Cabot Top Ten Trader Issue: July 31, 2023

Overall Bullish, but Still Some Turbulence

The major indexes all closed last week near their highs, which is one big factor keeping the top-down evidence very bullish—the intermediate-term trend is clearly up, and despite some selling on strength, most stocks are in solid shape. Hence, nothing has changed with our big-picture positive thoughts. That said, right now, we don’t think the situation is as strong as the indexes suggest—new highs have fallen off by a good amount, especially over the past couple of weeks, and just looking at a variety of names, it’s clear many are consolidating even as the S&P and Nasdaq tested new high ground late last week. Again, we’re not saying that’s a big bugaboo, but right now, we continue to think being more discerning when looking for entry points (either on dips toward support or possibly an upside earnings gap, depending on the setup) makes sense, as does pruning some laggards if you have them. We’ll keep our Market Monitor at a level 7.

This week’s list has something for everyone, with a decent amount of cyclical exposure but also some true blue growth names as well. Our Top Pick is Southern Copper (SCCO), which could be leading a new group move in metal stocks in general (and copper in particular).

Stock 1

Aehr Test Systems (AEHR)

Why the Strength
Aehr Test Systems’ business is being propelled by the rise of silicon carbide (SiC) semiconductors and silicon photonics, a material increasingly favored because it can be used in smaller-sized chips that have more efficient power consumption than traditional semiconductors. Aehr makes wafer testing and burn-in systems used by manufacturers of SiC and photonics-based chips, which are fast-growing markets. That said, this is still a small operation: In Aehr’s fiscal 2023 (which ended May 31), the results of which were announced two weeks ago, sales rose 28% to $65 million, bringing record earnings per share of 59 cents, a rise of 55%. Beyond the percentage growth the business is seeing, even more important may be Aehr’s positioning in the SiC market, with Aehr adding four new SiC manufacturers as clients in the past year. Global SiC production was probably just 220,000 wafers last year, but it’s expected to grow very fast, to 4.5 million annually by 2030, according to brokerage William Blair. That’s being driven mostly (though not solely) by EV adoption, which requires chips that can handle high heat and maintain a long, useful life in cars and chargers. Aehr is seeing good response to its Fox-XP offering, a multi-wafer testing and burn-in product that will help facilitate larger production volumes. The system allows rapid testing at scale that helps reduce chip failure, something especially vital with photonics, because they’re likely to be co-located with other chips that would be damaged by a bad photonic-based chip. Aehr said in the springtime that it got its first order for Fox-XP from one of the world’s largest chipmakers. It didn’t name the customer, but it’s likely to generate many more orders in the future. For the current year, analysts see revenue up 58% to more than $100 million, and analysts see earnings up 76%. It’s a small but good story.

Technical Analysis
AEHR has been in a solid, though wild, uptrend for many months, with plenty of very sharp dips along the way. The latest of those took the stock down from 40 to 23 in March and April, but the 40-week line held, AEHR ramped to new highs in June and then gapped on earnings a couple of weeks ago. The latest choppy period has centered on 50; aiming to enter on a bit of weakness and a stop in the lower 40s seems like a reasonable risk/reward.

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Stock 2

Boeing (BA)

Why the Strength
Boeing needs no introduction—it’s the granddaddy of the aerospace sector and basically part of a duopoly in terms of commercial jet construction with European peer Airbus. The story of the past few years has been mostly one of struggles; the pandemic hurt things, of course, but that led to persistent supply and cost issues and the company has had some trouble ramping production, too. Really, though, this has never been about demand—the backlog here is $440 billion (jet demand remains strong after some dry post-pandemic years)—and now it appears the firm is getting over the execution hump: Boeing is transitioning to 38 737’s per month while 787 production is up to four (translation: production targets from earlier this year are on track), with overall first-half deliveries of 266 planes, up 23% from 2022’s first-half tally, which is driving the top line higher. Granted, earnings remain in the red, but more important here is free cash flow. Despite some snafus, management has stuck to its cash flow targets (~$4 billion of free cash flow, or north of $6.50 per share), with higher targets (up to $10 billion) looking out three years, too, and analysts see earnings following suit in the not-too-distant future. Plus, in terms of the industry, it probably doesn’t hurt that Airbus has been tripping up some on its own supply chain snags. That’s basically the whole story—Boeing has tons of demand, and if management can execute, sales, earnings and especially free cash flow should kite higher from here. In terms of mega-cap names, we like it.

Technical Analysis
Timing is everything in the stock market, and BA looks like it could be the perfect example of that. The stock had a rough go of it from its peak in early 2021 to its lows in May, June and September of 2022. But the stock came alive and ripped well above its moving averages by January of this year. And then … the stock went dead, for months and months, with 195-ish the low and 220-ish capping any rallies. But now, finally, BA looks like it’s up and out, with a nice post-earnings breakout and (importantly) two solid rally days to finish last week. We’re fine grabbing some here or on dips, with a stop near the 50-day line.

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Stock 3

KLA Corp. (KLAC)

Why the Strength
Just as the global semiconductor shortage shows signs of easing, a new threat to the chip industry has emerged. China’s export restrictions on gallium and germanium—two critical elements for microchip production—go into effect in August and threaten to create yet another supply chain disruption for the industry. The news highlights the ongoing move among domestic chip firms to decrease their reliance on China while also looking to automate more of their production. And that’s good news for KLA, a provider of semiconductor metrology equipment used by chipmakers to test wafers for imperfections after the manufacturing process. (The company leads the inspection space of the industry with a greater than 50% market share.) With Washington imposing restrictions against certain types of chip sales to China, KLA should benefit, particularly in the high-growth area of process control solutions which play into cutting-edge electronic devices. Demand for the outfit’s bare wafer, optical and other inspection tools was resilient in the June quarter despite a “challenging” environment. Although revenue of $2.4 billion was 5% lower from a year ago, it exceeded expectations while per-share earnings of $5.40 beat estimates by a whopping 54 cents (a reason for the stock’s latest show of strength). At least three major Wall Street banks subsequently raised their share price outlooks for KLA, with one analyst noting that KLA’s exposure to fast-growing trends in advanced packaging and silicon carbide power “is helping to sustain the team’s specialty semi equipment segment,” while another analyst said the firm’s exposure to leading edge, next-gen manufacturing “continues to drive strong demand.” It looks like the long-awaited chip downturn will be much tamer than feared here.

Technical Analysis
Like most of its peers, KLAC ended last year’s bear market after bottoming in October and turning on a dime, rallying over 150 points by late January. Shares pulled back in the next three months but established support above the 200-day line, then turned up again in May and galloped to new highs. However, that was followed by two more months of tightening and tests of the 10-week line—but last week’s earnings-induced pop looks solid. We’re OK starting a position here or on minor weakness.

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Stock 4

Microstrategy (MSTR)

Why the Strength
Microstrategy is the largest publicly traded holder of Bitcoin in the world. At the end of Q1, the business held 140,000 Bitcoin, accumulated since 2020 at an average price of $29,800. While the company’s stock market fortunes are firmly lashed to the movements of cryptocurrency, Microstrategy’s original, ongoing, business line is providing business intelligence software. Its primary product, One, is an enterprise-wide database and analytics platform. The company is expected to see product revenue tick a little higher when it announces Q2 results tomorrow after the close, to $124.7 million and earnings of 67 cents a share. Financial results matter mainly because the company uses excess cash from operations to buy Bitcoin, and plans to use capital market fundraising to bolster its acquisition of the digital currency. Microstrategy began pouring its capital into Bitcoin in 2020, believing in the long term it will be a non-sovereign reserve currency with value powered by its scarcity. This year the company has been working toward lowering the amount of its $2.2 billion debt it has backed by its Bitcoin holdings. Now 11% of its holdings are pledged as collateral, after paying off a high interest load in the first quarter. At an $8.8 billion enterprise value, Microstrategy is priced higher than the $4.1 billion-ish in Bitcoin it owns, but it’s a play for Bitcoin bulls, especially those who believe the Lightning payments network effort to lower Bitcoin transaction costs will lead to wider adoption of the currency. (Microstrategy is developing its own Lightning-based payments platform to enable large-scale corporate Bitcoin networks.) Feel free to argue about Bitcoin’s long-term future, but many stocks in that “sector” look good today and Microstrategy is one of the strongest, making it an interesting speculation.)

Technical Analysis
MSTR isn’t something to bet the farm on, with hair-raising volatility on the upside and downside. That said, the setup around here looks fairly tempting: After hacking around wildly from last May into April of this year, the stock actually formed a normal-looking launching pad for the next 10 weeks and blasted off to start July—and then exploded higher over the next two weeks, followed by a constructive pullback on very light volume as the moving averages start to catch up. If you buy, keep positions very small, aim for dips and use a loose leash.

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Stock 5

NOG Resources (NOG)

Why the Strength
With global oil supplies tightening while the economic outlook for top consumer China improves, a few exploration and production (E&P) companies are back in the spotlight. Among the top performers in this space are non-operated players that have no direct involvement in the operations of drilling wells or rigs, allowing them to control capital spending while quickly scaling. Northern Oil & Gas is the leading non-operated E&P company in the U.S., with a primary strategy of investing in minority working and mineral interests in oil/gas properties. The firm has a core interest in many of the nation’s premier petroleum basins, with a main focus on the Williston Basin in Montana and the Dakotas, with additional exposure to production in Pennsylvania, New Mexico and Texas. All told, Northern has stakes in 9,400 gross wells across 260,000 net acres with a total daily production of 87,000 barrels of oil equivalent. The company has been on a torrid acquisition spree in the past year as part of its growth strategy: In January, it closed the Mascot (Texas) development project in the Midland Basin, which is expected to add around $300 million of unlevered free cash flow through 2025; in May, Northern acquired a 30% stake in the Forge assets in the Delaware Basin in partnership with Vital Energy; and in June, it bought one-third of the gas assets of a Delaware Basin-focused E&P company. Northern’s numbers are a bit weird due to hedge gains/losses and all the acquisitions, but there’s no question the numbers have picked up a lot and, with oil back above $80, they should continue to improve. So, too, do the shareholder returns, with the latest quarterly dividend of 37 cents per share up from 34, 30 and 25 cents the prior three quarters. The Q2 report is due August 4.

Technical Analysis
NOG hit a peak near 40 in June 2022, and after a fairly impressive comeback, was hit again at that level in November of last year. That did lead to some pain—the stock dipped as low as 25 during the banking crisis—but overall resulted in a fresh, attractive-looking launching pad. And now NOG is back near those prior highs, well ahead of most peers and E&P firms, which is an impressive showing. We’ll set our entry price down a bit given resistance and the upcoming quarterly report.

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Stock 6

Old Dominion Freight (ODFL)

Why the Strength
Less-than-truckload (LTL) shipping is used for transporting a shipment which is larger than a parcel but small enough that it doesn’t require a full truckload. Old Dominion is the nation’s number-one player in that field, offering regional and national ground and air-expedited shipping services, while also offering truckload brokerage, warehousing and supply chain consulting; all in all, it’s the one of the world’s largest truckers based on total freight. The stock’s recent strength is largely because one of its biggest trucking rivals, Yellow, is now filing for bankruptcy amid a cash crunch and a threatened union strike, which should increase Old Dominion’s (and many of its peers) market share. To be fair, the company is also facing its own share of industry-wide economic woes, with revenue per day in the last quarter decreasing 15%, while tonnage per day was down 14%. Old Dominion reported Q2 results last week that missed sales and earnings estimates while highlighting the challenging macroeconomic environment. Revenue of $1.4 billion was 15% lower from a year ago, due primarily to the decrease in LTL tons per day, while EPS of $2.65 was off 20% from a year ago. However, management indicated that market share remains “relatively consistent” in an environment where overall freight demand has been subdued. And both the top brass and industry analysts see better trends emerging in the LTL shipping business in the coming quarters as inflation pressures diminish and supply chains return to normal—with Yellow’s bankruptcy expected to boost business, too. The company just approved a new share purchase authorization for up to $3 billion (to begin after the current $2 billion buyback program is completed), and while Wall Street expects a 7% revenue drop for 2023, a lot of those guesstimates are changing with Yellow and with the stronger-than-expected economy.

Technical Analysis
ODFL topped near 370 in late 2021, fell to 230 last summer and returned to its old highs in early February. But that led to another, shallower consolidation, with a low near 300 in April, May and June as the stock held on to its 40-week line. But the past few weeks have clearly seen a change: ODFL is up seven weeks in a row, with volume accelerating, likely as the group looks ahead to a Yellow-less world. We’re not chasing it here, but think a shakeout of some sort (maybe a sell-the-news reaction to Yellow) would be intriguing.

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Stock 7

Palantir (PLTR)

Why the Strength
Most of the action in AI stocks so far has been (for good reason) driven by the picks-and-shovels players (like Nvidia), knowing there will be massive investment in the sector. But what about the platforms themselves? Many figure it will be commoditized (free or nearly free to use), but it’s unlikely big players (including defense-related government sectors) will hook their massive data sets into just any old AI platform—not only will functionality be key, but so too will security, not just from outside but making sure the platform itself only accesses whatever data it should. That’s the big idea with Palantir, which has been working on some form of its AI architecture for years, so much so that Q2 already saw it release an initial version (one for businesses, one for defense outfits; Ukraine is using Palantir’s software for targeting and damage assessments) of its comprehensive platform to select customers, allowing them to deploy new language models on their own data sets with specific instructions that can produce not just answers but who or what systems to then hand off tasks to. (In the Q1 call, in fact, management said it deployed a pre-release version to an insurer who, within a few days, was able to automate its claims processing!) Management was hyper-bullish on that same Q1 call, basically saying they will be the platform of choice going forward and that it was receiving hundreds of inquiries—though the issue is that this is all theoretical for the moment, with Palantir’s core software business doing fine but not exactly producing rip-roaring growth. But investors are obviously looking ahead—the Q2 report is due a week from today, with all eyes on any traction its platform is generating.

Technical Analysis
PLTR came public in 2020, topped out in 2021 and then crashed into the single digits; it didn’t hit a nadir until earlier this year and then spent months bottoming out. But when the AI buying frenzy started, PLTR kicked into gear—and in a big, big way, with the stock exploding higher on six straight weeks of monstrous volume. From there, the stock had some downs and ups, which served as a rest period until late last week when it began to take off again. It’s crazy volatile, but if you’re game, a small buy on dips is fine by us.

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Stock 8

RH Inc. (RH)

Why the Strength
California-based RH is an upscale home-furnishings company specializing in furniture, lighting, textiles, rugs and bathware and much more. The company’s marketing strategy is unique in the luxury furniture space, as RH displays its high-end furnishings in expansive design galleries located in prime markets aimed at wealthy customers and vacationers (with some of these galleries including fancy restaurants as an added attraction). Of course, the macro housing picture has been tough in recent quarters: In the face of slumping housing sales, the company’s Q1 revenue declined 23% while per-share earnings of $2.21 topped estimates by 14 cents (but were also substantially lower from a year ago). However, there are some company-specific positives here—management is “cautiously optimistic” that its global brand growth strategy, which includes expanding into Europe (the new gallery RH England recently opened on a 73 acre, 60 room estate that was first built in 1615 and has three restaurants; the firm is also updating and opening new North American galleries as well) will pay off in the coming years. On that score, the company upgraded its 2023 revenue forecast in May, raising the midpoint by 5%, to just over $3 billion, partly based on increased promotions it expects will boost sales. It also raised its Q2 sales forecast to a midpoint of $770 million (up 4% sequentially if realized). Significantly, the company sees an even bigger runway in selling spaces, with plans to make a big splash in the $1.7 trillion North American housing market with the launch of RH Residences, fully furnished luxury homes, condominiums and apartments with integrated services. There’s a lot going on here, but the expected housing turnaround and the firm’s big ideas has investors thinking positively—analysts expect the bottom line to dip this year, but see double-digit growth resuming for several years after that.

Technical Analysis
RH was a winner during the pandemic years, thanks to the home improvement trend in light of lockdown boredom. That trend came to an abrupt halt in late 2021, however, and shares collapsed in the months that followed, with shares ultimately surrendering 70% of their value. From its nadir in the middle of last year, shares spent many months building a bottom with support in the 230 area, and RH finally got going in June—and it’s been smoke up a chimney ever since. If you want in, aim for dips of 10 or 20 points.

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Stock 9

Sourthern Copper (SCCO) ★ Top Pick ★

Why the Strength
After a demand slump in the first few months of this year (due partly to global recession fears), the prospects for copper have notably improved following China’s latest economic policy decision to boost copper-intensive industries like automotive and electronic products. That should be a boon for Mexico-based Southern Copper, one of the world’s largest integrated producers and owner of the highest proven reserves of the red metal of any listed company. Of course, the backwards-looking results don’t appear anything special: Southern Copper announced last week a mixed Q2, with output for copper (up 12%) and zinc (up 13%) up nicely, though silver was off 9%; while prices in Q2 were down 11% for copper and 35% for zinc (but up 7% for silver). Not surprisingly, the overall results—sales up 1%, earnings up 3%—were relatively flat. But as with most commodity names, the story is about what’s to come: Going forward, the company has plans for several major expansion projects with an eye toward increasing copper output over the longer term, including from its Pilares mine in Mexico (which recently bumped up its annual copper production capacity by 35,000 tons) and a new zinc concentrator at its Buenavista, Mexico mine which is already ramping after receiving new material to process. (When completed, the project is expected to double the firm’s current zinc capacity while adding additional copper production). All told, management plans to invest around $2 billion annually in the coming years to achieve a projected 70% increase in copper output by 2031. Wall Street sees a tiny earnings increase this year, but expects the bottom line to leap 20% in 2024—with both numbers likely conservative if China’s stimulus plans succeed.

Technical Analysis
SCCO topped around 80 in February 2021, May 2021, April 2022, January 2023 and April 2023—clearly a long-term resistance area. But after a dip in May, shares found support near the 40-week line a couple of times, and now shares are changing character, with a good-volume move to new all-time highs. We like the action, though think it’s better to wait for a bit of weakness before buying.

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Stock 10

Transocean (RIG)

Why the Strength
We won’t rehash everything we’ve written of late about the offshore drilling sector, but suffice it to say that after years in the doghouse, the ultradeepwater sector has cut cost to the bone, with industry capacity much tighter than the boom times of 2014-2015 ... just as many big oil players are looking to secure long-term supplies offshore due to very solid cost characteristics (breakeven prices often at $40 oil or below). Throw in the fact that offshore rigs don’t grow on trees (the sector’s cycles tend to persist for years) and that’s leading to a surge in dayrates and bookings (some short-term, some long-term). And Transocean is benefiting—the firm is one of the bigger players in the sector, with 39 ultradeepwater and harsh environment rigs (down from 90 total rigs in the 2014 period), though a dozen of those are still cold stacked and one is under construction. The stock is strong today because, despite there still being some balance sheet work to do and recent results being just OK, the future looks bright: The backlog bottomed out in the first half of 2022 and is now accelerating higher, with the latest quarterly fleet report revealing a whopping $1.2 billion worth of new orders, driving the total backlog up to $9.2 billion (up $600 million from two months ago). And given that breakeven dayrates for the company’s current on-the-water fleet size is south of $300k, today’s $450k to $500k (and growing) dayrates should basically fall to the bottom line (CapEx should be less than 10% of revenues this year). There’s nothing revolutionary here, but Transocean seems well positioned for what could be a multi-year upturn, with recently higher crude prices helping the cause. Earnings are due tonight, though the backlog/fleet status report is already out.

Technical Analysis
RIG started to come back from the dead last fall, romping into the high 7s in February and March before the banking crisis hit all cyclical names. Still, shares held firm after an initial gut punch, with the mid-5s offering support for a couple of months. And now RIG is moving, rallying five weeks in a row to new price highs, albeit with plenty of volatility. We’ll set our range down a bit, thinking any reasonable post-earnings wiggle should be buyable.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on August 7, 2023.