Cabot Top Ten Trader Issue: March 13, 2023

Air Pockets

What was promising action two weeks ago got off to a bad start last week (with further Fed jawboning), but it was the late-week collapse in regional banks (sector down 16% last week and much more today) that caused the market to hit one giant air pocket. You’ve undoubtedly read the headlines and stories, so we’ll skip that and do what we usually do—get into the evidence. Clearly, at this point, the intermediate-term trend has turned down and the broad market is under a lot of pressure; we’re not in the business of catching falling knives, so we’re in the better-safe-than-sorry camp. That said, there are still many potential leaders in a variety of fields that are pulling back sharply, but normally—including some (like many from last weeks issue) that are hardly giving any ground at all. That doesn’t mean they can’t give up the ghost, of course, but at this point we’re playing some defense—we’re moving our Market Monitor to a level 5—but also taking things on a stock-by-stock basis, which means giving some resilient names a chance.

This week’s list has a collection of mostly resilient names, with some steady actors but also a few true growth stories, too. Our Top Pick is a young upstart—Samsara (IOT) has a great story and a powerful chart. It’s certainly higher risk, so keep positions small and look for weakness.

Stock 1

Arista Networks (ANET)

Why the Strength
Despite lingering supply chain issues, Arista easily beat expectations in its fourth quarter reported last month, showing strength in all its customer verticals, including the core group of the Cloud Titans – dominant Internet businesses including Meta and Microsoft that require huge amounts of infrastructure, like Arista’s switches, that direct reams of data through the Internet and corporate data centers. Those two customers alone accounted for 41% of Arista’s $4.4 billion of sales in 2022. The concentration isn’t ideal, of course, but it comes from a position of strength: Both are spending massively to deploy Arista upgrades into their global networks. Corporate customers overall have been spending to boost the speed and throughput of data on their corporate campuses and have also pivoted to add more spending on distributed networks, accommodating the larger group of work-from-home and hybrid office workers spawned by the pandemic. That means Arista expects strong growth to continue this quarter, with management saying sales should hit $1.28 billion, 45% greater than a year ago. Arista has no direct exposure to consumers, meaning recent weakness in demand for home networking hardware and devices won’t affect it, but general macroeconomic concerns and the potential for client spending caution could be headwinds down the road. Arista management doesn’t discuss order backlog but sounded a confident note on that topic. With low debt and lots of cash, Arista is well-positioned to remain a leader in cloud networking. Expect full-year 2023 sales of $5.5 billion and EPS $5.80 – both would be 27% gains year-over-year.

Technical Analysis
ANET had a huge gap up in late 2021 as it was clear demand from its cloud clients would boom, but with the market topping out back then, the stock hasn’t been able to get going, with a dip as low as 90 last summer and repeated tests when the market gets weak. However, the end result now is that ANET has built a huge, year-and-a-half-long launching pad—the stock picked up steam this year, nosed to new highs last week and has pulled in grudgingly since. If you’re game, you could nibble here or on further dips with a stop near 130.

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Stock 2

Dick’s Sporting Goods (DKS)

Why the Strength
Many retailers are feeling the lingering effects of inflation as consumers rein in spending on items like apparel in particular. Sporting goods and apparel retailer Dick’s, by contrast, has managed to buck this trend thanks to a post-pandemic surge in health consciousness among its customer base. The results have been astoundingly positive for the company, which just announced plans to open 20 Dick’s branded House of Sport store locations nationwide through 2024, with possibly as many as 100 locations in the coming years. The stores, which the firm describes as “multi-sport experiences inside and outside” (and a key part of its growth strategy), allow customers to test out sporting gear in actual field conditions, including climbing rock walls, running on tracks, using batting cages or trying out golf clubs on putting greens. Additionally, Dick’s plans to convert over 100 stores to premium full-service footwear outlets while taking the “elevated athlete experience” to over 75% of its locations. Dick’s also exceeded comp sales expectations in Q4, growing comparable store sales by over 5% from a year ago, increasing revenue by 7% and posting per-share earnings of $2.93 that beat the consensus by four cents. For the full year, the company reported record sales of $12.4 billion that rose 1% from 2021, but soared over 40% from pre-pandemic 2019, prompting Dick’s to more than double the quarterly dividend (2.7% yield). Big picture, the pandemic earnings boom was expected to vanish, but instead, demand has remained resilient and earnings are still elevated at $12 per share last year vs. $3.69 in 2019—and several big institutions have raised guidance, looking for double-digit bottom line growth this year.

Technical Analysis
DKS was the dog’s dinner after hitting a peak in September 2021, as it ended up getting cut in half by the time the selling wave ended nine months later. But as it turned out earnings weren’t retreating the way many thought, shares recovered—the stock established a bottom above 70 last June, catapulted above the 40-week line in August and after a few months of choppy, sideways trading, has extended itself to the upside this year. Last week’s high-volume earnings gap looked good, but we’d favor aiming for dips given the market.

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Stock 3

DraftKings (DKNG)

Why the Strength
This past weekend, Massachusetts became the 33rd state allowing mobile sports betting. DraftKings is one of six approved sportsbooks that have gone live to serve what is estimated to be a $310 million annual state market. Investors love the fast growth of the U.S. sports betting market; it was only in 2018 that federal restrictions on expanding sports wagering was struck down by the Supreme Court. Since then, Americans have bet $200 billion on sports, generating $15.4 billion in sportsbook revenue. There are dozens of sports books all trying to grab a share of the exploding U.S. market, and some of those probably will fail, but DraftKings is widely expected to be one of the firms left standing, if not leading the way. This year the business should see $3.1 billion in revenue, nearly 10 times what it was four years ago. Customer acquisition and retention costs have been the big concern of Wall Street, but DraftKings appears to be gaining traction as it grows: Last quarter the company lost 53 cents a share, nine cents narrower than expected, while generating 81% more revenue at $855 million with 31% more unique customers. The incentives sportsbooks are offering to gain customers in new markets shows some newfound discipline that is helping calm investor worries. Last year, as New York opened to mobile sports wagering, DraftKings offered bettors up to $5,000 additional money in deposit matches and risk-free bets; with Massachusetts, the same offer is “just” $1,500. There remains lots of growth ahead: Just 36% of Americans are able to bet legally now, plus betting volume is seen increasing as new products, like betting during games on outcomes of the next play, become commonplace. Long term, DraftKings should be able to clock 20% annual top-line growth for the foreseeable future, and near term, cash flow is working its way toward breakeven.

Technical Analysis
Sports betting stocks peaked two years ago after costs overwhelmed excitement over revenue for the sector. DKNG was no exception, falling from 74 to 10 last summer. That kicked off months of super-choppy bottoming action, with tests of the 10 to 11 area multiple times through year-end. But that led to DKNG moving nicely higher in January and popping higher on earnings in February. The pullback in this lower-priced name has been sharp but reasonable since then—if you’re OK with using a loose stop, we’re fine with grabbing a few shares on a bit more weakness.

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Stock 4

Frontline (FRO)

Why the Strength
Given what’s going on in the world right now, the strongest stocks in the market tend to be those with solid, reliable growth prospects. Frontline … is not one of those situations, as it’s one of the largest oil tanker transport firms out there, with a fleet of 66 ships of varying sizes on the water that’s young (just five years old on average) and relatively energy efficient, which fetch them higher dayrates. All in all, Frontline took the industry’s down times to shape things up, and it also canceled its buyout of Euronav, which cleans up the story a bit. And that could lead to huge upside for a couple of reasons: First, even at the average dayrates from the past two decades, Frontline thinks it can crank out free cash flow of $2.50-ish per share annually, while at current rates, it’s more like $4 per share (which Q4 showed). And, second, the top brass is very bullish on the future, with (a) China’s economic reopening going ahead, (b) the Russia invasion still causing disruptions and (c) industry-wide, supply will be tight, with giant lead times and tiny order books (2022 was the lowest in decades) meaning that capacity could shrink in 2024 for the first time since 2002! Now, to be clear, long-term projections in the tanker sector should be made in pencil, but it’s looking like cash flow here will be healthy-to-fantastic for at least many quarters to come—and because it pays out most of that as dividends (77 cents payable March 31; the figure varies by quarter) it should keep many investors interested.

Technical Analysis
FRO began to pick up speed last summer, racing to multi-year highs as business turned up. There were deep pullbacks with the market in September/October and again in December (that was also related to acquisition uncertainty with Euronav), but it’s been a homesick angel since then, soaring to 19 before shaking out with the market the past couple of days. It’s a risk for sure, but we’re OK with a nibble on this dip as long as you’re willing to use a stop near the 15 area (just below the 50-day line).

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Stock 5

Meta Platforms (META)

Why the Strength
2022 was a year Meta (formerly Facebook) would rather forget. Earnings fell nearly 40% while costs and expenses rose 23%. What’s more, big spending on CEO’s Mark Zuckerberg’s widely touted virtual world concept (dubbed the “metaverse”) has been a drag on the company, with Meta’s Reality Labs (the metaverse segment) being the main contributor to last year’s profit slump and stock implosion. Not all the news is bad, however, as some key metrics show that Meta’s core business is still doing fairly well despite the metaverse-related setbacks. Daily active users of the firm’s Facebook platform recorded two billion daily active users as of December, an increase of 4% from a year ago. More impressively, the Family of Apps (FOA) segment, which includes Facebook, Instagram Messenger, WhatsApp and other services, posted an average daily active people (DAP) of around three billion for December (up 5%)—the highest it has ever been. More importantly for investors, ad impressions across the FOA increased 23% in Q4 and on the cost front, the top brass got the market’s message after last year: The company has big plans for 2023, calling it the “year of efficiency,” as more cost-cutting measures are coming along with a focus on increasing profitability. Meta also plans to deploy more artificial intelligence (AI) tools to enhance the productivity of its engineers and boost the revenue-per-minute generated by Reels, its short-form video product (Meta’s answer to TikTok). Meta is also exploring a new text-based social network (codenamed P92) that would compete with Twitter. Wall Street sees an earnings turnaround, with a 12% earnings gain this year and 21% in 2024, both of which are likely conservative

Technical Analysis
META reached an all-time peak at 382 in September 2021, then fell off a cliff during last year’s bear market. The decline ground to a halt in early November at 90, with shares bouncing to 125 by December. Four weeks of tightening followed, which paved the way for the moonshot to 200 early last month after Q4 earnings and the talk of 2023 belt-tightening. The recent dip has been well controlled, especially given the market environment; if you’re game, you could nibble here with a stop under the 10-week line.

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Stock 6

Samsara (IOT) ★ Top Pick ★

Why the Strength
Now here’s a new name with a very big idea: Samsara is a cloud software operation that focuses on firms with large physical operations—think about a trucking or shipping outfit, a big farming company or even departments of transportation for cities or states, all of which have tons of trucks, plows, harvesters, haulers and so on. Samsara has become the best way for these organizations to dramatically boost efficiency: Its platform helps with telematics (real-time info on the entire fleet) that can boost safety and even idling time; offers video-based safety apps (and in-cab alerts!) for drivers; the digital inputting of driver reports; and even diagnostic data of the fleet so the most needy machines get servicing to prolong their life. Taming insurance premiums (a huge expense for these kind of firms) is also a huge draw, with the platform using AI to analyze driver behavior and even road conditions to cut back on potential accidents—and, more important, records the data so insurance outfits can better underwrite the entire fleet. It’s a huge idea, and to be fair the valuation here is big ($10 billion on a $750 million revenue run rate), but the potential looks even bigger and Samsara is starting to sign up some bigger fish. Revenues have been cranking ahead nicely and topping estimates, while the number of clients that are buying at least $100k each year is growing even faster (north of 50% in Q4) and free cash flow should reach breakeven by year-end. We think there’s a long runway of growth in this enticing niche.

Technical Analysis
IOT came public in late 2022 and was crushed after that as the bear market got going; shares plunged from near 30 to about 9 in May, and after a summer rally, dipped to a slightly lower low in November. The initial bounce from there was just OK, but IOT has changed character this year, rallying persistently through February and gapping up on gigantic volume after Q4 results this month. It’s not for the faint of heart, but further weakness could be tempting for a starter position.

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Stock 7

TechnipFMC (FTI)

Why the Strength
Remotely operated vehicles (ROVs) are used to explore ocean depths for oil and gas deposits and are also used in other subsea applications (such as repairing underwater equipment), allowing companies to reach depths not possible with divers. This is where U.K.-based TechnipFMC comes into play. The company is a global leader in traditional and renewable energy solutions, providing design, engineering and manufacturing of the systems used to access energy resources on land and at sea—including what are regarded as the world’s most advanced ROVs, manipulator arms and exploration submarines. With major producers like ExxonMobil, Shell and Petrobras planning multi-billion-dollar subsea projects in the next two years (projects that won’t be pulled because of minor swings in prices), TechnipFMC has a large potential growth runway ahead of it. This was highlighted in the company’s latest earnings, which boasted a backlog of inbound orders (a key metric) in Q4 that increased 22% from a year ago (up 20% for all of 2022) to over $9 billion across both its subsea and surface technology segments (and which will take years to be filled). Although the company reported a per-share loss of five cents in Q4, it posted solid revenue of $1.7 billion (up 11%) and free cash flow of over $500 million (easily over $1 per share). For 2023, TechnipFMC is targeting full-year revenue growth of around 12%, with adjusted EBTIDA expected to reach $870 million (up 34% if realized). Management is also committed to shareholder returns, repurchasing $100 million in shares last year, with plans to initiate a dividend in the second half of this year. Yes, it’s an oil service firm at heart, but Technip has some certainty to its growth outlook that should keep investors interested.

Technical Analysis
Like most peers, FTI was a nothingburger for a few years as the oil sector languished, and even its post-pandemic run wasn’t anything to write home about. But since last summer, the stock’s character has changed as business, orders and cash flow have lifted. FTI has been in a solid uptrend since, with the late February earnings lift giving way to an acceptable market-induced weakness since. We’ll set our buy range up a bit, thinking a strong bounce off the 50-day line would be a good sign.

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Stock 8

Terex (TEX)

Why the Strength
Aerial work platforms (AWPs) are used to help workers safely deliver tools and materials to high places in construction projects, and they’re in high demand for commercial building and electrification projects. Terex offers materials processing machinery (crushers, chippers and shredders) and mixers (mainly cement trucks) used in a variety of industries, including construction, energy, recycling, minerals and materials management. It’s the company’s industry-leading AWPs (scissor lifts, tower and rough-terrain cranes) that are the main attraction, however, and an aging global fleet, historic loan dealer inventory levels, plus strength in the non-residential building sector (thanks to both private and public demand) should contribute to a buoyant market for the foreseeable future. This was underscored by a strong year-end earnings report that showed healthy consolidated bookings levels for 2022 (and the second-highest bookings rate in recent history). Significantly, the backlog of over $4 billion increased 22% from a year ago, covering around 70% of this year’s revenue. Total Q4 revenue was $1.2 billion (up 23%) with full-year sales of $4.4 billion increasing 14%. Per-share earnings of $1.34, meanwhile, beat estimates by 21 cents. The company was able to keep costs in check in 2022 in spite of inflationary pressures and supply-chain disruptions, and management is focused on a multi-year growth plan that includes capitalizing on long-term growth trends in electrification and infrastructure spending. For 2023, Terex guided for sales of around $4.7 billion (up 7% if realized) and EPS of $4.80 at the midpoint (up 11%), though Wall Street sees those as conservative. A modest valuation (12x trailing earnings) also helps.

Technical Analysis
TEX was nailed with everything else early last year, but then built a base consisting of a series of higher lows between July and September. The basing process was short-lived but strong enough to support the powerful uptrend that has been underway since October and especially in the new year, with many weeks of massive volume pushing TEX up before and after Q4 earnings. The recent dip was sharp, but sets up a potential trend-knockout scenario—we’ll set our buy range up from here, thinking a strong bounce could mark a resumption of the rally.

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Stock 9

Transdigm (TDG)

Why the Strength
Big investors are always looking for steady growth, and that’s particularly true as we see a potential banking crisis and increased odds of a recession coming. Transdigm fits that mold, with a sturdy business tied to a long-term trend and with a big moat around its business. The firm is one of the major suppliers to the aerospace industry, making everything from batteries and cockpit security systems to various pumps and valves for planes; according to the firm, 90% of its products are proprietary and it’s the sole supplier for something like three-quarters of its offerings, which obviously is a good thing. Also helping is that the firm isn’t just tied to Boeing or Airbus’ production, which as we’ve seen in recent years, can be a bit helter-skelter; about 60% of revenues are from commercial clients (that’s the main growth driver) with 40%-ish defense, and a full three-quarters of its EBITDA is from after-market services/repairs, which is vital as it effectively means Transdigm gets years of recurring-type revenue as planes age. (That aftermarket figure should come down a bit as Covid artificially boosted it, but it’s still the big dog.) Combined with a handful of mostly of bolt-on acquisitions each year and the company has an enviable record of growth that should continue: Q4’s numbers glided past estimates, and management hiked estimates for EBITDA and earnings for 2023, with Wall Street now seeing 30% and 20% earnings growth for 2023 and 2024 (respectively). The valuation isn’t a bargain, but Transdigm is a proven growth outfit that should crank out solid numbers for years to come.

Technical Analysis
TDG topped in the 680 area in early 2020 before the pandemic crash, and then rallied back to that area by mid-2021. But it never got above there, and the stock flattened out for most of 2022 as well, dipping to 500 a couple of times before finding support. But then TDG turned up, rallying nicely, tightening up in December and moving to new highs this year with a persistent uptrend. The dip in recent days is sharp, but like some other names, sets up a trend-knockout situation; we’ll set our buy range up from here, looking for strong snap back to enter.

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Stock 10

WW Grainger (GWW)

Why the Strength
Grainger is a top industrial supply and equipment provider, with its offerings running the gamut and with retail locations in numerous countries. Stellar Q4 results were the reason for the strength, as shares popped in early February after Grainger reported revenue of almost $4 billion that missed expectations but increased 13% from a year ago, led by strong price realizations and strength in its High-Touch Solutions segment (North American customers with complex buying needs); that segment benefited from lower freight costs and continued improvement in product mix and saw sales rise 17% in Q4. Grainger’s fastest-growing division in the quarter was Endless Assortment, its online-only business which includes Zoro.com and Japan-based MonotaRo.com. It grew 18% in Q4, driven by “strong” new customer acquisition and repeat business, as well as enterprise customer growth. Meanwhile, earnings of $7.14 per share beat estimates by 13 cents and clipped ahead by 31%. The company said it’s off to a solid start this year and expects growth to be especially strong in the first half, led by Endless Assortment. Management guided for sales to rise to a midpoint of $16.5 billion this year, a 9% improvement from 2022 if realized, and for earnings of $33.25 per share in 2023 (up 11% and in line with Wall Street’s estimates). The sanguine Q4 report and guidance prompted a major Wall Street bank to upgrade the stock, with Wall Street as a whole looking for steady, reliable double-digit growth this year and next.

Technical Analysis
GWW sports the type of setup we like to see; it’s basically a long series of base-on-base formations over the last three years, which typically helps to minimize the impact of corrections. The most recent base was formed in November through January, which prepared the way for last month’s earnings-driven breakout to new highs—and so far, the market-induced selling has been tame. If you want in, we’re OK with a nibble on further dips and a stop in the low 600s.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on March 20, 2023.