Cabot Top Ten Trader Issue: March 18, 2024

Positive but Choppy

Everything we’ve written during the past week or two remains true: The intermediate-term trend of most major indexes and most leading stocks is still pointed up, which is the most important factor out there and why you should stay generally bullish. But there’s no doubt we’re seeing much more choppy action, with most leading stocks (and plenty of growth-oriented measures) basically marking time since early February and a few starting to pull in. The good news is that, while we are seeing some sluggishness and a larger number of potholes, there are some areas of the market that are perking up—retail names started to pop three or four weeks ago, and more recently we’ve seen some commodity areas begin to flex their muscles. As we said last Friday, then, it’s not so much that there are major red flags out there, but more that the very bright green light has dimmed some as money starts to slosh around and some uncertainties (like interest rates and the Fed) pop up. We’ll again leave our Market Monitor at a level 7.

This week’s list is heavy in commodities and newer retail names, and our Top Pick comes from the former—Southern Copper (SCCO) has been basing out for more than a year, but now looks to be leading a group move in copper issues. The stock (and commodities in general) can move around a lot, so try to enter on dips and use a loose leash.

Stock 1

Comfort Systems (FIX)

Why the Strength
The boom in nonresidential construction spending trend that kicked off with the passage of the CHIPS Act in 2022 continues, driven by a torrent of new construction for high-tech manufacturing facilities. Comfort is a leading provider of commercial and industrial building systems, including heating, ventilation and air conditioning (HVAC), plumbing and electrical and fire protection. Its revenue has lately been aided by new development of data centers, life science, chip fabs and battery plants, with more than half of Comfort’s annual sales coming from new construction, while manufacturing makes up a third of revenue and technology accounting for the rest. In its Q4 earnings report, the top brass noted that construction finished an already strong 2023 on an “up note,” with notable profit and activity increases in its modular fabricating business for electrical and HVAC, resulting in record annual results across several metrics. Total sales of nearly $1.4 billion jumped 22% from a year ago, with earnings of $2.55 beating estimates by 16%. A big reason for the stock’s strength was the forward-looking backlog, which continues to impress; continuing an upward trend from recent years, the firm’s unfulfilled business at the end of December was $5.2 billion—up 27% year-on-year and up a whopping 20% just from the prior quarter. Cash flow in Q4 was an “extraordinary” $149 million, and Comfort finished 2023 with over $550 million in free cash flow—more than double the year-ago level and totaling something near $15 per share, well ahead of earnings. The company also just announced the closing of two acquisitions, Summit Industrial and J&S Mechanical, which Comfort said would expand its work on large technical construction projects in the Western U.S. region. Looking ahead, management also expects the new acquisitions will help Comfort grow operational results in 2024, while Wall Street sees mid 20% growth on both the top and bottom lines this year.

Technical Analysis
Heading into 2024, FIX was already in steady, multi-month upward trend that was only briefly interrupted by the correction in September and October. However, the start of February put the stock into high gear with earnings providing even more upside impetus. Shares shot up even further to record levels around 320 earlier this month before getting stretched and pulling back closer to the 25-day line. We think the odds favor more consolidation near-term, so we’ll set our entry range down a bit from here.

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Stock 2

Hims & Hers Health (HIMS)

Why the Strength
Now here’s a big idea: Hims & Hers Health is an online prescription platform that is capturing share in some very big fields, selling low-cost medications for help with issues like hair loss, ED, dermatology, birth control, weight loss and mental health. We see two big advantages here, the first being time and privacy—the company has access to more than 650 board-certified physicians and nurse practitioners that can take your data (filled out online), respond to questions and act on a prescription quickly (often within 24 hours), with packages delivered discreetly right to your door, so there’s no need to make an appointment and have a conversation with the doctor that may take weeks. (Everything is on a subscription basis, too, which adds a recurring revenue element to the story.) But there’s also the personalized treatment angle, too: Right now, 30% of all subscribers are using some sort of personalized offering (again, that one of their physicians can formulate for a customer), and for some newer offerings like weight loss, that figure is up near 100%--and those using these personalized offerings have proven to be much “stickier” than others. Partly because of this, top brass thinks dermatology, mental health and weight loss can each bring in over $100 million in sales by 2025! Simply put, the idea just makes a lot of sense, and growth has been awesome and should continue to be: The firm ended last year with 1.5 million subscribers (up 48%), while revenue leapt the same amount in Q4 ($870 million of sales last year, so this is no tiny outfit) and EBITDA is positive and should double in 2024. And with renewal rates near 85% and with very reasonable customer acquisition costs (paid back in just a few months, on average), the model has solid underpinnings when looking down the road. It’s a great story.

Technical Analysis
HIMS came public in late 2020 and proceeded to tank during the bear market, living in the low-priced range for months with huge volatility, including a big 50% haircut during the spring, summer and fall of last year. The stock improved after the market bottomed, rallying back up to the 8 to 10 area and consolidating for a bit, but it was the Q4 report that really changed the outlook—HIMS exploded higher by 31% on 7.5x average volume the day after the report and it’s continued to chop its way higher from there. It’s not for the faint of heart, but we’re OK with a small position and a loose stop here or (preferably) on dips.

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Stock 3

Hyatt Hotels (H)

Why the Strength
Given that the market had been in the muck for two years, we’re still seeing a lot of well-established names that are just now coming out of multi-year ranges as investor perception turns the corner thanks to the fact that earnings and cash flows remain buoyant and the outlook continues to improve. Hyatt is a good example of that: It’s one of the big hotel players, though because it’s still much smaller than the likes of Hilton or especially Marriott, there’s still a solid, steady expansion story—and with travel trends continuing to outpace expectations, results through 2024 at least should impress. In Q4, the firm cranked out 5% or so sales and EBITDA growth, but revenue per available room (as well as the number of rooms themselves) were both up about 6% and franchise-related growth was strong overseas. All that is well and good, but the difference here is that most investors have expected this business strength to stall out for a while, but instead, the top brass thinks things will crank ahead and even accelerate this year—it sees total rooms rising 6% and revenue per room up 4%, while EBITDA soars 17%, with free cash flow likely up in the 5% to 10% range and coming much, much larger than earnings (about $5.80 per share last year, vs. $2.56 of reported EPS). And nearly all of that cash ends up being returned to shareholders, partly through a token dividend (0.4% yield) but mostly via share repurchases (4% of the share count was gobbled up last year, and more of the same is expected in 2024). Of course, Hyatt isn’t going to double in a month, but the intermediate- and longer-term picture here is very solid.

Technical Analysis
We wrote about H three weeks ago but missed our entry point—but, after a nice post-earnings move and a modest, low-volume dip, we’re taking another swing at it. The positives in the chart really go back to the market bottom in October, when shares moved up seven weeks in a row and followed that up with a super-tight two-month range (usually a constructive sign) as the 10-week line caught up. So far, H has given up only a small amount of its recent burst—we think entering here with a stop near the rising 50-day line is a good bet.

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Stock 4

Maplebear (CART)

Why the Strength
Maplebear is the legal name of Instacart, the leading U.S. grocery shopping intermediary on the Internet. Instacart lets consumers select, pay for and get groceries delivered through deals with many large chains covering 85% of U.S. stores; in exchange, Instacart takes a cut of sales, usually 5% to 6%. What’s appealing about the company is that online shopping is still a small part of the $1.5 trillion Americans spend annually on groceries, leaving lots of room for expansion. Online grocery carts probably account for just 4% of total spending, with Instacart having the dominant market share of that emerging slice at more than 70%. Adoption of online grocery shopping services is seen growing at 13% annually for the next four years to about $77 billion and investors are bullish about opportunities for further expansion outside the U.S. The firm’s latest quarter, reported last month, shows Instacart is executing nicely. In Q4, Instacart saw gross volume of $7.9 billion resulting in net revenue of $803 million and healthy earnings per share of 44 cents. For the current quarter, management says to expects gross volume of around $8.1 billion, which would be up around 8% year-over-year, and a small net loss (mostly based on seasonality). Opinions aren’t fully bullish around the business, however, especially as some predict the pandemic-boost of remote grocery shopping will continue to ease and be a headwind to the sector’s expansion. Plus, DoorDash and Uber are long-term threats to market share as they get deeper into the grocery delivery fields. In response the company is aggressively redirecting its spending, cutting 250 workers in recent weeks to redirect funds toward incentives it offers to habituate newer customers to using Instacart more often. Management says its superior user interface, powered by AI, will help lock newer shoppers after its marketing spend eases. The bottom line is it’s a leader in a big, growing industry, which of course has plenty of appeal.

Technical Analysis
CART went public in September at 30. First day enthusiasm drove shares up to nearly 43 but then CART faced weeks of the typical post-IPO droop until it found its footing in the 23 to 28 range. Last month’s earnings heartened Wall Street enough that shares have been on a good rally since, breaking the old ceiling and enjoying a persistent uptrend while notching new closing highs. The first pullback should prove buyable, so we’ll set our entry range lower, looking to enter on some sort of shakeout.

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Stock 5

Permian Resources (PR)

Why the Strength
As this week’s Top Ten list shows, commodity stocks that were setting up in recent months have started to come to life, with oil names—bolstered by resilient prices in the $80 area and M&A activity in the group—helping to lead the charge. Permian Resources definitely looks like one of the leaders (Diamondback Energy, written about earlier this month, is also a top dog) and it has a great story to tell: Following its big acquisition of Earthstone in Q4, the company is the second largest pure-play in the Permian basin (and largest pure-play in the Delaware) with over 400,000 acres (as well as 70,000 royalty acres), and it’s one of the most efficient operators as well, with the lowest “controllable cash costs” (a company metric) per barrel of output among its peers. In fact, a good part of the story does come down to continued improvement on the cost side—Earthstone had higher drilling costs than the company in general, and Permian Resources is wringing out synergies faster than expected and expects drilling costs per foot to fall 10% this year. Even with lower oil prices year-over-year, results here have been resilient, with Q4 free cash flow coming in at 47 cents per share, and like the rest of the industry, Permian is passing along a lot of that to shareholders, via base (1.5% yield) and variable dividends (the two combined totaled 15 cents per share in Q4) and share buybacks (nine cents per share equivalent in Q4; it just bought back another two million shares this month)—plus, with free cash flow expected to rise this year, those figures should grow nicely if oil prices remain resilient. The last angle is M&A, where, ironically, the firm’s purchase of Eathstone has made it a better target for some major oil firms that have been looking to bolster their Permian basin exposure. As far as oil plays go, we like it.

Technical Analysis
PR was resilient during the bear market, even outperforming the broad oil group, hitting higher highs in late 2022 (most of the sector topped mid-year) and then gliding up to 15 level last summer. That last move led to a retreat in November when investors started to chase after growth names, but the action that followed was solid, with a lot of tightness in the 13 area and support in February at the 40-week line. Now PR is running again, with a big-volume, persistent move to new price highs. If you want in, aim for dips of a few dimes.

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Stock 6

Southern Copper (SCCO) ★ Top Pick ★

Why the Strength
Copper prices in the U.S. hit an 11-month high last week in large part of supply issues that favor the bulls. In China, smelters have agreed to reduce production in reaction to lagging profitability, and this is after supplies were already tight following the closing of a big mine in Panama last year. Granted, demand from China is lagging along with its economy, but the resilient economic outlook in much of Europe and the U.S. has traders thinking the demand outlook should remain steady if not improve. Responding to the favorable supply/demand outlook are shares of Phoenix-based Southern Copper; it’s one of the world’s largest integrated copper producers and owner of one of the largest proven reserves for the metal with the industry’s lowest cash costs and longest mine life (it also produces silver, molybdenum and zinc as byproducts through operations in Mexico and Peru). In the fourth quarter of 2023, revenue of $2.3 billion were down 19% from the prior year’s Q4, while earnings of 58 cents a share half the year-ago level. The less-than-stellar results were due to lower volumes for copper, silver and zinc, although it was partly offset by higher molybdenum volumes. And though prices for copper and silver were favorable in the quarter, molybdenum and zinc prices fell—down 13% and 17%, respectively—weighing on results. However, the focus is on the future: The company expects copper production to increase 3% in 2024, while silver production is seen jumping 12% and zinc output is expected to soar 80%. And with prices for all three metals on the rise, continued price strength should result in significantly higher profits for Southern this year. Indeed, an expected shortfall in global copper production, coupled with higher demand for the metal from the booming renewable energy sector, recently prompted a major Wall Street bank to predict copper prices will reach $6.80 a pound by 2025—up a whopping 65% from current prices. Analysts, meanwhile, see positive but subdued growth this year followed by an acceleration in 2025, but those guesses could be trampled if the recent copper price surge (up 12% from its February lows) continues.

Technical Analysis
SCCO has outperformed most of its industry peers during the last 12 months--while the stock has spent a good part of that time range-bound while also quietly making a series of higher highs and lows. After the most recent peak in late December, shares spent a couple of months tightening up while the 40-week line served as support during pullbacks. SCCO took perked up last week and then surged on its heaviest weekly volume since May 2022. We advise aiming for pullbacks if you want in.

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Stock 7

Sweetgreen (SG)

Why the Strength
Sweetgreen is a fast-food chain that has strong traction with younger consumers thanks to its emphasis on healthier-for-you fare like salads and warm bowls. The pandemic roiled its core offerings (mainly fare for city workers heading out for a quick lunch), but Sweetgreen has rebounded strongly, with management just reported the 11^th straight quarter of revenue growth above 20%. A lot of the strength comes from having cracked the code to produce fresh, consistently goods salads on a large scale, similar to the way Chipotle Mexican Grill figured out the same formula with Tex-Mex. The danger is being pigeon-holed in consumer’s minds as “just” salads, something Sweetgreen has started aggressively working on, introducing a series of protein-focused dishes last fall called Plates; offerings include caramelized garlic marinated steak, herb-roasted chicken and miso-glazed salmon. The top brass says the Plates menu has boosted dinner orders significantly and is performing especially well in Texas and the southeast. In its latest quarter, reported at the end of February, Sweetgreen beat estimates with sales of $153 million and a narrower net loss of 24 cents per share. Seasonality means the current quarter will come in roughly flat on a sequential basis, but should be up 21% year-over-year. For 2024, management says it sees sales between $655 and $670 million, up 15% or so from a year ago but with the back half of the year stronger thanks to a couple of dozen new store openings. (The restaurant count should increase a bit over 10% this year and continue growing after that, so there’s definitely a cookie-cutter aspect to the story.) Longer term, Sweetgreen expects Infinite Kitchen–its rebrand of a robotic-based fast food chain Spyce it bought last year–to excel in heavy-volume urban locations, where its robots can prepare 500 salads an hour and provide margins about 7% better than a Sweetgreen outlet.

Technical Analysis
SG came public at 28 in late 2021 and initially surged as high as 56, but then slumped to nearly 6 a year ago as growth stocks went over the falls. Much of the past year has seen SG stabilize with shares building a nice bottom in the 9 to 12 area from September through February, and now the buyers have shown up—the Q4 report caused SG to go wild, moving up on its two heaviest volume weeks ever, and then rallying further last week. Given the choppy environment, we don’t advise chasing it here, but it does quack like a potential new leader—look for a shakeout to enter.

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Stock 8

Tapestry (TPR)

Why the Strength
Apparel and footwear stocks are some of this year’s strongest performers to date, thanks in part to strong luxury fashion sales despite higher-than-normal inflation. Luxury house Tapestry is a leader in this space and is well on its way to becoming one of the industry’s most dominant players. The New York-based company already owns a portfolio of some of America’s most recognizable fashion nameplates, including Coach, Kate Spade and Stuart Weitzman. But in a bid to become more competitive with its large European competitors, Tapestry is aiming to expand its fashion footprint by agreeing to acquire Capri Holdings last August, owner of the prestigious Versace, Jimmy Choo and Michael Kors labels. The deal is part of Tapestry’s strategy to appeal to a new generation of shoppers across multiple demographics while enhancing its access to the higher-end consumer segments in luxury. It all sounds good, though the deal is still in limbo as regulators in Europe and the U.S. take a closer look at it. Analysts, meanwhile, believe the Capri acquisition has the potential to increase per-share earnings by double digits going forward, though, again, there’s some mixed opinions on that. Also part of Tapestry’s growth strategy to appeal to a younger generation of shoppers are recent collaborations with popular brands like Disney and celebrities like Kirsten Dunst, while featuring some of its high-ticket items on social media platforms, attracting the attention of Gen Z customers. In fiscal Q2 (ended December), Tapestry saw total sales of $2.1 billion increase 3% year-on-year and earnings of $1.63 a share rise 20% and easily top estimates, while achieving revenue and EPS records during the key holiday season. Looking ahead, Wall Street sees 10%-ish earnings growth this year and next, but news about the Capri buyout will be key. Regardless of that, Tapestry itself is doing well, has a cheap valuation (11x earnings) and a solid dividend (3% yield), which should keep buyers interested as they wait for word from regulators.

Technical Analysis
TPR was range bound for much of last year before getting nailed in August and collapsing to 26 in November. However, instead of building a bottom, the stock turned on a dime in very impressive fashion, zooming higher eight weeks in a row and, after a month-long rest, ratcheting up another six weeks to challenge resistance near 50. We’re not chasing it here, but a dip of a point or two would be tempting, with a stop under the rising 50-day line. A bit more retrenchment would be tempting, with a stop under the 50-day line.

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Stock 9

Tidewater (TDW)

Why the Strength
Oil prices have had a lot throw at them in recent months and even years, not the least of which are a worldwide tightening trend from central banks (which are still draining liquidity) and relatively weak worldwide economies (especially from China’s manufacturing sector). But despite that, oil is resilient in the $80 range, which is bolstering stocks and the outlook for many explorers and service firms. Tidewater is a leading global purveyor of larger offshore support vessels and marine support services to the global energy industry, including services for offshore crude oil and natural gas exploration, field development and production and windfarm development and maintenance. Improving supply and demand dynamics influencing the offshore vessel industry contributed to stellar numbers for Tidewater in Q4. The company saw its revenue increase 62% from a year ago, to just over $300 million (the highest quarter level in eight years), while full-year revenue crested the $1 billion mark for the first time since 2015 thanks in part to recent acquisitions. And though earnings of 74 cents a share missed estimates by a few cents, they more than doubled from a year ago. Of significance, the average day rate for the company’s vessels increased to over $18,000 per day—up $200 from Q3 and up 32% for the full year (thanks partly to the firm ditching lower specification vessels for high-spec ones), which management described as “faster than anything we have seen in the industry.” Meanwhile, other metrics were equally impressive, including full-year free cash flow of $111 million that more than doubled from 2022. Moving ahead, the company sees growth continuing this year and beyond thanks to a a record-low vessel newbuilding order book and improving offshore vessel demand visibility. Tidewater guided for revenue to increase 40% this year, to around $1.4 million, while EBITDA and free cash flow should grow at much faster rates (gross margin expected to rise from 47% in Q4 to 56% by year-end), with increased share buybacks likely, too. It’s a good oil service story.

Technical Analysis
TDW isn’t in the first inning of its overall advance, but the buyers remain in control. After getting above 70 last September, the stock stalled out and eventually corrected hard in November, but the 40-week line held up as support and shares actually returned to their old highs near year-end before another few weeks of chopping sideways. Now, though, we see the stock moving decisively out to new price highs on three straight weeks of good volume. We’ll set our buy range down a bit, though we’re not looking for a huge retreat.

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Stock 10

Valero Energy (VLO)

Why the Strength
A combination of refinery outages, coupled with the traditional start of the driving season, are contributing to higher prices at the pump—with analysts predicting even more price spikes on the horizon. This is but one reason for Valero’s strength, with another being the company’s position as one of the world’s largest independent oil refiners—as well as a major producer of corn ethanol and renewable biodiesel—providing exposure to what one major Wall Street bank called a new “Golden Age” for refiners in the wake of global underinvestment across the broader energy sector. To that end, the bank just upgraded shares of the company as gasoline crack spreads (which are directly related to refining profit margins) hit their highest level in over 18 months while supplies continue to tighten. What’s more, another major bank recently called Valero the “best positioned to perform in any environment.” The recent share price strength initially kicked off during Valero’s Q4 earnings call in January, when management said it expects first quarter refining margins will be supported by tighter supply due to several projects ahead of the summer driving season. The company said its 14 refineries will operate at just 85% of combined total throughput capacity in Q1 (down from 94% in Q4). Demand for diesel, meanwhile, was said to be 7% higher so far in Q1 compared to a year ago, thanks to low inventories and stronger heating demand in the U.S. and Europe. Q4 revenue of $35 billion was down 15% but still beat estimates by 3%, while EPS of $3.55 beat the consensus by 20%, contributing to the firm’s second-best year ever in adjusted earnings (another reason for the strength). Valero also returned 73% of cash flow from operations to shareholders in Q4 through share repurchases (share count down 11% from a year ago!) and dividends (current yield 2.6%). Analysts set a low bar for 2024, but (a) the stock is still trading at just 11x this year’s estimates and (b) those estimates themselves could prove way too low given the movement in crack spreads.

Technical Analysis
VLO hit an all-time apex at 150 in January 2023, but was unable to get past this level, prompting the sellers to eventually cause a 31% correction. Then the stock make it back to that resistance last Sept3ember before spilling over again, but this time, the base-building effort was much more well controlled, with VLO dipping just 21% and closing tightly for much of November and December. And after again testing the 150 area, the stock’s character has now changed, clearly moving to new price highs. If you want in, look for dips.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on March 25, 2024.

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