Cabot Top Ten Trader Issue: August 26, 2024

Note: Due to the Labor Day market holiday next Monday, you will receive your next Cabot Top Ten Trader update on Tuesday, September 3.

A Key Week Coming Up

As we’ve written, the market’s rebound has been very impressive, with the action of individual stocks even more encouraging than the major indexes. That said, there are a couple of flies in the ointment (we’re not huge fans of defensive sectors rallying strongly) and this week looks like a good test for a couple of reasons: First, there are some key quarterly reports coming out in key technology areas (Nvidia’s report on Wednesday will obviously be much talked about), and trend-wise, many growth-oriented measures are closing in on five-week highs, which could turn the intermediate-term trend up … if all goes well. As for the here and now, though, nothing has officially changed: The rebound since the early-August panic has been great, but it’s what happens from here that will tell the tale—if we see more breakouts and further upside, it would obviously be bullish, but while some retrenchment from here wouldn’t necessarily be bearish, it would be a sign the market likely needs more time to set up. We’ll leave our Market Monitor at level 6 this week, still aiming to start with smaller positions and generally trying to enter on dips.

This week’s list is a bit more diversified than the past two weeks, with a couple of zingers but also some rate-sensitive names and even a turnaround. For our Top Pick, we’re going with one of the zingers: Aspen Aerogels (ASPN), which is very strong following quarterly results, has triple-digit growth and a great story—if you enter, be sure to keep it small and use a loose stop.

Stock 1

Aspen Aerogels (ASPN) ★ Top Pick ★

Why the Strength
The boom in electric vehicles (EVs) and alternative energy generation is heavily dependent on batteries and other forms of power generation that require high-tech thermal insulation. This is where Aspen enters the picture—the Massachusetts-based firm uses aerogel technology that helps energy companies design and operate more efficient, safe and profitable facilities (including power plants, steam distribution systems, buildings and pipelines), and its products are used to optimize the performance and safety of EVs and other energy infrastructure assets. Aerogels are a class of porous, ultralight material derived from a gel, in which the liquid component for the gel has been replaced with a gas without significant collapse of the gel structure. The result is a solid with extremely low density and extremely low thermal conductivity. Indeed, aerogels have been compared to “frozen smoke” due to their virtual weightlessness and translucent appearance—a huge benefit for reducing the weight and improving battery performance for EVs and other applications. In Q2, Aspen reported revenue of $118 million that increased a whopping 144% year-on-year, with earnings of 21 cents blasting past estimates by 15 cents. EBITDA grew to $29 million, a big improvement from the year-ago $11 million loss, resulting in an EBITDA margin of 25%. The revenue and profitability growth were seen across both of Aspen’s business segments, with Thermal Barrier sales accelerating as clients ramp production to capture demand, while supply to Energy Industrial segment customers is also increasing. Going forward, management plans to expand product supply in the latter category, which it said is supported by a tightening global emissions regulatory environment and an EV market that favors recently launched models (many of which are equipped with Aspen’s PyroThin aerogel thermal barrier material). Wall Street sees revenue jumping 70% this year, followed by several more years of 30%-ish growth as earnings take off.

Technical Analysis
ASPN hit its highwater mark at 62 in late 2021, crashed below 6 during the bear market and began to get going with most other growth stocks in late 2023. Being lower priced and a small-cap name, shares have been herky-jerky, but the stock made it up to 31 in June thanks in large part to a massive earnings rally in early May. The correction from there was brutal (47% deep!), but the 40-week line offered support and now ASPN has roared back to its old highs on heavy volume. It’s not for the rent money, but a small position here or on dips and a loose stop under 25 is fine by us.

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Stock 2

Barrick Gold (GOLD)

Why the Strength
Hezbollah’s launching of hundreds of rockets and drones on Israel this weekend, followed by Israel’s airstrike response, serves as a reminder as to why safe-haven demand for gold remains strong in an otherwise favorable environment for risk assets; it also doesn’t hurt that most expect money to become easier going forward thanks to the Fed and other central banks. Growing interest in the defensive-oriented metal has pushed prices to record highs of late, casting an attractive light on top miners like Barrick. The Toronto-based company is one of the world’s lowest-cost gold miners and the second largest by production (two million ounces produced last year), and it lays claim to having the best portfolio of Tier One gold assets (annual production of at least 500,000 ounces of gold and with industry-beating production costs). Moreover, the miner plans to double its copper exposure by 2029, which is significant given the copper-driven nature of the alternative energy (electrification of everything) boom. On that front, Barrick just announced that two of its world-class copper projects are set to deliver into a strong market: In Zambia, an expansion is expected to nearly double the mine’s production to 240,000 tons per year, while a big project in Pakistan is targeting 400,000 tons of copper and 500,000 ounces of gold per year. As for the here and now, the company reported an 8% sequential increase in production of the red metal in Q2, at 43,000 metric tons, while gold production increased 1% to 948,000 ounces. The solid production drove a 12% year-on-year revenue increase, to $3.2 billion, while earnings of 32 cents beat estimates by a nickel, with free cash flow rising to $340 million (from $79 million in Q1). Looking ahead, management guided for all-in sustained costs (AISC, a key metric) to average $1,370 this year—well under the yellow metal’s current price tag of $2,550—with future production growth expected to be driven by the Pueblo Viejo project in Latin America (which analysts regard as Barrick’s key opportunity in the region), with an aim of lifting its annual production volume to over “800,000 ounces for more than 20 years.” Wall Street expects earnings to improve 54% this year and 32% in 2025, accompanied by substantial FCF growth as higher gold prices filter through to the bottom line.

Technical Analysis
Along with the bullion, GOLD hit a major peak at 26 in the early part of 2022, tumbling 50% over the next few months before bottoming in November. A major rally back to 20 followed, but despite two different attempts, the stock couldn’t overcome resistance and spent the next 15 months flopping around in a six-point range. But the action of the past two weeks looks like the real McCoy, with shares catapulting to yearly highs following the quarterly report—if you want in, we’re OK entering around here.

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Stock 3

CBOE Global Markets (CBOE)

Why the Strength
Cboe is a classic Bull market stock, being the world’s go-to derivatives and exchange network, delivering cutting-edge trading, clearing and investment solutions, with products that span multiple asset classes (including equities, derivatives, FX and digital assets) across North America, Europe and Asia Pacific. Accounting for much of the stock’s strength is the recent explosion in equity market volatility as reflected by the Cboe’s own volatility gauge, the well-known and widely utilized VIX index (which measures market risk and investor sentiment). Earlier this month, the VIX hit its highest level since the early 2020 pandemic panic based on a sudden wave of market-wide selling pressure related to geopolitical and economic fears, as investors flocked to VIX options to hedge against potential tail risks. This was massively beneficial for Cboe, as the company typically outperforms in volatile environments due to the increase in trading volumes, especially in S&P 500 options and VIX futures. Even before that event, the company’s business was strong, reporting Q2 revenue of $514 million that grew 7% from a year ago, with EPS of $2.15 beating estimates by 5 cents and lifting 21%, the firm’s quickest growth rate in a couple of years. The results were driven by a contribution from each part of the firm’s ecosystem, with improved volumes in its cash and spot markets (up 15%), solid volumes across the derivatives franchise (notably index option and futures products, up 11%) and continued expansion of its Data and Access Solutions business (up 5%). Management, meanwhile, is focused on maintaining a “strong and flexible” balance sheet while investing in organic growth initiatives to drive “durable” revenue, margin and earnings growth. (Margins here are notably huge, 33% on a pre-tax basis.) Among those initiatives are the introduction of Cboe S&P 500 variance futures in September and the launch of options on VIX futures in October (both subject to regulatory review). Wall Street sees a 10%-ish revenue increase for Q3, likely conservative given the volatility already seen and some possible pre-election ups and downs in September.

Technical Analysis
After a solid upside run that began around the middle of 2022, CBOE ran out of steam earlier this year, falling just shy of reaching the 200 mark. The decline that followed from February into July coincided with a diminution in broad market volatility, taking 17% off the stock at its nadir. But when the VIX picked up and the broad market rallied, so did CBOE, with an exceptional early-August buying cluster helping to drive the stock to new highs. If you want in, we’re OK starting a position on pullbacks.

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Stock 4

Comfort Systems (FIX)

Why the Strength
The nascent boom in AI data center construction is expected to proceed at a 20%-ish growth rate between now and 2030, providing a huge tailwind for providers of heating, ventilation and air conditioning (HVAC) for those centers. Comfort is one such beneficiary: It’s a leading provider of commercial and industrial building systems, including HVAC, plumbing, electrical and fire protection. It operates under two segments, with its Mechanical slice of the pie making up about 80% of revenue and specializing in HVAC system installation, repair and replacement; the Electrical segment makes up the rest and handles electrical construction and engineering for commercial and industrial customers. Industrial sector demand—including data centers and other manufacturing customers—drove head-turning sales growth in Q2 while pushing the backlog to “extremely high levels.” Revenue of $1.8 billion increased 40% from a year ago, driven by a 49% sales increase in the Mechanical segment, a 12% increase in the Electrical segment and a 30% jump in overall same-store revenue. Other metrics were equally impressive, including per-share earnings of $3.74 that beat estimates by 60 cents and EBITDA that reached $200 million for the first time, doubling the total from a year ago. Margins in the Electrical segment also increased “significantly” to 24% (from 17% a year ago), while Electrical segment margins improved to 19% (from 18%). Meanwhile, the same-store backlog was 25% above where it was a year ago, with demand continuing at “unprecedented levels” as project pipelines remain “robust,” with the revenue mix trending towards data centers, chip fabs, battery plants, life science and food. In light of these developments, the top brass said it was optimistic the strong results will continue in the second half of this year and into 2025. Analysts see earnings continuing to crank ahead for at least the next couple of quarters, with estimates likely conservative after that.

Technical Analysis
FIX has been acting well for a couple of years, with a relatively smooth rise from October 2022 until last September, and after a sharp decline with the market, an acceleration higher into March. Shares essentially topped out there (they did make a slightly higher high in May), with the stock churning in a tight range until the big market-induced shakeout three weeks ago. FIX held the 40-week line on that shake, and now shares have moved back up (on low volume) toward their prior highs. We’ll set our buy range up from here, aiming to enter on a clear breakout.

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Stock 5

Credo Tech Group (CRDO)

Why the Strength
Credo Technology Group is a pure-play business in the realm of connectivity needed for high-powered AI computing facilities. The company operates in the highest end of the market, where its products are seen as difference makers: Providing faster speeds through ethernet cables, as well as sophisticated power cables, cards that act like gear switches for third-party data transfer equipment and chiplets to manage it all. Credo also licenses out some technology, which provides about 10% to 15% of sales. Credo says its edge is the fact it rarely just supplies gear “off the shelf"; instead, the company works with clients to design set-ups to be their most efficient (known for its lower power consumption while retaining top performance), often developing new iterations of hardware to suit customer needs. The gold rush in AI means Credo has a base of “hyperscaler” customers – businesses that are spending ferociously to establish themselves in AI – like Microsoft, which was 26% of sales in the firm’s active electrical cables (AEC, probably the key segment) last period. The explosion of AI is seen as transformative for the company, with projections that Credo’s top line can go wild from $193 million in fiscal 2024 (just ended in April of this year) to $316 million this year to an early analyst forecast of $480 million in fiscal 2026. The next big event will come next week, on September 4, when Credo reports fiscal Q1 earnings, with consensus Wall Street expectations falling on the high end of management’s earlier guidance of $58 to $61 million revenue. That would actually be slightly slower growth sequentially, but up more than 69% from the year-ago period, almost all of which should thanks to AI-related demand. The company is playing its outlook for the full year close to the vest, but says AI spending should accelerate throughout the year and end up being double fiscal 2024’s sector spending. Whatever the exact figures, it’s looking like Credo is becoming a key infrastructure cog in the AI buildout.

Technical Analysis
CRDO broke out of a big range in May, as AI-powered earnings excited investors. Shares rallied all the way to 34 in the middle of July but then they got caught up in the correction, giving up all of their post-breakout gains. That looked decisive, in true tennis ball fashion, CRDO began bouncing right after its low … and it hasn’t stopped, with last Wednesday seeing a big-volume move to new price and relative performance highs. The upcoming earnings report will be key (as will Nvidia’s report this Wednesday), so we’ll set our buy range down a bit, trying to enter on a further shakeout.

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Stock 6

PayPal (PYPL)

Why the Strength
PayPal needs no introduction, as it was one of the first big “fintech” plays out there, moving payments away from traditional credit cards and banks, and with its popular Venmo service, was really the pioneer and remains a leader in the huge peer-to-peer money transfer area; all told, PayPal is offered at something like 2,400 merchants out there (usually online, but some offer payments in store as well) and has 229 million active monthly accounts and an annual payment volume of $1.6 trillion, making it a giant online commerce player. However, the stock has been through the wringer since 2021 as competition set in, growth slowed and investor perception faded—many thought the firm would be left behind given the big number of newer players. However, business never really got hit badly, and now, with a reasonable valuation and some uptick in growth metrics, it looks like the stock is starting a turnaround. In Q2, payment volume lifted a solid 11%, helping currency-neutral revenues to rise 9% and earnings to surge 37% and easily top estimates while margins (nearly 20% pre-tax) remained healthy. While growth isn’t going to go wild, management hiked estimates for the rest of the year and sees its stock as cheap—it’s trading at just 13 times trailing earnings—and has been buying back plenty of it given the firm’s solid free cash flow (about equal to earnings), with the share count down 6% from the prior year. Of course, a big part of the story will be how some newer offerings (like Fastlane, which allows people to pay securely without any passwords or shipping details, or its Complete Payments platform for small businesses) do as they hit the market. But, to us, the bigger part of the story is that Wall Street thinks the worst of the slowdown is behind PayPal, with a re-valuation starting to take place.

Technical Analysis
PYPL has a great run during the last bull market, but slowing growth and fears of competition destroyed the stock, which fell from over 300 in 2021 to a low of 50 last October. This year saw some stabilization, with a rally into the high 60s a couple of times, but shares were back at 57 in June and July, so it wasn’t like the bulls really stepped up. However, the Q2 report seems to have changed PYPL’s character, with a gap up in late July, and after shaking out with the market soon after, shares have ramped to 52-week highs—four straight weeks of gains leaving the stock above all its moving averages. We’re OK with grabbing a few shares here or on a small exhale.

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Stock 7

Procept BioRobotics (PRCT)

Why the Strength
On Friday, Procept introduced Hydros, an AI-assisted robotic surgical system in Procept’s specialty of urology. Procept’s robotic surgical system is used for benign prostatic hyperplasia (BPH), commonly called enlarged prostate, a huge market that affects 8.2 million U.S. men who are in treatment today, a figure that will grow as the population ages. A treatment gaining in popularity for BPH is aquablation, a surgical procedure in which a jet of water is used to destroy excess prostate tissue that causes BPH; aquablation’s biggest advantages over other options is that it’s minimally invasive and tends not to affect sexual function and doesn’t lead to incontinence. Hydros uses AI to assist doctors in identifying problem areas and developing a treatment plan, trained on thousands of real-life ultrasounds from prior BPH patients; studies have shown that doctors using AI assistants like this are more effective than either doctors or AI operating on their own. Hydros is available right now, but management expects the sales shift to the new system, from their first generation offering called AquaBeam (more than 400 installed systems), will occur gradually throughout the next year as sales teams roll through training. Pulling sales teams for education may even slow sales somewhat, but selling robotic surgical equipment is a high-touch sale: The average AquaBeam system sells for $380,000, with Hydros expected to be priced higher than that. Once a system is sold into a medical facility, follow-up sales come from selling additional handsets costing about $3,200 to use with each unit—similar to seat licenses in enterprise software. With the Hydros launch, management reaffirmed prior guidance that some 33,400 handset sales, plus a few dozen system sales, will produce revenue of $217 million for 2024, a jump of 59% over the prior year, with another 40% gain seen in 2025. Of course, being small and investing in a new launch, the bottom line is still in the red, but the upside potential here is big if aquablation therapy takes share.

Technical Analysis
PRCT changed character last fall with the market when it boomed after earnings around Halloween, rallied to 50 in February, and after a couple of months of tightening up, surged again after another quarterly report, reaching 77 in May. Then came the correction, which resulted in a 30% deep, double-bottom base, but the action since the early-August low has been notable, with PRCT not only moving to new highs but doing so on its biggest weekly volume ever after the Hydros launch. We’ll set our range down a bit, aiming to enter on further weakness.

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Stock 8

Sweetgreen (SG)

Why the Strength
Sweetgreen is strong today because it’s one of a few growth-oriented cookie-cutter restaurant stories out there that’s likely in the early innings of a long growth wave—but also because it has a technology angle that could see it pioneering a new kind of restaurant in the years ahead. At its heart, Sweetgreen is best known for its various salads and warm bowls with fresh, tasty ingredients, thanks in part to an emphasis on having deals with local growers. Importantly, the firm doesn’t want to be known just as a salad shop; lunch sales (including in big cities as workers head out for a bite) remain the key, but it recently branched out into protein-focused plates (salmon, steak, etc.) that’s expanded their business (dinner is now 40% of sales, up from 37% a year ago), and it plans more innovation there going ahead. In Q2, business continued to crank ahead—sales rose 21% (the 13^th straight quarter of 20%-plus sales growth), same-store sales lifted 9% (4% from traffic, 5% from price/menu mix) and the firm opened four new locations (new openings have seen sales equal to or greater than the company average); it’s likely to boost the store count by 15% to 20% annually, aiming for the lower end next year and the higher end beyond that. All that is to the good, but there’s also a lot of excitement about the firm’s Infinite Kitchen concept (which it got from Spyce, a firm it acquired a few years back), where there are some employees (namely a host to guide customers, as well as a worker at the end to add small stuff like herbs) but machines do the heavy lifting, allowing customers to order (via kiosk or ahead of time via the app) and machines to dispense the dishes. It’s still early with just a few out there, but 2024 will see the firm opening seven new ones this year and retrofitting two or three others; early returns show much higher margins (no surprise), something like 30% restaurant-level margins vs. 20% for the firm as a whole. To be fair, growth for the company as a whole is expected to slow some in the quarters ahead, but the long-term growth plan is solid and the Infinite Kitchen possibilities are big.

Technical Analysis
SG isn’t for the faint of heart, as shares can make some big moves—but there’s no doubt the trend is up and the stock is trying to break out again. The original blastoff came March 1 after earnings, leading to a huge run to 26 in April, though that was followed by a 29% downdraft during the market’s spring retreat. Another earnings gap in May brought new highs, but there was no progress after that, with a 38% (!) decline into July. And now we see another bullish earnings gap for SG, with repeated big-volume buying as shares nose to new highs before today’s dip. We’ll set our buy range down from here given the stock’s volatility.

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Stock 9

Toll Brothers (TOL)

Why the Strength
From a fundamental perspective, the setup for homebuilders is as bullish as it’s been for a very long time: There have now been many years of “underbuilding” compared to historical averages (read: housing shortage), leading to plenty of pent-up demand from new and trade-up buyers, all while prices remain elevated (due to the lack of supply) and as the Fed is about to enter an easing phase that’s already seeing mortgage rates fall to multi-month lows. Toll Brothers is the lead dog in the high end of the homebuilding market (the average home sale price in its backlog is over $1 million), which insulated it a bit during the housing slowdown of 2022 and early 2023 due to higher rates; earnings here have grown every year as its customers are often willing to pay all cash (28% of buyers in the most recent quarter paid cash, up from its long-term average of 20%). And now investors are looking ahead to even better times: In the quarter ended July, while sales and earnings were essentially flat from a year ago, they topped estimates (earnings of $3.60 beat by 29 cents), and more important, new orders (in both units and dollars) rose 11%, with the top brass saying July (the last month of the quarter) was the strongest of the three and the first three weeks of August were tracking well, too—leading management to hike its annual expectations for both home deliveries and margins. Another big plus is that Toll is actively returning cash to shareholders given its buoyant results—the share count is down more than 6% from a year ago, and the firm upped its buyback guidance, too. At the very least, earnings should remain elevated for many quarters to come, and they should likely rise if the housing market gets a tailwind.

Technical Analysis
Like most builders, TOL has made solid progress from the market low last October, but it’s been hectic since March, with pullbacks of 15% (into April) and 20% (into July), and after a run to new highs, another quick 15% dip with the market in early August. But that last retreat was halted at the 50-day line, and now TOL has ramped again, partly with the group but also thanks to its own quarterly report last week. We’ll set our buy range down a bit, but we don’t expect a huge retreat.

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Stock 10

Zillow (Z)

Why the Strength
Zillow is America’s premier online real estate portal, allowing prospective homebuyers and renters to save time and money by using search filters (for views, amenities such as air conditioning, upcoming open houses and square footage), virtual 3D tours and inspections of the properties they’re interested in. Moreover, Zillow enjoys a big advantage over its competitors since 80% of its online traffic is organic in nature, meaning it doesn’t have to spend nearly as much on advertising to bring customers to its various sites. The overall housing market has obviously been a headwind in recent years, but despite that, Zillow raised eyebrows on Wall Street earlier this month when it released Q2 results that featured broad-based home sales and rental growth. Total revenue of $572 million rose 13% from the year-ago Q2, with earnings of 39 cents a share beating estimates by 30% and adjusted EBITDA of $134 million increasing 21% (all reasons for the stock’s strength); the 17% pre-tax margin was very impressive given the sluggish environment. The revenue growth was broad-based with residential revenue improving 8% to $409 million (the main driver for EBITDA growth), rental-related revenue jumping 29% to $117 million and mortgage revenue soaring 42% to $34 million. Zillow outperformed the broad residential real estate industry (which grew 3%) for the eighth consecutive quarter in Q2, which management said puts the firm on a solid path to deliver “strong GAAP profitability” over time, plus double-digit revenue growth in 2024 while it expands EBITDA margins. Loan origination volume, meanwhile, increased 125% to $756 million, which the company expects to lead growth for Zillow Home Loans as it boosts its offerings (including tools, products and services for buyers, sellers and agents) and improves its go-to-market integration with its Premier Agent partners. All told, it’s a solid, well-run operation with a leading position in its field that’s in great position to benefit from an industry pickup as the Fed starts to open the spigots.

Technical Analysis
Z set up a deep (41% deep) launching pad from last summer through year-end, but as Fed rate cut hopes faded, the stock couldn’t punch through the 60 level—leading to another tedious decline (37% deep) into May. Shares again started to repair the damage after that, but the market’s July/August plunge dented the stock … though shares held above prior support, a bullish clue. And since the Q2 report, Z has been a different animal, gapping up off those lows and running back into the mid-50s. With old overhead, we don’t expect a straight-up advance, but you can consider nibbling on weakness with a stop under 50.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on September 3, 2024.

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