Cabot Top Ten Trader Issue: December 12, 2022

All Eyes on the Fed

As has been the case for the past few weeks, the evidence hasn’t changed much, with an on-the-one hand, on-the-other-hand situation: The intermediate-term trend has remained stubbornly up (good), but the longer-term trend is down and no real progress has been made for a few weeks (bad). Stocks are still being mostly rejected by resistance (bad), but the selling pressures haven’t followed through in most cases (better). And many timing indicators have improved (good), but not enough to tell us the sellers have truly run out of ammo (bad). Now, this week’s inflation data and Fed meeting could change the market’s tune—or not. As always, we’ll take it as it comes, a method that’s served us relatively well this year, keeping us mostly cautious as the less-is-more environment continues. We’ll leave our Market Monitor at a level 5 and will let you know in Friday’s update if anything’s changed.

The good news is that we’re continuing to come up with solid-looking charts from a variety of areas—if the market can kick into gear (and breakouts start working), we think there will be a surprising number of names to work with. Our Top Pick this week is ASML Inc. (ASML), a turnaround (and dominant) play in the chip equipment field, which itself is acting surprisingly well. The price is high, so if you buy, just buy fewer shares.

Stock 1

Academy Sports & Outdoors (ASO)

Why the Strength
Academy Sports & Outdoors resembles a pandemic play that saw sales for its various outdoors and sporting wears spike as people’s buying habits changed, and now business is sloughing off some due to tough comparisons (same-store sales slipped 7.2% in Q3, partly due to a decline in ammo sales). But under the hood, there’s a lot to like here, which is why the stock popped to new highs last week. First, it looks like the same-store sales declines will ease as comparisons get easier, footwear (up 5.1% in the quarter) and apparel (up 1.5%) continue to grow and as e-commerce (up 11% from last year) does the same. (The firm stuck to its long-term outlook for low single digit same-store sales growth and high single digit total sales growth.) Second, management is thinking big, aiming to become the largest outdoors play in the country, with its 268 store count today growing by 80 to 100 over the next five years (up 30%-plus; nine have been opened so far this year and management sees the potential for 675 locations in the long-term) that one analyst thinks could add a whopping $4 per share of earnings to the already-elevated bottom line. And third, the stock is super cheap (~8x earnings), which has led the top brass to put a lot of money toward share buybacks of late (share count down 13.3% from a year ago!), which should help keep earnings per share up in the near term. The bottom line here is that, instead of giving up a good portion of its pandemic-induced earnings gains, Academy should see the bottom line hold up for a bit and then push higher starting late next year. It’s a unique situation with a growth angle that should keep buyers interested.

Technical Analysis
ASO’s long-term chart is hard to beat, with a big correction in the spring, monster-volume support at the lows, a rebound back to its highs in the fall and then a tight, proper launching pad near those highs during the following three months—resulting in last week’s huge-volume breakout. Near-term, some wobbles are possible given the sell-on-strength environment, but we’re OK grabbing a few shares here or on dips.

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Stock 2

Alnylam Pharmaceuticals (ALNY)

Why the Strength
Alnylam is focused on the discovery and commercialization of RNA interference (RNAi) therapies for rare diseases for which there are limited or inadequate treatment options. The company’s pipeline consists of 17 treatments in various stages of testing for diseases ranging from Alzheimer’s and Alpha-1 liver disease to hemophilia and hypertension, and four of its drugs have been approved for commercial distribution. In August, Alnylam released positive topline results for its drug Onpattro, for ATTR amyloidosis patients with cardiomyopathy (a rare but often fatal heart condition), which sent the stock soaring. Onpattro brought in $475 million in sales for Alnylam last year, and the latest results open up the potential for a much bigger market for the drug (a similar drug by Pfizer garnered $2 billion in sales last year). More recently, the firm received FDA approval for expanded use of its drug Oxlumo for treating primary hyperoxaluria Type 1 (an ultra-rare kidney disease) in pediatric and adult patients. On the financial front, although the company is bleeding red ink, revenue is growing nicely and Q3 was a strong quarter for its commercial portfolio. The results, which featured a 41% top-line bump of $264 million, were led by $145 million in sales of Onpattro (up 20%) and $25 million for Amvuttra in its first full quarter since getting U.S. approval in June. (The company also just received marketing approval in Europe for Amvuttra for treating adult patients with Stage 1 or Stage 2 polyneuropathy.) Additionally, Oxlumo sales of $16 million rose 10%, while sales of Givlaari (for treating acute hepatic porphyria) jumped 43% to $46 million. Looking ahead, Wall Street sees revenue ramping about 50% in each of the next two years.

Technical Analysis
ALNY’s aforementioned pop on the Onpattro expanded label in August looked like a go signal, but of course the market soon began a retest of its spring lows, which capped the stock. That said, ALNY held up pretty well (23% correction), rounded out a base and, two weeks ago, lifted above some resistance on good volume. It’s still battling the August high, so if you want in, minor weakness should provide a decent opportunity.

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Stock 3

ASML Inc. (ASML) ★ Top Pick ★

Why the Strength
Dutch company ASML is essentially a monopoly on supplying the high-tech ultraviolet lithographic systems necessary to produce advanced computer chips. That means all the major chipmakers are customers. Even though the semiconductor industry is experiencing a cyclical consumer slowdown, demand for ASML’s machines remains relatively resilient in part because of a deep backlog that makes customers less likely to cancel orders for the machines, which cost hundreds of millions of dollars. ASML’s photolithographic systems work by projecting onto light sensitive materials, engraving patterns on the wafers to form the integrated circuit. The chip industry is continuing to migrate toward making smaller, better performing chips, meaning the spectrum of light used to etch chips now is a constraint. ASML recently began selling a new generation of machines that cost more than $400 million – double earlier models – each using what they’re calling extreme ultraviolet (EUV), in which very short wavelengths can be used to create chips with smaller etchings of less than 10 nanometers, about 10-billionths of a meter long. The business has been facing some headwinds from needing to comply with U.S. restrictions on technology exports into China, which is 15% of business, as well as cutbacks by European customers. But the sell-off this year on those two factors looks overdone, as ASML has fixed pandemic supply chain issues and is starting to ship orders faster than expected, recognizing deferred revenue as a result. In the third quarter sales came in at $5.7 billion, with management saying this quarter will come in much higher. And even better, the top brass meaningfully hiked its 2025 outlook this year (35 billion euros vs. a 27 billion outlook just one year ago) while Wall Street sees a big earnings recovery next year.

Technical Analysis
This year has been the first protracted downtrend in ASML since the Great Recession. Shares touched all-time highs around 870 a year ago then gave up more nearly 60% of its value during its move to a low of 363 in mid-October. But the action since the low has been eye opening, with a monster comeback after earnings above the 40-week line, and now shares have been trading tightly for a month—a sign that the weak hands are likely out. We’re OK snagging a little here or (preferably) on weakness.

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Stock 4

Atkore (ATKR)

Why the Strength
Infrastructure spending is booming, which is welcome news for Atkore: It’s a big player in multiple infrastructure industries and most of its products hold leading positions in each of its end markets. This becomes even more relevant in view of the company’s huge array of offerings, which include electrical and mechanical products (conduits, cables and tubing), as well as safety solutions such as metal framing and perimeter security. The products are sold under several brand names and its customers include non-residential construction, diversified industrials, alternative energy, healthcare and data centers. Last month, the company turned heads when it reported fiscal Q4 results that trounced Wall Street’s estimates, which catapulted the stock higher. Revenue of just over $1 billion beat the consensus by $48 million and increased 11% from a year ago, while per-share earnings of $5.52 beat by 44 cents (up 26%). Meanwhile, full-year net income rose 55% and hit a record, adjusted EBITDA soared 50% and free cash flow increased by 28% in what management described as a “fantastic” fiscal 2022 across all facets of its business. Moreover, Atkore made six acquisitions and repurchased $500 million of stock (the share count was down 10% from a year ago in fiscal Q4) during the year and expects to more of the same in the months ahead. Granted, some of the earnings boom this year was due to higher prices, which are expected to normalize, but earnings should still come in north of $14 per share next year, leaving the stock with a sub-10 P/E ratio—and even that estimate will likely prove conservative.

Technical Analysis
After a stellar 2021, ATKR hit a major wall of resistance around 120 that November, chopped sideways for six months and then collapsed as low as 70 by September. But the fact that business has remained so resilient brought buyers back in, with ATKR embarking on a strong, persistent advance since the low, including a big earnings-induced jump in mid-November. Given that shares are toying with old resistance in that 120 area, a dip is likely, so we’ll set our buy range down some.

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Stock 5

CNH Industrial (CNHI)

Why the Strength
Trends in rising food prices, helped along by a shrinking supply of available farmland due to urbanization as well as overall inflation, have bolstered the outlook for farm machinery sales. Equipment and services provider CNH isn’t a household name, but it’s the #2 player in agriculture machinery (behind John Deere), with sales expected to top $22 billion this year, and it also does good business in industrial machinery as well. Its brands include the well-known Case IH, which makes tractors, combine harvesters and tilling implements, and New Holland, which also makes tractors, planters, sprayers and harvesters, along with Steyr, a forestry and ag tractor producer for the European market. Despite continued supply-chain constraints, global ag and construction market strength led to record Q3 revenue of nearly $6 billion for CNH, a 24% increase from a year ago, along with EPS of 41 cents that beat expectations by eight cents. While recession risk is a concern, the company sees a strong ag sector cycle—led by North and Latin America—and “sustained demand” for most of its products in the year ahead. Additionally, CNH said both industrial and ag segments have been shielded from steep cost hikes by “strong price realization,” allowing the firm to achieve higher sales volumes in both segments. As for the future, CNH is investing heavily in precision ag products that allow farmers to maximize the use of high-priced fertilizers, while also developing a line of electric tractors (it just revealed the industry’s first all-electric light utility tractor with autonomous features, with production to start in late 2023). CNH also expects public sector building activity to remain healthy, boosting construction equipment demand. A low (12x) P/E a decent (1.8%) yield tie a bow on the package.

Technical Analysis
CNHI was doing well until the middle of last year, when the 16 area became a barrier—it made it up to 17 a few times after that but eventually gave in to the bears, with a decline under 11 in July and a retest of that level in late September. But CNHI has been a different beast since then, with an accelerated uptrend after earnings in early November and a move back to that resistance area (near 16) of late). A bit more weakness would be tempting.

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Stock 6

Crocs (CROX)

Why the Strength
We took a swing at Crocs in October but missed our entry price, but now, after the stock has consolidated a bit, we’re taking another shot. The firm is well known, with its plastic clogs growing in popularity over time and especially during/since the pandemic, as work-from-home (i.e., less formal wear) has become common. And that core business remains in good shape—in Q3, currency-neutral sales of Crocs rose 20%, including an 18% gain in direct-to-consumer revenue, driven by overseas sales (up 82% in Asia and 46% elsewhere outside North America). The top brass thinks it can nearly double Crocs sales by 2026, too, with better sandal sales and continued penetration in Asia. But the story also involves Heydude casual footwear and slippers, which it acquired in February—sales there boomed 87% in Q3, and with operating margins a few percent below those of Crocs, there should be the potential to boost margins down the road. All of that is to the good for investor perception, but the ringer is that, after a massive boom in earnings since 2020 (from $3.22 per share to north of $10 per share this year), most expected things to “normalize” going ahead … but after a series of beat-and-raise quarters (Q3 earnings topped estimates by 14%), Wall Street is now expecting earnings to actually tick higher in 2023, which is likely conservative and, even if it’s not, leaves the stock trading at a ridiculously low multiple (9x earnings). The debt load is a bit high (used to acquire Heydude), but there’s definitely a lot to like.

Technical Analysis
CROX had a beautiful, persistent advance after the pandemic crash, finally cresting around 180 last November when the market topped—followed by a horrible, persistent downtrend into late May that saw the stock lose nearly three-quarters of its value! However, after a quick double bottom in June/July, shares rallied to 80, held their ground despite the market’s retest in the fall and surged to new recovery highs during the latest rally. The century mark has been resistance, but we do like the look of the recent rest—we’re OK nibbling here or on dips.

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Stock 7

H World Group (HTHT)

Why the Strength
The Chinese government says residents no longer need a negative COVID-19 test to travel between regions of the country. They also no longer need to gain clearance to enter establishments with health codes – QR codes linked to a user’s phone that trigger an alert if the tracking system decided they had come in contact with an infected person. Both of those are big steps for getting mainland Chinese traveling again. H World Group is one of the country’s larger hotel operators, with 8,176 hotels under 20 different brands that it owns and operates, leases and operates or operates for other owners for a fee. The company is present in 17 countries but primarily focuses on mainland China, with a notable minority of business in Germany. In its latest quarter ended Sept. 30, H Group revenue was 4.09 billion renminbi (about $575 million), equaling about 90% of pre-pandemic revenue on a per-room basis. The business had a net loss of 1.21 renminbi per share (17 cents). When management reported the results two weeks ago, they forecast growth of about 9% for the fourth quarter despite the negative effect of continued lockdowns (an October lockdown cut that month’s per room revenue to 74% of 2019 levels). That heartened investors, rallying shares about 10%. The subsequent easing of travel restrictions fed into the positivity, adding about another 10% to shares. H Group appears well-positioned to post a major rebound, with company data saying their branded chains are showing better resilience than independent Chinese hotels. And its shifting focus to more economy and mid-tier accommodations should benefit from China’s increasingly budget-conscious consumers. Pre-COVID, H Group was a solid, profitable growth outlet, and there’s no reason it won’t get back there as restrictions ease.

Technical Analysis
HTHT bottomed with most Chinese stocks way back in March with a huge wash-and-rise shakeout and reversal—but the stock has had a series of retests since, including its sharp October dip back to 24. (The all-time high was 64 back in February 2021.) But we like the action in recent weeks, with a strong bounce and then moving out to multi-month highs after earnings. HTHT will be volatile, but if you’re game, you could take a stake on dips.

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Stock 8

Inspire Medical (INSP)

Why the Strength
Inspire Medical has always had a great story, and interestingly to us, the story has actually gotten better this year; the odds of this firm becoming much bigger in the years ahead are better than ever. The story revolves around sleep apnea (17 million people in the U.S. have it), which is currently treated by CPAP machines, which work well but suffer from huge rates of non-compliance (one third to two thirds of patients who have it don’t use it much), and that says nothing about surgery (lots of potential side effects) or simply the millions who go untreated. Inspire’s system, on the other hand, looks like a breakthrough: Via a two-hour outpatient procedure, a doctor implants three tiny devices (sensing lead, neurostimulator and a stimulation lead) that are controlled by the patient and, when turned on (they usually wait 30 days to go live), open the obstructed airway during sleep. Data involving well over 3,000 patients have been conducted, and the results are outstanding, with 45% less sleepiness after a few months, much less snoring and, health-wise, a 70% improvement in oxygen levels, too. Up until mid-year, though, one hitch we saw was that those with the devices implanted could only get MRIs of the head, neck or extremities, which was likely a deal breaker for many—but in May, the FDA approved full-body scans, so patients don’t have to worry about complications down the road. The cost of expansion here (entering new territories with sales teams and training, plus national TV advertising) are high, which is why the bottom line remains deep in the red, but the consistent, rapid sales growth (70%-plus) makes is clear that Inspire’s offering is being adopted rapidly—and there should be years of growth ahead given the size of the market.

Technical Analysis
INSP peaked with the market last November and held up well for a while but eventually went over the falls in the spring, plunging a bit more than 50% at its nadir. The rally after that was OK, but shares backed off into the fall, but (a) etched a higher low and (b) have shown some real power after earnings, moving to eight-month highs. The latest retreat looks normal to us; we’ll set our buy range near the recent lows.

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Stock 9

Lattice Semi (LSCC)

Why the Strength
Lattice Semiconductor specializes in making programmable chips for several key industries, but the auto space is where a big portion of its growth has come lately. The company’s field programmable gate arrays (FPGAs) are used by automakers for video bridging, control systems and entertainment and infotainment systems. The story here is that FGPAs afford its customers tremendous flexibility in being able to custom design how they’re used after buying them, quickly filling gaps caused by the global chip shortage. Beyond the auto sector, Lattice is seeing record demand for its products across several other end markets, including 5G network infrastructure and data centers. Additionally, software represents a growing portion of the firm’s sales and investment as it allows customers to adopt Lattice products and tweak them to their own specifications. In Q3, record top-line growth of 31% from a year ago was driven by the company’s industrial and automotive segment (up 45%), and Lattice expects this segment to see its third consecutive year of double-digit growth, though the communications and computing segments also contributed. Earnings of 48 cents per share, meanwhile, beat estimates by four cents. The company announced the launch of its newest FPGA platform, Lattice Avant, which it believes will double its addressable market while creating lots of new opportunities. Going forward, management guided for revenue of around $175 million in Q4 (up 23% if realized and in-line with estimates) and announced a share repurchase authorization of up to $150 million (nearly 2% of the market cap) through next December. After a boom this year, Wall Street sees another 15% earnings bump in 2023.

Technical Analysis
LSCC had an excellent three-year run before hitting a record peak at 85 last November with the Nasdaq. Then came the correction, though most of the damage was over with quickly—it plunged to 47 in January, dipped to 43 in May and July and had what looks like the final retest under 45 in October. And now the buyers are back, with earnings kicking off three huge-volume accumulation weeks in November and LSCC has held its gains nicely thus far. A bit of weakness would be intriguing.

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Stock 10

Super Micro Computer (SMCI)

Why the Strength
Super Micro offers a broad range of energy-efficient server platforms designed for several markets, including cloud computing, data center, enterprise, 5G and edge computing. Indeed, the firm’s servers are among the most energy-efficient on the market, which is a big selling point all the time and especially today as electricity prices are soaring. The company has reinvented itself in recent years by evolving from mainly selling server components to offering its own complete systems, including “Total IT” solutions (server, storage and networking hardware along with security software, with each customized for various applications). Moreover, the firm’s “plug-and-play” hardware architecture is designed so that parts and components can be easily switched out for upgrades instead of entire systems being replaced entirely (another key selling point). Financially, the company crushed sales and earnings expectations in its fiscal Q1 (September quarter), as record revenue of $1.8 billion increased 79% from a year ago, while per-share earnings of $3.42 topped estimates by 88 cents. Super Micro touted “unprecedented growth momentum” at the start of its fiscal year 2023, noting that the quarterly sales jump was 10 times the industry average, which it attributed to soaring demand for its energy-saving Green Computing and Total IT solutions. Growth has accelerated strongly in recent quarters, and Wall Street doesn’t see any near-term end in sight: It expects 30%-plus sales growth and north of $10 earnings per share in the current fiscal year.

Technical Analysis
SMCI is a wild child, with many pops and drops over the past year. But the action in recent months points toward buyers wresting more control—the rally to 75 in August was excellent, and while the pullback that followed was sharp, that occurred during the market’s retest phase. And when the pressure has come off the indexes, SMCI soared to 95 on big volume. We think the recent dip is normal thus far, though we think further dips are possible.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on December 19, 2022.