Cabot Top Ten Trader Issue: August 5, 2024

Damage Control

It looked like the bulls were ready to put up a fight last Wednesday, when the market had a sharp up day, but it’s been all down since then, lowlighted by today’s action, as the market was roiled by a variety of worries, spanning from the Yen carry trade to recession fears to some bad news in the chip sector. Stepping back, we have two thoughts: Short term, there was definitely some panic today, with the VIX volatility index (a fear gauge) reaching its third highest level of the past 35 years (2020, 2008 were the others), and the fact that we saw a decent intraday bounce in many stocks (closed well off the lows) implies some sort of relief rally is possible. That said, the sharp, straight-down action from the market peak less than four weeks ago (preceded by a very narrow, divergent situation) also tells us a good amount of repair work is likely needed even if we do bounce. In terms of actions, we’re not sticking our head in the sand, but we haven’t been pushing the envelope for many weeks, so if you have a good-sized cash position, we wouldn’t necessarily sell wholesale. That said, you should honor most stops (simply holding everything and hoping isn’t advised) while remaining patient—eventually, this correction will bottom out and fresh leadership will emerge, but for now, we advise staying mostly safe, with new positions kept small. We’ll drop our Market Monitor to a level 4 (from 6) given the damage.

This week’s list has a lot of proper charts even after the latest selling storm. For our Top Pick, we’re going with Alnylam Pharmaceuticals (ALNY), which recently came alive on positive drug trial results that will dramatically expand the opportunity for the big-selling drugs already on the market. Keep it small and aim for dips.

Stock 1

Alnylam Pharmaceuticals (ALNY) ★ Top Pick ★

Why the Strength
Alnylam just reported a quarter where net product revenues lifted a very solid 37% year over year as it sees a lot of traction from its line of treatments based on RNA interference (RNAi), which focuses on disarming the triggers of genetic diseases. It’s now been six years since Alnylam launched its first commercial treatment, and the company tallied $410 million in net product revenue for Q2 and $660 million overall (including lumpy joint venture and royalty revenue). The business has six drugs on the market right now, used by about 500,000 patients, and another 10 drugs in late-stage trials. Alnylam’s two core drugs—Amvuttra and Onpattro—treat diseases caused by TTR, a misfolded protein in the body, which in turn causes accumulation of another protein called amyloid to build up in organs, leading to heart disease, a lack of tolerance for exercise and other risky conditions. Worldwide some 50,000 people have hereditary ATTR Amyloidosis and another 300,000 have the “wild type,” which displays itself later in a patient’s life. The two drugs produce three-quarters of company product sales and are the fastest growing, while two others—Oxlumo and Givlaari—round out Alnylam’s proprietary drug sales treating other rare diseases (two more treatments are sold via joint ventures with Regeneron and Sanofi). Management says the growth prospects for its proprietary portfolio remains strong, upping its full-year revenue guidance by about 15% after the Q2 report to a midpoint of $1.61 billion for in-house drugs, with JV sales on top of that probably $600 million. Successful Phase III trials for an expansion of Amvuttra to other ATTR indications wowed investors a few weeks back and has management saying they are on track to grow sales strongly for many more years to come. Funding drug development, including a bump in R&D costs moving ahead as it takes full control of a drug from a Regeneron partnership, means Alnylam probably continues to post losses, but the focus now is the intermediate- to longer-term potential for its various offerings.

Technical Analysis
ALNY broke free of a multi-year soft period when it spiked higher in late June on the trial results, embarking on a rally that took shares to 264. There was some profit taking after that, but it was very reasonable, and shares then popped again after earnings last week—and today, held up decently given the maelstrom out there. We’ll set our buy range down a bit given the environment, but ALNY is a name that could counter-trend given its unique story.

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Stock 2

Clearwater Analytics (CWAN)

Why the Strength
Clearwater Analytics is a cloud software provider for the investment industry, which faces an onslaught of challenges when it comes to accounting and analytics, with everyone from asset managers, insurance and pension firms, nonprofits and big corporations needing to deal with ever more complicated regulations, transparency and reporting as operations go global and assets are increasingly non-traditional (level 3 assets like CLOs, real estate, private shares, mortgage-backed securities, etc.). Clearwater’s suite makes accounting for all of this a snap for its clients, which has many ditching a patchwork of legacy technologies (and big teams of employees) for its solution, which automatically ingests and aggregates data, reconciles it, has one accounting engine for all asset classes and one platform for all risk, regulatory and performance measurements, too. Translation: It radically simplifies things, to use the company’s words, which is one reason why the firm has a 99% revenue retention rate, and the firm claims it wins 80% of the deals it goes after, too. The firm sees a big industry that’s ripe to be upended, especially as it continues to expand offerings, and it’s steadily grabbing share: Sales are kiting higher at a 20%-ish rate, while margins are big (32% EBITDA margins this year!), same-customer growth is healthy (up 10%) and annualized recurring revenue continues to kite higher (up 22% in Q2)—and the firm sees more where that came from, with a long-term target of 40% EBITDA margins. It’s a good niche story that should play out for many years as the underlying factors here are likely to intensify going forward.

Technical Analysis
CWAN came public in the heydays of 2021 then proceeded to tank with growth stocks and spent the past year bottoming out. Now, though, it’s looking tempting: The stock has etched a big launching pad since last December (29% deep, 35 weeks long), with May and early June seeing a nice rally off the lows and then a tighter, well-controlled base in June and early July. The stock nearly tagged new highs after the latest earnings surge, and even today’s dip was very reasonable—the market is obviously the wild card, but if you’re game, we’re OK with a small buy here or on modest weakness.

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Stock 3

DoorDash (DASH)

Why the Strength
There’s no doubt growth stocks are in a correction right now, but that’s actually the best time to start looking for new leadership—preferably names that have established growth stories, solid sponsorship and whose stocks have recently reacted well to earnings. DoorDash fits all three categories: The firm is one of the big players in restaurant delivery, which has grown steadily for years, got supercharged during the pandemic and—as opposed to most other pandemic plays—has continued to grow nicely since then, too, and the top brass has run a tight ship, allowing margins to expand. That said, while restaurant-related growth remains the core of the business, the real potential here is DoorDash expanding into other verticals, allowing people to get groceries, beauty supplies, home improvement goods, alcohol and more delivered to their homes using the firm’s app; while the company said it’s gaining share in the restaurant field (more than half of new restaurants that sign up for a delivery partner choose DoorDash), it’s the same for other non-restaurant clients as well, where business is ramping steadily. Throw in a growing ad business (obviously its app and marketplace are a huge source of eyeballs) and results remain excellent: In Q2, order volume lifted 20%, revenue grew faster (up 23%) as the take-rate moves up (13.3% of marketplace volume), while EBITDA is booming, totaling $430 million, up a huge 54%. There is competition (from Uber and others), but it’s still early days in the overall delivery movement, even in the U.S., so there’s no reason to think DoorDash can’t grow many-fold from here, especially as churn decreases and choice among new verticals increases.

Technical Analysis
DASH corrected down to its 40-week line last fall but then staged a huge gap up on earnings, kicking off a great rally where shares progressed higher in a relatively smooth fashion until they reached 143 in March. Then came a sharp correction, lowlighted by a gap down on earnings in early May) that saw the stock reach as low as 100 a couple of weeks ago. But support held at that point and DASH popped back to multi-month resistance after earnings, with the 115 to 120 area looking like key resistance. Today was another good sign, with big-volume support showing up after a gap down. It’s not a classic setup, but if you want in, we’re OK with a nibble here and a stop under today’s lows.

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Stock 4

Dutch Bros (BROS)

Why the Strength
Fundamentally, Dutch Bros has a business that’s about as sure a bet as there is to get much bigger over time—and, given the recent spate of economic fears, shouldn’t be too impacted by that, either. The firm is known as a coffee shop, but it’s actually much more of an overall beverage provider, with cold or frozen beverages making up most of its business and with unique offerings (like its own energy drink, high-protein coffee, boba, etc.) attracting new and repeat customers. Even operations-wise, the firm is unique, such as having runners that go out and take orders for those using the drive-thru (they even have “escape” lanes if your order is ready before you get to the take-out window) and, business-wise, the firm is big on promoting from within, especially having experienced managers run new (company-owned) locations. The expansion plan here is giant, too, with 876 shops at the end of March, up a huge 22% from a year ago (11 straight quarters of at least 30 shop openings!), with a goal of 4,000 down the road. (The store economics are good, not amazing, with a 30% cash return in year two.) That said, costs were an issue for a while and same-store sales were very mundane, but that’s been shaped up in recent quarters, with sales growth remaining excellent (same-store sales rose 10% in Q1) and margins now picking up, allowing the bottom line to flourish. As we said above, long term, we have little doubt Dutch Bros will get much bigger—but short term, earnings are out Wednesday (August 7) after the close, with analysts looking for 27% top-line growth; the reaction to the report will obviously be key (see more below).

Technical Analysis
BROS bottomed out in September of last year, but it never really kicked into gear until May of this year, when the Q1 report gapped the stock up in a big way, with buyers pushing it up to 43.5 in early July. Since then, of course, it and growth stocks have been weak; BROS has been living below its 50-day line for nearly two weeks (which knocked us out of the stock) and, of course, it got slapped around with everything today. That said, we see a potential new setup here if the earnings report on Wednesday is well received—a gap above 39 would look like a chance to re-start a small position.

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Stock 5

GoDaddy (GDDY)

Why the Strength
Building an online presence has become something of a prerequisite for entrepreneurs today, and GoDaddy is one of the leading ways for individuals and small businesses alike to quickly get up and running. The company is especially popular for businesses operating on a budget, offering domains, email, website building offerings (including online stores), hosting, payments, security and marketing, and it boasts 21 million customers that pay an average of $200 per year with an admirable 85% customer retention rate. A big attraction for investors is the firm’s outstanding free cash flow (FCF) profile: GoDaddy recently told analysts that increasing FCF per share over the long term remains its “North Star,” and management expects FCF per share, which is already big, to continue to grow at healthy rates for many years to come. The company didn’t disappoint on this front when it released Q2 results last week: Through earnings of $1.01 a share missed estimates by 7 cents, revenue of $1.1 billion increased 7%, led by 15% growth in Application & Commerce (A&C) sales of $406 million, plus a 24% leap in A&C bookings. Total bookings of $1.3 billion rose 11% on a currency-neutral basis, and more pertinently, the company raised its 2024 FCF target to at least $1.3 billion, which is north of $9 per share and represents growth of 20% year over year (a reason for the stock’s latest strength). Management attributed much of the recent growth and margin improvement to the firm’s innovation on the AI front, with its AI-powered GoDaddy Airo accelerating customer interactions by helping them improve their websites and grow their businesses (all new and existing English-speaking markets have access to this tool, with further expansion into 90 countries coming later this year). Looking ahead, GoDaddy raised its full-year revenue expectations to around $4.5 billion at the midpoint, up 7% if realized, though it’s the free cash flow and share buyback program (share count down 6% year-on-year) that are the main pillars of the story, along with what is still a tame valuation.

Technical Analysis
GDDY blasted off last November when shares soared after earnings, breaking out of a range and kicking off a run that has continued to this day, albeit with a couple of tests of the 50-day line along the way. One of those tests was seen last week during the market’s late-week sell-off, but the quarterly report brought in another round of buying, with GDDY hitting new highs on Friday and holding up fairly well today. If you want in, we’re OK with a small buy here, though use a tight stop in the upper-130s.

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Stock 6

Granite Construction (GVA)

Why the Strength
California-based Granite is a heavy civil construction contractor and construction aggregate manufacturer, owning or leasing quarries in several western states for extracting mostly sands, gravel and crushed stone products used for building roads, bridges, dams and other infrastructure projects. On the development front, Granite provides infrastructure services for residential, energy and commercial customers, as well as for industrial sites and other facilities. The ongoing boom in state- and federal-level infrastructure spending is a big reason behind the company’s recent strength. This summer, Granite was awarded several multi-million-dollar contracts in California and Washington to improve highway traffic flow in the former and replace bridges in the latter. Meanwhile, the firm has just expanded its footprint in the southern region of the U.S. with its acquisition of Dickerson & Bowen of Mississippi, which will add four asphalt plants and three sand and gravel pits to its holdings (the deal is expected to close in Q3). Last week’s Q2 report was an additional source of strength as revenue of $1.1 billion increased 20% from the year-ago quarter, with earnings of $1.73 a share beating estimates by 34 cents and EBITDA of $130 million improving by a head-turning 60%. During the earnings call, management emphasized that the Construction segment is growing and is in a “strong position” to win work and drive growth for the remainder of 2024 and into 2025, with price increases for aggregates (up 10%) and asphalt (up 5%) in the first half of this year being a key focus of the Materials segment. The effects of the price increases, plus recent acquisitions, also led to a 2% profit margin increase in Q2, while operating cash flow improved “significantly” in the first half of the year. For 2024, management expects revenue of around $4 billion, up 14% if realized, while earnings and EBITDA move up nicely.

Technical Analysis
GVA exited a multi-year holding pattern last November when it broke out from long-term resistance around 45. Another couple of months of backing and filling followed, but by February the stock was in the early stages of a multi-month gallop to record levels. Shares did stall out in May and saw a couple of wobbles in June and then again in July, but GVA has been pushing higher since then, with even some post-earnings churning unable to dent the stock. We’re OK nibbling on minor weakness with a stop near the 50-day line.

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Stock 7

Green Brick Partners (GRBK)

Why the Strength
Green Brick is a residential land developer and homebuilder with a focus on the U.S. single-family housing market. Like its peers, the company is benefiting from a multi-year low in available housing stock, with the housing supply deficit estimated to be around 2.5 million homes. The insatiable, unfulfilled demand for single-family housing has even prompted a big-name hedge fund manager to accumulate a sizable stake in Green Brick in recent years, accounting for nearly 30% of his entire portfolio (and his largest single stock position). Indeed, Green Brick’s story writes itself as its business model has allowed it to grow with one of the least leveraged balance sheets (assets are 4x liabilities) and with one of the lowest debt costs of any of its small- and mid-cap peers. The company delivered record results in Q2, with home closings revenue of $560 million growing 22% year-on-year and per-share earnings of $2.32 beating estimates by a whopping 55 cents, helping Green Brick generate the highest homebuilding gross margins (35%) in the industry. Net new home orders of 855 units rose 4%, with 1,926 homes sold and 1,980 homes started year to date, increasing its backlog by 16% (in units). The company said it’s poised to continue capitalizing on what it believes to be “long-term secular demographic shifts,” with further long-term tailwinds provided by shortages in its infill and infill adjacent submarkets (around 80% of its first-half 2024 revenue comes from these locations), and assisted by the “golden handcuffs” effect of locked-in, low-rate mortgages, limiting supply. Additionally, the top brass said Green Brick has created a strong runway for growth with “superior” land and lot positions, which grew by 2,500 additional future home sites in Q2, and the backlog value increased to $650 million (up 17% year to date). Further out, the company is focused on securing new land opportunities to fill its pipeline and build up as many lots to its builders as quickly as possible. Analysts see the bottom line booming 36% this year and moving even higher in 2025, both of which could prove conservative given the recent plunge in mortgage rates.

Technical Analysis
GRBK spent the first half of 2024 churning inside a trading range between 50 and 60 while still managing to make a semblance of progress in the form of higher lows. The six-month consolidation paid off in July when shares rode a moonshot on the suddenly brightening interest rate outlook. The rally went nearly straight up for three weeks before the market’s plunge took some of the steam out. However, the pullback has been controlled so far, and we’re OK nibbling here or (preferably) on dips with a stop in the low 60s.

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Stock 8

KB Home (KBH)

Why the Strength
Despite mortgage rate volatility and affordability issues, large numbers of prospective homebuyers remain undeterred in their desire to purchasing housing. This “resilient” demand was noted in the latest earnings call for KB Home and accounts for the higher orders—and selling prices—the firm is seeing across the country. The Los Angeles-based company is one of America’s top 10 homebuilders by revenue, constructing several types of structures including attached and detached single-family homes, townhomes and condominiums; its biggest customers are first-time buyers and trade-up buyers, which means it should have more sensitivity to the latest dip in mortgage rates. Although revenue in Q2 was 3% lower from the year-ago quarter at $1.7 billion, earnings of $2.15 soared past estimates by 19%. Net orders increased 2% to almost 4,000, while net order value rose 7% to $2 billion due to the order growth and the higher average selling price of those orders. Other metrics were also impressive, including an improvement in the cancellation rate (from 22% to 13%). And while the company’s ending backlog of 6,270 homes declined 14%, management said KB is “well positioned” to achieve its financial goals for the rest of 2024, with a “healthy” backlog of committed buyers valued over $3 billion along with “meaningful improvement” in its build times. Additionally, the company’s joint venture, KBHS Home Loans, saw a “solid” increase in its capture rate, with 86% of customers’ mortgages funded through its joint venture (compared with 80% a year ago), which helps KB manage the backlog more effectively. Further out, KB said housing market conditions remain “favorable,” supported by an undersupply of new and resale homes, solid employment, wage growth and rising household formations. Wall Street sees earnings ramping up around 20% for all of 2024 and another 6% in 2025, both of which could prove conservative if rates stay down or fall further.

Technical Analysis
KBH didn’t make much net progress from early January until early July, but it did etch higher highs and higher lows during that time. Then came the change in character, with KBH soaring a couple of weeks back when a tame inflation report increased the odds of future Fed rate cuts. We wrote it up then but it failed to drop into our buy range—but now we’re re-recommending it, thinking the latest shakeout (even as rates fall further) makes for a decent risk/reward situation. As with everything, the market is a risk, but we’re OK nibbling here or on dips with a stop around 70.

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Stock 9

Sprouts Farmers Market (SFM)

Why the Strength
Sprouts Farmers Market is the second-largest natural and organic food retailer in the U.S., after Amazon’s Whole Foods, making it one of the few pure plays to follow the growth of consumer demand for healthier grocery carts. Sprouts reported sales of $1.9 billion in the recently reported second quarter. That’s up 12%, including an impressive 6.7% same-store sales gain. In a sign that the gains aren’t inflation-driven, the quarter was nicely profitable too, as net income per share rose 33% to 94 cents. Part of that is management’s focus on its in-house Sprouts brand, which offers better margins than name brands; it accounts for more than a fifth of all sales in Q2. Management has used all the cash to eliminate its debt and start a share buyback program that still has about $585 million left to spend. With 419 locations now, Sprouts has designs to triple that over the long term (it should open 35 total for 2024). While the grocery business is highly competitive, management does a good job distinguishing the stores with dedicated “foraging” teams that seek out products to stock that competitors don’t sell. It also does a lot of promotions that excite its core customers, like giving away free basil plants on Earth Day, and pushing deeper into stocking products for a variety of specialty diets, like keto and vegan. The company is also in the early days of testing a loyalty program that could goose customers to do more of their grocery shopping there. For full-year 2024, Sprouts sees sales rising nearly 10% to $7.5 billion, with same-store sales up about 5%. Management says total earnings per share for the year should be around $3.33, though the continuing share buyback (share count was down 2.2% from a year ago in Q2) probably makes the final EPS look even better.

Technical Analysis
SFM has been on an uptrend for nearly two years, with the trendline recently getting steeper as continuing excellent execution on quarterly earnings draws in more investors. Earnings last week sparked the strongest buying in 14 months and rallied SFM to an all-time high near 104 before the market’s selloff took a chunk out of it—though the damage has been very limited, and the earnings gap area could provide support on dips. We’ll set our buy range down from here, aiming to enter on further dips.

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Stock 10

United Therapeutics (UTHR)

Why the Strength
Pulmonary hypertension (PH) is a condition that develops when the blood pressure in the lungs is higher than normal, forcing the heart to work harder, and it afflicts about 1% of the world’s population. United develops therapies for PH and pediatric neuroblastoma and is also developing, in conjunction with 3D Systems Corp., a manufacturing process for printing personalized human lungs (which it calls the “world’s most complex 3D-printed object”) using the patient’s own cells. (The initiative, which is still in the developmental stage, was inspired by the chronic shortage of donor organs.) Last week, the company reported a mixed Q2 with revenue of $715 million beating estimates and increasing 20% from a year ago, while earnings of $5.85 missed the consensus by 63 cents. That said, business is still basically steady-as-she-goes: United reported a fifth straight record revenue quarter that was driven by “continued traction” for its leading drug, Tyvaso, in pulmonary hypertension associated with interstitial lung disease, along with strong fundamentals for its other products in PH and neuroblastoma. Also contributing to the quarter’s strength was an 18% increase in Unituxin sales (for pediatric patients with high-risk neuroblastoma) while Remodulin sales (a continuous pump therapy available for treating PH) jumped 16% and sales of the oral PH drug Orenitram rose 13%. On the pipeline front, Teton for idiopathic pulmonary fibrosis and Advance (IP receptor agonist) for PH are currently in Phase III of their respective clinical trials, while RemoPro (injected treprostinil prodrug) indicated for PH is in Phase II trials. Elsewhere, United is exploring the potential use of stem cells to revitalize damaged tissues in what could be a revolutionary treatment for sepsis, so there are plenty of pathways for United’s continued growth. Wall Street sees 22%-ish growth on both the top and bottom lines for this year, with mid-teens growth likely in 2025.

Technical Analysis
After a lively rally in the second half of 2022, UTHR hit the wall at the end of that year, dropping from around 280 to just under 210 by last June—and the stock needed eight more months of basing before it was ready to turn up again. The reversal came in February, when earnings provided a shot of adrenaline, with additional impetus provided by May’s quarterly report. The stock was at new highs last week when the mixed Q2 report pulled it lower, but support near the 10-week line showed up on the dip and shares held up well today. We’ll set our buy range up from here, thinking a further recovery will signal the overall uptrend is set to continue.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on August 12, 2024.

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