Cabot Top Ten Trader Issue: June 3, 2024

Some Abnormal Action Appears

After a sharp correction in early April, the market posted a nice, but not powerful, rebound for four weeks that saw some names begin to emerge. But the past two weeks have definitely hurt the near-term evidence—partly when looking at the overall market (intermediate-term trend is basically sideways at this point, especially for broader indexes) but also leading stocks, where some abnormal action has appeared, including many software stocks coming unglued. There’s still more positive evidence than not, and frankly, most Top Ten stocks written about in recent weeks are handling themselves well—but at this point it’s very much a mixed bag, with some stocks acting fine, some coming under the gun and lots of up-and-down action. We’ll leave our Market Monitor at a level 7, but it’s vital to be in the right names and sectors while being willing to take partial profits on the way up and cut losses quickly if things don’t work out.

This week’s list has many resilient names, including a few that have been out of the spotlight for a while. Our Top Pick is Globus Medical (GMED), a small medical device outfit that, thanks to a good-sized acquisition of late, looks like a major player in the spinal surgery area, with new products and technology selling well.

Stock 1

Carvana (CVNA)

Why the Strength
Carvana is often thought of as a meme-type stock, but there’s much more to the story than that, with a big turnaround situation after the firm had a rough go of it. Carvana is an online-only used car retailer that allows customers to buy, sell and finance automobiles, and the advantages here are numerous, including a huge selection (more than 37,000 cars on the website, including very detailed, 360-degree photos and no cars that have been in reported accidents), generallly lower prices than brick-and-mortar players and next-day delivery in select markets. Plus, to get over the online hesitation of many, there’s a seven-day money-back guarantee, too. Selling a car is nearly as easy (I did this a few years back; got a solid price and process was easy), as is financing. The firm, though, hit a major speed bump in 2022 as its breakneck expansion pace ran headlong into elevated used car prices and rising interest rates; at one point there was even a question about Carvana’s ability to survive given its debt load and expenses. But those dry times resulted in tons of belt tightening while expansion into new markets halted, and the underlying story didn’t change—which paved the way for today, when Carvana looks to be back on track. In Q1, revenue growth returned to the black as unit sales picked up nicely (91.9 million units, up 16%), gross profit per vehicle sold expanded nicely (hitting new highs) and EBITDA margins did the same. While growth won’t be what it was a few years back, the top brass is all about driving profits and margins these days, which should keep EBITDA on the upswing assuming the economy and interest rates behave themselves.

Technical Analysis
CVNA broke out from a wildly volatile base in February after the Q4 report, galloping to north of 90 before a sharp pre-earnings dip to the upper 60s … followed by yet another powerful upmove after Q1 earnings. Once again, after that sharp advance (as high as 129), CVNA has sagged, but volume’s been light and the 50-day line is approaching, providing a reasonable setup. We’ll set our buy range up from here, thinking a show of strength would tell us the overall upmove is resuming.

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Stock 2

Credo Tech (CRDO)

Why the Strength
An accelerating shift toward generative AI, along with growing demand for high-bandwidth, energy-efficient connectivity solutions in the global data center market, are reasons Credo is garnering Wall Street’s attention. The California-based company is a high-speed connectivity provider for data centers, delivering a range of solutions including integrated circuits, active electrical cables (AECs) and SerDes chiplets (for handling serial data communication over extremely short distances). Credo’s growth story is thanks in part to data center demand for high-performance computing, especially from hyperscalers like Microsoft (its largest customer). Investors had been waiting for a sign business was beginning to surge, and in last week’s fiscal Q4 report (ended April), they got it: Credo posted a massive 89% year-on-year revenue increase, to $61 million, and achieved record full-year revenue of $193 million (up 5%), while quarterly earnings of seven cents beat estimates by three cents (reasons for the stock’s strength). The company said it diversified its revenue across a growing base of customers and products in 2024, but for Q4, around three-quarters of its sales was driven by AI workloads—obviously music to the market’s ears. The firm described the fiscal year as “fruitful,” thanks to a successful ramp at a new hyperscale customer and the expansion of its AEC engagements with hyperscalers, Tier 2 data centers and service providers. Credo said 2024 also saw notable wins at domestic and international hyperscalers for optical digital signal processor products, driven by AI back-end network deployments. The SerDes IP licensing business delivered “solid” Q4 results, while the chiplet business saw “significant” growth led by a large customer, which also engaged Credo to develop a next-generation chiplet for future deployments. Most important, all of this looks like the tip of the iceberg—moving forward, management expects an “inflection point” in AEC sales growth during the second half of fiscal 2025, while analysts see 60% revenue and triple-digit earnings growth in the year ahead. It’s a solid small-cap story.

Technical Analysis
CRDO came public in January 2022 at 12, rallying over the next few weeks before meeting with strong resistance at 18 in March. That level proved to be a ceiling until last November, when the stock broke out and had a decent run … before giving it all back in April. But now, finally, we think CRDO has changed character, with an earnings-induced move to new price and relative performance peaks on its third heaviest volume day ever last Thursday. Expect volatility, but we’re game for starting a position here and using a loose stop.

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Stock 3

Flex Ltd (FLEX)

Why the Strength
Flex is a leading player in the global electronics manufacturing services (EMS) and original design manufacturing (ODM) spaces. It offers components, circuit board fabrication, design and engineering services to some of the world’s biggest companies at one of the industry’s lowest costs. Between its two main operating segments, Reliability and Agility, it has exposure to sectors ranging from autonomous cars and mobility, electrification, medical devices and equipment, drug delivery, industrial devices, power systems and data centers. Frankly, business here has been just so-so, but recent revenue declines are turning up and—more important for the stock—margins are expanding, which should keep earnings growth in good shape. In Flex’s fiscal Q4 (ended March), total revenues were off 12% as some areas of business slowed, but its next-gen mobility business grew over 50%, as vehicles continue to integrate more advanced technology and content, while the cloud business grew 40% (twice what Flex expected), fueled by generative AI use in data centers. Meanwhile, profit margins improved a couple of percentage points on favorable mix cost action initiatives, helping per-share earnings of 57 cents beat estimates by two cents and rise 30% from last year, while free cash flow was “very strong” at over $800 million for the entire year, or around $2 per share. Elsewhere, medical device growth was above Flex’s 15% expected growth rate, thanks to new digital technologies and smaller form factors used in chronic care treatment. Looking ahead, Flex said power- and compute-based revenue in just data center and automotive will likely account for 40% of the company’s total sales by fiscal 2029, which it said is a “significant” long-term opportunity, with secular trends in other industries leaving the firm with “plenty of room to grow.” The top brass guided for another year of at least $800 million in free cash flow in fiscal 2025, while analysts expect earnings to jump 11% this year and 15% next—all of which is likely to prove conservative.

Technical Analysis
FLEX formed a big (and tight) base-on-base formation for most of last year before decisively breaking out on the upside in mid-December—and the run from there was both powerful and persistent, driving the stock to just over 30 in March. The consolidation that followed wasn’t hugely severe but it was choppy, and it included a huge dip after the fiscal Q4 report. But that proved to be a shakeout, with FLEX quickly recouping lost ground and then leaping to new highs. With the major trend up, we’re OK buying some here or (preferably) on dips.

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Stock 4

Freshpet (FRPT)

Why the Strength
You’re not likely going to brag about dog food stocks at the weekly country club soiree, but Freshpet has always had a great, durable growth story that’s right up there with any firm, and that growth should last for many years to come. The firm is the hands-down leader in the fresh pet food segment of the market, which plays into the mega-trend of Fido and Whiskers being treated more like family; studies have shown that better, fresher food leads to longer, healthier lives, and thus many owners are willing to pay a premium for good food. As we’ve written about before, the company’s growth has been amazingly consistent thanks to marketing and distribution (now in more than 27,000 stores, 23% of which have more than just one Freshpet fridge), with sales lifting at least 25% for six straight years, and yet it has just 3% of the dog food market and “only” 12.4 million buying households (up 24% from a year ago, but less than one in five of the 65 million or so total dog-owning U.S. households). The firm hit some hiccups due to execution issues (margins got crimped, hurting earnings and EBITDA) in 2022 and early 2023, but after a series of moves including price hikes and investments in capacity (a new facility is now cranking out a quarter of the firm’s output and has another production line going live in Q3), everything is pointed upward: Q1 saw sales boom 34%, driven by volume growth (up 31%, a figure that’s been accelerating over the past few quarters), margins expanded in a huge way (gross margin of 45% vs 38.5% a year ago) and EBITDA of nearly $31 million was up from just $3 milliion the year before, all of which easily topped estimates. And that means the firm’s 2027 targets (24% sales and 48% EBITDA growth annually from 2023-2027) are on track to be achieved, if not exceeded. After a tough period, we think the underlying story here is as good as ever.

Technical Analysis
FRPT has had a nice move since its long bottoming process ended last November, but it’s been mostly a stair-step pattern, with nice runs before and right after earnings reports, usually followed by plenty of choppy action as the moving averages catch up. Indeed, the stock’s March-April rest/dip giving way to an earnings pop to new highs in early May, and FRPT has crawled higher from there a bit with a few decent-volume buying days. We definitely think the buyers are in control, but we’ll target entering on dips of a couple of points.

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Stock 5

Globus Medical (GMED) ★ Top Pick ★

Why the Strength
Robot-assisted spinal surgery (RSS) is considered to be one of the revolutionary developments of the medical industry in the last two decades, and while still an emerging technology, it has dramatically reduced surgical errors for spine procedures due to better precision. Medical device maker Globus is a leader in the RSS field, developing solutions that enable surgeons to promote healing in patients with musculoskeletal disorders. Its products include orthopedic implants and artificial joints, as well as the top-selling ExcelsiusGPS (EGPS) surgical robotic system used for drilling and screw placement during spine surgeries, plus the Excelsius3D (E3D) three-in-one imaging platform for assisting spine and orthopedic surgeries. The stock’s recent strength was the result of a stellar Q1 report which saw revenue of over $600 million soar 120% from a year ago (bolstered by a big acquisition of peer NuVasive) and earnings of 72 cents beat estimates by 15 cents. During the earnings call, management emphasized that NuVasive was fully integrated during the quarter by combining product portfolios and “unlocking synergies to drive future growth.” The $1.1 billion merger is expected to double Globus’ revenue base, and while Globus said it hasn’t yet seen positive tailwind effects from NuVasive accounts, the firm believes that will come later this year. Driving the Q1 growth was the company’s U.S. and international spine business, as well as trauma products, while enabling technology sales grew 28%, led by increased sales of the EGPS and E3D systems,. Globus described its R&D pipeline as “prolific” and it introduced five new products in Q1 with “meaningful collaboration” between NuVasive and Globus teams expected to accelerate product launches going forward. Looking ahead, the company guided for full-year revenue of $2.47 billion and EPS of $2.80, up 55% and 20%, respectively, if realized. It’s a decent growth story and the merger looks like a big catalyst going ahead.

Technical Analysis
GMED hit a high-water mark of 84 in August 2021 and then spent more than two years grinding lower, despite a couple of powerful counter-trend rallies along the way. The bear market ended last November when the stock hit 44; after a rally into the upper 50s, shares tightened up for months above round-number support at 50. And now we have the Q1-induced breakout, with GMED gapping up early last month and pushing higher since, despite the market’s volatility. We’re OK grabbing some shares here or on dips of a couple of points.

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Stock 6

Impinj (PI)

Why the Strength
Impinj is an Internet of Things chip company. It manufactures identification endpoint integrated circuits (it calls them RAIN chips) that cost a few pennies to make and can be attached to items to allow them to be tracked automatically. RAIN is battery-free, doesn’t need line-of-sight to work and gets read at rapid speed. That makes it well-suited for things like combating theft in retail and enabling quicker, more accurate self-checkout as well as building more robust supply chain visibility across industries. Impinj feels the potential market includes literally trillions of items, which suggests a big upside given it just shipped its 100 billionth chip this spring. Also helping the upside is a recent legal settlement with its main competitor, NXP Semiconductor, where NXP paid Impinj $45 million upfront for violating patents and will pay a royalty for the next 10 years that could be nicely additive—the first royalty check was $15 million (north of 50 cents per share) covering the past year. Management is also encouraged by the European Union’s move towards digital product passports (DPPs), in which most items, from tires to laundry detergent, will be tagged and contain manufacturing, recycling and carbon impact information. In addition to aiming to be one of the suppliers of the DPPs, Impinj hopes that the effort will be a catalyst for selling readers into consumer homes or, in the best-case scenario, get mobile phone operators to buy Impinj reader chips to install in future models. That may be a bit pie-in-the-sky right now, but it’s a reason for optimism. The current business is a bit choppy – Q1 sales were down 11% on the year at $76.8 million in part because of constrained manufacturing capacity. That said, the top brass says things are improving now, with Q2 sales expected to be as high as $99 million with net income per share of 74 cents (more than double Q2 2023) including the NXP settlement, and analysts see the top and bottom lines gradually picking up steam from there.

Technical Analysis
PI suffered a setback in 2023, tanking from April through October to a multi-year low of 48 as business hit a wall overnight. That said, there really aren’t many arrows you can throw at the uptrend that got underway after the low, with shares consistently marching right back up to their old highs by March of this year. After a few weeks of rest, the Q1 report saw the stock hit new highs, and the recent trading has been very much under control despite some tech stock wobbles. We’re OK entering here with a stop near the 50-day line.

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Stock 7

Pinterest (PINS)

Why the Strength
Picture-sharing social network Pinterest (covered in the May 6 report) is experiencing a post-adolescent growth spurt thanks to its creative use of artificial intelligence. The popular social media site is well known for its recipes, home-and-style inspiration and crafting ideas, and its recent strategic decision to boost ad-related sales by partnering with giants like Amazon and Salesforce has been a contributing factor to that growth. But “aggressively implementing” NextGen AI has been another key contributor, as the company outlined in its Q1 earnings call, by allowing it to sharpen its focus on user intent while driving outcomes like saves, clicks and conversions. Indeed, management said its recent AI investments have enabled “greater returns for advertisers” along with gaining access to performance budgets, which in turn has allowed Pinterest to find its “best product market fit in years.” The key metrics support the company’s bullish appraisal of its strategy, with growth in monthly active users (MAUs) continuing to accelerate on a year-over-year basis, including Q1’s 12% jump (up from 7% in the year-ago Q1); this translates to more advertising that can be shown on the platform along with attracting more monthly active creators and increasing platform engagement. What’s more, Pinterest’s MAU growth is coming mainly from its biggest-spending regions of the U.S. and Canada, with average revenue per user (another key metric) showing the fastest growth of any of its major global regions—up 19% in Q1, more than six times than it generated in the rest of the world. The acceleration is also seen in revenue growth while EBITDA increased more than four-fold in the quarter. The stellar numbers also just prompted a major sovereign wealth fund to raise its holdings in Pinterest by 14%, while Wall Street sees many quarters of strong growth ahead.

Technical Analysis
We missed getting into PINS last month since the stock never dipped into our suggested buy range after the recent blastoff, which was kicked off by the Q1 report. Shares moved up in the next couple of weeks to new price highs, though along with most tech stocks, PINS stalled out at that point and has come down of late—and the dip looks reasonable, tagging its rising 25-day line on Friday. We think it’s at a solid risk/reward entry around here.

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Stock 8

Sweetgreen (SG)

Why the Strength
Sweetgreen is one of a handful of cookie-cutter restaurants out there that have turned very strong this year as the growth potential comes into focus and some money rotates out of tech areas and into other risk-on sectors. Sweetgreen is best known for its salads and warm bowls that include lots of yummy ingredients, and it’s been able to produce them with consistently high quality across its various locations, thanks in part to many deals with local producers to get fresh produce. But the firm is also branching out into protein-focused plates (miso-glazed salmon, caramelized grilled steak, etc.) that’s helping broaden the appeal and boost dinner sales. The firm ended March with 227 restaurants (it will open 25 or so this year, though 15% to 20% unit growth can be expected in 2025 and beyond), with the group of six new openings in Q1 already achieving average weekly revenue that’s greater than the average for all locations! Then there’s the firm’s Infinite Kitchen model, with machines used to dispense food (less labor costs); the two open so far have similar sales figures as other Sweetgreen locations, but the restaurant-level margins are 10 percentage points above the firm’s average—which is why seven of this year’s new openings will be Infinites, as well as three to four retrofits of existing locations. Growth here has been solid and Q1 continued that trend (revenues up 26%), and while earnings are in the red, EBITDA is about breakeven but headed higher and restaurant-level margins area improving nicely (18% in Q1 vs. 14% a year ago). Long term, if the top brass executes, there’s no reason Sweetgreen won’t grow many-fold from here, with the Infinite Kitchen idea a potential driver.

Technical Analysis
SG’s never-ending post-IPO decline and bottoming effort finally ended on March 1, when the stock exploded higher on earnings and went wild for a few weeks afterwards, reaching 26.5 by the end of the month. The market yanked it lower from there, with some ugly action in early May, but the damage wasn’t unreasonable and the Q1 report saved the day, creating another huge upside gap. We didn’t want to chase it at that point, but now has started to pull back, and while the day-to-day action is sloppy, the dip has been very reasonable (still above its 25-day line). If you’re game, we’re OK with a small buy on weakness is fine by us.

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Stock 9

Tandem Diabetes (TNDM)

Why the Strength
As the incidence of diabetes increases in an aging population, the market for automated insulin pumps has expanded to accommodate diabetes patients looking for ways to avoid frequent injections and reduce blood glucose testing. Enter Tandem, which specializes in making products aimed at helping Type 1 and 2 insulin-dependent diabetics, with an emphasis on insulin infusion therapy. Its flagship product, the T:slim X2 Insulin Delivery System, is the first pump to integrate with multiple continuous glucose monitoring (CGM) sensors and is one of the world’s best-selling automated pumps. The company boasts over 450,000 customers in 25 countries, which it sees as a “scaling renewal opportunity” based on high levels of customer satisfaction, and with over four million Type 1 and 2 patients in the U.S., Tandem sees lots of room for growing its target markets going forward. Tandem’s worldwide pump shipments of around 25,000 increased 9% from a year ago in Q1, helping revenues reach $192 million, up 13%, while the loss per share was 17% less than expected (both reasons for the stock’s latest show of strength). Most of all this upturn in business looks durable—in the quarter, the company started a series of launches, including the Tandem Mobi with Dexcom’s G6 continuous glucose monitoring (CGM) device (which management said is outpacing expectations); the T:slim X2 integration with the Abbott Freestyle Libre 2 Plus CGM sensor; and a rolling launch of the X2 with Dexcom G7 sensor integration outside the U.S. Tandem also received FDA clearance to expand its Mobi pump indication for use in patients ages two and older. In the wake of these bullish developments, a major Wall Street bank has just upgraded Tandem shares after being “encouraged” by early progress in the company’s launch of the Mobi insulin delivery system, while another institution initiated a “buy” rating on Tandem last week. Analysts like what they see here and expect mid-teens sales growth this year and next.

Technical Analysis
TNDM had a big run during the prior bull phase but was decimated during the bear market, falling from 156 to 14 (!), and it didn’t find support until last November. However, shares immediately ran higher from there, reaching 31 by year-end, and then effectively consolidated into mid-April, making no net progress. But since then TNDM has been very strong, bouncing off the 50-day line, gapping up on earnings and trading just above the 50 level in recent days. We like the action but suggest aiming to enter on normal weakness.

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Stock 10

Wix.com (WIX)

Why the Strength
Wix is a cloud-based platform that specializes in making it easy to get a website up and running with many value-added features including e-commerce payments capabilities. Originally formed as a way to get simple websites up quickly and cheaply, Wix has evolved into a more full-service provider of things like email marketing programs and development tools for professional developers who build more sophisticated websites for larger enterprises. In August, the company launched Wix Studio, focused on marketing agencies, and has seen more than one million accounts created in the months since. Management expects Studio to feed growth for years to come as it gains critical mass. Already in the first quarter, reported two weeks ago, Wix credited Studio with helping surpass expectations. The business tallied $420 million of sales, $457 million in bookings and $1.29 of earnings per share (vs estimates of $1.03), all above guidance. The other contributor to the strong quarter was management’s expansion of AI-powered tools for users to help design websites by describing in a chat the style and goal of the site they want to build. Wix also says its AI capability makes it simpler for users to find stock photos that more closely reflect the image they want to present. While Wix highlights Studio and AI as paths to growth, its core business provides a strong base: A recent price hike trimmed the user base slightly but was more than offset by sales gains. The outlook is for the back half of the year to return to an expanding user base, now counting some 200 million accounts. For the year, analysts see sales up 12% and earnings up about 20%, though most see those numbers heading up after the blowout Q1 report.

Technical Analysis
WIX saw its kickoff along with most growth names last November following a big bear market and a long bottoming process. The run from there was very solid, taking it up to round-number resistance near 150, though that was followed by a 20% pullback with the market in April. Shares did tighten up near their lows, which is constructive, and WIX then took off, surging before and (especially) after its quarterly report. The dip since then looks normal to us; we’ll set our buy range down a bit more, aiming to get in on a bit more of a retreat.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on June 10, 2024.

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