Cabot Top Ten Trader Issue: July 24, 2023

Finally Seeing Some Rotation

After a non-stop run for two-plus months, we’re finally seeing a bit of sloppiness in the Nasdaq and some growth stocks that have had huge runs—we offer no predictions, but combining the recent action with the fact that the advance has been going on 12 weeks and earnings season is upon us, and further stumbles are certainly possible in growth. All that said, it’s been more about rotation than outright selling, as the broad market has actually picked up steam, and none of this alters our big-picture bullish thoughts, as the top-down evidence remains overwhelmingly positive. Put it together, and we’re still bullish, but we also wouldn’t be pushing the envelope right here as we see how individual stocks react to earnings. We’ll pull in our Market Monitor a notch to a level 7 to reflect some of the near-term wobbles.

This week’s list reflects the market action, with more non-tech names, be they cyclical plays, drug firms or even a bull market-related business. Our Top Pick is Blackstone (BX), which is just lifting off from a long bottoming base.

Stock 1

Acadia Pharmaceuticals (ACAD)

Why the Strength
Acadia markets the only treatment for Rett syndrome, a rare, progressive neurological condition that affects about one in every 10,000 girls by the age of 12. The drug, dubbed trofinetide, is an oral treatment marketed as Daybue in the U.S., the first country to approve a Rett syndrome treatment. The FDA gave the greenlight to the drug in March, and Acadia likely brought in $22 million in Daybue sales in Q2, the results of which will be announced August 2. But Daybue sales should hit $50 million this quarter as more insurers agree to pay – about 20% of Rett patients have paying insurers today, so there’s plenty of upside just as that figure grows. Expectations are that trofinetide will be approved by the European Union and in Japan, though a timetable isn’t set. But in advance of expected approvals, Acadia recently secured worldwide rights to the treatment from its developer, Neuren Pharmaceuticals, in exchange for a $100 million up-front payment, up to another $363 million if the drug is approved worldwide for more than one indication, plus royalty payments in the mid-teens to low 20 percentage points. The deal also includes global rights to a clinical-stage treatment – NNZ-2591 – for Rett and Fragile X syndromes. It’s a hefty price tag but the market sees Acadia capturing most of trofinetide’s big potential, which caused the stock to pop. For seven years, Acadia’s business has been driven by a drug it developed, Nuplazid, a treatment for Parkison’s-related hallucinations. Nuplazid’s sales are much larger – it will produce about $143 million in sales in Q2 and about $548 million for the full year. Backed by cash flow from Nuplazid, Acadia doesn’t need any financing to make the Daybue deal work, and analysts see the overall top line up 25% to 30% this year and next, with 2024 bringing positive earnings, too.

Technical Analysis
ACAD broke out of a two-year-long bearish trend to start 2023, and saw fine progress from 17 to the mid-20s on the back of the commencement of Daybue sales. Acquisition of the worldwide rights to the drug really excited the market, gapping shares 25% higher two weeks ago. There’s been some profit-taking on above-average volume, but at this point ACAD has largely held onto its gains. There’s obviously some risk, but a nibble on further dips with a stop in the mid-20s seems like a good risk/reward.

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Stock 2

Argenx (ARGX)

Why the Strength
Argenx is a Dutch commercial-stage biotech that develops antibody-based medicine for treating rare autoimmune diseases based on the unique properties of a llama’s immune system. Its lead product Vyvgart (efgartigimod) is a treatment for generalized myasthenia gravis (or gMG), a neuromuscular disease that causes weakness in the skeletal muscles; the drug was recently touted by a major Wall Street bank as having “megablockbuster potential” as an autoantibody-mediated disease therapy, with the stock getting an upgrade. What’s more, last month, U.S. regulators granted approval of Vyvgart Hytrulo (efgartigimod alfa and hyaluronidase-qvfc) as a subcutaneous injection for patients with gMG; the company said the drug will be indicated in the U.S. for a set of gMG adults who account for about 85% of total gMG patients, so it’s clearly a broad indication. But the stock’s recent moonshot was the result of last week’s release of Phase II trial results for Vyvgart Hytrulo in adults with chronic inflammatory demyelinating polyneuropathy (CIDP), a neurological disease that leads to weakness and reduced senses in the arms and legs. Trial data showed that those on treatment achieved a 61% reduction in the risk of relapse versus a placebo, with 67% of patients showing evidence of clinical improvement. While Argenx has many other pipeline candidates, Vyvgart is the main story here; Wall Street even sees the company as a prime takeover candidate due to the drug’s success. The latest positive results for Vyvgart allowed Argenx to raise over $1 billion in a global share offering, and analysts think the firm can reach operating profitability by 2025 based on the drug’s momentum. In a preliminary disclosure, Argenx said Q2 Vyvgart sales totaled $269 million (up over 200% from a year ago), while analysts seeing strong top-line growth for many years. Earnings are out Thursday (July 27), though the recent news should remain the focus.

Technical Analysis
ARGX actually bottomed in early 2022 and nosed to new all-time highs last summer after Vyvgart hit the market, but then it entered a long, tedious sideways range—from last August until last week, the stock was corralled between 335 and 415 for the most part. But the massive-volume, multi-day blastoff on the trial news has obviously changed the outlook. It’s not without risk, but if you want in, you can nibble on pullbacks.

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Stock 3

Autoliv (ALV)

Why the Strength
Global sales of electric vehicles (EVs) are set to hit another record in 2023 while expanding their share of the global car market to around one-fifth, according to industry experts. Sweden-based Autoliv specializes in automotive safety systems and produces airbags (with a leading position in this market), seatbelts and steering wheels for all major car manufacturers, as well as mobility solutions and safety products for motorcycle riders. However, a growing part of Autoliv’s business comes from the EV market, which accounted for 45% of the firm’s order intake last year. In Q2, there were some key car model launches among the firm’s clientele, with Autoliv’s content per vehicle more than doubling from the prior quarter, and with over 50% of that content going to EVs, which helped it obliterate estimates in Q2: Revenue of $2.6 billion increased 27% from a year ago, and per-share earnings of $1.93 were up 114% and beat estimates by a whopping 51 cents (the reason for the stock’s strength). The eye-popping sales and earnings growth were the result of outperforming light vehicle production that rose “significantly” in all regions and was helped by new product launches, higher safety content per vehicle and an improving global supply-chain environment. Looking ahead, management guided for a record number of new launches, especially in China and South Korea. The company also expects a quarter-by-quarter improvement in adjusted operating margin for the remainder of 2023, thanks in part to further cost reductions and supply chain improvements. Following a small setback last year, the bottom line should lift nearly 50% this year and another 40%-plus next.

Technical Analysis
After suffering through last year’s soft global auto market and shedding nearly 40% of its value from January through September, ALV got off its knees, rallying above its 40-week line in October and pushing to the mid-90s at the end of January. Then came a tight (albeit tedious) 19%-deep, 19-week long launching pad—ALV started to perk up a month ago, but it was last week’s earnings move that changed the outlook. We’re OK getting in around here.

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Stock 4

Beacon Roofing Supply (BECN)

Why the Strength
Beacon is the largest publicly traded distributor of roofing materials and related building products in the U.S., with around a 20% market share; half of its business is residential, but 30% is commercial with the rest complementary products—and, importantly, 80% of the total pie is repair and remodel activity (re-roofing due to age, weather damage and the like), which insulates the firm from the wobbles of the residential housing market. Thus, while things have slowed down, analysts see earnings down “only” 14% this year from all-time highs last year (much better than many housing suppliers and builders), and the firm has a long-term plan in place to grow sales and EBITDA by 8% to 10% annually through 2025, thanks in part to acquisitions and moving into new areas: 45% of the roofing industry is very fragmented (not controlled by large firms or by Beacon itself), so it’s rolling up some peers to get bigger. So far this year, Beacon’s completed five acquisitions, while also opening 14 locations in new areas—and this comes on top of a decent-sized buyout late last year (of a firm named Coastal, with $250 million of revenue and 18 branches in the commercial roofing and waterproofing area). Throw in cost controls, improving margins and (of course) expectations of a stronger overall real estate market going forward, and investors are anticipating good things; earnings should return to growth in Q3, estimates are rising quickly (2023’s $6.43 estimate is up from $6.06 three months ago) and the valuation (12x earnings) is attractive. Beacon looks like a solid housing-related play.

Technical Analysis
From a peak just above 60 in May 2021, it was a long, almost straight sideways two years for BECN, as the stock hung between 50 and 65 nearly the entire time. But shares traded somewhat tightly near its 40-week line in April and early May, and then it changed character in June, with a decisive, persistent move to new highs on solid volume. BECN is starting to exhale a bit as its moving averages catch up—further weakness would be tempting, with a stop near the 50-day line.

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Stock 5

Blackstone (BX) ★ Top Pick ★

Why the Strength
Blackstone is one of the biggest “bull market” stocks out there, a firm whose cash flow (and dividends) improves when asset values are on the rise. That was obviously a bad thing for 18 months, but now the outlook is obviously improving. Blackstone’s total portfolio totaled an even $1 trillion at the end of June, up 6% from the year before, split fairly evenly (about 30% each) between real estate, private equity and credit/insurance, with hedge fund solutions making up the rest. (To be fair, real estate makes up nearly half of distributable income, so it’s the most important piece of the pie.) The firm has made a big move to emphasize permanent capital (that can’t flee when things get tough; makes up about one-third of all assets now), along with more fee-related assets (making it less dependent on one-time sales and realizations)—nearly three-quarters of assets are fee-earning now. Of course, that didn’t stop things from slowing during the bear market—fee-earnings assets actually nosed lower in Q2 sequentially (fee-related earnings up just 1% in the first half of the year), the first decline since 2018, while total distributable earnings per share were down 37% compared to the first half of last year and inflows slowed to $30 million in the quarter. Even so, Q2’s results led to a solid dividend (79 cents per share; $3.42 total paid out in the past year), and the focus here is on the future—if real estate hangs in there and a new equity bull market has arrived, Blackstone’s asset and fee levels should expand, with inflows accelerating as long-term sentiment improves. Obviously, if the market really turns tail, all bets are off, but we see the odds favoring much better results ahead.

Technical Analysis
Not surprisingly given its business, BX had a big, incredibly smooth run from the vaccine blastoff in November 2020 to its top in November 2021—and then had a huge, jagged decline during the bear phase that took it down more than 50%. The bottoming effort that started in February was a bit sloppy, but selling volume dried up, BX tightened up in May and now the stock has leapt to multi-month highs on a solid volume cluster. We’re OK snagging some shares here with a stop in the low 90s.

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Stock 6

ChampionX (CHX)

Why the Strength
As crude oil prices begin to percolate, strength in the offshore drilling market is growing, providing greater opportunities for ChampionX. The Texas-based outfit is the result of a 2020 merger between engineered drilling equipment supplier Apergy and the oil well production chemicals division of Ecolab. The combined company serves onshore and offshore oil pipeline customers by helping them improve the capacity and efficiency of their operations through four main segments: Production Chemical Technologies (chemical solutions in production and midstream operations), Production and Automation Technologies (artificial lift and digital automation technologies for oil/gas extraction), Drilling Technologies and Reservoir Chemical Technologies. Production chemicals that allow for increased oil extraction from established wells is the biggest business for ChampionX, and segment sales here increased 15% from a year ago in Q1, with the firm just winning a five-year contract extension for production chemicals from a supermajor oil company in Southeast Asia. ChampionX reported strong results across several key metrics in Q1, including adjusted EBITDA (up 41%) and buoyant free cash flow. Revenue of $948 million increased 10%, with per-share earnings of 36 cents in line with estimates. Free cash flow of $69 million was “above typical first quarter patterns” and substantially higher year-on-year, allowing management to return 80% of it to shareholders through dividends (a 1% yield) and share repurchases (share count down about 3% from a year ago). The firm said it remains committed to return at least 60% of free cash flow through the current cycle, which it sees continuing for years to come thanks to “favorable demand tailwinds.” Wall Street sees earnings up 42% this year and 29% next, though the Q2 report is out tonight (see more on that below).

Technical Analysis
CHX hit 30 in May 2021, and then it started a long sideways-to-down phase, with shares bottoming out last July near 17. The stock took off after that, reaching nearly 34 in October … but that began another choppy-to-down phase that lasted many months. Like many names, though, CHX tightened up in April and May and has lifted to the upside the past few weeks. With earnings out tonight, we’re paying attention to the reaction—we think any controlled dip would be buyable, but any big move would have us looking elsewhere for now.

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Stock 7

Digital Ocean (DOCN)

Why the Strength
DigitalOcean is a cloud infrastructure provider focused on the small and medium business niche, estimated to be a $100 billion market and growing 25% annually. The company believes it sits in a sweet spot between hyperscale cloud providers, which aim to service very large global businesses, and cut-rate providers that seek to grab customers focused purely on cost. DigitalOcean, on the other hand, offers simple implementation, reasonable and straightforward pricing, support for clients and doesn’t lock clients into a certain tech stack; it thinks it can be the go-to player for smaller firms while the behemoths focus on enterprises. Many customers start out very small, sometimes spending just $15 a month, as a test-run for an app or features they want to explore. Over about four years, a small portion of those catch on and become very large customers. (Average revenue per customer was $88 in Q1, up 16% from a year ago; the firm has 147,000 customers paying at least $50 per month.) Cloudways, a web-hosting customer that DigitalOcean ended up buying last year, started out spending $12 a month and became a $1 million monthly spender. Buying Cloudways cut one large customer from its mix, but added a simple, front-end service for customers to manage their web operations, where they can then transition into cloud services. In an encouraging sign, Cloudways saw a 46% increase in customers to start 2023 compared to Q1 2022. And then earlier this month, DigitalOcean bought Paperspace, which will add AI and machine learning testing capabilities for clients. Growth is likely to slow some here, but the numbers are still fantastic—mid-20% revenue growth, surging earnings and plenty of free cash flow (about $1.50 per share this year, about double that of last year) are what both Wall Street and management see coming, and it doesn’t hurt that the firm bought back a huge slug of stock (6% of the firm) in Q1 alone. It’s a good story.

Technical Analysis
DOCN came public in early 2021, had a huge move to 130 by the November 2021 Nasdaq top, and then fell all the way to 23 near the end of last year—despite continued solid results. The rally this year has been great, though not without some big potholes (40 to 29 in April; 47 to 37 in June), but the Paperspace buyout earlier this month caused a big-volume move that has pushed the stock to higher highs near 50. We’ll set our buy range lower given DOCN’s volatility.

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Stock 8

Royal Caribbean (RCL)

Why the Strength
A survey conducted by a major East Coast port found that the number of passengers sailing in and out of the port in the current cruise season will likely exceed prior expectations by 60%, with even more increases expected for the 2023-24 season, concluding that “cruising is back.” One of the biggest winners in this ongoing travel boom is Royal Caribbean (covered in the May 15 issue), the world’s third-largest cruise line by annual revenue. In Q1, the company generated a record level of bookings and provided nearly two million vacations to its customers. In doing so, it also exceeded 100% capacity—and at prices that were higher than pre-pandemic 2019 levels. (Greater than 100% capacity occurs when additional guest(s) stay in a double-occupancy cabin.) Royal Caribbean expects that the bookings strength will continue through the rest of this year based on higher ticket prices and onboard revenue initiatives. And while demand has been strong across all products and markets, the company anticipates the “exceptional strength” from its North American customers will continue to carry the day going forward (although Royal Caribbean added that European bookings are “nicely” outpacing 2019 levels with peak summer sailings in that region trending “particularly well”). Management also said the firm’s addressable market is “meaningfully larger” than it was before 2019, and its research shows consumers plan to continue prioritizing leisure travel and experiences over goods going forward. Wall Street sees a 55% revenue bump for Q2 (the report is expected out Thursday, July 27), while earnings should continue to soar well into next year.

Technical Analysis
We missed getting into RCL after our last write-up of the stock on May 15, as shares never pulled back into our buy range—after a sharp upmove to its February highs, RCL took off on the upside and reached 105 late last month. Now the stock is exhaling a bit, pulling in to its 25-day line on light volume. If you’re aggressive, you could nibble here or on dips ahead of the earnings report this week, or just wait to see the stock’s reaction.

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Stock 9

United Airlines (UAL)

Why the Strength
Nobody is claiming that airlines are now true growth stocks, but it’s looking like this upcycle for the industry will be much more durable and profitable than past ones—even as ticket prices are starting to come off from elevated levels—thanks in large part to pilot shortages, supply chain issues (new planes and repair work) and infrastructure tightness (crowded airports and limited airplane slots). United Airlines has been outspoken about the issues, allowing it to get ahead of the first two (including a new pilot agreement), though it’s still working on infrastructure limitations (expanding at smaller hubs and especially internationally). Of course, capacity here is still going up a lot as the industry catches up from the pandemic cutbacks—United flew 17% more miles in Q2 than a year ago—but demand is still super-strong and costs are in check, which is leading to a mountain of earnings and cash flow. Indeed, in January, United said it thought it could make $11 per share this year, but analysts refused to believe it; now they’re coming around, but the top brass here actually upped their full-year guidance ($11.50 at the midpoint) and that includes some conservatism about higher costs in the second half of the year. And free cash flow is even larger (north of $9 per share in the first half of the year!), allowing the firm to rapidly pay off debt (down $2.6 billion from a year ago). In last week’s conference call, management said demand in September and October look strong relative to even July and August, as well as compared to pre-pandemic 2019 levels, which is obviously a good sign. And longer term, they continue to think margins can improve one to two percentage points each year into at least 2026, thanks in large part to bets on international travel. If management is even half right, United’s bottom line is going to be massive for a long time to come.

Technical Analysis
UAL and most airlines looked ready for prime time in January, when the stock showed outstanding price and volume action, but the market wasn’t ready yet, with the March banking-induced dip causing shares to fade. But the 40-week line held, UAL tightened up and then began to push higher in May—with the momentum continuing into late June. There was a pre-earnings wobble, but we think the earnings reaction last week (along with the higher earnings estimates) paves the way for higher prices.

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Stock 10

Weatherford (WFRD)

Why the Strength
As the energy sector heats up, producers are under pressure to squeeze as much petroleum as they can from new and existing wells while containing rising costs. Global equipment and service provider Weatherford makes this possible by combining proven technologies with the latest advances in digitalization that cover all areas of production. Its segments include Drilling and Evaluation (DRE), Well Construction and Completions (WCC) and Production and Intervention (PRI, including production automation, pressure pumping and sub-sea services). As oil and natural gas exploration and drilling activity increases around the world, Weatherford is seeing growth across all segments of its business and in all geographies—especially Latin America and the Middle East. In the former region, Weatherford was recently awarded two multi-year contracts to provide multiple product line offerings for onshore gas and shale wells (including one from Brazilian oil/gas giant Petrobras), while garnering a three-year contract with two oil majors in the latter region. The company also sees near-term opportunities in Asia, the Mediterranean and Sub-Sahara regions, driven by “robust offshore project sanctions and startups.” Plus, big picture, the fact the firm went through the wringer (Chapter 11 in 2019, was finally relisted on the Nasdaq in 2021) means the operation is lean and the balance sheet is in good shape. In Q1, Weatherford easily beat expectations in reporting a 26% rise in sales while generating margins ahead of the company’s record Q4 2022. The solid results were driven by revenue increases of 27% in the DRE segment, plus 22% increases in both WCC and PRI. Free cash flow, meanwhile, improved $91 million from the year-ago quarter and per-share earnings of 97 cents beat estimates by 19 cents. When Weatherford reports Q2 earnings after the close on Wednesday, analysts expect the top line to rise 16%, with earnings booming well into 2024.

Technical Analysis
After hitting a peak around 40 in April last year, WFRD was more than halved by the sell-off that followed. It reached the nadir in July at 18, immediately turning a corner and going on to make a succession of multi-year highs over the next several months. The March high near 70 did lead to a sharp two-week retreat, but WFRD held it together, remained rangebound into June and has started to pick up steam in the past month. Earnings this week will be key, so we’ll set our entry range down toward the prior high, thinking any dip will find support.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on July 31, 2023.