Cabot Top Ten Trader Issue: March 11, 2024

Extended Leaders Being Tested

Starting a month ago, we began to see some leaders chop around, with lots of volatility but not a lot of progress; even the Nasdaq itself is barely higher than it was a month ago. Then we saw more short-term froth appear (lots of gaps up, speculative moves among many names) followed by Nvidia’s monstrous reversal last Friday. We’re not making any grand declarations here, but overall, most of the “extended” leaders—and by that we mean names that have been running for three-plus months without any rest or pullback—are being tested, with more than a few wobbling and zeroing in on intermediate-term support and a few already cracking. Now, with that said, most of the other evidence remains fine, whether it’s for the overall market (trends up) or for “fresher” leadership names (usually outside of AI/chips/networking that have emerged in recent weeks), which continue to act well. We’re leaving our Market Monitor at a level 7, but how things play out over the next few sessions will be key.

Not surprisingly, this week’s list mostly lives outside the tech arena, with many names that have recently taken off and some that are pulling into areas of support. Our Top Pick is Eagle Materials (EXP), which blasted off in late January, enjoyed a big run and is now shaking out normally.

Stock 1

AeroVironment (AVAV)

Why the Strength
With multiple wars raging around the globe, the market for military unmanned aerial vehicles (UAVs) is booming. Just last week, for instance, the United Kingdom announced it was increasing production of military drones in the form of a $160 million UAV program to assist Ukraine in its war with Russia. Virginia-based AeroVironment is a leader in this space, specializing in technology that allows the modern warfighter and first responder to be more capable, more aware of their environment and more secure. Its products include unmanned aircraft systems and ground vehicles, UAVs and loitering munition systems (drones that hover over a target area before locating and crashing into it), all of which can be used for surveillance and reconnaissance by commercial industries and the U.S. military, as well as for actual attacks. One of AeroVironment’s more famous products is the Switchblade 600 drone (known as the “tank-killer”), which has been successfully battle-tested in recent years and is described as being “tremendously important” to the defense of Ukraine. Last week’s fiscal Q3 report (ended January) featured solid top- and bottom-line results, fueled by record demand and strong execution that has the firm on track for its best fiscal year ever. Revenue of $187 million increased nearly 40% year-on-year, while earnings of 63 cents per share nearly doubled from a year ago and beat estimates by 83% (reasons for the stock’s strength). Other highlights included “tremendous growth” in the loitering munition systems segment, which saw record Q3 sales as AeroVironment finished the quarter with a funded backlog of $463 million in future business (up 12%). Management said the firm is well positioned for double-digit revenue growth in fiscal 2025 (which starts in May) and raised full-year midpoint guidance to $705 million, up 30% if realized. Wall Street sees the bottom line more than doubling for 2024 and lifting 21% in fiscal 2025, which is likely conservative.

Technical Analysis
AVAV spent the first few months of last year stuck in a roughly 20-point lateral range and made no net progress through August. That changed in September as earnings blasted the stock out of the range and eventually pushed it to a yearly peak at 140 by early December. A pullback followed, with shares spending the next couple of months tightening up in close proximity to the 50-day line, prepping AVAV for last week’s blowout fiscal Q3 report that took the stock to a record high. We’re OK taking a swing at it after the late-week dip with a stop near the prior highs.

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Stock 2

Agnico Eagle (AEM)

Why the Strength
For months, gold took a back seat to higher-risk assets, but the yellow metal has just grabbed the spotlight once again with a powerful breakout to new all-time peaks after a multi-year consolidation. The charge higher is likely the result of the market’s perception the Fed will lower interest rates (many analysts see it happening as soon as June), boding well for gold prices while taking some wind out of the sails of the U.S. dollar. Benefiting from the metal’s recent strength is one of the blue chips in the group: Agnico Eagle, a senior Canadian producer with a pipeline of high-quality exploration and development projects in the U.S., Canada, Mexico and Columbia, and owner of two of the world’s largest gold mines. With gold prices remaining elevated last year, Agnico posted a solid fourth quarter that capped a record year across several metrics. The company reported an all-time high in gold mineral reserves at 54 million ounces (up 11% year-on-year), plus a stable production profile at what it described as “industry leading costs,” anchored by its stake in Canada’s two biggest gold operations, Detour Lake and the Canadian Malartic mine. Revenue of $1.8 billion increased 27% from the year-ago Q4, earnings of 57 cents beat estimates by seven cents and free cash flow was a record $300 million. Payable gold production also hit a quarterly record of over 900,000 ounces at production costs per ounce of $861, with all-in sustaining costs (AISC, a key metric) of $1,227—miles below the current gold price of nearly $2,200 and a further reason for optimism going forward. To that end, the top brass declared the company’s three-year outlook “stable,” with payable gold production expected to range between 3.4 and 3.6 million ounces annually between now and 2026, while AISC is also expected to remain tame, remaining around recent levels for the foreseeable future. Analysts see revenue increasing around 10% in each of the next few quarters, but that’s likely too low if this breakout leads to a run in the yellow metal.

Technical Analysis
AEM doesn’t have a typical Top Ten-type chart, but there are more than a few positives here. First was the fact that, thanks to a solid rally in late 2022 and early 2023, the stock has easily held above its bear lows. Second, support in the 45 range has been tested three times in the past year and held each time. And now we’re seeing real accumulation, with big-volume support off that support area last month followed by five straight big-volume buying days as gold began to get going. We’re OK starting small here and adding more on continued strength.

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Stock 3

Apollo Global (APO)

Why the Strength
The market may be getting volatile here, but the long-term trend is up and, just as important, the Federal Reserve seems likely to ease sometime in the months ahead, both of which bode well for Bull Market stocks like Apollo. The company has $651 billion of assets under management with a heavy emphasis on credit-related asset management and retirement services; the firm sees a huge opportunity as the landscape has changed dramatically over the past decade or two, with private credit (instead of banks) making up 20% of the market, up from just 4% in 2000. Like most peers, Apollo has placed a greater emphasis on fee-generating assets ($493 billion of the total) that produce consistent income, while spread-related earnings (money lent out at higher rates than it’s borrowed) are big, too, both of which combined to produce a solid Q4 and 2023 as a whole—fee and spread earnings totaled $1.95 per share in Q4 and north of $8 per share for all of 2023 (up around 25% from the year before), with a chunk of that being returned to shareholders (1.7% dividend yield, modest share buyback program). However, the bigger idea here is that an improved investing environment will result in far more assets coming in the door—inflows were $32 billion in Q4, which is decent, but that will move up in a big way if sentiment improves. Indeed, even beyond the tailwind from a better market, Apollo’s top brass has an intermediate-term goal of $1 billion of total assets and fee- and spread-related earnings of more than $9.50 per share by 2026—and it’s tracking well ahead of those figures. Bottom line, if the bull move remains intact (with normal dips and corrections along the way), Apollo’s asset base and earnings power should grow nicely.

Technical Analysis
APO is never going to be the market’s fastest-moving name, and indeed, after hitting new highs last summer and fall, the stock wasn’t the biggest mover when the market got going in November. Even so, shares did act well and eventually did show some power, with eight weeks up in a row (including the last four on above-average, accelerating volume). And now we see APO starting to exhale, with a well-controlled dip as its moving averages catch up. If you want in, we’re OK with a position here and a stop under the century mark.

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Stock 4

Block (SQ)

Why the Strength
Block sells cutting-edge software and hardware payment products that facilitate digital payments for businesses of all sizes. It operates through two segments, Square and Cash App: The former provides real and virtual terminals, hardware products and software solutions for restaurants, retail, point of sale and online checkouts, while the latter facilitates peer-to-peer payments and offers Bitcoin and stock investment brokerage services. Beyond digital payments, the fast-growing Cash App (one of the most popular financial apps) is pivoting toward becoming a digital bank (a so-called “bank in your pocket”) on par with major traditional lenders in terms of its customer offerings. Through its partners Sutton Bank and Wells Fargo, Cash App offers debit cards, direct deposit and even no-fee savings accounts with up to 4.5% interest rates on deposits. Today the digital banking service accounts for about two million paycheck deposits, or 3% of the firm’s monthly Cash App active users. But persuading Cash App users to become its bank customers is a big part of the company’s growth plans going forward. Another part of the growth strategy is the Cash App Card, a free, customizable debit card connected to a customer’s Cash App balance. The card reached 23 million active users in Q4, more than 40% of the firm’s total active base (up from 20% a year ago), which Block says is one of its most successful products and pivotal for growing its direct deposits. Combine all of that with a lot of cost cuts in recent quarters, and the financial front is looking very solid, with stellar Q4 results prompting several big Wall Street institutions to raise their target prices (a reason for the stock’s strength). Revenue of $5.8 billion lifted 24% from a year ago, while EBITDA came in at $562 million, about double what was seen last year. And looking ahead, the top brass sees EBITDA rising 47% this year, though it also said it thinks its guidance will prove conservative. Block remains a solid growth story.

Technical Analysis
SQ had a huge bear market collapse and actually knifed down to new lows last October near 40, but the stock attracted new buyers after that, turning up on a dime and pushing back to 80 by year’s end—a resistance area (80 to 85 or so) that’s been in place for over a year. SQ backed off from there in January, but the result has been a well-controlled launching pad with the recent earnings pop tight trading a good sign. Minor weakness would be tempting.

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Stock 5

Eagle Materials (EXP) ★ Top Pick ★

Why the Strength
Construction spending from the federal infrastructure spending bill passed in 2021 is expected to increase substantially in the coming years, and that’ll be a boon for Eagle Materials. The Dallas-based firm produces both heavy and light construction materials, including concrete, construction aggregate, gypsum, wallboard and sand for hydraulic fracturing, and it expects to benefit from this spending trend—as well as from what it sees as a long-term tailwind in private non-residential spending. What’s more, Eagle expects an additional boost from increased heavy industrial projects focused on computer, electric and the onshoring of semiconductor manufacturing as a result of many subsidies and incentives included in the CHIPS and Inflation Reduction Acts of 2022. The company further believes the downturn in residential construction is bottoming thanks to lower mortgage rates and a nationwide housing deficit, with each of these factors contributing to a positive outlook for materials demand in 2024 and beyond. Against this favorable backdrop, half of Eagle’s markets have just implemented price hikes, with the other half to increase prices in April. In fiscal Q3 (ending December), revenue of nearly $560 million increased 9% from a year ago, with earnings of $3.72 per share up 165% topping estimates by 17 cents. The solid results were led by an 18% rise in the firm’s Heavy Materials segment (concrete, cement and aggregates), due mainly to higher cement sales, plus higher aggregate sales volume and record concrete pricing (up 13%). Eagle’s gypsum wallboard business continues to benefit from a long-tail construction backlog that has kept demand steadier than expected in its key domestic markets. Management described the near-term outlook as “dynamic” and expects stronger conditions for housing and wallboard demand in the second half of 2024. Wall Street sees 6% sales and 14% earnings growth this year, though it should exit the year showing faster growth than that.

Technical Analysis
Like most construction peers, EXP’s situation turned on a dime in November, with shares rallying back to marginal new highs within a few weeks—and then it proceeded to trade super-tightly for a few weeks, a bullish sign. The earnings breakout was powerful and led to a huge-volume rally that has finally run into some selling during the past two days. We wrote up EXP a month ago and missed our entry point—but now we’ll take another swing at it, as entering here with a stop near the 50-day line seems like a decent risk/reward.

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Stock 6

On Holdings (ONON)

Why the Strength
On Holding is a Swiss company that specializes in athletic footwear, especially running shoes that use the company’s CloudTec system to provide soft landings and a strong rebound to help athletes into their next step. It’s a young business as far as the competitive footwear industry goes, founded just over a decade ago, and it came public less than three years ago. But On’s shoes have a cult following and some high-profile sponsorships, including men’s tennis legend Roger Federer (who’s an investor and helped develop his own On tennis shoe) and fellow tennis star Iga Swiatek, who won the French Open last year after inking a sponsorship deal. A big part of the story is the firm’s expansion into new areas—running was the first step, but obviously, tennis is growing while offroad/hiking is a new area, along with apparel and even kids offerings. Essentially, the upside here is that On can become a mini-Nike or Reebok of sorts if the top brass pulls the right levers, and it doesn’t hurt that many people wear the brand casually thanks to comfort and that the brand is popular. Business has been growing fast, with sales in the third quarter (reported in November) rising about 47% in local currency terms to the equivalent of $525 million, with EBITDA up 44% and earnings booming. But all eyes are on tomorrow morning, when the company will release Q4 results—consensus expectations are for sales of CHF453 million (about $516 million), which would be a 23% rise over the prior year quarter. Net income per share of about CHF 0.22 would be well ahead of last year too. Even so, it will mostly be about the 2024 outlook—something much better than expected could bring in the buyers.

Technical Analysis
ONON looked to be blasting off a year ago, when Q4 results caused the stock to go wild on the upside—but shares never could kick into gear after that, leading to a good-sized correction last fall (37% from high to low) and what’s eventually morphed into a year-long consolidation. That said, there have been some positive signs of late, including the fact that shares rallied five weeks in a row to seven-month highs, and that leads us to tomorrow’s report: A strong gap up would likely be an opportunity to start a position.

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Stock 7

Pure Storage (PSTG)

Why the Strength
Pure Storage is a cloud-based storage (and storage-as-a-service) business that pitches corporate customers on abandoning their legacy data archiving operations and switching to its all-flash drive systems to save money and risk, since flash is both cheaper at scale and not prone to physical breakdowns like even the most reliable hard drives. There are lots of cloud storage players out there, but management says what it has is different because Pure Storage operates only flash drives, giving it an operational and cost edge. The company says customers pay roughly half of what a traditional provider charges, and as the business gets larger economies of scale, costs should be hammered down even further. Of course, all of this is already a nice growth business as corporations age out of their existing on-premise systems, but the emergence of AI appears to be speeding up cloud adoption and boosting storage needs. That’s because companies see the fragmentation of their data as holding them back from taking advantage of AI, so they’re seeking to migrate disparate systems onto one of Pure Storage’s platforms. The high energy usage of AI adds to the migration appeal, with Pure Storage saying it can cut electrical usage by 20% in its environments compared to traditional setups. The combination means that Pure Storage’s subscription services Evergreen and One doubled in sales in its fiscal 2024, reported February 28, accounting for about 40% of sales at year’s end. Management is saying this year’s revenue will grow about 11% to $3.1 billion with earnings per share advancing about the same to $1.55, but those numbers are being held back in part because of the move toward more subscriptions (smaller payments up front, larger over time). Indeed, in Q4, annualized recurring revenue was up 25% despite the 3% revenue decline. It’s a solid long-term growth story and the AI kicker is finally helping investor perception.

Technical Analysis
PSTG had a big rally a year ago when the AI frenzy first got underway, but the stock essentially went sideways from last July through February as investors waited for evidence the boom was underway. The Q4 report wasn’t a blowout, but it’s clear that investors are now looking ahead to better times—shares gapped up more than 30% over two days following the report, and while it’s sold off with other tech names the past couple of sessions, PSTG is in fine shape. We do expect volatility given the wobbles in the leaders, so we’ll set our buy range down a bit from here.

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Stock 8

Samsara (IOT)

Why the Strength
While the stock has been super choppy for months (more on that below), Samsara is a name we’ve always kept an eye on for one simple reason: The company has emerging blue chip written all over it, with a huge runway of rapid and reliable growth ahead thanks to a one-of-a-kind story. The firm is the leader in offering cloud software to firms that have tons of physical assets. Whether it’s a city’s department of transportation, a distribution firm that has a huge fleet of trucks, an oil and gas operator with tons of equipment or even an airline with lots of on-the-ground assets, Samsara and its gigantic moat of data (last year alone it collected more than nine trillion data points) dramatically boosts a client’s bottom line through vehicle telematics, video-based safety monitoring, safety training, equipment monitoring and more that result in fuel savings, fewer accidents, lower insurance premiums, lower maintenance costs (pre-emptive repairs instead of waiting for something to start smoking) and improving utilization. And Samsara is broadening both its offerings (digitized forms for frontline workers to enter inspections, incident reports and more) and expanding outside the U.S., too (16% of net new recurring revenue in Q4 was international). The size of the opportunity is enormous given how much equipment/trucks/everything is out there, and Samsara is making steady progress in capturing it: In Q4, not only did annualized recurring revenue lift 39% (to $1.1 billion), but net new ARR inked in the quarter was $99 million (about half from new clients, half from existing customers that are boosting purchases), up 39% from a year ago and a big acceleration from recent quarters, all while clients keep paying more money (1,848 pay at least $100k per year, up 49% from a year ago). The hitch here is valuation, which is very large, but the top brass is bullish, seeing 30%-ish revenue growth this year, and it usually lowballs those outlooks.

Technical Analysis
IOT has made some progress over time, but the vast majority of that has come from earnings gaps higher (good) that quickly run into some resistance (not good). To be fair, this setup looks better than the prior ones, mostly because the stock’s recent consolidation was straight sideways (19% from high to low, compared to a tough 34% drop in the second half of last year) and last week’s volume was IOT’s heaviest ever. We’re game to take a shot at it—though we advise starting small in case the sellers reappear.

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Stock 9

Sterling Infrastructure (STRL)

Why the Strength
Companies that specialize in sustainable infrastructure projects are on the move right now, thanks to a boom in federal infrastructure spending (Congress has already invested $12 billion in “clean” energy infrastructure since 2022, with billions more allocated). Sterling is a leader in this category, providing building and transportation solutions through its subsidiaries. There’s Sterling’s Building Solutions segment that provides residential and commercial concrete foundations for single-family and multi-family homes, parking structures, elevated slabs and other concrete work. And there’s also its Transportation Solutions business, which includes infrastructure and rehabilitation projects for roads, bridges, airports, ports and light rail systems. But E-Infrastructure is the main attraction here, has the biggest upside among Sterling’s operations and is the most profitable segment as it serves as one of the world’s largest specialty site developers for customers in the e-commerce, data center, distribution center, warehousing and energy sectors. For full-year 2023, E-Infrastructure revenue grew 4% and profit grew 16% while operating margins also expanded and (most important for investors) the segment backlog rose 35% from a year ago, led by a move toward large multi-phase projects. Data center demand was the largest contributor to awards in Q4, as customers are “racing to build the capacity needed for AI technology.” This in turn contributed to an 8% year-on-year increase in total revenue, earnings of $1.30 that beat estimates by 30% and a 37% jump in adjusted EBITDA (all reasons for the stock’s strength). Sterling finished 2023 with a backlog of more than $2 billion in future business (up 46%), and management is confident the momentum can continue, anticipating another year of bottom-line growth “well in excess” of sales growth, led by continued strong demand for new data centers, transportation projects and residential construction. Wall Street sees 11%-ish top- and bottom-line growth this year, but it’s a good bet those will prove too low.

Technical Analysis
STRL had a terrific run from its bear low in 2022 into August of last year, when a great Q2 report gapped the stock to just above 80. Then came a well-deserved consolidation that included a good-sized shakeout to the 40-week line in November and, after testing new high ground near year’s end, a more controlled basing period in January and February. Now STRL is off and running again thanks to the blowout Q4 report. We’ll set our buy range down a bit, looking to enter on a bit more weakness.

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Stock 10

Toll Brothers (TOL)

Why the Strength
Every week brings another handful of key economic reports and speeches (we have an inflation reading this week), but when you step back and look at the facts, you see that (a) leading economic indicators remain in good shape, (b) mortgage rates have very likely already seen their cycle highs, with the latest retreat helping the cause and (c) the Fed seems more likely than not to be cutting rates sometime during the next few months. Add in a very low supply of new homes, and we think homebuilders can continue to surprise on the upside—and that especially goes for the names with exposure to the higher end of the market, where inflation and lingering economic uncertainty aren’t much of a factor. Thus, it’s not surprising that Toll is probably the best performer in the group, bolstered by a sterling Q4 report in late February—not only did sales rise 9% and earnings leap 32% in the quarter (earnings were 24% above expectations!), but the vital forward-looking measures impressed, with net signed contract value of just over $2 billion rising a huge 42% from a year ago. As is the case in most quarters, Toll saw a big percentage of its buyers pay in cash (25%), and even among those that took a mortgage, the loan-to-value ratio was just 67% (putting down 33% on average), which was down two percentage points from the average of the prior four quarters. Looking ahead, management is bullish because of all of the above factors, believing its fiscal year (ending in October) earnings won’t just hold up but will actually push higher by 10% or so. Obviously, if the macro picture significantly changes (huge housing supply comes online, major recession, etc.), then that would alter the outlook—but the most likely outcome is a continued bullish environment for Toll and peers for many quarters to come.

Technical Analysis
TOL has followed the path of most homebuilding stocks, with a move to new highs last summer, a tough early-autumn dip through October and then a stunning recovery that saw the stock move straight up from 68 to 106 in a month and a half. TOL then tightened up for 10 weeks, and following its quarterly report, is showing solid strength, with shares gapping to new highs three weeks ago and motoring higher since. As with most stocks, we’re aiming to enter on further dips.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on March 18, 2024.

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