’s; Lilly thinks the FDA may approve the potential blockbuster by year end, with other irons in the fire as well. For now, though, it’s the weight-loss angle that will drive perception.

Technical Analysis
LLY has been strong for over a year now, so like its peer Novo Nordisk in that it’s not at the very start of its run. That said, it continues to act like the buyers are in control, with tight, controlled consolidations followed by strong upmoves. The latest example of that was a reasonable four-month rest into January, and then a quick run to the 800 level before and after earnings. And now LLY has again calmed down, moving sideways for seven weeks while pulling back less than 10% as the 50-day line catches up. Buying here with a tight stop near the recent lows looks like a solid risk-reward situation.

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Stock 6

Howmet Aerospace (HWM)

Why the Strength
A major U.S. airline just placed its biggest plane order in over a decade, underscoring the continued steep recovery across the entire aerospace industry as multi-year backlogs are worked off. Howmet (covered in the February 20 report) provides engineered metal products—mainly aluminum and titanium—used in aerospace, defense and commercial transportation applications, as well as fastening systems, bearings and forged aluminum wheels for heavy trucks. The company operates through four segments, with aero engine products (including airfoils and rolled rings for engines and gas turbines) being its largest and fastest-growing market. For 2023, revenue of $6.6 billion increased 17% year-on-year, driven by the commercial aerospace business (up 24%), with full-year adjusted EBITDA jumping 18%. While the defense aerospace business was flat for the quarter, it was up 10% for the full year, driven by legacy fighter programs and replacement parts demand. What’s more, with defense budgets on the rise worldwide, the company sees continued tailwinds in the market for fighter aircraft, drones and helicopters going forward. (Specifically, Howmet expects increased F35 engine spare parts demand due to new requirements as the fleet continues to expand globally.) Other markets, including those supporting the oil and gas sector, were said to be “healthy,” with natural gas turbine demand seen increasing as the energy transformation accelerates. Management also said the balance sheet “has never been stronger,” with solid cash generation supporting near half a billion dollars in debt paydown in 2023. On the buyback front, Howmet repurchased $100 million in shares during Q4, retiring just under 1% of the float, with $700 million still available on the buyback authorization. It’s not a name you’ll brag about at cocktail parties, but Wall Street sees steady 20% earnings growth this year and next, and Howmet usually exceeds estimates.

Technical Analysis
HWM broke out in early 2023 and enjoyed a smooth, steady run to round number resistance near 50 before sagging with the market into the late-October low. But Q3 earnings arrested that downturn in a hurry, allowing the stock to again glide higher, this time toward 70 a few weeks ago. The past four weeks have seen a couple of sharp selling waves, but like many stocks, the bears haven’t been able to take control, with HWM holding support as the 50-day line catches up. If you want in, we’re OK buying here with a tight stop in the low 60s.

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Stock 7

Magnolia Oil & Gas (MGY)

Why the Strength
While oil prices faded and stayed down for the past year and a half, the new playbook for the industry remained in place—generally less CapEx, more returns-focused drilling activity and big earnings and free cash flow (usually leading to good-sized dividends and share buybacks) even at modest energy prices—and now that oil is swinging higher again, those metrics are set to boom for many. Magnolia Oil & Gas isn’t as well known as some bigger explorers, but it has all the makings of a winner: The firm’s operations are all in drilling-friendly south Texas, with more than half a million acres in the Eagle Ford and lesser-known Austin Chalk areas, and the enticing part is that the wells are showing low production declines over time—one area (Karnes county) actually has some of the best returns in the entire U.S.! And management here is dedicated to running a tight ship, with CapEx no higher than 55% of EBITDA every year (operating margin is the second highest of its peer group over the past three years), with very little debt (zero net debt as of year end!) and yet aims to grow production in the high single digits. All of that has led to excellent overall results ($413 million of free cash flow last year, nearly $2 per share) and tons of cash returned to shareholders—the firm has a solid and growing dividend (1.8% yield) that’s protected even at $55 oil, while it aims to buy back at least 1% of outstanding shares per quarter (Q4 share count was down 4% from a year ago) and more if the environment is bullish. Indeed, last year’s results came with oil prices averaging $68 for the year, so if the $80-plus prices sticks (or goes even higher), Magnolia’s shareholder returns should boom. Earnings are due May 8.

Technical Analysis
MGY peaked in the 28 to 30 area a couple of times in 2022 and then corrected sharply into the spring of 2023. And for most of the following few months, it was dead as a doornail, hovering between 19 and 24 or so—with the stock not far from multi-year lows in January of this year. But that’s in the past: MGY’s path of least resistance is now clearly up, with shares rallying nine weeks in a row to their highest level since mid-2022. We wouldn’t chase it here, but the next pullback/shakeout should be buyable.

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Stock 8

Meta Platforms (META)

Why the Strength
Meta’s cost-cutting measures in the wake of the ad spending downturn of 2022 have paid off handsomely, as evidenced by recent results, and that’s a key reason for the stock’s strength. The social media juggernaut boasts nearly four billion monthly active users (virtually half the world’s population!) across its portfolio of apps, which include Facebook, Instagram and WhatsApp, so it makes sense that much of the focus has been on ad sales. Indeed, digital advertising comprises the lion’s share (98% last year) of Meta’s revenue, and the recent monetization of short-form video content via its Reels platform (competition with TikTok) has been successful to date. And with advertiser sentiment improving with expectations of stronger growth this year (almost half of all marketers grew their digital ad spend by at least 10% in Q1, according to a recent poll), it’s not surprising that Wall Street institutions are hiking their expectations for Meta. Beyond advertising, the company is also focused on harnessing the power of generative artificial intelligence to keep existing users from falling away while also attracting new viewers to its various platforms, as well as creating new avenues of revenue growth. These include the Meta AI virtual assistant (for answering questions, generating photo-realistic images, etc.), the launch of new large language models (to generate text, improve algorithms and attract new developers) and the AI-powered Ray-Ban Meta smart glasses (to let users to speak to the glasses and receive info on what the wearer is seeing). On the financial front, revenue of $40 billion rose 25% from a year ago in Q4 (the fourth straight quarter of accelerating growth), while EPS of $5.33 surprised the consensus by 7% and pre-tax profit margins of 41.9% were more than 10 percentage points above where they started the year. In the wake of these results, Meta initiated a token dividend (a 0.4% yield), and management said shareholder returns, including buybacks, will play a major role going forward. Analysts see sales up 17% this year and earnings up more; the Q1 report is due out April 24.

Technical Analysis
Usually, after a big winner implodes during a bear market, its luster is lost for a long time, but META has been the exception, experiencing a stellar rebound since bottoming in 2022. After a huge rebound into last summer, shares built a four-month base, finally getting going in December and then booming on Q4 earnings—and while the 500 level has been sticky, META has shown no desire to pull in much despite some growth stock wobbles. We’re OK buying some here.

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Stock 9

Robinhood (HOOD)

Why the Strength
There are many Bull Market stocks that are still acting well, but Robinhood has probably the highest potential of any, as it’s still young and is much more leveraged to newer investors—thus, if big-picture sentiment improves over time, it’s positioned to gain lots of users and capital. Of course, it’s not just all about the market here, as the company has been making plenty of moves: While there are still limitations on what can be traded (like bonds, preferred stocks and the like), the company is expanding internationally (in the U.K. late last year, while introducing crypto trading in Europe in December, too), is focusing on alternative products for more frequent traders (including 24-hour trading for lots of stuff, with index options and futures being added this year) and is making a swing for traditional users, too (new retirement account program that includes matches from the company!). There’s also a subscription offering (Robinhood Gold) that, for $5 per month, gives you higher yields on cash deposits, better trading tools and a higher match on IRA deposits, too. There’s also some hubbub about its new credit card (hasn’t launched yet but a waitlist is being built) that gives Gold members an industry-best 3% cash back on all spending; some think this isn’t sustainable (interchange fees won’t cover it), but there’s reportedly large interest in it, and of course, it could bring more people to its platform. Growth has been solid (partly from higher interest income) and recent monthly metrics show how quickly Robinhood could grow—in February, custodial assets rose 16% from January (!), while trading volumes all grew double digits from the prior month and cash sweep balances (big for interest income) were up 8%, too. Obviously, if the market stumbles in a big way, all bets are off, but we think Robinhood will surprise on the upside. Earnings are due May 8.

Technical Analysis
HOOD had a long, wild bottoming effort from the middle of 2022 into January of this year, when shares were sitting at 11, no higher than they were two years before. But the stock tightened up at that point and then exploded higher on the Q4 report, launching a big rally that took shares to round-number resistance near 20. The pullback since then has been normal, but we’ll set our buy range down from here, thinking a bit more near-term weakness could be coming.

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Stock 10

ServiceNow (NOW)

Why the Strength
Enterprise spending on generative AI and workplace automation is one of today’s biggest growth trends, with several research specialists (including a recent Bloomberg report) pointing to all things GenAI becoming a more than trillion-dollar market by 2032 (versus $40 billion in 2022). ServiceNow is well known for its software platform for businesses that allows clients to digitize workflows and enhance productivity, which has led to years of steady, rapid growth. More recently, the company has emerged as a leader in several additional software markets, including artificial intelligence used for IT applications and digital process automation (used for customer onboarding). On that score, ServiceNow is including AI technology in its products, including its Now Assist GenAI solutions portfolio, which feature new capabilities to transform experiences and increase productivity, along with offering premium Pro Plus subscriptions. The company also recently formed a collaboration with Amazon Web Services (AWS) that will allow the Now Platform and the entire suite of solutions to be available as Software-as-a-Service (SaaS) offering in the AWS Marketplace; it’s expected to provide new automation opportunities for multiple industries and use cases, including manufacturing, supply chain, call centers and cloud transformation. In Q4, ServiceNow’s GenAI products drove the company’s largest net new annual contract value (ACV) contribution ever for the first full quarter of any of its new product family releases. (The firm had a record 10 new customers sign deals over $1 billion in ACV, including Chipotle, Air France, and Busch.) Revenue of $2.4 billion increased 26% from a year ago, led by a 27% subscription sales leap, with earnings of $3.11 beating estimates by 33 cents. When Q1 earnings are released on April 24, the firm expects subscription revenue of around $2.5 billion (up 25% if realized), allowing ServiceNow to expand its leadership position in enterprise AI solutions.

Technical Analysis
NOW built a nice base-on-base formation from early 2023 through the market low in October, and the breakout from there was excellent, with a persistent run higher with just one shakeout (to the 10-week line in January). The last eight weeks have brought another consolidation, this one just 10% deep—and shares are starting to perk up again, looking ready to move if growth stocks cooperate. We’ll set our buy range up from here, looking to grab shares if buying power shows up.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on April 15, 2024.

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