Cabot Top Ten Trader Issue: July 22, 2024

An Avalanche of News

The market had been relatively quiet on the news front for weeks if not months, but the past few sessions have brought an avalanche of news and rumors involving inflation (and potential Fed rate cuts), rumors that chip sales to China could be further restricted (kicking off the selling in the key chip group), rumors of China/Taiwan tensions, a worldwide tech shutdown and, this weekend, a shakeup in the 2024 election, all of which have caused some reverberations. Whatever the reason, here’s where the evidence stands: The top-down measures look fine, with the intermediate-term trend still up for most indexes and the breadth surge earlier this month should portend good things down the road … but there’s no doubt that leading stocks (especially growth stocks) have gotten very sloppy, with a pickup in breakdowns and distribution—though there remain a bunch of areas that are set up well heading into earnings season. All in all, we’ll move our Market Monitor to a level 6 and stay flexible: A strong rebound and some positive earnings gaps could still launch many new leaders, but we need to see the buyers step up in individual names to get more aggressive.

Another piece of good news is that it’s still not hard to find strong stocks with good stories, as this week’s list has names from a variety of areas. Our Top Pick is D.R. Horton (DHI), which, while obviously not the fastest name, looks like it’s going to lead a fresh upturn in the homebuilding sector after last week’s quarterly report.

Stock 1

Cirrus Logic (CRUS)

Why the Strength
Unceasing demand for artificial intelligence should provide a steady, if indirect, tailwind for Cirrus (covered in the May 28 issue). The Austin-based fabless chip producer is known for its analog, mixed-signal and audio DSP integrated circuits and supplies audio and voice processing chips used in perennially popular Apple products, including iPhones. Apple is the firm’s biggest customer, accounting for nearly 90% of annual revenue, which right now looks like a good thing: A major Wall Street bank just raised its share price outlook for Cirrus (the reason for the latest share price strength) based on an improvement in build expectations for the iPhone 16 as a result of Apple’s push into AI (and weaker demand for Android devices). The story here is that Apple’s new Intelligence AI capabilities only work with newer phones, which is expected to unleash a wave of phone upgrades, much bigger than the normal upgrade cycle, in turn boosting sales for Cirrus. And while Cirrus doesn’t specifically offer AI chips, the company believes generative AI will drive fast, dramatic technology demands in voice interface and user assist in smartphones, which Cirrus is positioned to deliver. The top brass also sees opportunity in an AI-driven upgrade cycle for smartwatches, laptops and virtual reality products. Moreover, at a recent conference, Cirrus confirmed that Apple’s new iPhone 16 product launch scheduled for September will include a higher average selling price (ASP, estimated by analysts at +5%), along with continued ASP growth in the coming years—all of which leaves room for Cirrus to capture more money per iPhone sold. Looking ahead, Cirrus expects “significant” sales growth from its camera controller products, as well as higher demand related to smart codec and boosted amplifiers, PCs and power management. Wall Street has set a low bar for sales and earnings this fiscal year (both flattish), but this could easily prove conservative if the widely anticipated acceleration in the GenAI product cycle materializes, and the valuation (21x trailing earnings) isn’t outrageous even after the recent upmove. Fiscal Q1 results are due out on August 6 (post-market).

Technical Analysis
CRUS has been a top semi performer since our last writeup, as investor perception changed for the better after a multi-year consolidation earlier this year—the run of 10 weeks up in a row right out of the chute usually portends good things forward, telling you institutions are consistently gobbling up shares. Near term, the stock did get a bit stretched on the upside but is now pulling back with everything else; we’re OK buying a few shares here or (preferably) on dips, with a stop under the 50-day line.

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Stock 2

Coinbase (COIN)

Why the Strength
We’ve been keeping an eye on Coinbase for a few months now, thinking the consolidation that began in March will eventually give way to a big upside run—and it’s possible that time is getting close, with crypto prices rallying nicely even in the face of a risk-off move in growth stocks of late. While there are more and more plays out there (from miners to owners to power companies), Coinbase looks to us like the go-to institutional way to play the growth of the crypto economy; trading revenue is still the big draw, and it continues to expand its offerings (its derivatives arm just launched futures contracts on a variety of smaller crypto coins), though results can swing wildly depending on what the market is doing—in Q1, transaction revenue totaled $1.08 billion, more than double Q4’s tally (!), though most think Q2 saw a good-sized retrenchment. Long term, volumes should increase both here and overseas, which of course is a good thing, but we’re just as interested in two other factors: The first is Coinbase’s emphasis on subscription and service revenue, which includes everything from stablecoins to blockchain rewards/staking to interest income to its Coinbase One offering (better trading tools for a flat subscription fee), and that segment brought in $511 million in revenue in Q1 and, while it can bob and weave a bit, is likely to grow more steadily over time. And the second is very basic and something we’ve written about before: After spending endlessly during the boom times of 2021, the top brass has cracked down in a big way; in Q1, non-transaction costs were down a whopping 17% from a year ago while full-time employees are down as well. When you put it together, you can see the potential—earnings catapulted to $4.40 per share in Q1 when the stars aligned, and while that won’t be repeated in Q2, the bottom line could go even higher during the next sustained crypto run. Q2 earnings are out August 1.

Technical Analysis
COIN is crazy on a day-to-day basis—its average daily range is about 15 points!—but we’ve been keeping an eye on the stock as, after a huge run from the market lows last October, the past few months of base-building action look relatively normal. We wrote up the stock in late June, aiming to buy if the stock showed strength … but it didn’t, retesting its lows over the next couple of weeks. But now we’re seeing some interesting action, with a big-volume buying week as COIN attacks resistance. We’re OK taking a swing at it here, but consider keeping it small and using a loose stop, percentage-wise.

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Stock 3

D.R. Horton (DHI) ★ Top Pick ★

Why the Strength
The markets have been wrong before, but at this point, traders are pricing in a 90%-plus chance that the Fed cuts rates in September and they’re also looking for at least two rates cuts this year—and that is definitely one reason there’s been a rush of buying in homebuilding stocks during the past two weeks, with hopes that demand will pick up as money becomes looser (which helps the economy as a whole) and mortgage rates likely fade. Plus, of course, there’s also the fact that business has been strong despite the higher rates of the past couple of years, with big margins, earnings and cash flow as housing prices have refused to dip. D.R. Horton is the granddaddy of the group, and it just reported another better-than-expected quarter: Sales inched up 2% from already elevated levels while earnings per share of $4.10 not only rose 5% but topped expectations by 35 cents while pre-tax margins came in at nearly 17%. The growth figures aren’t eye-openers, but perspective here is important—after seeing earnings lift from $4.29 per share in 2019 to $16.52 in 2022, the downphase has seen earnings “only” slip to south of $14 last year … and now, with the Fed likely to ease, expectations are the bottom line can grow from here, with analysts expecting earnings to rise to nearly $16 next year, which is likely conservative. Helping the cause is a consistent share buyback program, with the share count down 3.4% in the latest quarter vs. a year ago, and the Board just reloaded that program with another $4 billion. It’s not an unknown story, obviously, but Horton looks like an institutional way to play a pickup in building activity if the long-awaited Fed shift from foe to friend occurs later this year.

Technical Analysis
Like most homebuilders, DHI had an excellent surge after last fall’s market bottom, but it didn’t last long, stalling out in mid-December; shares did nose to new highs in March, but that was quickly given up, leading to a tedious 20% drop that took shares just below their 200-day line earlier this month. However, the inflation report two weeks ago caused a rip-roaring recovery, and last week’s earnings report caused another rush of buying to new highs—two straight big weekly-volume buying weeks. Short-term wiggles are possible with the market and interest rates, but DHI acts like it’s starting a new upturn; we’re OK buying some here or on minor weakness.

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Stock 4

Golar LNG (GLNG)

Why the Strength
Natural gas is expected to experience a demand surge in the years ahead with the rise of power-hungry AI data centers, as utilities worldwide invest in bringing more natural gas power plants online. A key player in this sector is Bermuda-based Golar, which is the world’s leading provider of floating LNG (dubbed FLNG) capacity (about 25% more than the next closest competitor, and that doesn’t count a new vessel that should hit the water in 2027), which are floating production and storage units that facilitate the liquification of gas and its preparation for transport after it has been extracted from sea beds; it also owns two traditional LNG carriers that can transport the product around the world. Already this year the company is seeing an uptick in interest among countries with vast natural gas reserves looking to monetize their resources, including Nigeria, which just signed a project development agreement with Golar to deploy an FLNG production unit off the coast of the Niger Delta. Argentina entered the mix two weeks ago when Buenos Aires-based Pan American Energy signed up with Golar for a 20-year deployment of an FLNG vessel to tap into a shale formation in that country’s Neuquina Basin, the world’s second-largest shale gas resources (and the reason for the stock’s latest show of strength). Golar’s FLNG vessels, Hilli and Gimi, maintained market-leading operational track records in Q1, allowing the firm to continue advancing FLNG deployments (mostly in West Africa and South America) with “increased prospective client interaction” for its FLNG offerings. Although revenue of $65 million decreased 12% from a year ago due mainly to lower prices, earnings of 45 cents a share beat estimates by 23%. On the LNG front, Golar said demand remains “strong,” with several potential large LNG clients lined up. Wall Street sees business doing fine for the rest of this year before surging in 2025 with possible upside beyond that. The 2.9% dividend yield is a nice plus, too. Earnings are due out August 15.

Technical Analysis
GLNG hit a multi-year apex at 30 a couple of summers ago around the same time natural gas prices peaked. The stock initially fell in sympathy with the commodity, but instead of following gas prices to the utter depths (down 80%), the stock had a controlled pullback to 20, where it spent several months forming a bottom. The character change came in March, with the stock trending higher along its 10-week line from that point into May—before a big upside acceleration beginning in early June goosed by the Argentina deal. Dips toward the 25-day line would be tempting.

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Stock 5

Halozyme (HALO)

Why the Strength
Halozyme is acting like a brand new stock during the past few weeks thanks to a sharp change in investor perception surrounding the firm’s patent position: For years, Halozyme’s claim to fame has been its Enhanze drug delivery system, which is based on an enzyme that safely breaks down cellular barriers to bulk liquid flow—allowing IV treatments to be given at a far faster pace (often minutes instead of hours), which is more convenient for patients and is a boon for treatment clinics. The company has been able to ink deals to produce Enhanze versions of popular drugs from many big players (two of them—one from Argenx, one from Roche—received approvals in June), resulting in a stream of milestone payments (which often continue even after approval) and royalties, driving sales and earnings nicely higher in recent years. However, the stock had been stuck in the mud during the past couple of years. Why? Patent worries, with many thinking Halozyme’s shelf life could be short (only a couple more years) before competition is allowed to come in. But a recent E.U. decision involving the patent on an Enhanze drug extended protection to 2029, and many are taking it as a sign that Halozyme has a years-long runway ahead of it. Indeed, after the patent decision, the top brass here bumped up an already-huge long-term forecast, saying that it thinks royalty revenue (due to growth in existing offerings and many more approvals to come) can lift about 140% from last year through 2027, while total revenues double and earnings move from up $2.77 last year to $7.30 or so in 2027! Of course, perception is reality, so if some fresh worries pop up on the patent front it would hurt the stock, but it certainly looks like the best is yet to come and the E.U. decision cleared the air. Earnings are likely out in early August.

Technical Analysis
HALO is the kind of fresher name that could have juice if the market (and the upcoming earnings report) cooperates. The stock bobbed and weaved for about a year (May 2023 to May of this year) before finally tightening up a bit, and the patent-induced breakout in June came on the stock’s heaviest volume in more than a year. Perhaps more important is that HALO has been edging higher since then, ignoring the market’s tumultuous action and holding north of its 25-day line. If you don’t own any, we’re OK snagging a piece here or (preferably) on dips, with a stop under the post-gap lows.

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Stock 6

Intuitive Surgical (ISRG)

Why the Strength
Intuitive Surgical is the dominant player in the steadily growing surgical robotics market, which allows surgeons to achieve a wider range of motion than the human hand through use of thin robotic arms when operating on patients. (Robotic procedures are also far less invasive, involve fewer risks and usually lead to faster recovery times.) The company provides robotic systems along with software and instruments and is best known for its robot-assisted da Vinci Surgical System, which covers a wide variety of medical procedures and has been used in over seven million surgeries worldwide. Intuitive just released the latest upgrade to its top-selling system, the next-generation da Vinci 5, which features the most realistic 3D images with better color and resolution along with instruments that deliver up to 43% less force on tissue during surgery. Most of the firm’s revenue come from instruments and accessories sales to existing customers (consumables = recurring revenue), and Intuitive believes the latest upgrade (the first major one since 2014) will result in a significant sales boost going forward. A 3% year-on-year increase in da Vinci placements in Q2—including 70 da Vinci 5 systems (which cost around $1.4 million each)—plus a 17% jump in worldwide da Vinci-enabled procedures, led last week’s solid earnings report (the reason for the stock’s strength). Revenue of $2 billion increased 14%, while earnings of $1.78 a share beat estimates by 24 cents and were up by a quarter from a year ago. The company also said it grew its da Vinci surgical system installed base to 9,203 systems as of June, an increase of 14% from last year’s Q2, with placements the strongest in the U.S., Japan and India (albeit weaker in Europe and China). Intuitive also just received FDA clearance that allows its single-port robotic surgical system, the da Vinci SP, to perform thoracic procedures, which management sees opening another long-term opportunity (it was cleared for prostate and ENT procedures earlier this year). Analysts see steady, mid-teens top- and bottom-line growth for the next couple of years.

Technical Analysis
ISRG broke out from a very nice-looking launching pad on earnings in January, looking like it was ready to join the market’s party—but while shares did advance a bit from there (to round number resistance near 400), it then stalled out for months, not correcting much (10% from high to low) but making no real progress until May. Since then, ISRG has been much more under control, gliding to nearly 450 before a pre-earnings shakeout—and a strong-volume bounce off the 50-day line following earnings. It’s tricky given the market, but we’re OK taking a swing at it on a bit of weakness with a stop near last week’s low.

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Stock 7

Lantheus (LNTH)

Why the Strength
The federal government is proposing raising the reimbursement rate for specialty diagnostic radiopharmaceuticals—agents that help identify disease in medical scans. While the final decision won’t come until later this year (could take effect next January), it promises to be a huge boost to Lantheus. The rule would increase the amount paid for Lantheus’ Pylarify, a diagnostic agent used in PET and CT scans of prostates, as well Pylarify AI, which is an AI-based analysis and reporting of those scans; research shows that doctors assisted by AI that have been trained on thousands of x-rays do a better job of identifying cancerous growths. The system is used in every academic hospital in the U.S. and is accessible to 90% of patients who have insurance coverage for it. Pylarify just hit the market a couple of years ago but it’s been a hit, accounting for $259 million in revenue in Q1, up one-third from last year. The new reimbursement proposal probably turbocharges the revenue the company can make by nearly doubling the top price paid under specific circumstances. Before this, Wall Street started having concerns Pylarify would see market share shrink due to a current billing cap and the emergence of a competitor, Blue Earth, that’s priced closer to that cap. Even though Blue Earth’s results are inferior to Lantheus’, the expectation was that a segment of clinicians would move toward the less-good, but fully paid, option. Still, even before the Medicaid/Medicare fee proposal, Lantheus was expecting 2024 to reflect strong momentum, projecting sales up 17% for the full year to about $1.5 billion, with earnings around $7 per share. The longer-term outlook no doubt improves with the pricing revamp. Lantheus also dominates in an ultrasound enhancing agent for echocardiograms, called Definity. It generated $77 million in revenue last quarter, up 11% year over year, but the big draw is Pylarify.

Technical Analysis
Fears of slowing growth pulled LNTH down from a peak near 100 in the middle of last year to 50 in January, but then it began to repair the damage, with a leap above its 40-week line after Q1 earnings in early May. Interestingly, the stock became very tight at that point, which is usually a constructive sign, and sure enough that was followed by the giant boom two weeks ago on the potential rate change. We’ll set our buy range down a bit and use a stop near the century mark.

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Stock 8

TechnipFMC (FTI)

Why the Strength
After a multi-year decline, the oil and gas deepwater drilling cycle has been heating up lately, driven by new projects in Guyana, Brazil and the Middle East. Moreover, with governments the world over pledging to reduce carbon emissions in the decades ahead, oil companies like Shell and BP are meeting the world’s energy needs by drilling the deep waters of the Gulf of Mexico (which releases fewer greenhouse gases than onshore drilling). A leader in assisting these efforts is TechnipFMC, which designs, engineers and manufactures the systems used to access energy resources both offshore and onshore—including what are regarded as the world’s most advanced exploration submarines. In recognition of the company’s efforts, a major Wall Street bank named TechnipFMC as its top pick among offshore drilling services, as “the best way to play the duration of the offshore development cycle, with unmatched earnings visibility driven by its medium-term guidance of $30B in subsea order inbound from 2023 to 2025” (a reason for the stock’s strength). More recently, shares got a boost when it was announced the firm was awarded a “large contract” (typically between $500 million and $1 billion) for integrated engineering, procurement, construction and installation work for a subsea system at Energean’s Katlan development in the Mediterranean Sea (the contract will be included in the firm’s second-quarter inbound orders). Subsea inbound orders in Q1 increased by a whopping 62% from the prior quarter (up 23% year-on-year), to $2.1 billion, while the company’s total backlog of $13.2 billion increased 41% from a year ago. Per-share earnings of 14 cents beat estimates by two cents, while the aforementioned three-year subsea order outlook of $30 billion increased 20% (and could rise higher if the environment is supportive). When Q2 earnings are released this Thursday (pre-market), analysts expect the bottom line to jump over 200%, with many more quarters of growth after that.

Technical Analysis
FTI has trended steadily higher in the last couple of years despite some of the potholes seen in the overall oil/gas sector. After a powerful move higher last summer and into the fall, the stock encountered resistance around 22 in early November and then spent the next few months consolidating while the rising 40-week line caught up. The result was a fresh multi-month rally to about 27 in April before yet another correction. But now FTI is back at it, advancing nicely during the past month and notching new highs. You can wait for the quarterly report to see how the stock reacts, but if you’re aggressive, a nibble here or on dips is fine by us.

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Stock 9

Twist Biosciences (TWST)

Why the Strength
Twist Bioscience produces cell-free DNA (cfDNA) used by biotech clients in research and drug development. The business mainly makes its money from researchers doing next-generation gene sequencing, generally a non- or mildly invasive way of examining patient blood for diseases, often rare cancers, and with expectant mothers for possible complications in a fetus. Twist can produce more than a million combinations of sequences to the specifications of researchers. That’s already a robust business because the quality of Twist’s cfDNA typically allows clinicians to do as much sequencing as needed, but Twist isn’t standing still, with much of the excitement surrounding the stock revolving around its Express Genes offering. That’s a service where the company offers anything in its entire cfDNA portfolio to be produced and delivered in just five to seven days—much swifter than normal and also for a much higher price. The business just started offering Express Genes in January, and already the service accounted for 15% of Q2 revenue, helping overall sales rise 25% to $75.3 million. The bottom line remains deep in the red, but its gross margin grew 10 points to 49%, a mark that is well up from 31% a little over a year ago. Management is targeting large biotech and academic consumers of cfDNA clones for subscription Express Gene programs, which will combine fixed pricing for the customer and help Twist reach its goal of a 50% or better gross margin for fiscal 2025. For the current quarter, expectations are for sales of $77.4 million, a rise of 21%, and analysts see the top line up at a 20% to 25% rate through next year while losses shrink somewhat.

Technical Analysis
We wrote about TWST a few weeks ago but it just missed our entry range—but the stock continues to act well, so we’re taking another swing at it today. Shares have been in an orderly uptrend since a huge gap up after earnings in May, kickstarting what’s been a choppy but fruitful advance. The latest dip with growth stocks last week looks normal (TWST was actually up last week), finding support north of its 25-day line and round-number support near 50. If you’re game, you can start a small position on dips with a stop in the mid-40s.

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Stock 10

Virtu Financial (VIRT)

Why the Strength
Despite last week’s hiccups, we continue to see strength in Bull Market stocks, whose businesses are in some way tied to asset prices and the health of the markets. Virtu is a market-making specialist, providing its institutional clients with deep liquidity and competitive bids in over 25,000 securities in order to create more efficient and stable markets worldwide. Lower levels of market volatility would normally be a hindrance for market makers like Virtu (which generally thrive on higher volatility that widens bid/ask spreads and increases profits), but this year’s market strength—along with the revival of the meme-stock craze—has attracted enough added interest in equities from investors that Virtu’s financial performance has improved nonetheless. Indeed, the stock went wild on the upside after last week’s fantastic Q2 report: Revenue of $693 million jumped 37% from a year ago, led by a more than $100 million increase in net trading income. Per-share earnings of 83 cents thrashed estimates by 23 cents and more doubled from a year ago, while adjusted EBITDA soared 80%. While Virtu’s core equity market-making unit is expected to continue performing strongly going forward, the cryptocurrency market has big growth potential as well; crypto-based spot etherium ETFs (generally the second most popular crypto to bitcoin) are set to begin trading this week in what is seen as a key victory for the industry’s efforts to bring digital crypto assets into the mainstream. The company is preparing to make markets for Ethereum products (including options), with the potential for “significant growth in net trading income and operating leverage effects” (the firm is already a liquidity provider for Bitcoin ETFs). Management further cited ETF block trading and improving options market share as growth opportunities going forward. Wall Street expects earnings to surge this year and remain elevated in 2025; a 3.2% dividend yield and low valuation (12x earnings) are added attractions.

Technical Analysis
VIRT collapsed from 38 in early 2022 to 16 in early 2023 as the bear market ravaged the stock, and then shares spent another 11 months bottoming out, with a successful retest of the 16 level in February of this year. However, since then, the action has been very good: VIRT advanced persistently into May before it got choppy with the broad market, eventually seeing it pull back below its 50-day line earlier this month. But after earnings, the buyers have clearly stepped up, driving the stock to two-plus-year highs on very good (though not out-of-this-world) volume. Aim to enter on weakness.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on July 29, 2024.

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