Cabot Top Ten Trader Issue: June 17, 2024

Still Challenging

It’s been a while since we remember seeing such a split tape. On the one hand, there are still a decent number of stocks that act well and are generally advancing both short- and intermediate-term, and some growth measures are perking up to new highs. However, on the other hand, more and more names across a variety of areas are hitting air pockets or simply falling by the wayside; indeed, market breadth has been terrible by many measures of late and most indexes are simply treading water. To us, the divergence and narrow environment tells us the risk of a big character change (whether that’s a market decline, or a vicious rotation) is elevated, and that’s why we continue to advise holding a decent chunk of cash—but with plenty of stocks still acting well, we’re also OK with selective buying in names that are under strong accumulation. We’ll again leave our Market Monitor at a level 7, though we remain flexible and will adjust exposure if need be.

This week’s list is another eclectic one, with an increasing number of turnaround-type stories. Our Top Pick is Hewlett Packard Enterprises (HPE), which is very cheap but is starting to see some AI benefits—and the stock has shown exceptional power, with the past two quarterly reports bringing huge-volume buying as the stock has moved to new all-time highs.

Stock 1

Broadcom (AVGO)

Why the Strength
Broadcom is a chip and infrastructure behemoth, with north of $40 billion in revenue thanks to having its hands in nearly every tech cookie jar out there, from networking to servers to broadband and wireless, as well as cloud, cybersecurity and even mainframe areas, too. Business has been good (humongous margins here) for a while, and the firm isn’t afraid to make big moves—its buyout of VMware (finalized last November for a cool $69 billion) dramatically expanded its reach into things like hybrid cloud, app delivery acceleration and edge computing. But, of course, the big driver going forward looks to be AI, which is still “small” (about one-quarter of revenue) but is growing like mad and the top brass is very bullish going forward. Indeed, the stock is strong today because of its fiscal Q2 (ending in April) report: Overall sales lifted 43% and organic (not including VMware) sales were up 12%, but AI-related revenue totaled $3.1 billion, up a whopping 280% from the prior year, thanks mainly to hyperscaler demand for accelerators. Meanwhile, on the VMware front, the firm is transitioning everything to a subscription basis, with annualized booking value (a company metric) ending at $1.9 billion in April, up from $1.2 billion three months before. To be fair, some of the firm’s other chip areas are still struggling a bit (wireless should be flat this year), but others like server storage (down 27% from a year ago) have hit a nadir; all in all, non-AI chip revenue as a whole has likely bottomed out and will expand modestly from here. Management hiked its outlook to $51 billion in revenue for the fiscal year while EBITDA is expected to total $31 billion (61% margins!!), up about 34% from 2023’s tally. Simply put, Broadcom is a blue chip in one of the market’s strongest sectors and should be a big AI player going forward.

Technical Analysis
Like a lot of AI stocks, AVGO’s original breakout came back in May of last year, so it’s not in the first inning of its overall advance—but there’s no doubt the buyers remain in control. The stock’s latest rest started in early March and led to a 14-week sideways range, but the stock began to show accumulation earlier this month and then the roof blew clean off after earnings last week. We’re not chasing it here, but a post-report exhale would be tempting. As for the stock price, it’s up there, of course, but just buy fewer shares than you normally would.

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Stock 2

Burlington Stores (BURL)

Why the Strength
Last year’s bankruptcy of retail giant Bed Bath & Beyond opened a pathway for expansion for New Jersey-based Burlington, which has picked up 50 of the former retailer’s storefronts across the U.S. The company formerly known as Burlington Coat Factory offers a diverse array of high-quality, branded apparel and merchandise at prices that are more heavily discounted than traditional department stores. To that end, lower markdowns in Q1 drove a near two percentage point gain in profit margins from the year-ago quarter. And while comparable-store sales were weighed down at the start of the quarter, a 4% jump in March and April resulted in an overall comp sales gain of 2% for the full quarter, showing that off-price retail demand is hanging in there. In total, revenue of $2.4 billion increased 11%, while earnings of $1.35 a share improved 61% from a year ago and beat expectations by 30 cents. Management said the industry-beating results were partly boosted by the 14 new stores Burlington added to its roster in the quarter, which now total 1,021; the company said it’s on track to open 100 new outlets this year and regards store openings as a key top-line driver going forward. Burlington further emphasized that its “strong” margin expansion in Q1 was thanks to faster-than-expected progress on its supply chain efficiency initiatives. And all of this should pay off handsomely going forward: Burlington said it’s on track to nearly double 2023’s sales, to $16 billion, over the next five years while operating profit is expected to triple over that same period. For Q2, the company guided for a 1% comp sales increase and a 10% revenue jump, and longer term, earnings are expected to rally north of 20% each of the next couple of years.

Technical Analysis
BURL had a huge downturn for much of 2023, nearly retracing all of its off-the-bottom rally in late 2022/early 2023, but the November earnings reaction changed the tone, leading to a big gap up and a steady rise to near 230 in March. The retreat from there was sharp but normal, finding support near the 40-week line, and then BURL gapped up nicely on its latest quarterly report, with a couple of weeks of calm consolidation since. We’ll set our buy range up from here, looking to enter on a resumption of the earnings pop.

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Stock 3

Corning (GLW)

Why the Strength
Corning has long been known for its high-quality cookware products, but over the years, the company has branched out into several segments that produce specialty glass and ceramics used in industrial and scientific applications, including for TV panels and mobile phone displays, as well as for automotive components and medical instruments. More recently, Corning is benefiting from massive growth in AI data centers, with recent big wins from enterprise customers in this market; as a result, the company expects its Optical and Display segments will be the biggest drivers going forward. Additionally, in order to meet the computational demands of generative AI, its customers are building fiber-rich secondary networks to connect graphics processing units (GPUs), which increases demand for the optical fibers Corning makes. (The company described fiber as the “ascendant technology” in the burgeoning field of optical communications, in which Corning has a leading position.) Another growth opportunity for Corning is its environmental technologies segment, which specializes in gasoline particulate filters—the U.S. EPA recently announced new emissions standards for gasoline vehicles and hybrids as early as 2026 (for model year 2027), and the firm foresees notable benefits from sales of its filters. Business has been sagging for a while and Q1 was no exception, as revenue of $3.3 billion was 6% below the year-ago level, with earnings of 38 cents off 7% (though above expectations). However, the top brass said it believes Q1 was the lowest point of the year for sales and that the order book “grew nicely” from Q4 levels. Corning also sees an opportunity to increase annual sales by more than $3 billion within the next three years, and Wall Street sees the top and bottom lines gradually accelerating from here. It’s not changing the world, but Corning is likely at the front end of a new growth wave. A decent dividend (2.9% yield) doesn’t hurt the cause, either.

Technical Analysis
GLW had a solid rally off last October’s low near 26, with earnings producing a final peak at 33 in late January before shares ran out of steam. Three months of backing and filling followed, but the stock held up well during the market selloff earlier this spring—and then the mid-April test of the 40-week line held and the Q1 report brought the buyers back in, with the upmove relatively smooth ever since. We’re OK nibbling here or (preferably) on dips.

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Stock 4

Crocs (CROX)

Why the Strength
Crocs’ considerable investments in diversifying its product line and expanding its reach are starting to pay off. The iconic maker of the molded foam, brightly colored clogs that were once “only” popular among chefs, healthcare workers and children has grown its recently acquired HeyDude casual footwear brand into a trendy label that was just named as one of the top eight preferred footwear brands in a major teen fashion survey. (Crocs also just appointed a new president for HeyDude with the aim of making the brand even more appealing to the youth demographic and with plans to open 30 new HeyDude outlets this year.) The company has further enhanced the Crocs pop-culture appeal through customized shoe collaborations with mega-businesses like Disney, NBA, Hello Kitty and Pixar’s Toy Story line. Altogether, Crocs believes these initiatives will help fuel “durable and consistent growth,” with HeyDude expected to become a billion-dollar business next year (it currently makes up 25% of the company’s annual sales). But Crocs hasn’t forgotten its roots, and though the firm is attracting new customers via its newer franchises and partnerships, the classic clogs business led growth in the latest quarter. In Q1, revenue of $939 million increased 6% from a year ago, with earnings of $3.02 soaring past estimates by 34% (the reason for the strength). Other highlights of the quarter included the firm’s children’s business, which grew by double digits, and the rollout of two new sandal franchises, 2-Strap and the Getaway. The North American segment took “meaningful” market share in Q1, growing 9%, supported by underlying strength in wholesale sell-out and DTC channels, while international sales grew 24%, with triple-digit growth in China (which the top brass view as a big growth opportunity). Looking ahead, Wall Street conservatively estimates 5%-ish sales growth in each of the next three years, but this is likely to prove conservative given the momentum behind HeyDude and the core brand. Meanwhile, the tame valuation (13x trailing earnings) should work in the bulls’ favor.

Technical Analysis
CROX had a huge decline during the bear market (184 to 46!), a strong rally into last year (back to 151), followed by another tough decline to 74 in November. Since then, the stock has been making solid progress, albeit with lots of ups and downs along the way, the latest of which started with the market’s decline in April. But the retreat never got out of hand and the Q1 report gapped the stock up, with CROX moving out to multi-year highs since. We’ll set our buy range down a bit, aiming to get in on a little bit of an exhale.

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Stock 5

Guardant Health (GH)

Why the Strength
Guardant Health bills itself as an oncology company, but instead of developing cures, it’s a testing outfit: The firm’s Guardant 360 offering is a blood test (the company calls them tissue-free biopsies) that can detect certain forms of cancer, help doctors and patients decide on therapies and even give early indications on how successful immunotherapies or targeted treatments are. Big picture, it’s part of the (in our opinion, revolutionary) trend toward more accurate and insightful non-invasive tests, and while the bottom line is deep in the red, demand for the offering has been strong for years: Revenues have grown nicely every year (from $287 million in 2020 to an estimated $681 million this year), are actually accelerating a bit of late (its 31% growth in Q1 was the fastest in five quarters) and with Guardant estimating the market is worth $20 billion in the U.S. alone, analysts see growth continuing for a long time to come. That’s all to the good, but much of the excitement now revolves around the firm’s new blood test for colorectal cancer, which has had very solid detection results for stage II/III patients (including 99% true negatives); an FDA advisory panel recently backed the firm’s offering (dubbed Shield), and it could be a huge seller with obvious advantages vs. stool-based tests (like Cologuard from Exact Sciences), never mind colonoscopies, with early signs pointing toward a massive increase in compliance rates (which obviously saves lives). Long term, lung and other cancers could be next up, but even with what’s happening now, Guardant looks like a big idea.

Technical Analysis
GH’s chart has been a classic horror show for years, falling from a pandemic-era high near 180 all the way to 16—and that low didn’t occur until this April, a year and a half after the indexes hit their nadir! However, it’s in Top Ten today because the last couple of months look like a big character change, with eight weeks up in a row, four of which came on big volume, and with the stock easily surpassing its 40-week line, too. There will almost surely be dips and shakeouts, but the trend looks to be turning up—we’ll set our buy range lower and use a loose leash.

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Stock 6

Guidewire Software (GWRE)

Why the Strength
Technology business Guidewire is making good inroads into the sleepy world of property and casualty insurance. The California-based company sells a cloud-based platform for the P&C industry that supports the entire insurance lifecycle including managing call centers and handling policies, billing and claims. Guidewire convinces firms to pursue digital transformation by providing them more cost savings than what they pay to the company, which is a small percentage of policy premiums directly written. Today the company has 540 insurance clients worldwide handling about $600 billion in premiums, and trends for its clients are good, with the industry boosting premiums to make up for greater claims costs from inflation. Guidewire’s customer base produced annual recurring revenue for the firm of $828 million at the end of its fiscal third quarter, April 30, up 8.5% from a year ago. (ARR is for expected sales from clients who have been fully onboarded.) That resulted in Q3 top-line revenue of $241 million gaining 14% thanks to very strong subscription revenue (up 35%) and associated subscription support revenue (up 28%). Net income of $0.26 a share handily beat consensus, and as is usually the case with subscription outfits, cash flow should be nicely larger than earnings ($140 million of operating cash flow this year, around $1.70 per share). The positive business trends mean management has heightened expectations for the full year, with a projection that ARR will end up around $860 million, which would be the second straight year of ARR growth around 16%. Fiscal 2025, starting in August, should see revenue growth accelerate a bit as earnings and cash flow continue to head higher. It’s not changing the world, but Guidewire is a niche cloud player offering real benefits to a steadily growing industry (P&C premiums aren’t going down), which should lead to reliable growth for a long time to come.

Technical Analysis
Software stocks have recently gone over the falls, but that makes GWRE’s action more notable: Shares had a steady rally from last June, finally stalling out with most growth stocks in early March, but instead of falling much, the stock basically treaded water, gyrating between 107 and 125 for two-plus months. GWRE looked ugly heading into the earnings report, but that likely wiped out the weak hands, and now the stock is looking great. We’re OK starting a position here or (preferably) on dips.

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Stock 7

Hewlett Packard Enterprises (HPE) ★ Top Pick ★

Why the Strength
Hewlett Packard Enterprises certainly isn’t an AI leader, but investors are thinking it will reap some benefits soon: As artificial intelligence workloads become more demanding on the enterprise level, companies are under pressure to keep up by regularly upgrading their servers, in turn creating a “virtuous cycle” for the company. HPE is the result of the 2015 Hewlett-Packard split up, with this firm offering hardware and software solutions for high-performance computing (HPC) and artificial intelligence, as well as providing servers, storage, networking, containerization and software for both general and specific use cases. Earlier this month, the company released financial results for fiscal Q2 (ended April) in which revenue of $7.2 billion increased 3% year-on-year and per-share earnings of 42 cents beat estimates by 8%. While these aren’t head-turning comparisons, both the top and bottom lines sailed past the company’s own guidance and beat Wall Street’s estimates, led by a conspicuous acceleration of AI systems sales that doubled from the previous quarter (the reason for the stock’s strength). Even more impressive was the firm’s annualized revenue run-rate (ARR, a key metric) of $1.5 billion which jumped 37%, while free cash flow of over $600 million nearly doubled from a year ago. In the wake of the sanguine results, a number of major institutions upgraded their outlooks for HPE on growth opportunities in the AI and cloud spaces, as well as HPE’s leading position in ISS servers and supercomputers (thanks to its ownership of Cray). Management emphasized that it was seeing “stronger” AI order conversion and anticipates continued revenue growth driven by increased AI systems demand, continued adoption of its GreenLake edge-to-cloud platform and ongoing improvement in the traditional infrastructure market (including servers, storage and networking). The firm sees Q3 sales up 10%, and the cheap valuation here (11x earnings, 2.4% dividend yield) means any upside surprises should be rewarded.

Technical Analysis
HPE has been relatively stuck in the mud for the past few years as earnings flattened out, with slightly higher highs mostly coming from dividends; just looking at the stock itself, the 20 level has contained shares since early 2018 (!) while the upper teens consistently capped the stock during the past couple of years. However, the earnings reaction at the end of February was a clue something was up, and after another few weeks of base-building. HPE has broken out on the upside following the latest quarterly report, with those two buying weeks the biggest seen in many years. We think you can enter here with a stop near the recent earnings gap.

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Stock 8

Nextracker (NXT)

Why the Strength
Nextracker was spun out of Flex Ltd in part in early 2023 (and fully spun off at the start of this year), and that created a potential new leading stock in the solar sector: The firm is the global leader in solar trackers, which are used in huge utility-scale solar farms to gradually move the panels during the day so they’re angled toward the sun. While tracking isn’t new, the company’s offering looks to be best in class, with hundreds of patents around its technology (including software that runs the show, unique row-by-row controls and risk mitigation during extreme weather), and while it does add a few percent to the cost of a big farm, it pays off over time with far higher efficiencies for each solar panel. Business here is good, as solar deployments continue to grow rapidly and Nextracker takes share—in fact, sales growth has been accelerating of late (about two-thirds of sales are in the U.S.) while EBITDA (up 164% in Q1) and earnings have been leaping at triple-digit rates. And, impressively, orders have been even stronger, with the firm ending March with a backlog over $4 billion, up more than 50% from a year ago! While there’s some sector risk here (some of the industry is driven by subsidies), we like that Nextracker really isn’t affected much by the various panel wars out there—if anything, lower panel prices probably help entice more utility-scale solar construction. For the year ahead, the top brass has guided to 14% revenue and 20% EBITDA growth with strong free cash flow, though given its history of lowballing estimates, those will very likely prove too low.

Technical Analysis
NXT has shown signs of wanting to get going a couple times over the past year only to be dragged down by the solar sector, but now it’s making another run at it while the group improves. The selloff from the recent high near 60 wasn’t pleasant, but NXT held near its 40-week line and had a great reaction to earnings, with two big weeks of buying volume. Plus, there’s been no real selling since then—in fact, shares tested their old highs last week before backing off some. We like the setup and will set our buy range up from here, thinking another push higher should result in a breakout.

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Stock 9

Seagate (STX)

Why the Strength
Seagate has established itself as one of the world’s top mass data storage providers, with products ranging from classic hard disk drives (HDDs) to solid state drives to storage subsystems and other computing solutions. Lately the company has seen higher demand for its offerings due to (what else?) artificial intelligence. A major institutional bank recently highlighted the rise of generative AI technologies as being a key catalyst for significantly higher earnings in the coming year for Seagate, as well as providing the firm with a longer-term tailwind. Another bank also just raised its target price for Seagate based on the higher storage needs of cloud and enterprise customers related to AI. Fiscal Q3 earnings (ended March) were the major catalyst for the stock’s latest strength: Although revenue of $1.7 billion was 11% lower from a year ago, it grew 6% from the prior quarter, while earnings of 33 cents a share more than doubled on a sequential basis and beat estimates by four cents. The company pointed to improving cloud and data center demand as a key driver for the bullish March quarter, which the top brass said paves the way for the ramp of its Mozaic hard drive platform, featuring Seagate’s cutting-edge Heat-Assisted Magnetic Recording (HAMR) technology (which increases the storage capacity of hard drives beyond the limits of current recording methods). The company sees a “constructive market trend” ahead in its Video and Image Apps (VIA) business, driven by increasing use of higher-definition cameras and AI analytics, with China’s economic recovery expected to be a major contributor to VIA’s growth. Additionally, Seagate sees a long-term opportunity for its HDD products as enterprises begin leveraging trained AI models to transform data with value-enhancing applications and data-rich content. After a tough downturn, a new business upturn is here: Wall Street sees earnings leaping from here, with fiscal 2025 (starting this July) expected to total nearly $6 per share.

Technical Analysis
STX built a big bottoming base for much of last year, finally getting going with the market in November and rallying up to the century mark in March. What followed was a jagged consolidation, but shares re-tested the 100 level in May, leading to one more quick dip to 90. And since then, STX has powered ahead on good (not amazing) volume, hitting new price and relative performance peaks. If you want in, aim for modest weakness.

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Stock 10

Universal Display (OLED)

Why the Strength
Universal Display makes organic light emitting diodes – OLEDs – which are next-generation LEDs that make for brighter, more energy-efficient phones, computer monitors and TVs. The difference is technically complex but, simply stated, OLEDs are tiny individual lightbulbs that can be any color and can combine to create an image, while LEDs provide the backlight illuminating images created on the LCD screen—the result being that OLEDs make for much more vibrant, detailed pictures. For that reason, they’ve had great success in the premium, hotly competitive smartphone market, with OLEDs as a category now seeing 50% market share in phones. That means the market is dependent on phone sales strength, but also means there is a lot of space to expand into TVs, computer monitors, tablets and elsewhere, as OLEDs have just 3% of the market in those categories. Apple (which makes its own screens) just introduced its first OLED screen iPad, which should mean Universal Display’s largest customer, Samsung, should follow suit. Already this year Samsung has announced big plans to expand capacity for making IT products with OLED capability. Another emerging market is EVs, including from Audi and BYD, which are starting to include OLED displays mainly for their superior power efficiency. Thus, the industry is headed up, albeit with fits and starts, and Universal is the main way to play that, though to be fair, it’s a down-the-food-chain operation (one or two big clients sneeze and it catches the flu). Even so, business is picking up after a slow period: Revenues should be up around 17% this year, and Q1 was much better than that, with earnings easily topping estimates and leaping 43%.

Technical Analysis
OLED enjoyed a solid but jagged recovery from its break lows, with lots of false starts along the way, but it eventually made it up to 195 in December. That led to a stair-step correction that saw shares slip 24% from high to low, but the early-May earnings report brought in the buyers again, and now, after yet another earnings reaction, OLED sits at new highs near round-number resistance at 200. We’ll set our entry range down a bit from here.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on June 24, 2024.

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