Cabot Top Ten Trader Issue: January 29, 2024

Same Story—Bullish but Picking Our Spots

We could pretty much cut and paste last week’s write-up here, as nothing much has changed with the evidence, and thus, with our positioning—the primary evidence remains bullish, with the trends of the indexes pointed up, and the action of leading stocks remains very solid. In fact, we’re very impressed that we continue to see many massive-volume upmoves, with some stocks moving to new highs on their heaviest volume in many years (sometimes of all time!). With that said, the broad market is mostly marking time, which is normal so far but clearly lagging the leading stocks, while interest rates (while backing off a bit today) are testing key intermediate-term levels. Long story short, we’re still bullish and are keeping our Market Monitor at a level 8, but are being more discerning on the buy side, especially with names that have been running for three months.

This week’s list has everything from popular tech names to cyclical tech to development-stage biotech, though as mentioned above, we like that we’re seeing some big-volume moves. For our Top Pick this week, we’re going with Western Digital (WDC), which has a history of trending in good times and looks set for a big turnaround.

Stock 1

American Express (AXP)

Why the Strength
American Express needs no introduction, as it’s one of the big credit card players in the industry and also offers a variety of financial services. Long-term, the growth story here is very steady, as more people and businesses both here and overseas grow wealthier and expand their card usage (Amex is perceived to be the upper end of the spectrum), while near-term, the story remains mostly about the resilient U.S. economy despite the Fed’s multi-year tightening cycle—and, of course, hopes for even better times ahead now that the Fed has called off the dogs. In Q4, the company’s results were mixed compared to expectations, with revenues less interest expense (up 11%), earnings (up 27%) and charge-offs coming in a bit weaker than estimates, though overall expenses were better off. But more important is the big picture and the future—right now, both the percent of accounts more than 30 days past due (1.3% vs 1.5% pre-pandemic) and net write-offs (2.0% vs. 2.2%) are rising but still below where they were in 2019, and the firm expects more sanguine activity ahead, anticipating earnings of nearly $13 per share in 2024, up mid teens percentage-wise from last year and ahead of expectations. (Interestingly, 32% of Amex’s U.S. consumer business is from those 43 years old or younger, with another 37% from 44 to 59, so there should be plenty of built-in growth as they age and expand their spending.) There are plenty more details, but you have the gist of the story: This is a blue-chip credit card and financial services outfit that looks like a safe bet to thrive as the economy improves. A modest 1.2% dividend helps the cause.

Technical Analysis
AXP isn’t the normal Top Ten stock, but it can move over time, and the chart looks to just be getting going: Since early 2022, the stock traded in a wide 70-point range (130 to 200, ballpark), with shares coming within 10 points of their low in October. AXP then rallied nicely back to 190, and after a dip to the 10-week line, lifted strongly both before and after earnings, with last Friday’s pop the highlight. We don’t expect the stock to go straight up, but the breakout portends higher prices ahead.

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Stock 2

ASML Holding (ASML)

Why the Strength
ASML management says 2024 will be flat, but investors don’t quite believe them. For one, the Dutch maker of advanced semiconductor manufacturing equipment surprised with its Q4 results, released last week, as sales of €7.2 billion exceeded guidance with strong quarterly of bookings of €9.2 billion after amassing just €10.9 billion in the first three quarters. That order figure, which obviously tends to be forward-looking, is what investors keyed on, as well as the fact that earnings easily topped estimates. ASML management is saying they expect this year will be a transition based on historical chip sector recoveries, getting lower margin equipment out the door in anticipation of strong demand in 2025 and beyond. Yet there remain signs this year could come better than expected: Demand from mainland China has been very strong for ASML’s older equipment, which is offsetting a U.S.-mandated prohibition on exporting its best machines to China. Indeed, that country is a wild card—management won’t project sales there other than saying demand looks fundamentally strong. Elsewhere, there’s plenty of demand for what ASML does best: Designing very advanced equipment that produces the world’s most cutting-edge computer chips, using extreme ultraviolet light (EUV) lithography for printing. It’s the unquestioned leader in the space, meaning that even if 2024 sales come in at current projections, around €27.5 billion with slightly lower earnings per share of €20 to €21, 2025 is expected to see a 20%-plus jump in revenue as demand bounces back, driven by AI chip demand and the long-term sector outlook. Bottom line, while the timing isn’t exact, investors are thinking the sector’s slow times are about over and are pricing in bigger and better things.

Technical Analysis
ASML looked like it was getting going last May and June, but like the market, it succumbed to a correction that led to a tedious dip (27% deep) before bottomed in October and running up with the group in November and December. The early-January wobble wasn’t pleasant, but the 50-day line offered support, with ASML rallying nicely of that support—and then exploding higher last week on its heaviest weekly volume in more than a decade! We’re OK buying some here or (preferably) on dips. FYI, yes, the stock is high priced, but just buy fewer shares as it can obviously move.

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Stock 3

Dell Technologies (DELL)

Why the Strength
As the artificial intelligence transformation continues apace, the demand for AI servers is predicted to reach $150 billion in just the next three years—up a staggering 400% from the market’s current size. PC maker Dell is set to become a major player in the lucrative AI-server market and continues to expand its footprint in this space. Although Dell’s fiscal Q3 (ended November 30) report initially disappointed Wall Street in late November, with total revenue posting yet another decline (down 10%), the stock quickly regained lost ground when analysts digested the massive growth in Dell’s AI server sales. Overall server and networking revenue rose 9% sequentially in Q3, which Dell said was fueled by customer demand for generative AI—a tailwind the company expects to continue in 2024. Indeed, while still tiny compared to the overall business, Dell generated over $500 million in AI-optimized server sales in the quarter, a more than four-fold increase from the year-ago Q3 number. Management said AI server orders comprised 33% of total server orders in Q3 while customer demand for these servers has nearly doubled sequentially, further noting that demand remains “well ahead” of supply with increasing interest from customers in higher education, financial services, healthcare and manufacturing. Dell also sees a “green shoot” in its traditional service business as data centers are beginning to replace “older” servers from the pre-Covid era. Finally, regarding Dell’s PC segment, analysts expect 2024 to see a new commercial PC refresh cycle, as global PC shipments just ended an eight-quarter decline (Dell expects AI-enabled advances will further bolster its PC sales). Wall Street is expecting another sluggish year overall, but our guess is that will prove conservative, and the valuation (13x earnings) gives the stock some cushion.

Technical Analysis
After a bumpy couple of years, DELL recovered above the 10-week line last April and has closed above that trend line for all but two weeks of the last several months. The first major test of the trend line in August ended when shares exploded higher on earnings, while two more tests—one in October and the other in December—saw the stock quickly snap back after each dip. Now shares have gained more strength, including a big-volume push to new highs two weeks ago. Dips of a point or two should provide a buying opportunity.

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Stock 4

Eagle Materials (EXP)

Why the Strength
Eagle Materials is a U.S. housing and construction play, so if the Fed really does shift to becoming an economic tailwind, Eagle’s already strong results should continue to improve. The firm is a big player in Portland cement (most often used for concrete; it’s the largest U.S.-only player) and gypsum wallboard (80% of which goes into residential construction and remodeling), and the top brass has a good history of making the right moves, with very efficient and low-cost operations (best margins in the group; wallboard and paperboard operations have been profitable every year no matter the environment) and prudent expansion both organically and via M&A (its tripled its cement capacity since 2010; has 40-plus years of raw materials for paperboard), which has helped the firm’s bottom line over the last decade or so. And that general uptrend continues today, which is a big reason why the stock is strong—last week, Eagle reported another steady-as-she-goes quarter, with sales (up 9%) and earnings (up 16%) easing past estimates, led by the 18% sales jump in cement and (to a much lesser extent) aggregates; average net sales prices for cement lifted 13% as demand is outstripping U.S. supply. Analysts have nudged up their estimates after the report, with 10% to 15% growth expected through this year, with plenty of upside potential should the housing market (both construction and sales activity, which leads to more remodels) pick up and as infrastructure spending remains strong. A solid buyback program (share count down 5% from a year ago) is an added plus.

Technical Analysis
EXP ran to new highs with many housing-related names in the middle of last year before suffering a 26% dip in the summer and fall, including a two-week drop below the 40-week line. But the action since the market’s low has been excellent, not only with a seven-week run to new highs, but then a tight five-week zone—and a move to new highs on good volume after earnings last week. We’ll set our buy range down a bit, thinking a normal exhale is likely after the post-earnings buying wave.

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Stock 5

Eyepoint Pharmaceuticals (EYPT)

Why the Strength
Retinal diseases are increasing in Western countries, with the prevalence of such diseases rising as high as 20% of the population above the age of 40. Massachusetts-based EyePoint is focused on developing therapies that improve the lives of patients afflicted with serious retinal diseases using micro-electromechanical systems and nanotechnology to enhance drug delivery. Two of its treatments, Dexycu (for reducing inflammation in ocular surgery patients) and Yutiqu (for chronic non-infectious uveitis, another inflammation disease), have already been commercialized (though the latter drug franchise was recently sold). The story, though, mostly revolves around pipeline candidate EYP-1901 (Durasert E), which has been grabbing most of the headlines of late after meeting its key primary and secondary goals in Phase II clinical trials as a maintenance therapy for wet age-related macular degeneration (AMD). The company said the experimental therapy indicated a “favorable safety profile with no drug-related ocular or systemic serious adverse events” and that the results support the drug’s advancement into Phase III testing, likely during the second half of this year. The favorable results prompted a number of big Wall Street institutions to upgrade EyePoint’s share outlook, including a major bank that just initiated coverage of the stock with an overweight rating, citing the potential of EYP-1901 (another reason for the strength). On the financial front, the company reported revenue of $15 million in Q3 that increased 52% from a year ago, along with a per-share loss of 33 cents that beat estimates by 15 cents (profitability isn’t expected until 2027). Looking ahead, management said the firm’s cash holdings of $136 million will enable it to fund its current and planned operations into 2025. It’s obviously going to be an event-driven outfit, but if the biotech stock resurgence gains steam, this small-cap name has good potential.

Technical Analysis
EYPT has a typical chart for a development stage biotech name, with lots of big, jagged moves with the market and (most often) on news. The stock was cut in half during the market’s summer/fall correction last year, but then came the trial results in early December, which gapped EYPT toward 20 in one day. After some wiggles, the stock has recently gotten its act together, running to new price highs last week. If you want in, aim for dips, start small and use a loose leash.

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Stock 6

Netflix (NFLX)

Why the Strength
After losing over a million subscribers in 2022 (widely blamed on a big increase in monthly fees along with tons of competition), streaming service juggernaut Netflix quickly responded with a strategy to regain those lost members and return to growth. Part of that strategy entailed the recent launch of a new, much cheaper ad-supported subscription plan (just $7 a month versus $23 for the premium service), a crackdown on password sharing (important, as the company thought it had tons of shared accounts) and the introduction of a mobile game service. Those efforts have clearly paid off, as annual subscription growth hit its fastest rate since 2020 in last year’s third quarter. What’s more, last week’s Q4 report delivered even better news, as global streaming paid memberships increased further—up 5% sequentially and 13% higher year-on-year—once again topping pandemic-era subscription numbers. The company has stated that a big part of its focus going forward is on revenue as its “primary top line metric,” and last week’s Q4 report saw revenue expand by 13%, to nearly $9 billion, which management said “reflects the benefits of paid sharing” and recent price changes; earnings of $2.11 per share was miles above the year-ago number (even though it missed estimated by 5%). More important was the outlook, with the top brass looking for currency-neutral Q1 revenue growth of 16% and subscriber growth above last year’s Q1 tally of 1.8 million, with global revenue per user also set to rise. Wall Street was pleased with the mostly sanguine results, pushing shares significantly higher in the wake of both earnings and last week’s announcement that Netflix has partnered with entertainment giant TKO Group, parent company of WWE, to feature the popular WWE Raw pro wrestling program on its streaming platform next year as part of Netflix’s drive to increase sports and live events content. Analysts see the bottom line mushrooming this year.

Technical Analysis
NFLX had a great off-the-bottom rebound from mid 2022 until January of last year, building its first “real” base, and it took off in the spring—but, like the market, the rally only lasted a few weeks before a tough correction unfolded. All in, shares dipped 29% and cracked their 40-week line before storming back with the market, starting with the Q3 report, and after many weeks of tight trading below 500, after last week’s Q4-induced surge. Dips would be tempting.

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Stock 7

Scorpio Tankers (STNG)

Why the Strength
There’s no industry that’s more cyclical than shipping, and for energy shippers, right now is boom times for a couple of reasons. First off are the long-term fundamentals: As with many shipping niches, investment in ships that transport crude or refined products has been lagging despite an aging fleet, with newbuild deliveries expected to be far fewer than the number of ships turning at least 20 years old (and thus potentially next in line to be scrapped) for many years—all while total demand has surpassed pre-pandemic levels and seaborne fleet miles are outpacing even that demand due to disparate regional refining growth. Then there’s the here and now, with attacks in the Red Sea causing havoc with tanker routes and charter rates. All of that leads us to Scorpio Tankers, which has the largest and most modern fleet of product tankers (takes product from refineries to bulk storage), with 111 ships of varying sizes. Because of the long-term factors above, business has been excellent for a couple of years, which the top brass has used to cut debt significantly (net debt is down from $2.9 billion to $1.2 billion in the past two years) and buy back plenty of stock (Q3 share count was down 17% from a year ago!) and pay a nice dividend (2.0% yield)—and investor perception is coalescing around the view that the charter rates will stay elevated or even grow further going ahead, which will keep Scorpio’s bottom line in the stratosphere—indeed, Q4 charter rates were about $33,000 per day, a rate that should produce free cash flow north of $10 per share, and of course that was before the Red Sea attacks of recent weeks. Of course, nobody is saying Scorpio will be a long-term hold, but the stars are certainly aligned today.

Technical Analysis
STNG counter-trended from the market for much of the past couple of years, when it rallied in 2022 in a very big way, corrected in the first half of last year and then rebounded in the summer and fall. But now it’s in gear with everything else, with a nice move above resistance in the middle of December and, after some tight weekly closes, some huge-volume moves to new highs in recent days. We’ll set our buy range down a bit, looking for a normal exhale to enter.

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Stock 8

Super Micro Computer (SMCI)

Why the Strength
Super Micro Computer is a provider of server systems and many of the building blocks that go into them, and the stock is strong today because it reported preliminary fiscal Q2 revenue that shattered prior guidance, saying sales for the period will come in between $3.6 billion to $3.65 billion, compared to about $2.8 billion it previously signaled and consensus estimates of around $3 billion from Wall Street analysts. (The preliminary sales mark is double the revenue of the year-ago period, too.) Earnings per share will be nearly as strong, at least $4.90, versus prior guidance of $4.24 and up about 50% from Q2 2023, which ended Dec. 31, 2022. Management will detail its financials on an earnings call with analysts this evening, and offer guidance for the current quarter, but it’s very likely demand for systems continues to be strong thanks to AI, cloud and 5G development. Super Micro Computer’s main product is Plug-n-Play Rack-Scale, an easy-to-install server system. Its whole GPU line has been refreshed in in the past year, with server systems called Sapphire Rapids, Genoa and H100 powered with NVIDIA and AMD chips. The company says it foresees an expanding customer base that should result in faster sales growth than seen in previous product cycles. One wrinkle that’s helping the business is that AI-driven data center expansion also means data centers will consume a lot more electricity. Super Micro says one of its competitive advantages is that its liquid cooling design uses far less electricity than competitors, up to 40% less as high-powered chipsets come to market. The trade-off is that Super Micro ‘s servers are pricier upfront, but long-term minded corporate clients are increasingly seeing that math makes sense on saving energy bills, as well as being able to tell consumers they’re greener.

Technical Analysis
SMCI had a huge, huge run last year and looked to have something of a blowoff top in the summer before a big gap down in August kicked off a deep 37% correction. However, the 230 area provided repeated support, shares moved back toward their highs in December and January, and then the preliminary earnings result led to a tsunami of buying, with SMCI easily leaping to new highs. The trick is that earnings and the fiscal Q3 outlook are due tonight—we’d rather not chase another gap higher from here, so we’ll put our buy range a bit down from tonight’s close, thinking a post-earnings shakeout should provide an opportunity.

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Stock 9

Western Digital (WDC) ★ Top Pick ★

Why the Strength
After suffering through a post-pandemic contraction, industry experts believe the storage sector is on the cusp of a multi-year boom due to (you guessed it) AI-related enterprise storage growth, led by data centers. Western Digital is a top provider of hard disk drives (HDD), NAND flash memory and other data storage devices and solutions to customers worldwide. Analysts expect the company’s HDD products to benefit from the exponential expansion in cloud storage and artificial intelligence demands, both of which rely heavily on HDDs. While the company’s overall HDD shipments and sales have declined in recent quarters, the downtrend seems to be at an end while the nearline (on-site storage) data center HDD market is expanding. Those positive expectations drove the stock’s latest surge higher as a major institutional bank just named Western Digital as its top sector pick, also bumping up its target price by 40% based on the higher NAND prices the firm is seeing. Also last week, Western Digital released financial results for fiscal Q2 (ended December 29) that saw revenue of $3 billion decline 2% year-on-year (due to lower e-solid state drive bit shipments), but that was a big improvement over recent declines, and a per-share loss of 69 cents exceeded expectations by 41 cents. Moreover, revenue rose 10% from the prior quarter, with cloud sales increasing 23% sequentially—the first return to growth in this segment in six quarters—thanks to an increase in nearline shipments. In the firm’s consumer segment, sequential revenue growth was led by seasonal strength in flash volume shipments and selling prices. For fiscal Q3, management guided for revenue to increase 18% at the midpoint (up 7% sequentially) and sees nearline HDD demand continuing to improve going forward. Wall Street sees earnings in the black in the June quarter and kiting higher from there. It’s an interesting turnaround situation.

Technical Analysis
WDC ended the 2022 bear market at the end of that year at 30 and popped higher initially, but effectively spent the next many months building a bottom—indeed, while there were some decent upside in the summer and fall, the stock’s late-October shakeout wiped away most of that. But WDC changed character after that shakeout, not only rising, but doing so on many weeks on eye-opening volume, including last week’s move, which came on the biggest weekly volume in 14 years! Yes, there could be a pullback, but we’re not expecting a huge retreat; we’re OK entering here or on a little weakness.

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Stock 10

Worthington Enterprises (WOR)

Why the Strength
Ohio-based Worthington designs and manufactures market-leading brands across multiple industries and operates under three segments: Building Products (architectural, metal framing and ceiling solutions), Consumer Products (office furniture and outdoor living) and Sustainable Energy Solutions (on-board fueling systems and gas pressure cylinders). The company was historically known as a steel processor, but it recently completed a spinoff of its steel business as part of a strategic effort to focus more on building products along with shareholder returns. In fiscal Q2 (ended November 30), Worthington reported solid results despite economic headwinds facing some of its sectors. Although revenue of $1.1 billion was 8% lower year-on-year, it beat estimates, while per-share earnings of 78 cents also beat the consensus and increased 77% (both reasons for the stock’s strength). Consumer Products revenue was down 4% due to lower selling prices in the outdoor living business. Building Products sales declined 13%, also due to lower average selling prices, and the Energy business was down 28% because of lower volumes. However, efficiencies boosted the bottom line, and while Consumer Products and Energy Solutions sales were down from a year ago, both segments delivered sequential earnings improvements, and management said both segments are well positioned for a “solid” performance in 2024. Wall Street has set a low bar for the coming year in terms of sales and earnings expectations, but Worthington said there were some encouraging green shoots in the last couple of months of 2023 in the form of a sequential sales improvement in the consumer business, prompting the company to expect a return to more “seasonally normal trends” in the coming two quarters. Estimates here are likely very conservative.

Technical Analysis
WOR bottomed near 23 in late 2022 and had a choppy recovery during the next year, with higher highs and higher lows, but with tons of corrections and dead periods along the way. However, shares began to trade more tightly in October and November before exploding higher on huge volume in December as the steel spin-off was completed, rushing up to nearly 60 before a good-sized dip. WOR held the 50-day line more recently and has begun to resume its upmove—we’re OK starting a position here with a stop near the recent low.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on February 5, 2024.

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