Cabot Top Ten Trader Issue: June 5, 2023

More Improvement

The market finished solidly in the black thanks to a strong end to last week, with the broad market even beginning to kick into gear; interestingly, while the intermediate-term trend is still neutral overall, a couple of broad up days from here could kick it into the green. Even better is the action of leading stocks, with more names emerging and, importantly, more names holding their recent upmoves (as opposed to the sell-the-strength activity seen for months on end). To be clear, there’s still a lot of proving to do, as most stocks remain below key moving averages, the number of stocks hitting new highs is tame and the like. Overall, we think the evidence has taken another step in the right direction—we’ll move up our Market Monitor to a level 6 and see what comes from here. We’re encouraged, but are taking things on a day-by-day basis.

This week’s list has a ton of strong names and other good setups that could lift should the market continue to improve. Our Top Pick is Palo Alto Networks (PANW), which looks like the leader of the improving cybersecurity group, having lifted out of a long consolidation. Dips should be buyable.

Stock 1

Abercrombie & Fitch (ANF)

Why the Strength
Recent reports show that quite a few big-box retailers are having a tough time selling discretionary items to cost-conscious shoppers, but certain fashion retailers are having a surprisingly easier time navigating the inflationary and economic headwinds. Consider Abercrombie & Fitch’s recent earnings report, which featured a consensus-beating profit figure (thanks to strong demand for its leading brand), along with solid gross margins and healthy inventory levels. The company, which owns both the Hollister and Abercrombie brands and which has long been known for its hip, teen-oriented apparel, has been executing a strategy in recent years to broaden its appeal with clothing and accessories geared toward children and young adults, as well as teens. The strategy involves closing the company’s underperforming stores and growing its more popular Hollister brand, and it appears to be working after Abercrombie set several records in the quarter—including the highest Q1 sales in more than a decade. Revenue and same-store sales both increased 3% from last year’s Q1, led by Abercrombie brands’ growth of 14%, which the firm attributed to its “powerful brand transformation” and robust sales of women’s clothing. Inventory levels, meanwhile, declined 20% in the quarter thanks to an improving supply chain, while the operating margin of 4% improved from a year-ago loss thanks to all of the above plus reduced freight costs. The key reason for the stock’s strength, however, was per-share earnings of 39 cents that obliterated estimates by 37 cents, prompting several big Wall Street banks to raise their share price targets. (Analysts now see earnings of $2.01 per share this year, up from an estimate of $1.48 a month ago.) Going forward, management said improving the top line is the main focus and guided for revenue to grow by 5% in Q2, with sales and margins likely to kite higher for many quarters after that.

Technical Analysis
ANF cratered from a multi-year high of 48 in November 2021 to a low at 15 last August. After a basing period, it turned the corner last fall on a strong holiday shopping outlook, with shares enjoying a persistent uptrend before hitting resistance at 31 in February. A three-month correction followed, but ANF found support at the 40-week line in early May, exploded higher on earnings two weeks ago and has continued higher in recent days. There’s still some resistance around here, so we’ll set our buy range down a bit.

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Stock 2

Advanced Micro Devices (AMD)

Why the Strength
In a sign the artificial intelligence (AI) revolution is gaining speed, 110 of the companies that comprise the S&P 500 mentioned the technology during their Q1 earnings calls—a record number. At the center of the AI race are the companies that provide the data center chips needed to train AI models, and AMD (covered just a couple of weeks ago) is front and center. A rumored partnership with Microsoft should increase AMD’s gains in the AI realm, with the software giant (and biggest investor in OpenAI) said to be assisting AMD’s expansion into AI processors, according to reports which, if true, should help AMD catch up to market leader Nvidia. The company also provides the MI250X data center chip used to power Europe’s LUMI supercomputer, which trained the world’s biggest finished language model to date. Moreover, the company’s data center MI300 superchip will provide up to eight times better performance than MI250X and is due to be released later this year; it’s been selected to power El Capitan—the world’s fastest supercomputer—at the Lawrence Livermore National Lab (the firm’s chips also power more than 100 of the world’s fastest supercomputers). Additionally, AMD is seeing growth in the video game market, as its gaming processors are in high demand and are used to power some of the industry’s most popular consoles, including Sony’s PlayStation 5; on that score, the firm just launched the industry’s fastest gaming processors. AMD is further benefiting from the accelerating cloud transition; the chip giant’s hardware provides power for data centers worldwide, and its customers include Oracle, Microsoft’s Azure and Alphabet’s Google Cloud. Wall Street sees a sales reset this year, but growth should resume in Q3 and likely surge from there.

Technical Analysis
We just missed getting into AMD two weeks ago after the stock took off on Nvidia’s earnings report—if you bought some, we’d hold on. But if you didn’t, we think the latest action brings the stock closer to a lower-risk entry: AMD’s comeback from its March/April correction was a big clue, and overall, the stock zoomed to new 15-month highs on four straight weeks of big, above-average weekly volume. We’re OK with a small buy here or (preferably) on dips with a stop down toward the century mark.

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Stock 3

Boeing (BA)

Why the Strength
Nobody is going to confuse Dow Industrials member Boeing with the latest hot AI-related name, but as we’ve written before, aerospace stocks have a history of trending as the airplane ordering and building cycles can last many years. Boeing is obviously the granddaddy of the group, and it’s showing some signs of coming out of the tough times of the past few years—things actually soured in 2019 and of course, the pandemic then put orders and production on halt. And even after that, supply chain issues have crimped the bottom line … and in fact, the top brass just said supply will be an issue for years; while there’s progress on that front, both it and peer Airbus will likely be constrained for years as they work off huge backlogs (Boeing’s backlog totals $411 billion and more than 4,500 planes). So why is the stock setting up? Because, directionally, things are headed in the right direction and free cash flow should soar going ahead: In Q1, sales posted their second straight big increase from the prior year, thanks to a 37% hike in airplane production (to 120 a month). Meanwhile, operating margins were nearly breakeven and management still sees free cash flow in the $5 to $8 per share range this year, with a possible move up to $15-plus in the years ahead. Beyond those goals are reports of improvement—the firm’s output of its newer 787 jet has been bumped to four a month, on its way to five per month by year-end, and management says it’s on track to boost production elsewhere despite supply issues. And underlying all of this is strong demand worldwide—being in Boeing’s position with airplanes in short supply is a good thing. It’s not going to soar overnight, but there’s little doubt results here should improve markedly for at least the next couple of years.

Technical Analysis
BA peaked back in early 2019 at 446 and was still hanging around the 115 to 120 area at its lows last year. But then it turned the corner, bursting above all its moving averages last November and rallying to 215 range by mid-January, and the past few months have seen the stock trade in a tedious-but-tight range (13% from high to low). BA perked up last week, though fell back from resistance today; we’ll set our buy range up a bit, thinking a resumption of the rally would lead to good things.

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Stock 4

Lululemon (LULU)

Why the Strength
Lululemon is known for its athletic apparel offerings that are based on a “Science of Feel” platform that focuses on creating a distraction-free and weightless sensation for the wearer of its yoga, running and workout clothing. Its latest strength is in part the result of a head-turning comparable sales increase and guidance raise during a difficult (for many retailers) first quarter. The company’s products are mainly geared toward upscale customers (who haven’t tightened their belts as much as other consumers), and the firm’s premium prices have found a good balance of boosting profitability while not being beyond the reach of the mass market. Revenue of $2 billion increased 24% in Q1 from the year-ago quarter, led by a 60% increase in international sales. Comparable store sales rose 14% (and even higher on a currency-neutral basis), with direct-to-consumer revenue comprising 42% of total sales. Meanwhile, per-share earnings of $2.28 beat estimates by 30 cents and rose more than 50%. Lululemon attributed the solid performance and continued momentum to customer loyalty (which means it doesn’t have to rely on aggressive marketing), product innovation and global brand expansion—accompanied by a “meaningful acceleration” in its China revenue trend. (China sales were up 80% in Q1 as the economic reopening progresses, with that country being a big part of the firm’s growth strategy; of the 30 to 35 new stores it plans to open this year, most of them are in China.) The company said it remains on track to deliver on its Power of Three ×2 growth plan, which is its international expansion strategy that calls for a doubling of annual revenue to $12.5 billion by 2026. For full-year 2023, Lululemon expects both revenue and EPS to increase around 17%, in line with Wall Street’s estimates.

Technical Analysis
LULU’s ride over the past year or so has been a wild one. From a peak last April at 405, shares collapsed to just under 260 in late May before firming up. A multi-month turnaround commenced from there until strong resistance showed up at 385 in December, leading to another trip lower. The mega-volume earnings move in March was a great sign, though the retail sector’s weakness yanked LULU down again—before another gap last week. We’ll set our buy range up from here, thinking follow-through on last week’s buying would lead to a real run.

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Stock 5

MasTec (MTZ)

Why the Strength
MasTec is a straightforward infrastructure play, though we’re not talking about roads and bridges here—the firm is focused on things like power delivery, communications infrastructure, oil and gas structures and, more recently, a variety of clean energy projects. The stock is strong today in large part because of some moves made by MasTec itself: Historically, it was heavily involved in oil and gas, which led to some good times but also some bust times, so management set out to diversify the business—and they have, with oil and gas now less than a third of orders, leading to steadier results from its other areas of business. Moreover, the firm is active on the M&A front (more than dozen smaller buyouts in the past couple of years), and most important, the industry is coming its way, with a building boom taking place: The top line has sped up in the past two quarters (up 32% and 66%), and while EBITDA and earnings can be lumpy, the future is bright as MasTec’s 18-month backlog has soared to $13.9 billion, up 31% from a year ago (as of the end of March). But even better than that is what’s to come, with the top brass going into detail in its latest conference call about the multi-year opportunities coming with 5G (building tons of new cell towers and connecting smaller cells), power delivery (upgrading and expanding transmission capabilities, partly to connect renewable energy sources) and oil and gas and clean energy (be it traditional projects for drillers or carbon capture and hydrogen-related equipment). After a hiccup last year, the earnings and EBITDA should rise north of 40% this year, with 2024 being another big growth year—all while the backlog and new orders remain strong. It’s a solid story.

Technical Analysis
MTZ fell to its bear market bottom near 63 in July and October last year before storming back during the next few weeks, rallying above its 40-week line for the first time since mid-2021. However, the spike into November didn’t lead to much, with a slightly higher high in March followed by a pullback during the market’s banking selloff. MTZ did hold its 40-week line, though, and now we see a change in character, with the stock lifting six weeks in a row (five of which on above-average volume) to nearly two-year highs. We’re fine grabbing some here or on a shakeout.

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Stock 6

Mobileye (MBLY)

Why the Strength
While most of the focus in the auto sector concerns the transition from internal combustion engines to electric vehicles, another big movement that’s coming full speed is the move toward more autonomous driving—and Mobileye is the go-to institutional way to play that. Today, much of the business is involved in the still-strong growth area of advanced driver assistance systems (ADAS), which started with things like backup cameras and blind spot detection but continues to advance to collision avoidance (both forward collisions and pedestrians and cyclists) and automatic braking systems, even for large commercial vehicles. It’s all based on the firm’s advanced chips and cameras (11 of them), as well as detailed surveys of nearly all the roads in the U.S. and Europe that allow its systems to “see” and anticipate potential accidents. That’s all to the good, and the ADAS market should grow 10% or so annually for many years. But the bigger opportunity is in Mobileye’s SuperVision offering, which is a hands-off navigation system that can handle standard driving functions on many road types (though still requires drivers to have their eyes on the road)—effectively the next step forward toward autonomous driving. More than 60,000 consumer vehicles are on the road with SuperVision today, mainly due to a big Chinese producer, but that should be a drop in the bucket compared to the potential down the road. It’s not all sunshine and roses—weakness in China is likely to keep 2023’s results under wraps (sales up 12%, earnings down from a year ago), but big investors seem to be focusing more on 2024 and beyond—not only are estimates very healthy for next year (sales and earnings up 30% or more), but Mobileye inked deals worth $6.7 billion of future revenue last year alone and sees the pipeline of opportunities even larger this year. (Porsche recently inked an ADAS deal with Mobileye, and will likely be a big customer of SuperVision down the road, too.) There will be some lumpiness in results as SuperVision ramps, and the valuation is up there, but there’s little doubt Mobileye is going to get much, much bigger going forward.

Technical Analysis
MBLY is another recent “shake and snap” name, as shares had a nice post-IPO rally to 48 in February, consolidated normally for a few weeks—and then were slammed after the Q1 report that lowered 2023 guidance, with the stock falling as low as 30 during the day. After a few days steadying itself, MBLY began to rebound, and as the market has improved, it raced all the way back to its old highs. That naturally brought in a little profit-taking last week, which looks normal—if you want in, you could nibble here and aim to average up on a decisive move north of 48.

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Stock 7

Palo Alto Networks (PANW) ★ Top Pick ★

Why the Strength
Industry analysts forecast that worldwide cybersecurity spending could increase 12% in 2023, to $219 billion, with an additional spending jump to $300 billion expected by 2026. The bullish spending trend has been a key driver for Palo Alto (covered in the April 10 issue), a leading player in the cybersecurity space with a recent focus on providing security solutions for hybrid cloud and remote workforces. Beyond traditional cybersecurity, Palo Alto also has exposure to the lucrative artificial intelligence (AI) boom, being an early participant in this technology after introducing machine learning (ML) capabilities seven years ago as part of its WildFire cloud malware protection offering. More recently, the firm rolled out the industry’s first ML-powered, next-generation firewall to prevent attacks and it has also overhauled most of its security subscriptions with advanced AI capabilities. The role of AI in cybersecurity was a major topic of discussion in the company’s fiscal Q3 (ending April 30) earnings call, which Palo said can “help deliver superior security outcomes in near real-time.” For the quarter, Palo’s billings increased 26% from a year ago, revenue rose 24% and remaining performance obligations (RPOs) soared 35%, while EPS of $1.10 beat estimates by 17 cents—all reasons for the stock’s strength. And the top brass expects the strength to persist, saying it sees “no impending recession and threats,” while adding that increased cloud activity and connectivity “continues to drive the threat environment” along with government-initiated regulatory mandates involving cybersecurity. For fiscal Q4, Palo sees billings and revenue increasing 18% and 26%, respectively, with earnings expected to boom over 60%. FYI, the stock is being added to the S&P 500 on June 20.

Technical Analysis
PANW held up better than all of its peers for much of last year, refusing to top until April and suffering an overall decline of less than 40%, far less than most others. Shares changed character after their low in January, racing to within 10% of their all-time highs, and then spent nearly three months chopping mostly sideways in a wide range. The March quarterly report brought a big-volume breakout, and last Friday’s S&P addition news caused today’s pop. We’ll set our buy range down a little from here.

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Stock 8

Samsara (IOT)

Why the Strength
The general cloud software field is perking up with the market and tech stocks, but we think the best opportunities will be with firms that are targeting large industries with sector-specific solutions that are saving clients time and money. Samsara might be the poster child for that: The firm’s platform is targeted at firms that have huge amounts of physical assets, such as state or city transportation departments, trucking firms, farmers, equipment rental outfits, oilfield service firms and more. The benefits here directly hit clients’ bottom lines—Samsara has best-in-class vehicle telematics (with to-the-second GPS tracking), which can dramatically boost the efficiency of drivers (less idling time, etc.); allows for huge boosts in safety (in-cab alerts and safety/driving training), resulting in big reductions in accident costs, workers comp claims and even lower insurance costs; streamline compliance activities for workers and the company itself; better use data to pre-emptively service vehicles before they sputter, drastically reducing downtime; and better secure sites and boost worker safety with AI-enabled cameras that can alert people when something is up. The idea simply makes sense, especially for large outfits that have a ton of assets (United Rentals, Iron Mountain, Werner Enterprises are clients), and the fact that Samsara is the leader here means its data hoard is a competitive advantage—and the top brass made it a point to say it’s been using AI to parse its data and improve its offering for many years. It’s a big idea, and Samsara is growing steadily—in Q1, annualized recurring revenue (ARR) was up 41%, and annualized recurring revenue for its largest customers was up 53%; 60% of net new ARR came from existing customers as they sign up for more services. Earnings and cash flow are near breakeven and expected to stay that way, but it’s looking like that may be conservative.

Technical Analysis
IOT came public just before the bear market got going, so it’s no surprise shares fell 70% or so from high to low. After a double bottom (with a little shakeout) in November, shares did improve, with a huge-volume earning gap in early March bringing the stock to 21. The next few weeks were choppy and included a big correction, but after steadying itself, IOT exploded higher again on earnings last Friday and followed through today. Shares are lower-priced and volatile, so if you want in, start small, aim for weakness and use a loose leash.

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Stock 9

Snowflake (SNOW)

Why the Strength
Data cloud company Snowflake has been a fundamental tech darling since its IPO a couple of years ago, and it’s easy to see why. Its products help customers connect big data to more intelligent software by providing cloud storage solutions that make analyzing and sharing information (even to outside suppliers and the like)—and turning those insights into actionable real-time decisions—simple. But lately, Wall Street has been questioning Snowflake’s future outlook in the face of a turbulent environment for cloud companies. Snowflake recently admitted that while long-term commitments to its offerings “have not changed,” some larger customers have cut back on storage (Snowflake charges on a usage basis) to save money in an uncertain economic outlook. Some of the questions will no doubt be answered at the company’s upcoming investor day presentation on June 27, in which Snowflake is expected to announce some “significant” new products. To that end, the firm has already been executing its growth strategy by expanding its platform while making acquisitions in the past several months (including Applica, Streamlit and more recently, search company Neeva), as well as introducing new products (like Unitstore). But the growth outlook remains the big question for Snowflake, as evidenced by Wall Street’s negative reaction to the fiscal Q1 report. Although the company easily beat top- and bottom-line estimates while reporting revenue that grew almost 50% from a year ago, analysts were disappointed the firm’s full-year product sales outlook was 4% below prior estimates. The pessimism is likely misplaced, however, since 1.) its net revenue retention rate is still healthy, and 2.) it expects product revenue to jump 34% this year, driven partly by AI workloads, while seeing machine learning and AI use cases on its platform “growing every day.” Long term, Snowflake sees revenues ramping to $10 billion by 2028, and the stock’s strong snap back (see below) tells us big investors are buying the dip.

Technical Analysis
SNOW fell out of favor last year, falling more than 50% amid the broad market bear. However, it found strong support at 110 last June and etched a bottom for many months, with successful retests in November and January, with shares holding the 130 area on the market’s banking crisis dip in March. More recently, SNOW rallied to near multi-month highs before getting hit on earnings—but then immediately snapped back last week to the 180 resistance area. We think the dip might have been the final shakeout; nibbling on a little weakness is fine by us.

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Stock 10

Trade Desk (TTD)

Why the Strength
Online advertisers are facing challenging times, with Google’s ad revenue recently dropping for a second straight quarter, while Meta grew ad sales by a mere 4% in Q1 (after three down quarters) in what some industry analysts describe as a “turbulent” digital advertising market. By contrast, Trade Desk has been experiencing solid growth thanks to its dominance in programmatic ad buying within streaming video services and connected TV (CTV) marketplaces—both of which offer ad-supported subscription tiers that cater to its business strategy. The company is the largest aggregator of connected CTV ad impressions across every major content provider, and its software platform allows advertisers to easily buy ad space across various platforms—including desktop, mobile and CTV—while quantifying the value of each ad placement and making real-time adjustments. Indeed, Trade Desk sees ad-supported streaming service platforms as a key part of its growth strategy and already counts big-name streamers like Disney and NBCUniversal among its partners. The company got off to a strong start in 2023, gaining market share as advertisers embraced the precision of data-driven advertising on the Trade Desk platform. Q1 revenue of $383 million increased 21% from a year ago, as the firm continued to “significantly outperform the digital advertising industry.” Per-share earnings of 23 cents beat estimates by 11 cents, with customer retention remaining over 95%. Trade Desk said 2023 will be a “pivotal” year for the industry as the shift from linear to connected TV accelerates while programmatic ads will feature more prominently than ever. For Q2, management guided for top-line growth of at least 20% and adjusted EBITDA of $160 million (up 15% if realized). It’s not the young buck it once was, but Trade Desk remains on the growth path.

Technical Analysis
TTD crashed from 114 in late 2021 to a low near 40 in May of last year, and it went on to test and hold that 40 level multiple times during the next many months. Finally, after a dip to 41 in early January, the trend turned up, with a spike to 66 after earnings in February. That led to a quick retrenchment, but TTD never breached its 50-day line and, recently, has let loose on the upside, registering new 16-month highs. We’ll set our buy range down a couple of points, thinking a near-term retreat is likely.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on June 12, 2023.