Cabot Top Ten Trader Issue: May 13, 2024

Not Perfect, but More Good than Bad

There’s no doubt the evidence has improved during the past three weeks, with the major indexes living above their 50-day lines, with the broad market returning to good health (solid breadth and few stocks hitting new lows) and with some leadership names perking up, too. Of course, that doesn’t mean it’s perfect out there—defensive-type indexes and stocks have been outperforming, earnings season has been very tricky and we’re even starting to see some hot and heavy action in speculative names, which usually isn’t a great sign. As always, we’ll just go with the collection of evidence, which has meant extending our line a bit but looking to be “pulled” into a more heavily invested position as more real leaders emerge. For now, we’ll leave our Market Monitor at a level 7, but if we see more participation, we’ll nudge that up further.

This week’s list has something for everyone, with a lot of charts showing power, usually following earnings. For our Top Pick, we’re going to the cyclical side of things—Scorpio Tankers (STNG) looks like a leader in the suddenly strong shipping group, with out-of-this-world earnings lifting the stock out of a tight area.

Stock 1

Celestica (CLS)

Why the Strength
A recovery in commercial air traffic, growth in defense spending, plus a major push in capital investments by chipmakers to support AI-related demand, are among the trends supporting the strength behind Celestica. The Toronto-based electronics manufacturing specialist operates in two segments: Advanced Technology Solutions (ATS) and Connectivity & Cloud Solutions (CCS), which include exposure to a broad array of industries such as enterprise communications, telecommunications, servers and storage, as well as healthcare tech. The CCS segment (65% of revenue) led Celestica’s recent blowout Q1 earnings, thanks in part to “very strong” growth in the firm’s enterprise and communications end market, plus cloud hyperscaler customer demand. And while revenue was essentially flat in the ATS segment, there were several positive margin contributions, led by improvements in the commercial aerospace and defense portfolio. Total revenue of $2.2 billion increased 20% year-on-year, thanks in part to a 38% jump in CCS sales, while earnings of 86 cents a share surged 83% and beat estimates by 27 cents. The company saw a 19% improvement in operating margins in the quarter, which contributed to adjusted free cash flow of $65 million that was miles above the year-ago $9 million. Of significance, management said it’s seeing signs of an early recovery in the memory chip cycle, which bodes well for the demand outlook in the wafer fab equipment market in 2024, prompting Celestica to guide for a return to growth in this segment of the portfolio this year. Moreover, the company said the recent ramp in chip manufacturing investments supports demand for processes used in generative AI applications, a trend that should bolster “continued momentum” in the portfolio well into 2025, while increased deployment of networking infrastructure from hyperscalers should sustain double-digit through this year. Looking ahead to Q2, Celestica guided for sales and earnings to increase 16% and 50%, respectively.

Technical Analysis
We were stopped out of CLS in mid-April essentially at break-even when the stock broke the 10-week line during the sector- and market-wide selloff. As opposed to many names, though, shares found support quickly and, while there were some post-earnings wobbles, the stock has returned to its prior highs (and round number resistance near 50). It’s not in the early innings of its overall run—CLS has had a big move since last summer—but we’re thinking there’s still gas left in the tank ... if the stock can breakout. We’ll set our buy range up above resistance.

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Stock 2

Delta Air Lines (DAL)

Why the Strength
We wrote up United Airlines a couple of weeks ago, and it’s pretty much the same story with Delta—investors seemed not to believe the super-strong results the group began posting in 2022 and through 2023, but now it’s looking like huge earnings and cash flow figures are here to stay, and with firms getting their balance sheets in order after the pandemic, investor perception is turning up. Delta is one of the big boys in the sector and has some unique aspects to it: It gets tons of money from premium revenue (anything above main cabin fares), while its co-branded credit cards account for 1% of GDP (!) and are becoming less tied to travel spending, which leads to big payments from partner American Express ($6.8 billion last year alone and growing). Moreover, in terms of operations, the top brass has focused on efficiencies and steady levels of CapEx that should keep the fleet at a reasonable age and allow margins to continue to expand. Indeed, this year is looking like a breakthrough on that front: In Q1, sales rose 8% but earnings grew 80%, and more importantly, the top brass sees free cash flow continuing to soar, from $200 million in 2022 to $2 billion last year to a forecast $3.5 billion this year, a lot of which is going to cut debt and lease obligations (down 12% in the past year) as Delta aims for an investment-grade debt rating. More important for equity investors is that the buoyant results are expected to continue for many quarters—analysts see already-elevated earnings up a bit this year and picking up steam in 2025, with a pickup likely in shareholder returns as debt gets further under control. It’s not a growth stock, of course, but we see intermediate-term opportunity in Delta and certain peers.

Technical Analysis
Like most airlines, DAL looked like it was getting going from a huge rest period last spring, but that ran into a wall and the stock tanked (down 39%!) into the fall. The recovery after the market bottom recouped about half of that decline, but led to another rest period that got very tight (a constructive sign) in February and March. And now the buyers are stepping up, with shares moving to multi-year highs. Dips of a point or two would be tempting.

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Stock 3

Glaukos (GKOS)

Why the Strength
Glaukos is a pioneer in treatments for glaucoma and other eye disorders. The company’s main product is iStent, used to lower intra-ocular pressure (IOP), one of the primary ways of treating glaucoma. iStent is the smallest approved device that gets implanted in the human body and it’s becoming a standard worldwide. In Q1, iStent contributed nearly half of Glaukos’ $85.6 million in revenue, which was up 16% year over year. For 2024, management sees total sales coming in 15% higher around $361 million. The business still loses money – a $2.21 projected loss for the year would be slightly narrower over 2023 – but Glaukos is a growth story with iStent but also thanks to a new product: Regulators recently approved iDose, the firm’s intracameral treatment that can deliver drugs to a glaucoma patient’s eyes for up to three years. It’s likely an important step in the treatment since the current course of regular eye drops is shown by studies to be largely ignored or done incorrectly by patients – more than half of prescriptions never get refilled after six months, so the opportunity is huge. The company said it gave early iDose access to 15 surgeons in the first quarter and all were successful in implanting them in patients, which will equip Glaukos’ sales force with useful information to go out and hawk the device widely. Glaukos says iDose gives it a portfolio extending to all stages of glaucoma, providing surgeons options to intervene against the progression of the disease far earlier than they’ve had. Investors are bullish on iDose, as the treatment probably generated $1 million in sales from the first 15 surgeons alone. Volume should pick up as Medicare sets the billing code and streamlines reimbursement for iDose, something expected to add a lot of tailwinds to sales in the back half of the year—analysts see sales gradually accelerating to 20% by year-end and up to 24% growth in 2025 while losses shrink.

Technical Analysis
GKOS popped off six-month lows on huge volume in mid-December, when the FDA’s approval of iDose was announced. Shares rallied to 97 a few weeks later and then built a reasonable base, with no net progress for a couple of months as it digested the move. But now GKOS is back in gear, with some volatile-but-bullish post-earnings action moving the stock to new highs. We’ll set our entry range down a bit from here.

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Stock 4

Louisiana-Pacific (LPX)

Why the Strength
Lumber prices have come down significantly from the record highs seen during the pandemic era, but they’re still holding above anything seen prior to 2018. That’s a big reason why home buyers are looking for cheaper—and more environmentally friendly—alternatives when building or improving a house. Enter oriented strand board (OSB), a plywood substitute made from compressed wood wafers that’s around half the cost of traditional boards. Louisiana-Pacific (LP) specializes in producing OSB and other high-quality siding and engineered wood products used by a growing number of homeowners, builders and remodelers for things like decking, sidewall sheathing and floor underlayment. Helping the cause is a recently expanded relationship with Home Depot, which offers LP’s top-selling SmartSide trim and siding collection; the product looks like real wood but is more cost-efficient than the real thing and is engineered to withstand weather-related impacts, including freeze/thaw cycles, high humidity, fungal decay and more. LP also just announced a strategic partnership with leading homebuilder Lennar to include its Siding Structural Solutions and OSB products in its homes. Last week, LP posted Q1 revenue of $724 million that increased 24% year-on-year, thanks to “robust demand” for siding and OSB, plus higher commodity prices. Moreover, improved operating efficiency during the quarter expanded margins while dramatically boosting earnings of $1.53 a share, beating estimates by 36% (all reasons for the stock’s strength). In the wake of the sanguine results, the firm said it expects siding sales to increase by around 12% this year (up from prior guidance) and raised its forecast for full-year EBITDA to $675 million, up more than 40% from a year ago based on the “historic growth trajectory” and strong demand for its SmartSide and Structural solutions. Wall Street sees earnings catapulting well above $5 per share this year and remaining elevated in 2025.

Technical Analysis
LPX had been bobbing and weaving between 50 and 80 since the stock’s 2021 top, though the stock did change character a bit last November—after hitting that 50 support level, shares boomed on earnings and after a January rest, actually nosed above that 80 area in March. LPX pulled back with the market at that point, but the dip didn’t get out of control, and after the Q1 report, we see the stock decisively moving to new highs. We’re OK taking a stab at the stock here or on minor weakness with a stop under the still-rising 50-day line.

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Stock 5

Oscar Health (OSCR)

Why the Strength
Oscar Health is a health insurance provider in states with ACA (Obamacare) marketplaces in effect. The company operates in 20 states right now, with Florida claiming nearly half its 1.4 million members. Oscar specializes in low-cost plans that draw in healthy people who make fewer medical claims while prodding them toward preventative care, which lowers long-term costs. And management is quick to exit unprofitable efforts, in the past year shuttering its Medicare Advantage product, exiting California and pulling the plug on a joint offering with Cigna. In the first quarter, the business blew past consensus, posting $2.1 billion in revenue, 11% better than expected and up 46% from a year ago, with particular strength in Kansas and Georgia, two states other providers have exited. Q1 also brought Oscar’s first positive net income, of $178 million, or 62 cents a share, which beat estimates by a big 34 cents. That now has Wall Street expecting Oscar to essentially break even for the first time this year, after losing $1.22 per share in 2023. Management says the year should produce $8.35 billion in revenue backed by better federal reimbursement rates and new initiatives like Spanish-language programs—it just launched “Hola Oscar” in Georgia to appeal to Latinos, for instance. Long term, Oscar sees its business underpinned by two things: One is that it believes Obamacare has reached a critical mass and that political resistance to the program is fading, even in states like Texas, which is considering its own healthcare marketplace. The other is that it believes it can utilize its integrated technology systems to create deeper datasets on expected health costs for various demographics and then sell the information to other health care providers who seek to better model their businesses. It’s not changing the world but Oscar is a well-run outfit with solid potential.

Technical Analysis
OSCR was at just 5 at last October’s market bottom but embarked on an enormous advance from there, soaring to 18 after Q4 earnings in February. Then came a base-building effort, with a tedious 28% correction, though that wasn’t unreasonable at all given the prior upmove. OSCR actually began to perk up in April even as the market fell … and it’s kept on going, nosing to new highs ahead of the Q1 release and then soaring after the numbers came out. If you don’t own any, you can consider grabbing some shares on dips back toward 20 and use a loose stop.

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Stock 6

Scorpio Tankers (STNG) ★ Top Pick ★

Why the Strength
A continued ban on Russian oil by the European Union, along with recent disruptions in maritime trade surrounding the Red Sea crisis, is causing shipping delays and increased travel times for petroleum shipped on the water. This in turn has resulted in significantly higher ton mile demand, shipping rates and earnings for ocean tanker shipping companies like Scorpio, the world’s third-largest tanker shipper by revenue. The company specializes in the transport and distribution of refined petroleum products using a fleet consisting of 110 of the latest generation of fuel-efficient tanker vessels that have been cranking out giant earnings for many quarters, and there’s no sign that will end anytime soon. Last week’s Q1 report was the big reason for the stock’s strength, as it featured total sales of $391 million that rose 2% year-on-year, plus per-share earnings of $3.97 that beat estimates by 34 cents and were up 20% from a year ago. The results were led by an increase in average daily time charter equivalent (TCE, a key metric) rate revenue of $39,660 per vessel, a 6% improvement from what was already very high rates a year ago. Scorpio noted that geopolitical disruptions have impacted the supply chain, resulting in a “significant” improvement in cash flows in recent quarters. This in turn has allowed the company to slash its debt hoard, substantially improving its cash breakeven rates—boosting long-term profitability even when the environment returns to normal. Consequently, management said it’s now able to turn its attention from debt reduction to capital returns for shareholders, which means the already-solid dividend (2.1% yield) could be hiked while the top brass is looking to buy back shares going forward as part of a remaining $250 million repurchase authorization. What’s more, with TCE rates averaging nearly $39,000 per day as of Q2, Scorpio should continue to spin off tons of cash, which management said could approach a mouth-watering $1 billion a year if current rates remain steady or increase further. Wall Street sees earnings increasing 30% for the full year and remaining elevated through 2025.

Technical Analysis
STNG counter-trended during the bear year of 2022 as tanker rates skyrocketed, finally reaching a peak near 64 in February 2023. Then came a big dip and a long base-building effort, with a fresh breakout finally arriving last December. The action since then has been just OK, with some upside but lots of sideways trading, too—but now, after some tightness, STNG has moved to new highs again after the Q1 report. If you want in, you can enter here or (preferably) on dips of a point or two.

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Stock 7

Southern Copper (SCCO)

Why the Strength
Worries persist over the global availability of copper supplies as China, the world’s biggest metals consumer, is facing a historic supply squeeze of mined ore even as copper prices have surged nearly 30% since February. Add to that a reduction in new mines being started globally, plus increasing copper demand for electric vehicles and power grids, and the outlook for the red metal has suddenly become very enticing. Indeed, copper prices have been on a tear since breaking out in March, rallying from $3.95 per pound to $4.65 or so now. Phoenix-based Southern Copper (covered in the March 18 issue) is one of the world’s largest integrated copper producers, with operations in Mexico and Peru; it’s also the owner of one of the highest proven reserves for the metal with the industry’s lowest cash costs and longest mine life. The widely anticipated shortfall in global copper production, plus higher demand from the alternate energy revolution, is a key reason for the bullish vibes; a major investment bank just raised its year-end copper price target by 20% on the assumption that mines like Southern will be under pressure to meet the booming demand for the metal, while another big bank upgraded shares of Southern on the prospects of copper entering an extended period of deficits, “which should lead to declining inventories and higher prices sooner than anticipated.” Indeed, it and other Wall Street analysts see the copper boom leading to improved free cash flow (FCF) and dividend flows for Southern, with a consensus estimate of around $2.8 billion annually in FCF at current copper prices, with much more if prices continue to rise. In its recently released Q1 results, Southern posted revenue of $2.6 billion which was 6% lower from a year ago, but up 13% sequentially, while earnings of 94 cents crushed estimates by 25%. Copper production increased 4% from the year-ago quarter, thanks to a nearly 50% boost in output at its Cuajone mine in Peru, as well as higher ore grades. Looking ahead, analysts see revenue continuing to improve while the bottom line jumps an estimated 20% this year and 30% in 2025. A 2.7% dividend yield is an added attraction.

Technical Analysis
SCCO spent the first nine weeks of this year consolidating along the 40-week line, which ended up being the tail end of a 14-month consolidation. Shares blasted off in mid-March on high volume as copper prices did the same, booming from 90 to 120 (round numbers) in short order. Now the stock is resting again, though it’s refused to give back any of its gains, with support near the 25-day line during the April dip and with SCCO challenging new highs of late. We’re OK with a buy here or on minor weakness with a stop in the mid-100s.

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Stock 8

Sterling Infrastructure (STRL)

Why the Strength
Texas-based Sterling (covered in the March 11 issue) is a leader in sustainable, high-growth infrastructure projects (think AI data centers and e-commerce warehouses), providing building and transportation solutions through its subsidiaries. Its offerings also include residential and commercial concrete foundations for single-family and multi-family homes and parking structures, as well as infrastructure and rehabilitation projects for roads, bridges, airports, ports and light rail systems. The E-Infrastructure segment (42% of revenue) is part of Sterling’s shift toward large, mission-critical projects, and it’s also the firm’s fastest-growing and highest-margin segment. But just about everything is in gear today, which helped product a great Q1 earnings report: Total revenue of $440 million increased 9% from a year ago, earnings of $1 a share beat estimates by 22, and EBITDA of $56 million rose 21% (all reasons for the strength). Although E-Infrastructure revenue declined 10% due to weather-related impacts across the East Coast, operating profit grew 12% in Q1 and the firm expects high single- to low double-digit revenue growth for 2024 based on continued anticipated strength in AI-driven data centers (which represent 40% of the segment’s backlog; results could end up higher if the recent large project winning streak continues). The company’s Transportation Solutions business, its second biggest, saw 34% sales growth in Q1, which drove 53% operating profit growth, while segment backlog there increased 64%. And Building Solutions grew revenue 23% driven by residential housing market strength in key population growth areas like Dallas, Houston and Phoenix. Going forward, Sterling’s total backlog of over $2.4 billion in future business (up 45%) is expected to contribute to full-year top- and bottom-line growth of 11% and 18%, though most expect that to prove conservative.

Technical Analysis
STRL had a big run into last August, which led to a sharp and long correction—all told, shares fell as much as 34% and made no net progress for nearly seven months. The breakout in February looked great, but we got shaken out of the name as the stock cracked support during the market’s correction. However, while STRL didn’t bounce much initially, earnings changed the stock’s character again, pushing the stock to new price and RP peaks. We’re OK buying some here or (preferably) on dips.

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Stock 9

Taiwan Semi (TSM)

Why the Strength
Taiwan Semiconductor pioneered the semiconductor foundry business years ago, and today it’s the largest firm in that sector in the world, and it’s a well-run organization—the firm has a pristine balance sheet, has been paying a regular dividend for 20 years, does business for just about all of the top players in the chip world and sports outstanding margins (north of 40% pre-tax). Of course, given its size and reach, Taiwan Semi at this point is mostly a play on the chip industry as a whole, which can be tricky at times—the smartphone slowdown and other factors kept earnings growth under wraps from 2017 to 2019, for instance, and these days the company is working on coming out of a sector-wide inventory correction last year. But despite some ups and downs (the top brass cut its industry growth outlook after its Q1 report, though it still sees the sector lifting 10% in 2024 not including memory), investors are looking ahead to the AI boom pulling results nicely higher in the quarters ahead. In fact, the stock is strong today because of the firm’s April sales report on Friday, which showed revenues (in local currency) soaring a huge 21% sequentially from March and up 60% from last April, well above expectations and giving investors optimism that a decisive turn up in business is finally at hand. Analysts see sales and earnings lifting north of 20% each of the next four quarters, with the bottom line likely to accelerate in 2025. It’s a bit of a down-the-food-chain story, of course, but big picture, Taiwan Semi is likely early in a new business upturn.

Technical Analysis
TSM staged a classic, beautiful breakout on its Q4 report in January, getting going from a seven-month base—and the blastoff worked well, with shares running into the high 150s in March before chip stocks started to top out. Shares dipped to 133 in short order and then dipped to 126 during the April selling wave, but that last move is starting to look like a shakeout: TSM quickly marched back toward new closing highs, helped along by the April sales report last Friday, before easing a bit today. We’re OK starting a position here with a stop in the upper 130s, and possibly buying more if it continues higher.

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Stock 10

Toast (TOST)

Why the Strength
Payment stocks have been tedious, though the firms themselves are doing just fine, so we’ve been on the watch for a change in investor perception. Toast might be seeing that now, as the firm has solid institutional sponsorship, rapid and reliable growth and story that should play out over many years. Frankly, one reason for that is that Toast isn’t just a payments outfit: The company is essentially a one-stop shop for restaurants of all sizes, offering products for operations (point-of-sale devices, kitchen displays, invoicing), financing (loans and advances to clients), marketing (managing gift card and loyalty programs, email marketing), mobile storefronts (online ordering, takeout and delivery), employee management (scheduling, payroll, tips) and more. Right now, the firm counts about 112,000 locations as customers—still small compared to 860,000 restaurant locations in the U.S. (“only” a 13% market share), never mind the tally in the U.K., Ireland and Canada, where the firm has launched—and there’s no doubt it’s gaining share. In Q1, sales, the client count and annualized recurring revenue all lifted in the low 30% range, topping expectations, while cash flow continues to scale, with gross profit dollars up 42% and EBITDA coming in at $57 million (up from a loss last year) and with a margin of 19%, 26 percentage points above a year ago! (Free cash flow was negative due to some timing issues—but it should scale like EBITDA going ahead.) Management hiked the outlook as a result, looking for full-year EBITDA margins to hold at 19%, which will probably prove conservative if all goes well. Thus, the near-term picture is bright, as is the longer-term, the latter of which will be flushed out more fully during Toast’s Investor Day on May 29.

Technical Analysis
We wrote up TOST a few weeks back, as it was challenging long-time resistance in the 26 to 28 area—but the market wasn’t ready, of course, pulling the stock lower during its correction and shaking us out. However, shares found support “only” 16% off their recent highs, and after stabilizing for a couple of weeks, last Wednesday’s earnings-induced move to new recent highs looks good. Of course, strength has led to some near-term selling in this environment, but we’re OK starting small here with a stop near 24, and potentially adding more on the way up.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on May 20, 2024.

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