Cabot Top Ten Trader Issue: January 17, 2023

Rare Strength—Now Want Follow Through

The broad market began to show strength in late December when the Nasdaq retested its September/October low but only about half as many stocks did the same. Then came the improvement we wrote about last week, when the number of new lows declined. And then we saw further progress, with new lows continuing to shrink to very bullish levels while a granddaddy blastoff measure (the 2-to-1 Blastoff Indicator) turned green. It’s all very encouraging, and we’re nudging our Market Monitor up a notch, but now we need to see more “primary” evidence turn positive, including the trends of the major indexes (intermediate-term nearly positive, but longer-term still down) and, most important, many more “real” breakouts from high relative strength stocks. We’re optimistic, but are in a trust-but-verify mode—if this is the real deal, we should see things continue to progress in the right direction. For now we’ll move our Market Monitor to a level 5.

This week’s list is heavy on many themes that are working, including solar, metals, infrastructure, China and travel, where many firms are posting huge results. Our Top Pick is American Airlines (AAL), which looks like a leader in a new group move for its sector.

Stock 1

American Airlines (AAL) ★ Top Pick ★

Why the Strength
Two and a half years ago the airline industry was on its knees as the pandemic slashed air travel to nearly zero, but now the pendulum has swung completely in the other direction—travel demand has nearly caught up with pre-pandemic levels while industry capacity remains relatively tight for a few reasons. Throw in cost cuts and recent fuel price declines and analysts see earnings and cash flow going through the roof in 2023—and some insiders (like Delta’s CEO) think it could take years to catch up with demand. American Airlines is one of the big players in the group, of course, and all of the above factors are coming together to produce great results. Just last week, the top brass meaningfully raised guidance, with the Q4 outlook now for revenue to rise 16.5% compared to the Q4 2019 (pre-pandemic) levels, even as capacity is down 6% from that time, with earnings in the $1.15 per share range. (It did get some benefit from Southwest’s cancellation horror show, with passengers scrambling for alternatives.) As for the company itself, management also said it’s on the back end of an investment cycle (less CapEx), which should allow for big cash flow and rapid deleveraging; the firm has a goal of cutting debt by $15 billion by 2025, but it’s already halfway there, slashing interest costs that should flow to the bottom line. Analysts see earnings of around $1.74 per share this year and $2.75 next, but if recent trends hold, those could both prove very conservative as the post-pandemic travel boom continues. It’s an intriguing stock and group move. Earnings are due January 26.

Technical Analysis
Despite the fundamental improvements, AAL was stuck in the mud last year, with the stock dipping to the 12 area or below in June, September/October and again in December—basically the same zone the stock was sitting at in the summer of 2020 when everything was at a fundamental stand still. But it’s hard not to look at the last two weeks as a big change in character—AAL (and most peers) have rocketed higher on giant volume, with the firm’s Q4 update last week helping; impressively, shares shook off Delta’s good-not-great guidance on Friday. Yes, it’s extended, but we’re thinking pullbacks will be contained; we’re OK starting here or (preferably) on dips.

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Stock 2

Array Technologies (ARRY)

Why the Strength
Solar stocks aren’t uniformly strong like they were a few months ago, and volatility remains very high, but the group has found renewed strength and the cream seems to be rising to the top. Array Technologies looks like a smaller ($3.5 billion market cap) leader in the group and there’s little doubt the firm is going to get a lot bigger in the quarters ahead. Array is a leader in making tracking systems for solar panels, which adjust automatically during the day to make sure the arrays are always facing in the direction that captures the most sunlight; Array says that its systems enable 25% more energy production and last for 30 years with minimal maintenance, all for just an 11% hike in project costs, and a couple of new offerings could boost those return figures further. Because of that, something like 90% of new ground-mounted solar systems use a tracking technology (ground systems themselves make up 80% or so of all new solar installations), and last year’s green energy bill should goose growth for a long time to come (though, to be fair, the full impact is still being worked out). There are a couple of regulatory unknowns that could produce a few hiccups, but there’s little doubt business is beginning to boom: In Q3, organic revenue (excluding its acquisition of STI, which boosted its presence in Europe and Latin America) rose 112%, while earnings of 18 cents per share topped by eight cents; free cash flow for the year should be much larger than earnings (67 cents per share or so), too. Better yet, executed contracts and awarded orders rose 77% in the quarter, which obviously bodes well for the future. Analysts see the top line growing just 21% this year, which we think should prove low—but even so, growing margins should see the bottom line leap toward $1 per share. It’s a solid down-the-food-chain solar story.

Technical Analysis
ARRY showed tremendous strength from May into August, when the green energy bill was passed and solar stocks went wild. Since then the stock has been a bit crazy, whipping from 24 to 14 (down 41%!), running back to 24, then falling off to 16. But we like how ARRY held its 40-week line on each dip, and last week’s higher-volume ramp is encouraging. If you want in, keep it small, aim for dips and use a loose leash given the volatility.

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Stock 3

Commercial Metals (CMC)

Why the Strength
Steel demand is on the rise once again, thanks to infrastructure spending and expectations of higher activity from top consumer China. Commercial Metals is a Texas-based steel and metal manufacturer whose offerings serve as the backbone for an array of highways, structures and other projects, providing milling products, metals recycling, fabrication and construction services. The company is a leading producer of steel rebar and its main end market is the construction industry. A strong fiscal Q1 earnings report (for the quarter ending November 30) was the catalyst for the latest strength, as Commercial Metals saw revenue of $2.2 billion expand 12% from a year ago, while earnings of $2.24 per share beat estimates by 28 cents and leapt 38%. The results were highlighted by record North American downstream backlog and project bidding volumes, with North America adjusted EBITDA jumping 41%. Also contributing was “historically strong” profitability in the company’s European operations, which the firm attributed to “operational and commercial agility.” Management said it expects domestic construction activity to pick up in 2023, thanks largely to the U.S. infrastructure spending bill that passed in late 2021, with a projected 17% annual increase in rebar consumption. And this isn’t just a near-term thing, with Commercial Metals embarking on long-term expansion: The firm is breaking ground on two new micro mills (one in Arizona and the other in West Virginia) that should each have half a million tons of annual rebar capacity. Moreover, the company sees opportunities with the semiconductor plant reshoring trend (it’s already shipping to some of these construction projects), plus increased planning for natural gas export facilities. Analysts see earnings dipping again this year, but (a) they should remain elevated near $5 per share, and (b) our guess is even that will prove too conservative.

Technical Analysis
After hitting an all-time peak of 47 last April, CMC took a dive along with the rest of the metals sector before halting its decline at 32 in early July. Shares spent the next three months running up to 44 in August and then etching out a final (higher) low at 35 in September. CMC rallied nine weeks in a row from there, hitting new highs, and after tightening up near year’s end, the stock is off and running again. We’ll set our buy range down a bit, but we don’t expect a major retreat.

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Stock 4

Exact Sciences (EXAS)

Why the Strength
Exact Sciences is positioning itself to become a leader in liquid biopsy tests for cancer. Its leading product is Cologuard, a home test for colorectal cancer. It’s a prescription, non-invasive test (stool samples get mailed to a lab). Launched in 2015, Cologuard continues to grow quickly, generating $1.42 billion in screening revenue, up roughly 40% on the year, in 2022. The test has caught on both because it’s a decent, if less accurate, alternative to a colonoscopy, which is invasive and time-consuming enough that people otherwise may skip screening. Exact Sciences seeks to build upon Cologuard’s success with additional liquid biopsy products, both for early cancer detection like Cologuard as well as at-home kits that monitor for the reappearance of past cancers, called minimal residual disease (MRD). A blood-based test for breast cancer recurrence, Oncotype DX, contributed more than $600 million in sales last year, with some 98% of U.S. oncologists having ordered at least one test in 2022. Overall, that and a handful of other tests have made Exact Sciences a notable (but still smaller player) in liquid biopsy, with about a 10% share of the market. But Exact Sciences has taken a more consumer-friendly approach than competitors (you can track your test progress on an app, for instance) and the expectation is that will keep Cologuard growing and give the company leverage to expand the footholds it’s carved out with its other tests. Investors are excited about the recent Q4 guidance (screening revenue up 45%), which blew away estimates and makes the 2023 estimates (revenue up 11%) look very conservative.

Technical Analysis
EXAS topped in early 2021 and had a very persistent decline into October of last year, rarely getting much above its 10-week line the entire time. But shares began to rebound sharply right away, getting above its 40-week line in December and holding above that trend line on the next pullback. Then came last week’s fireworks, with EXAS exploding higher after the higher Q4 guidance. Dips of a few points would be normal, and likely buyable.

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Stock 5

First Solar (FSLR)

Why the Strength
U.S. solar demand is expected to boom from a combination of lower prices—according to one firm, photovoltaic is the cheapest electricity source on a levelized basis—and long-term incentives locked in with last year’s green energy bill out of Congress. First Solar has been a leading manufacturer of high-performance solar panels for many years; its panels use cadmium telluride to convert sunlight to electricity, unlike most PV panels that use crystalline silicon, which allows First Solar’s panels to deliver more power in hot, humid conditions. Its panels are made at one of First Solar’s integrated plants in Ohio, Malaysia and Vietnam in hours compared to days for panels using crystalline silicon. The knock on First Solar has long been that its panels are too expensive compared to mass-produced Chinese options. The company has long disputed such calculations, but thanks to the massive climate-focused spending bill passed last year, the debate is basically moot: First Solar should be able to qualify for 17 cents per watt incentives, mostly eliminating any cost differential. While Q4 2022 results are still to be announced, it’s widely expected they’ll disappoint: First Solar was bedeviled by logistics problems all year, as well as taking a financial hit from a decision to focus purely on making panels and selling off divisions on project development and operations and maintenance. But the market is looking at 2023 and beyond, believing logistics has been sorted out, allowing First Solar to work on its fast-growing backlog of orders, more than 58 gigawatts last quarter (including 16.6 GW of orders in Q3 alone). After a loss in 2022, earnings per share should best $5 this year on $3.3 billion sales and more than double to over $9 in 2024 on sales well over $4 billion.

Technical Analysis
The passage of the massive climate spending bill in August smashed a long bear period for solar stocks, vaulting FSLR from 90 to 145 in early October. After that were a couple of higher highs and higher lows, with two dips just below the 50-day line. But now the buyers are back, with FSLR soaring back to new highs on solid volume. The intermediate-term advance isn’t in the first inning, but the recent action is certainly bullish—if you’re interested, look for dips.

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Stock 6

Hyatt (H)

Why the Strength
Anyone’s who been paying attention knows the post-pandemic travel boom has been humming for months, with prices up and availability tight for flights, hotels, rentals and more. That said, most travel stocks had been held back by recession fears, but that seems to be fading, which is causing many of the best to show outstanding strength. Hyatt is one of them, looking the best of out all the big hotel stocks, helped along by general industry conditions: Business has been plowing ahead nicely as travel picks up, with Q3 showing sales up 81% from a year ago and EBITDA up 129% (both were bolstered by an acquisition), with revenue per available room actually up 2% from the pre-pandemic Q3 of 2019. But there are a couple of other company-specific factors helping here, too, the first being a focus on fee-based revenue (much higher margins), which was up 50% from Q3 2019 and is contributing to healthy free cash flow. (Indeed, Hyatt actually bought back $187 million shares in the quarter.) Second, though, the company has remained on the offensive even during the slow times, with buyouts of AGL (an all-inclusive set of properties that saw revenue per room in the Americas up a whopping 29% in Q3 vs. 2019) and of Dream Hotel Group (likely to go through in the months ahead, bringing 12 upscale hotels and another 24 in development; will boost Hyatt’s New York City room total by more than 30%), resulting in net room growth of 6.5% this year and much more down the pike. (It’s also aiming to dispose of $2 billion of non-core operations by the end of next year to fund some of the buyouts.) All in all, 2023 is lining up to be another great year for Hyatt, with decent growth and much larger free cash flow. Earnings are due February 16.

Technical Analysis
H’s pre-pandemic high was near 95, and impressively, the stock retested that high as early as February 2021. Since then, though, the stock has bobbed and weaved, with the 95 to 100 zone consistently providing resistance. But, overall, H’s resilience has been noteworthy, and the stock’s big-volume ramp so far this year bodes well. We’re OK buying some here or on minor weakness with a stop in the low 90s.

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Stock 7

Jabil (JBL)

Why the Strength
Florida-based Jabil is one of the world’s largest suppliers of electronic manufacturing services, including electronics design engineering, packaging and consulting services for clients across several major industries (healthcare, retail, automotive and semiconductors to name a few). Apple is Jabil’s largest customer, accounting for 19% of its revenue, and the firm makes casings for several of Apple’s products, including the iPhone, and Apple is expected to produce more iPhones this year after manufacturing setbacks in 2022 due to China’s Covid lockdowns. Moreover, Apple is said to be working on several virtual and augmented reality projects—including a highly anticipated mixed-reality headset (due for release this year)—followed by a pair of AR glasses set for release at a later date. A rumored 500,000 units of the headsets are expected to be made in 2023 and much more beyond that, which could provide Jabil with another big growth runway. In its fiscal Q1 report (quarter ended November 30), Jabil reported revenue of almost $10 billion that rose 12% from a year ago, along with EPS of $2.31 that beat expectations by 7 cents. The results were led by an 18% jump in Electronics Manufacturing Services revenue growth and an 8% rise in Diversified Manufacturing Services. The company touted “strong secular tailwinds” as a reason for boosting its 2023 EPS growth outlook (by 25 cents from the prior estimate), which it attributes to the growing deployment of 5G networks in new global markets, along with expected upside in healthcare and the adoption of clean energy infrastructure. Growth isn’t huge here, but the arrow is pointed up and the stock looks cheap.

Technical Analysis
JBL topped near the end of 2021, corrected 32% to its low in the summer and then began a lengthy repair phase in the months that followed. Shares returned to their high in early December, then backed off very calmly, with a mini-shakeout to start the year. And now the buyers are flexing their muscles, with JBL romping to new highs on many days of big volume. We’ll set our entry range down a bit given the recent run.

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Stock 8

MasTec (MTZ)

Why the Strength
With infrastructure spending on the rise, firms that specialize in building and installation services are seeing plenty of opportunities. MasTec is one of the nation’s top power plant and green energy construction companies, specializing in the building and engineering of natural gas plants and renewable energy facilities. Its customers include energy firms, pipeline operators, wireless providers, broadband operators and government entities. MasTec’s Q3 revenue of $2.5 billion was marginally higher than a year ago (up 5%), while per-share earnings of $1.34 beat estimates by 6 cents. However, it was a record 18-month backlog of over $11 billion—a 32% increase—that really turned heads on Wall Street and served as the main catalyst for the recent strength (led by a “significant uptick” in oil and gas project activity). Also contributing to the strength was the company’s non-oil and gas business (which makes up 85% of total revenue), driven by eye-popping 88% growth in the Power Delivery segment and 33% growth in the Communications segment. While MasTec sees long-term opportunities in communications and pipeline services, it expects much of its future growth will be led by high customer demand for renewable power generation, power grid transmission, distribution and civil infrastructure, with strength in those areas lasting well into the next decade. To facilitate this growth, the company recently acquired Infrastructure and Energy Alternatives (IEA), which will allow it to increase its scale and capacity in the green energy areas. Wall Street expects sales (up 34%) and earnings (up more than 60%) to surge this year as the wave of recent orders are executed on.

Technical Analysis
MTZ hit a long-term peak at 120 in June 2021 and struggled to find its footing for the next 16 months. Before the wipeout was complete, the stock was nearly cut in half, but it managed to carve out a double bottom near 62 in last July and October. MTZ quickly turned the corner from there, exploding higher on strong volume and hitting 95 by early November. A trip down to the 40-week line followed, but shares found their footing and have gone on to make a higher peak. Minor weakness should be buyable.

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Stock 9

Schlumberger (SLB)

Why the Strength
Despite all the uncertainties out there, the energy sector is booming, with U.S. production of natural gas at a record level while crude oil production is near one. SLB (formerly Schlumberger, covered in the November 21 issue) is the world’s largest oilfield service company, offering technology and project management solutions for petroleum producers. While decarbonization has become a bigger focus for SLB going forward, traditional fossil fuels are where most of the action is right now. As China reopens, oil demand is expected to increase substantially this year, putting pressure on producers to meet the higher demand. Then there’s the Strategic Petroleum Reserve (SPR), from which around 180 million barrels of oil were released last year to help lower gasoline prices for U.S. consumers, but Washington will begin replenishing the SPR in February; that should further tighten the market and producers will turn to SLB for assistance in meeting this demand. At a recent Investor Day presentation, SLB said it anticipates a compound annual growth rate of 15% over the next three years as a result of “upcycle dynamics” (including the lack of investment for many years) and “strong pricing tailwinds.” SLB also sees its digital revenue doubling by 2025, and projects that revenue from clean energy projects will exceed $3 billion by 2030 (the firm expects this to ultimately become its biggest division). On the financial front, free cash flow is strong (up 64% in Q3 from a year ago), and SLB plans to return 50% of that metric to shareholders via dividends and buybacks through 2025. Analysts see earnings up nearly 40% this year, with the next update coming on with the Q4 report Friday morning (January 20).

Technical Analysis
We were stopped out of our prior position in SLB in early December when the stock violated the 50-day line during the energy sector (and overall market) shakeout—but that doesn’t mean we’re opposed to getting back in. Indeed, the entire sector has rebounded terrifically, and SLB’s latest move to new highs takes the stock out of a base-on-base formation (typically bullish). There hasn’t been a ton of power on the move, so we’ll set our entry range down a bit if you want to nibble ahead of Friday’s earnings report.

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Stock 10

Yum China (YUMC)

Why the Strength
Despite Covid-related restrictions in China in the third quarter, Yum China still managed to increase total system-wide sales by 5%, thanks to a strong takeaway and delivery business that offset a “subdued” dine-in business. But with China reopening and dine-in business expected to rebound, Yum (which operates China’s largest fast-food restaurants, including KFC, Pizza Hut and Taco Bell) is poised to benefit. (The persistent growth of food delivery across China should also resume and help the company’s cause.) Yum is still in expansion mode, having grown its footprint by 4,000 stores, to 13,000, since 2019 (up nearly 50%), with long-term plans to eventually have 20,000 locations across 2,700 cities in China. The firm’s growth plans hinge on a strategy which involves member loyalty programs for its biggest brands (accounting for 62% system sales and reaching 400 million members in Q3), delivery (which grew 19% from a year ago in Q3) and digital orders (which accounted for a whopping 91% of KFC and Pizza Hut revenue in the quarter). Management emphasized that its digital capabilities are crucial to streamlining restaurant efficiency, recently pairing it with artificial intelligence (AI) to maximize delivery coverage for each store, taking into account the operating hours of nearby stores, and also shortening customer waiting time. As a result of these innovations, delivery grew to almost 40% of the firm’s total sales in Q3. Additionally, Yum opened 239 net new stores in Q3 and guided for around 1,100 new openings for full-year 2022. Analysts don’t expect much of a sales bump in Q4, but see the top line gradually picking up steam in the next several quarters as China’s reopening (presumably) gains traction.

Technical Analysis
YUMC got hit with most Chinese peers starting in early 2021, with a big bottom in March. Unlike the sector, though, the stock’s action from there was solid, with a much higher low in October (most Chinese stocks slipped to lower lows) and some controlled upward action since then. Granted, YUMC isn’t as dynamic as other Chinese names, and today’s drop was sharp, but we think upside from here would be bullish. We’ll set our buy range above here, looking for a resumption of the recent rally.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on January 23, 2023.