Cabot Top Ten Trader Issue: August 14, 2023

Remain Patient

The market’s nascent downturn remains in effect, with the short-term trend of most indexes and sectors pointed down and with growth stocks continuing to bring up the rear—today was a nice reversal of that, but even so, after weeks of being the strongest thing out there, the Nasdaq is now lagging (again, in the short term). Because of that, we advise remaining patient here, spending most of your time managing your current portfolio while monitoring what stocks/sectors/themes remain resilient. That said, the pullback from a top-down perspective continues to look normal (and, frankly, looks a lot like previous initial pullbacks in bull phases), so we’re not hiding in our storm cellar, either—we’re hanging onto our resilient, profitable stocks while nibbling here or there on high-odds opportunities. We’ll leave our Market Monitor at a level 6 today.

One of the more encouraging things of the past three weeks is that we’re not having trouble finding good-potential names with solid charts; it’s not all oil stocks or defensive stocks, for instance. This week’s list is no different, and our Top Pick is Freshpet (FRPT), which is a great growth story and now, after a couple of bad years, all of the firm’s metrics are pointed in the right direction.

Stock 1

Adobe (ADBE)

Why the Strength
Adobe is a long-running leader in software for visual content, with the most-used apps for photo editing, drawing, page layout and video editing, while the PDF page format it created has become a standard around which the company sells a raft of services. Having thrived after switching to a subscription model last decade, Adobe has been firing on all cylinders this year, posting revenue of $4.8 billion in its second quarter, ended June, a rise of 10%, while earnings hit $3.91 a share, beating estimates. Management sees the back half of the year extending that strength, driven by product improvements, like with its mobile apps, along with fundamental growth in content creation, where some customers predict a five-fold rise in coming years. For 2023, that should add up to a 10% gain in sales to $19.3 billion and nearly $16 in EPS. Investors believe that Adobe’s position in the professional creative process gives it a leg-up in capitalizing on generative AI: In March, the company unveiled Firefly, a plain language image creator, as the first of a series of generative AI offerings. The program is targeted primarily to marketers who want to create images and advertising without learning Adobe Photoshop or other of its core programs – and, to show the potential here, such users made 500 million generations in its first six weeks! Demand should continue from the increasing desire to target campaigns for smaller sub-segments of potential consumers, requiring quicker creation times. To avoid alienating its core creator base, Adobe will also tag images and art with a “do not train” message that will forever travel with images, keeping them from being used by its own AI and, presumably, other programs. All in all, this is a solid blue-chip tech name that’s still doing well, with an AI kicker that could boost growth down the road.

Technical Analysis
ADBE lost nearly two-thirds of its value in 2022, the stock’s most prolonged bear move since 2009. Shares stabilized in the 330 to 400 zone from February through May before Q2’s strong earnings sparked a breakout, catapulting shares into the 550 area before the latest market dip. So far, ADBE’s retreat has been very well contained. We think it’s buyable here, with a stop in the 470 area.

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Stock 2

Carrier Global (CARR)

Why the Strength
Extreme temperatures this summer have put heating, ventilating and air conditioning (HVAC) specialists like Carrier in the spotlight. But summer heatwaves aside, the company is positioning itself to be a dominant year-round player in Europe’s massive energy transition trend. The Florida-based firm just acquired Germany’s Viessmann Climate Solutions, which is expected to enhance Carrier’s climate and energy portfolio, as well as giving it a bigger footprint in Europe; the deal is all the more significant given the push by the E.U. to increase continent-wide installations of heat pumps beyond the 16% current figure by 2030. And overall, the company expects worldwide installed base for air-to-water heat pumps to grow over 300% by 2030! Carrier is also planning to divest its other refrigeration and fire & security units in order to concentrate on HVAC (currently about 70% of total sales). This move, along with the Viessman purchase, puts Carrier on the path to becoming a major competitor in the residential energy solutions market. Further out, the firm’s goal is to become a leader in providing end-to-end climate solutions for residential and commercial customers by combining its solar charging stations and heat pumps with a comprehensive digital tool that interfaces with utilities. Additionally, Carrier is expanding its AI-driven digital platforms for enterprise clients—Abound, Lynx and BlueEdge—which allow them to monitor real-time carbon emissions and improve energy efficiency across their global portfolios (including buildings and temperature-sensitive shipping cargos). Granted, this won’t be a super-fast mover, but growth is accelerating some (sales up 13% and 15% the prior two quarters) and earnings have turned up after a soft three-quarter stretch. Double-digit earnings growth seems likely for a while to come.

Technical Analysis
CARR had a huge run after coming public in 2020, and actually held onto most of it even during the bear market. That said, the stock had trouble turning the corner, with shares meandering sideways for months after its late-2022 rally. CARR finally got going after Memorial Day at that point, with the uptrend accelerating after earnings late last month followed by a reasonable dip to the 25-day line. We’re OK starting a position here with a stop in the low 50s.

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Stock 3

Celsius (CELH)

Why the Strength
There aren’t many growth stories larger than Celsius right now, with rapid and reliable growth looking very likely for many years to come. The firm’s energy drinks are quickly gaining in popularity, as they have for years, thanks to mostly all-natural ingredients and also the fact that studies show them to turn on the body’s thermogenesis response (creating heat), burning calories. But the big thing in the past few quarters is a new distribution deal with Pepsi, which took a solid growth story and supercharged it—and the results are showing it. In Q2, not only did total sales more than double and earnings go wild (more than doubling estimates), but the conference call featured a bunch of bullish tidbits: The overall energy drink market is still expanding at a double-digit rate, and Celsius accounts for one-quarter to one-third of that growth; its market share has doubled but is still “just” 8.6%, so plenty of room for growth; club sales are ramping (up 120%) and a national rollout within BJ’s just started last quarter; categories such as universities, foodservice, hospitals, hotels, casinos and the like make up just 11% of Pepsi-related revenue, and the top brass sees huge potential there; and, looking ahead, Celsius is getting its ducks in a row with logistics and the like for international sales (up 76% in Q2 but just 5% of revenue), aiming for a decisive push overseas (with Pepsi’s help) early in 2024. Earnings estimates have taken a leap since the report, but given the size of the beats and pace of the growth, who knows how big the numbers could get. There is execution risk, of course, but so far, management (and Pepsi) have pulled all the right levers.

Technical Analysis
CELH etched a gigantic base-on-base formation during the bear market with resistance in the 110 to 120 area before the stock finally busted out on the upside after earnings in May. Shares did make some progress after that, but started to chop sideways and hit resistance near 150 (give or take)—and even dipped below the 50-day line. Still, the damage was limited, and last week’s earnings gap is obviously a good sign. We’re OK with a nibble here or (preferably) on dips.

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Stock 4

Consol Energy (CEIX)

Why the Strength
Coal isn’t exactly a hot story these days, but several major emerging countries have been increasing their coal consumption, which, along with cost controls and some longer-term deals, is a big reason behind Consol’s strength. The Pennsylvania-based producer of high-BTU bituminous thermal and metallurgical coal owns and operates some of the most important longwall mining operations in the U.S. and also owns one of the largest export terminals on the Eastern seaboard. Earlier this year, sales into Consol’s industrial export market exceeded sales to domestic power producers for the first time in company history, a trend the firm expects will persist in the foreseeable future. Indeed, last week’s Q2 results revealed that a record 78% of recurring revenue and other income came from export sales, while 64% derived from non-power generation sales, allowing Consol to continue a “strategic sales shift” away from lower-priced domestic sales and into stronger foreign and industrial markets. Overseas demand, meanwhile, is enabling the company to ramp up to full production at its Itmann (West Virginia) mining project, boosting margins. All in all, total sales of $661 million increased 21% year-on-year, and the firm’s Pennsylvania Mining Complex also achieved its second-highest quarterly revenue per ton sold and average cash margin per ton sold during Q2. Meanwhile, earnings and cash flow are out of this world: Consol’s earnings came in at nearly $5 per share in Q2 and free cash flow was nearly $12 per share in the first half of the year (!), and management repurchased nearly 6% of all shares during that time (with more in July). Throw in zero net debt and huge earnings estimates for 2024 and the firm is likely to be returning mountains of cash for a long time to come.

Technical Analysis
CEIX resisted last year’s bear market, peaking last August slightly below 80. A 35% correction followed over the next seven months, but even so, the stock dramatically outperformed the much bigger decline in benchmark coal prices. The bottom came in March, and CEIX changed character in early June, with a rally into the 70 area and, after a quick shakeout, a push back toward its highs. Last week’s post-earnings advance was powerful and we think a bit more weakness would be tempting to start a position.

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Stock 5

Freshpet (FRPT) ★ Top Pick ★

Why the Strength
Nobody is going to argue pet food is revolutionary, but Freshpet’s fresher, healthier food (almost all for dogs) plays into the mega-theme of pets becoming more a part of the family, and this company’s offerings lead to longer lives and better quality of life for Fido. Frankly, demand here has never been an issue—sales have grown at least 25% for 20 consecutive quarters (!)—but some company mishaps, the pandemic itself and heavy investments caused costs to ramp, while a series of price hikes (more than 25% total) also caused a few convulsions. But now it’s looking like most of that is in the past: Not only did Q2’s top line rise nicely (up 26%), but it wasn’t just from price hikes, with volume growth accelerating of late (up 18% in the latest quarter), while household penetration is doing the same thing. (All in all, Freshpet has just 15% of U.S. pet households as customers.) Moreover, gross margins are picking up nicely as a new production plant ramps up and all sorts of costs (inputs, G&A, etc.) fall back to Earth. Because of that, EBITDA, while small, is positive, growing and topping estimates ($55 million or so estimated for this year, vs. $20 million last), and the top brass has some bullish longer-term goals, thinking sales can grow 25%-ish annually through 2027 while margins leap a few percentage points, which of course will have EBITDA and earnings doing very well. Granted, after the last couple of years, there are fears management will lose control of things again, but with the industry growing nicely and with Freshpet being the leader, it’s more likely that big investors will start looking ahead to sustained good vibes.

Technical Analysis
FRPT was destroyed during the bear market, falling from 187 in early 2021 to a low of 36 (!) before staging a solid off-the-bottom rally into November of last year. And then shares went mostly dead—there were some encouraging signs (a huge shakeout-and-recovery in March; some excellent tightness in July), but net-net, the stock did nothing for eight-plus months. Now it’s looking like FRPT is leaving that behind, breaking out on earnings and holding up since. We’re OK with a nibble here or (preferably) on dips.

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Stock 6

Group 1 Automotive (GPI)

Why the Strength
After a tough 2022 for global automakers, industry experts are worried that high inflation could lead to continued affordability issues for prospective buyers even as vehicle inventories build up faster than anticipated. However, none of this is a concern for Group 1 Automotive, which continues to see record sales in the face of a weak macroeconomic backdrop. The firm operates dealerships and collision centers in 17 U.S. states and across 35 towns in the U.K., too. Through its omni-channel platform, the company sells new and used cars and light trucks, arranges financing and provides maintenance and repair services, with auto sales accounting for over 80% of the firm’s revenue. The big story here is that earnings went crazy in the pandemic and any adjustment lower has been very small and has come much slower than feared. In Q2, Group 1 set records across several metrics, including total sales which were the highest in company history! Total revenue of $4.6 billion rose 10% year-on-year, and earnings of $11.73 a share topped estimates by 65 cents. New vehicle revenue increased an impressive 19% sequentially and 22% from a year ago in the U.S., and it wasn’t just because of pricing, as new vehicle unit sales also jumped (up 15%). In the U.K., where most of Group 1’s sales are in the luxury space, auto demand remained “resilient” while new vehicle availability was “still constrained,” keeping per-unit profits strong. A key reason for the company’s industry-beating strength is the increased adoption of its digital platform, AcceleRide. In Q1, the firm sold a record number of vehicles through the platform, with nearly a quarter of U.S. sales now coming on it. The P/E ratio here is ridiculously low (6x earnings), and while not as aggressive as some peers, Group 1 is gobbling up shares (share count down 14% from a year ago) and pays a token dividend, too (0.7%).

Technical Analysis
GPI peaked in late 2021 near 215, fell as low as 136 at the bottom in September and rallied all the way back to new highs in January. That didn’t lead to a run, though, with another, tighter consolidation being formed through May—but since then, the buyers have been in control, with a breakout in early June and two tests of the 50-day line holding in recent weeks. It’s not going to be a barn burner, but GPI looks buyable around here with a stop in the 240 area.

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Stock 7

Natera (NTRA)

Why the Strength
Natera is a fast-growing business that’s centered on screening cell-free DNA (cfDNA) fragments in the bloodstream for diseases. The company established itself with a widely used prenatal test, Panorama, which is a noninvasive way of screening for a variety of fetal problems in the mother’s blood. Recently, most testing volume in California has shifted to Panorama from a competitor. Natera is emphasizing growing another test, Signatera, which screens for colorectal cancer and is used by nearly a third of oncologists in the U.S. today. Pursuing volume for Signatera has crimped margins a bit, but management sees that reversing course soon. In the most recent quarter, reported last week, revenues were up 32% on a volume gain of 23%, a clear sign of pricing leverage. Part of that comes from Medicare’s decision to cover Signatera as a screen for breast cancer, which is resulting in better volumes and higher rates. Medicare coverage is vitally important to the Natera, accounting for the majority of annual revenue, and the expansion of government coverage means Natera was able to bump up its sales expectations for the year to $1.025 billion or so. The company also has some tailwinds from a couple of court cases against competitors that validated Natera’s patents and probably will result in better royalty payments in the future. The company has a big focus on finding new applications for its cfDNA tests, especially in kidney health with a test called Prospera and in expanding Signatera further into women’s health. Trials are in various stages but so far appear promising. It will be some time before Natera turns market share into profits, but analysts see 25%-ish revenue growth this year and next, which is likely conservative.

Technical Analysis
After crashing early last year, NTRA rallied back to the 58 area last August, an area it again revisited in March of this year—but was rejected both times. The multi-month downturn from March wasn’t vicious—in fact, it was fairly well controlled—but shares sank persistently, eventually dipping beneath their 40-week line earlier this month. But it’s appearing in Top Ten today because of what happened next: A very bullish reaction to earnings over many days, with the stock quickly pushing back toward those old highs. We don’t think NTRA will go straight up, but it looks like a solid shakeout situation; dips would be tempting.

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Stock 8

Noble (NE)

Why the Strength
We’ve written about a couple of offshore drillers plus some offshore service plays of late, and the story with Noble—which looks like one of the real leaders of the entire theme—is similar, with the long bust period leading to industry consolidation, tighter cost controls and tighter supplies, so now that dayrates are kiting higher, cash flows and earnings are soaring. That all bodes well for the next two or three quarters, but the story here looks to be much bigger than that, with management relaying some specifics in its Q2 conference call: The top brass believes stronger demand and a lack of speculative building in the industry presents a “highly constructive setup for what we anticipate [being] a multi-year up cycle not just for dayrates but for sustainable free cash flow as well.” Looking at the industry, of the 99 marketed ultra-deepwater rigs, 92% are under contract, yet the top brass sees demand for another 10 to 15 rigs likely by year-end 2024; the 62 rig years worth of contracts inked in the first half of this year by the industry was up 35% from a year ago, with contract duration up to 11 months, from 8 months (and that doesn’t include some long-term fixtures with Petrobras); and overall dayrates should eclipse the $500,000 level fairly soon. Jackups are a weaker spot, of course, but management believes the first half of the year is the trough for rates in that area, too. Eventually, of course, there will be overbuilding (more supply) and dayrates will fall—but even at modest energy prices, many offshore wells spin off lots of cash and have a long life (don’t deplete as fast as onshore wells), so the upturn here is likely in the early innings. Noble has some ships coming off contract in Q4 and Q1 of next year (likely to be inked at higher dayrates), which is another plus. Throw in a new shareholder return plan, where nearly all of free cash flow is likely to be returned (2.3% dividend, and share buybacks too) and there’s a lot to like.

Technical Analysis
NE has acted about as well as can be since our write-up more than a month ago—shares have technically rallied seven weeks in a row, though the last month has shown plenty of tight action. We’re not ruling out a shakeout if oil prices wobble, but we’re OK entering here or on weakness.

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Stock 9

Novo Nordisk (NVO)

Why the Strength
Cardiovascular disease is the leading cause of death for both men and women in the U.S., and its links with obesity and diabetes are widely known. Denmark-based Novo Nordisk is known for its leadership in developing treatments to combat diabetes and obesity, with leading positions in hemophilia care, growth hormone therapy and hormone replacement therapy. Last week was a busy one for Novo Nordisk, which announced that its once-weekly weight-loss therapy, semaglutide (Wegovy), decreased incidents of major adverse cardiovascular events by 20% in a Phase III trial for obese or overweight adults with cardiovascular disease, sending the stock soaring. The company plans to seek regulatory approvals for a label expansion of Wegovy by year’s end, which is expected to add to the “overwhelming demand” the drug is seeing for its current weight loss indications. Novo Nordisk also said it has agreed to purchase Inversago Pharma, a privately held Canadian drug developer focused on weight loss medications, which is expected to close by the end of 2023. The announcement coincided with the company’s Q2 results, which saw revenue of $7.8 billion lift 24% in U.S. dollar terms, driven by diabetes and obesity care drug sales increases of 50% and 188%, respectively. And while earnings of $1.26 a share missed estimates by 6%, they were 53% higher year-on-year. The solid results prompted management to raise the company’s full-year sales growth outlook to around 30% and EBIT growth to 34%. Looking ahead, the company is seeking to expand the market for its blockbuster diabetes drug, Ozempic, and sees a “significant long-term opportunity” for its offerings in China. Analysts see the bottom line surging this year and up nearly 20% more in 2024.

Technical Analysis
NVO was in base-building mode during the first nine months of 2022, showing excellent relative strength versus the broad market—a big clue of what was to come. The stock took flight in late September and soon reached record levels, running to 173 by April. Three more months of high-level consolidation followed, with last week’s trial results blasting the stock to new highs on extremely heavy volume. A bit more of an exhale would be normal, so we’ll set our buy range down a bit from here.

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Stock 10

Tempur Sealy (TPX)

Why the Strength
The mattress market is facing headwinds from slowing growth in disposable incomes and a contraction in the housing market, resulting in a 15% year-on-year drop in U.S. mattress shipments last year, with the weakness continuing through June. Yet the weak backdrop hasn’t dented Tempur Sealy’s long-term growth outlook, as the firm is holding up far better than its peers today—and the sector as a whole should be turning up soon. Indeed, the Kentucky-based company just reported one of its strongest second quarters in its history: Tempur’s Q2 results featured a 5% revenue bump, to $1.3 billion, with North American sales increasing 5% and international sales rising 4%. Per-share earnings of 58 cents topped estimates by two cents, and the company said all three of its leading U.S. brands (Tempur, Sealy and Stearns & Foster) “performed well” in the quarter and put the firm “significantly ahead” of the general bedding industry trend. Management had even more reasons to be sanguine going forward, stating that despite “historically low” U.S. industry-wide bedding sales, the latest cycle has likely bottomed out. Moreover, the company recently opened its third domestic foam-pouring plant (with room for further expansion) to meet expected strong demand for years to come. The other piece of big news is Tempur’s agreement to acquire Mattress Firm in a whopping $4 billion deal (more than half the current market cap!), which will leave the combined entity with north of 3,000 locations and a top position in various slices of the industry. The deal isn’t expected to close until the second half of next year, but if management executes the potential is big. As it is now, analysts see earnings growth in the black in Q3 and accelerating after that.

Technical Analysis
TPX topped at 50 in late 2021, fell to 20 last June and then rallied all the way back to 44 by early February of this year. Then came a tidy, controlled four-month basing area, with support appearing above the 40-week line just after Memorial Day. The advance from there took the stock to new high ground, and after a dip to the 25-day line with the market, earnings caused a nice pop. We’re OK snagging some shares here, albeit with a tight stop.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on August 21, 2023.