Cabot Top Ten Trader Issue: July 10, 2023

Short-Term Wobbly, Big-Picture Still Fine

The title basically says it all when it comes to our thoughts: After a heady run, further short-term wobbles are possible, even likely, as the market and many stocks digest their May/June gains and as fear levels rise with interest rates. And to be clear, given that rates were basically the driver of the 2022 bear phase, they’re something to keep an eye on; a sustained uptrend would likely cap the market. With all of that said, though, to this point the consolidation in the major indexes and leading stocks has been completely acceptable, with very little abnormal action and with a lot of names finding support near their 25-day moving averages. If we start to see some names crack meaningful support, we’ll knock our Market Monitor down a notch or two, but today we’ll keep it at a level 8, as the odds continue to favor this being a normal rest period that will give way to higher prices.

This week’s list has a handful of names that have recently got going despite the market’s shenanigans. Our Top Pick this week is from a beaten-down group that’s come to life—Noble (NE) is one of many oil service and drilling stocks that’s come under strong accumulation (and seen some positive options activity, too), possibly signaling the start of a group move.

Stock 1

Adobe (ADBE)

Why the Strength
Tech giant and PDF pioneer Adobe is well known for its graphic design and editing software, and it’s a cloud leader with its Creative, Marketing and Document Cloud services. But in recent years, the company has been rapidly expanding into the artificial intelligence (AI) space, launching a generative AI and machine learning platform called Adobe Sensei, which is used to enhance certain features across its cloud offerings. The company also just integrated its latest (and more compelling) generative AI-based offering, Firefly (currently in beta), with its Creative Cloud applications to allow users to make images, transform text and accelerate color variation in graphics by using only text prompts. Once completed, the new offering is expected to simplify the process of creating AI images in Adobe’s super-popular Photoshop and Illustrator products. Adobe is also making a concerted push into the online merchant space by its purchase of Magento Commerce—a major Shopify competitor that has some big clients—and rebranding it as Adobe Commerce. To further its ambitions in online commerce, Adobe is developing a new AI solution called Project Fast Filtered that will simplify product searches on retailers’ websites by reducing search results from thousands to single digits (the tool is currently being tested for furniture products, plus athletic and leisure gear). Meanwhile, growth remains solid: In fiscal Q2 (ended June 2), Adobe reported a 10% year-on-year sales increase and earnings of $3.91 per share that beat estimates by 12 cents (a reason for the strength). Remaining performance obligations (RPO, a key metric) rose 10% to $15 billion, and investors are clearly thinking the newer AI offerings will bolster growth going ahead.

Technical Analysis
After plunging 60% during the bear phase, ADBE found bottom in October above 270, rallied to around 400 in January and then built its first proper launching pad. After two sharp-but-brief dips, ADBE broke out in late May and accelerated higher after earnings. And now we see the stock trading tightly, refusing to give up any of the move. We do like the pattern, but we’ll set our buy range down a bit, thinking shares could gyrate near term.

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Stock 2

Arrow Electronics (ARW)

Why the Strength
Colorado-based Arrow specializes in electronic component products (including semiconductors) and offers enterprise computing solutions (like storage and security), along with distribution and value-added services. It serves as a supply and distribution channel for customers in more than 90 countries and is a leading equipment provider for the global IT industry. Part of the story here is that Arrow’s streamlined operations allow it to crank out healthy free cash flow and maintain its leading market position even in down cycles, and since much of Arrow’s operations are business-to-business, it’s able to bypass the volatility of the consumer market; because of all that, it’s been buying back shares and paying off debt. That said, after boom times of late, the environment has turned more negative—Q1 revenue of $8.7 billion was 4% lower from a year ago, though both sales and per-share earnings of $4.60 topped expectations by 2%, with both metrics beating the midpoint of Arrow’s guidance (the reason for the stock’s strength) in what the firm called a “challenging environment” for suppliers and customers. Global enterprise computing solutions (ECS) sales rose 3%, led by Europe. And while Arrow’s global components (GC) segment saw a sales decrease of 3% on a currency-neutral basis, the company was still pleased by the overall GC performance given global market conditions, with strength in Europe (up 23%). However, the overall story here is that, while earnings are sloughing off, they should level out at around twice its pre-pandemic totals, with the top brass citing low cancellations, a significant backlog and an improving supply chain as helping. The valuation (9x low 2023 estimates) is another reason the buyers should remain in control.

Technical Analysis
ARW held on to most of its post-pandemic gains during last year’s bear and got back on track following its low-water mark at 90 last October. The renewed bull since then has come in two major stages, with ARW hitting its first peak in early February, then pulling back for a few months and finding support at the 40-week line. The latest run began with the Q1 report in early May and has seen shares break through last year’s high. If you want in, we’ll set our buy range down a few points, near the 25-day line.

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Stock 3

Chart Industries (GTLS)

Why the Strength
Chart Industries looked like a leader in the emerging green energy infrastructure sector last fall, but a giant acquisition of Howden sent investors scurrying due to the uncertainty and debt that was undertaken (more on that below). But the underlying story never really changed, and now, after eight months or so, investors are starting to think the deal will pay off. The company is a big player in everything from LNG to carbon capture to water and wastewater management to hydrogen (cryotanks, etc.) and more. And, really, business continues to hum—earnings (up 117%) and EBITDA (up 86%) both soared in Q1, but even better is that the backlog is going bananas (up 166%); yes, part of that is due to the buyout, but even excluding the acquisition, Q1 saw the firm achieve new record backlog in a variety of cryotanks, heat transfer, small- and large-scale carbon capture, water treatment offerings and more, with the buyout also helping its repair and servicing offerings. And there should be tons more where that came from—for big LNG projects, the potential industry bookings should be $7.6 billion over the next three years; the number of smaller LNG potential orders is up 50% from last year; the number of customers and potential customers in hydrogen and carbon capture is up nearly 40% from a year ago, and so on. Throw in the fact that merger synergies are coming in ahead of expectations and big investors might have seen enough to conclude management here is going to execute on its bullish plans: The top brass sees earnings north of $6 this year (nearly $7 per share of free cash flow) and big debt paydowns, while analysts see earnings north of $10 next year. Earnings are due July 28.

Technical Analysis
GTLS actually broke out of a year-long structure last November before the market gave the Howden acquisition a huge thumbs-down, as shares imploded 40% in one week (!) and nearly tagged the century mark in March. However, big picture, GTLS started to bottom out last December, and while the longer-term trend isn’t up, the stock looks like a turnaround—shares have advanced persistently from their lows to seven-month highs before some recent wiggles. It’s aggressive, but a nibble here or (preferably) on dips is fine by us, with the idea of gradually adding if GTLS heads up.

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Stock 4

Chemours (CC)

Why the Strength
DuPont spin-off Chemours is a chemical industry giant serving industries ranging from paints and laminates to advanced electronics, construction, energy and telecommunications. It enjoys a leading position in titanium technologies (TT, used in automotive and aerospace coatings) and fluoropolymers (a key ingredient for semiconductors and smart devices), with the latter currently enjoying robust global demand. However, the stock’s recent strength mainly concerns a legal settlement involving a so-called “forever chemical” the company makes that allegedly contaminated drinking water supplies in a number of U.S. cities. Chemours, along with parent company DuPont and its spin-off Corteva, agreed in principle to pay nearly $1.2 billion in damages involving PFAS, a chemical commonly used in fire-fighting foam. (Although it denied the charges in the underlying allegations, Chemours agreed to pay 50% of the combined settlement.) The PFAS lawsuit has been a headwind for Chemours in recent years, and now that it’s over, investors can begin focusing on the company’s growth prospects going forward. In Q1, revenue of $1.5 billion declined 14% year-on-year, but per-share earnings of 98 cents beat estimates by a whopping 47 cents. And there were signs that the expected business retrenchment is going to be tamer than thought—sales were 15% higher sequentially, while thermal and specialized solutions sales increased 14% from a year ago. Looking ahead, Chemours said that despite the weaker TT market, it’s seeing a recovery in volumes and a decline in raw material costs and is confident of a “gradual recovery throughout the year” in this business with improving margins across its portfolio. After a modest dip this year, Wall Street sees earnings catapulting higher in 2024, and a tame valuation (10x this year’s earnings, 2.7% dividend yield) helps the cause.

Technical Analysis
CC has spent the last couple of years stuck in a lateral range between 25 and 38, with one poke above that range last summer that was quickly rejected. More recently, though, the stock tightened up after a dip during the March banking crisis, and the rally that followed the resolution of the PFAS lawsuit was powerful (up 24% in one day) and came on massive volume (5x average and the highest in over a year), with follow-through buying bringing shares to multi-month highs. It looks like the path of least resistance is turning up; we’re OK starting a position here or on dips.

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Stock 5

Howmet Aerospace (HWM)

Why the Strength
The global aerospace market is experiencing boom times, thanks to a strong rebound in plane orders following the Covid dry spell (bolstered by a resilient post-Covid pickup in vacation travel) as well as defense-related spending. All of that is brightening the prospects for aerospace leader Howmet: The company provides engineered metal products—mainly aluminum and titanium—used in aerospace, defense and commercial transportation applications, as well as fastening systems, bearings and forged aluminum wheels for heavy trucks. But aero engine products account for nearly 50% of sales and are the main driver here. Revenue of $1.6 billion rose 21% year on year in Q1, with per-share earnings of 42 cents increasing 35%, led by Howmet’s aerospace segment—which grew for the eighth straight quarter. The strength was driven by a 26% increase in engine product sales, along with growth in commercial and defense aerospace, industrial gas turbines and oil/gas markets. Howmet’s Fastening Systems segment reported an 18% revenue increase due to growth in the narrow body commercial jet and defense aerospace markets, while Engineered Structures lifted 14%, also driven by commercial airline industry demand. And there should be a lot more where all of that came from—management is encouraged by what it deems as a solid demand picture, with the company raising its full-year guidance calling for a low double-digit sales increase for 2023, along with 18% higher in free cash flow this year, and analysts see earnings growth actually accelerating next year. It’s not the sexiest story, but Howmet’s should crank out reliable results for a long time to come. Earnings are due out August 3.

Technical Analysis
The trend in HWM since last October has been relatively persistent, with the stock hitting a speed bump just once (during the March banking fears) before resuming the rally. The action since early June has been even stronger, with a dip to the 50-day line leading to a rush higher toward round-number resistance at 50—you can grab some shares here, though dips of a couple of points are possible.

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Stock 6

Krystal Biotech (KRYS)

Why the Strength
Krystal Biotech got FDA approval for its first treatment in May, an injectable called Vyjuvek that is the only available treatment for a rare and serious skin disorder called dystrophic epidermolysis bullosa (DEB). DEB causes serious blisters on the skin, including sometimes the linings of internal organs, after even the mildest of agitation like scratches or heat. It’s a type of herpes simplex virus that often appears shortly after birth and which can display moderate to severe blistering. Krystal Biotech is just ramping up plans to distribute the drug through the U.S. and hasn’t presented guidance on expected patient numbers or revenue yet, but like many specialized drugs for rare disorders, the company should be able to charge a premium to treat as many as 3,000 people in the country who suffer from the affliction. (Roughly a third of those suffer from moderate to severe expressions of DEB and are the most likely to receive the course of treatment.) Right now, Wall Street is forecasting $27 million revenue for this year, rising quickly to $194 million next year. Profits should come the following year, with analysts expecting back-of-the-envelope results of $327 million revenue and $30 million of net income in 2025. Progress on Krystal Biotech’s dozen other treatments in discovery or clinical trials will also drive sentiment: About half are treatments for other rare genetic disorders, including one for cystic fibrosis that will see the first patient dosing occurring this quarter. The company also has a series of drug developments under its Jeune Aesthetics division, pursuing skin treatments to reverse the normal effects of aging. The balance sheet is in fine shape, with $350 million in cash and another $100 million in a marketable FDA voucher, so it should be good to go in getting Vyjuvek off the ground.

Technical Analysis
KRYS established a choppy uptrend a year ago, regularly testing support of its 200-day line from last September through March of this year. The FDA approval of Vyjuvek naturally spiked shares higher on tremendous volume, rallying from 87 to 118 in just two sessions, and with follow-on buying bringing shares up to 132 before the market’s latest consolidation. It’s obviously a speculation, but the tame pullback of late while the 50-day line catches up makes for an interesting risk/reward situation. Don’t invest the rent money, but we’re OK with a nibble here or on further dips.

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Stock 7

Noble (NE) ★ Top Pick ★

Why the Strength
Schlumberger recently said that it expects a huge wave of offshore contracts in the next couple of years as big players love the price dynamics (85% of offshore fields profitable even at $50 oil; most future rig bookings will be for fields that have a breakeven of $40 or below!) and the realization that, while green energy is growing, fossil fuels will be needed for a very long time. Combined with limited supply, that’s boosting dayrates for offshore drillers, which, after many years of dry times, have shaped up operations and are poised to see their bottom lines soar. Thanks in part to a big merger with Maersk last year, Noble (based in Switzerland) is one of the big players in the offshore drilling group, with 31 total rigs, including 15 modern ultra-deepwater (UDW) drillships (which often grab the best dayrates), 11 of which are Tier 1 (making up 24% of the global supply of those super high-end ships). Noble has inked nearly a quarter of the industry’s UDW contracts in recent years, with a current average dayrate of $400,000—but with the market tight (90%-plus utilization in UDW), dayrates continue to advance, nearing $500,000 in recent weeks. And all of that means Noble has a long runway of business coming in ($4.6 billion backlog as of early May) that’s just starting to hit the bottom line. In Q1, EBITDA was up five-fold from low levels a year before, while earnings were in the black for the fourth straight quarter—and analysts see both figures kiting higher for at least the next year and a half, with $6 of earnings per share possible next year. With low leverage (just 0.6x cash flow), Noble is looking to return more than half of free cash flow to shareholders, with an active share buyback program underway. It’s a solid cyclical story.

Technical Analysis
Despite oil stocks acting poorly over the last year, NE was able to work its way to higher highs last November and this February before getting walloped during the March banking worries. But shares held the 35 level (and the 200-day line) repeatedly over the next three months, and now we see the buyers pouncing, with NE surging two straight weeks to new highs on some impressive volume. A near-term pullback is certainly possible, but we’re OK starting small here with a stop in the low 40s.

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Stock 8

Nvidia (NVDA)

Why the Strength
Concerns that weighed on Nvidia’s shares for all of 2022 – mainly its valuation in the face of softening demand from cryptocurrency miners and the U.S. government’s efforts to restrict certain technologies to be exported to China – have evaporated. Credit generative AI for the renewal of enthusiasm. The company shattered expectations with its first-quarter report, saying in May that AI customers drove much of the demand for the period, with revenue nearing $7.2 billion, versus $6.5 billion consensus, and EPS of $1.09 when 92 cents was expected. Nvidia manufactures GPUs, software products and provides related services such as cloud platforms and acceleration libraries that AI innovators need in bulk. Nvidia sees its role increasingly as not just selling hardware, but the software to run high-processing-demand projects, like AI. Data center applications are the majority market for the California company’s chips, at 56% of sales. About a quarter of that has come from China, but the company sees so much demand that even losing some of the export market due to federal security rules shouldn’t affect results. Computer gaming is also important, at about a third of sales. While other areas like chip-hungry EVs and self-driving tools are also growth areas, all eyes are on AI, with a widespread investor belief that we’re near an inflection point in demand, with Nvidia as a natural picks-and-shovels leader in the space. That had management projecting current quarter revenue will hit $11 billion, which would be a 64% jump, driven mainly by AI demand in its data center arm. Analysts see earnings doubling this year and up another 40% next, and even that is probably lowballing it given the wave of demand hitting Nvidia’s shores.

Technical Analysis
NVDA bottomed last October and was still very iffy coming into the year, but when the calendar flipped, the stock changed character—shares rallied nine weeks in a row, including five straight big-volume up weeks, and then tightened up during April and early May. The much-publicized earnings gap was an eye-opener, and impressively, NVDA has held firm since then, actually showing some tightness (a constructive sign). If you don’t own any, we’re OK starting a position here or (preferably) on some weakness, with a stop near the top of the earnings gap.

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Stock 9

Samsara (IOT)

Why the Strength
The big thing Samara has going for it is that it’s the leader in a large niche that’s almost sure to see the firm get much, much bigger over time—as we wrote a few weeks ago, the company is the leading cloud software player for clients that have a ton of physical assets (grocery supply delivery, waste management, construction, transport firms, chemical carriers, wholesale/retail, etc.), offering things like top-notch telematics and GPS tracking (more efficient drivers, less idling time, in-cab alerts and safety training that lead to lower insurance costs), improved regulatory compliance, better equipment servicing (predictive analytics instead of waiting for a squeaky wheel) and much more. There’s an AI component here as well, as Samsara takes tons of Internet of Things data (hence the stock symbol; it’s taken six trillion data points including 1.9 billion trips taken) from its clients and uses it to constantly improve the platform (a competitive advantage in itself), and it’s also expanding into more areas such as worker training or personalized support and troubleshooting, which is huge as the firm’s clients have massive amounts of (often) blue-collar workers. The return on investment for the customers is huge (usually within months), and with three- to five-year subscriptions, there’s a lot of predictability in the results; Samsara claims its lifetime value from each customer averages eight times (!) the cost to acquire them! It probably won’t ever be a household name, but the firm has emerging blue chip written all over it.

Technical Analysis
We missed our entry point on IOT a few weeks back as the stock initially didn’t pull in from its powerful earnings move—but now it’s four weeks into a rest period, similar to the overall market, To be fair, the retreat did take back more of the powerful rally than we’d prefer (about 70% from the breakout level to the recent peak), but it’s certainly nothing abnormal to this point and we’re not underestimating the prior upside power. We like today’s support near 25—you can start a position here or on dips, though use a liberal stop.

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Stock 10

Thor Industries (THO)

Why the Strength
Recreational vehicle sales boomed during the pandemic, as many turned to the RV lifestyle as a way to escape cabin fever and indulge wanderlust—a trend further enabled by the work-from-home reality and federal stimulus checks. This created a shortage in available RVs with long wait times and higher prices for interested buyers … and booming earnings for RV makers like Thor. Now we’re on the other side of that mountain, with economic headwinds resulting in RV sales dropping more than 50% year to date and with earnings doing the same—but there are signs the dry times are coming to an end. Thor manufactures and sells towable and motorized RVs through 13 subsidiaries, including Airstream and Heartland RV, and it claims half the top 10 list of the nation’s best-selling RV makers. Thor hasn’t been immune to the industry-wide downturn and is seeing an inventory overhang (up 6% from a year ago) that weighed on financial results in the latest quarter. Indeed, the top line dropped a whopping 37% in fiscal Q3 (ended April 30), led by an RV sales plunge in North America. Not all the news was bad, however, as Thor managed to generate solid profits with EPS of $2.24 that more doubled estimates of $1.06, helped by cost improvements. Europe was also a bright spot for Thor, as both sales and backlog increased 20% over there. Thor’s cash flow was also “solid” in Q3, allowing the firm to pay down over $100 million in debt and repurchase $17 million worth of shares. More important, management hiked profit margin and EPS guidance for 2023, which has Wall Street sniffing a turnaround in the not-too-distant future. Analysts expect a big sales-and-earnings decline this year, but (a) that will probably prove overly conservative, (b) 2024 should see a solid uptick in earnings and (c) the valuation is compelling even given the tame estimates.

Technical Analysis
THO collapsed from 150 or so in early 2021 to a low of 66 last May before jaggedly bouncing back to 105 in early February. The sellers stepped up again at that point, with economic fears in March whacking the stock—but THO started to show some interesting action, with many weeks of tight trading just south of the 40-week line. The early-June quarterly report turned things around, and shares are resting just south of multi-month highs. If you want in, aim for modest dips.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on July 17, 2023.