Cabot Top Ten Trader Issue: May 22, 2023

An Encouraging Week

It’s still a narrow rally at this point, and we’re skeptical of anyone that’s trying to say otherwise—most indexes are in no man’s land, few names are hitting new highs and we read today that the “smallest” 400 stocks in the S&P 500 are essentially flat this year, and that says nothing of the rest of the market. And yet … we are seeing more names begin to pop higher, whether on earnings or some other news, with some shakeouts-and-recoveries, some earnings gaps that see immediate follow-through and more names setting up. (We don’t hate the selloff in defensive stocks, either.) It’s not definitive yet, but we will nudge the Market Monitor up to a level 5 and see how it goes.

This week’s list is another where growth names make a good showing, and with a variety of sectors (outside of retail, which has been rough) represented. Our Top Pick is Advanced Micro Devices (AMD), which is under extreme accumulation as big hopes for 2024 bubble to the surface.

Stock 1

Advanced Micro Devices (AMD) ★ Top Pick ★

Why the Strength
As the disruptive technology of artificial intelligence (AI) makes its presence increasingly felt, semiconductor device maker AMD (covered in the March 20 issue) is positioned to be a prime player in this lucrative field. The company has been releasing new products that leverage AI, including a new series of Ryzen 7000 chips the firm says are the first such products that contain an onboard dedicated AI engine. It also just revealed the AMD Alveo MA35D media accelerator with an integrated AI processor to power a new era of live interactive streaming services at scale—management made clear that demand is growing for AMD’s AI-related offerings with AI being its “number one strategic priority.” Last week, it was revealed that several hedge funds bought stakes in AMD in the first quarter (a reason for the strength), even as overall results were mundane, a sign that Wall Street recognizes the magnitude of the AI tsunami. Due to continued PC market weakness, Q1 revenue actually fell 9% from the year-ago quarter, while earnings did even worse, sliding by nearly half; they did top estimates by four cents, but the top brass wasn’t overselling things, calling it a “mixed demand environment.” There were bright spots, however, as more than half the quarter’s $5.4 billion in revenue came from AMD’s strategically important data center and embedded segments, with the latter showing annual growth of over 160%. AI-related deployments in its automotive business also expanded, while AMD’s share in the security, storage, edge server and networking markets continues to grow. Looking ahead, analysts see the PC market recovering in the second half of 2023, and while AMD’s full-year sales are expected to be down 3%, Wall Street is looking ahead toward a bullish 2024 with solid sales and (especially) earnings growth.

Technical Analysis
After a strong off-the-bottom run from November to March, AMD fell victim to the shakeup that hit the semiconductor stocks earlier this spring. After peaking around 100 in late March, shares were down almost 20% over the next six weeks in what was basically a classic correction (the market’s banking issues didn’t help). However, after a bad post-earnings reaction, AMD completely turned around, not just rallying nicely, but moving all the way up to multi-month highs on three straight weeks of huge volume! We suggest aiming for dips to enter, though we’re not expecting a huge retreat.

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Stock 2

Argenx (ARGX)

Why the Strength
Based in the Netherlands, Argenx is a commercial-stage biotech that develops antibody-based medicine for treating rare autoimmune diseases using the blood of llamas (not a joke). Significantly, its pipeline boasts a recent regulatory approval in several countries for Vyvgart (efgartigimod), a treatment for generalized myasthenia gravis (a neuromuscular disease that causes weakness in the skeletal muscles). Efgartigimod blocks proteins that recycle antibodies, reducing the level of antibodies attacking blood platelets, and the platform is based on the unique properties of a llama’s immune system (some regions of llama and human antibodies are nearly identical, believe it or not). Vyvgart is on track to reach blockbuster status this year, with analysts predicting global net sales exceeding $1 billion in 2023—and potentially reaching $2 billion in the coming years. Better yet, Argenx’s efgartigimod pipeline is robust, with 13 additional potential indications in various stages of development (including treatments for thyroid eye disease and membranous nephropathy). The company expects that by the end of 2023, efgartigimod will be approved, in regulatory review or in development across all 13 severe autoimmune diseases, with topline data for a study on the treatment of chronic inflammatory demyelinating polyneuropathy (CIDP) expected by July. Argenx also looks like a prime takeover candidate due to the drug’s success. Indeed, most of the company’s $219 million in Q1 revenue was from Vyvgart, resulting in a whopping 630% sales increase from a year ago, with the per-share loss of 52 cents narrowing while beating estimates by $1.82. Analysts see the drug lifting Argenx’s sales 125% higher this year and pushing the bottom line into the black by 2025.

Technical Analysis
ARGX resisted the weakness that plagued biotech stocks for a good part of the last two years, spending most of 2021 in a holding pattern while outperforming the sector. The stock broke free from the trading range last June after Vyvgart received regulatory approval in Europe, gaining 20% in the following two months, but then met resistance around 400. The stock meandered for several more months, but earnings and the takeover rumors catapulted shares to new highs last week on great volume. Aim for dips if you want in.

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Stock 3

DraftKings (DKNG)

Why the Strength
DraftKings looks like a classic example of “romance-transition-reality,” where the firm’s land-grab (and huge spending) phase saw the stock do great (romance); followed by a horrific drop as investors re-valued the money-losing company in the bear market (transition phase); and now shares are doing well (reality phase) as spending has come down and cash flow looks set to turn positive. The company, of course, looks like the leader in online sports betting, a market that continues to mushroom, and it’s also the top player in iGaming (online casino), which is smaller but doing well. But what’s causing the change in perception is that the firm (and sector) is out of the land-grab phase—customer acquisition costs are coming down, partly due to far fewer incentives and a bit less competition in newer markets, but general cost cuts and less marketing spend are helping too. But despite that, customer retention and take rates are on the rise as the industry grows at a more normal (but still solid) pace; the net effect is that markets entered a few years ago have seen revenue and margins on the rise. Impressively, Q1 saw revenue growth actually tick up to a very strong 84%, and the top brass now expects DraftKings to get to EBITDA breakeven in the current quarter (ahead of the Q4 breakeven estimate released just a few months back). To be fair, growth will likely slow going ahead but remain solid (full-year sales estimate is up 42%) while cash flow expands. It won’t be the go-go stock it was in 2020, but we think the future here is bright as institutions re-establish positions.

Technical Analysis
DKNG fell more than 85% from its 2021 peak to its low in May but then built a (very jagged) bottom for the rest of 2022. The early-year rally was solid, but the real setup came in February and March, when shares built a tidy launching pad. The pre- and post-earnings breakout was solid, and DKNG’s recent dip toward the 25-day line came on very light volume—before some higher-volume buying showed up, including today’s upgrade-inspired pop. We’ll set our entry range down a bit as the moving averages catch up; make sure to use a loose stop.

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Stock 4

Dynatrace (DT)

Why the Strength
Dynatrace isn’t growing as fast as the pandemic days, when spending on all things cloud exploded. But we always thought this was a story that had staying power, and that’s proving to be the case (and is a big reason mutual fund ownership hit a new high at 1,168 funds at the end of March). The company is one of the leaders in observability (i.e., the ability to track and monitor every piece of IT equipment or software across different cloud environments to make sure it’s working as it should) and application security (insights derived from observability often need a security response), which the top brass believes is at an inflection point and is a whopping $50 billion market; with increasing complexity occurring every day, big clients are moving away from in-house solutions and standard dashboards and alerts to sophisticated platforms that offer better insights, automation, log management, analytics and more. The details can give you an ice cream headache, but that’s the main gist, and Dynatrace’s offerings seem perfectly suited for big clients that are engaged in the never-ending transition to the cloud. Growth has been solid and reliable, with currency-neutral annualized recurring revenue up 29% in the March quarter (40% of business is overseas), with same-customer revenue growth of 19% and with gross retention rates in the mid-90% range. Meanwhile, remaining performance obligations are nearly $2 billion, up 28%. This year, growth should slow some (up 19% or so), and earnings will be flat-ish due to a higher tax rate, but the likelihood of many years of excellent growth are high.

Technical Analysis
DT went from 80 to 30 during the bear market, retested its low last fall and tightened up into late January just under 30—a long eight-month bottoming effort. The beautiful earnings pop after that looked like the real deal, but of course, the market wasn’t ready, and DT got yanked down during the banking selloff. But support near the 40-week line held, resulting in a nice base-building effort, with the past three weeks seeing accelerating accumulation. We’re OK nabbing some shares around here or (preferably) on dips.

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Stock 5

Eagle Materials (EXP)

Why the Strength
You don’t go to cocktail parties bragging about firms making gypsum wallboard and Portland cement (the type of cement that goes into nearly all types of concrete), but Eagle Materials is a big, low-cost player in both (100% exposed to the U.S. market and owns all its inputs), making it a clear play on infrastructure and residential construction, as well as the repair and remodel markets. (It also does a little business in recycled paperboard and aggregates, together making up 8% of sales.) Cement seems to be the main focus of expansion here (wallboard is closely tied to the health of the housing market, where cement has broader applications); with capacity in the U.S. tight and with expansion difficult due to regulations (Eagle is sold out!), the firm recently completed the buyout of Martin Marietta’s import cement business in Northern California to give it some added exposure to the strong demand. All in all, Eagle is another housing and construction play that saw earnings boom in recent years, and instead of slackening, they remain much stronger than expected—in the March quarter, both areas of the business grew in the low- to mid-double-digits, with earnings rising a strong 47% (21% above expectations) thanks to rising margins and an active share buyback program (share count at the end of March was down 8% from the year before; there’s also a token 0.6% dividend). More important is that analysts now see earnings actually rising mid/high-single-digits this year and next, as opposed to slight declines. Overall, Eagle is a big player in markets showing better-than-expected demand.

Technical Analysis
EXP’s action is like most construction and housing names, with a peak in early 2022, a fall into the summer and fall (it hit its ultimate low in September) and a nice rally for a few months after that. EXP did level off starting in February, but the pullback was tame, trading in a 15% range over 12 weeks. Shares actually broke out on May 4 and, after a brief pullback, extended their gains after earnings. At this point, we think pullbacks make sense if you want in.

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Stock 6

Flex Ltd (FLEX)

Why the Strength
Flex is a leading global technology, supply chain and logistics solutions provider, offering components, circuit board fabrication, design and engineering services to some of the world’s biggest companies at one of the industry’s lowest costs. Flex operates across 30 countries while serving customers in several major industries, and the company has garnered significant attention for its embrace of robotics and artificial intelligence (AI) across its manufacturing and logistics platforms. Earlier this month, Flex released March quarterly results that featured top- and bottom-line beats with revenue of $7.5 billion rising 9% from a year ago while per-share earnings of 57 cents beat estimates by 13%. Revenue for the full year improved 17% while EPS increased 20%—the third consecutive year earnings have grown at least 20%. The sanguine results were driven by a 24% jump in industrial segment sales and a 9% increase in health solutions revenue, aided by “very strong growth” in the firm’s renewable energy, hardware EV charging and data center power segments. Flex’s solar business that it spun off, NEXTracker (a utility-scale, sun-tracking solutions provider; in Top Ten last week), finished 2023 with nearly $2 billion in sales (up 31%), and the company sees a huge, multiyear growth opportunity in this business. And while the company said it’s still managing through shortages and extended lead times for some materials, it noted inventory improvements in Q4, with net working capital advances down 8% from the prior quarter. Looking ahead, Flex guided for fiscal 2024 sales and earnings to be relatively flat, though this could prove conservative given 1.) its growing backlog for NEXTracker’s large solar installations and 2.) its exposure to long-term mega-trends in automotive, health solutions, industrial and consumer devices. The PE of 10 tells us expectations aren’t high.

Technical Analysis
After hitting a long-term peak at 20 in 2021, FLEX fell victim to the broad market selling pressure of the early part of last year. The stock was down 24% in the first six months of 2022 before touching down at 14 where it established a low in early July. Shares turned up that same month and began a new ascent—a full three months before the broad market bottomed. FLEX achieved a multi-decade high at 25 in February before falling back again, but we like the big-volume (heaviest weekly volume since October 2020) earnings liftoff two weeks ago. A pullback of a few dimes would be tempting.

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Stock 7

Lam Research (LRCX)

Why the Strength
Lam supplies wafer fabrication and etching and deposition equipment critical for making advanced logic chips and NAND flash chips to some of the world’s biggest semiconductor companies, with major exposure to mega-growth trends in artificial intelligence and 5G communications. Despite an oversupply of memory chips (used especially for smartphones that are seeing lower demand right now), industry experts see a beneficial broad-based recovery in wafer fabrication equipment demand in the coming years. Indeed, the main driver for Lam is the increasing number chip fab plants being planned around the world in response to pandemic-era semiconductor shortages (primarily in the automotive industry), which aren’t expected to ease until next year. Although Lam’s Q3 (ended March 26) revenue of nearly $4 billion was 5% lower from a year ago, the firm reported record sales in the U.S. (16% of total revenue), while EPS of $6.99 topped the consensus by 46 cents and exceeded the firm’s guidance. Foundry-related system revenue also achieved record levels, which the top brass said demonstrated “solid progress” in both its leading edge and specialty technology segments. The results prompted a number of Wall Street analysts to either increase or maintain outperform ratings for the stock (a reason for the strength). Going forward, Lam is expected to launch a raft of new products that should boost sales soon, and the company’s installed base is experiencing impressive growth from customers’ technology upgrades (up 40% from the last downturn in the chip industry), a trend it sees benefiting its parts and services business. On the shareholder returns front, Lam is tracking towards its long-term plan of giving back 75% to 100% of free cash flow. A 1.2% dividend yield is an added attraction.

Technical Analysis
After peaking out at 725 at the start of last year, LRCX slid into the doldrums with the rest of the chip industry for the next nine-and-a-half months, with the nadir seen at 300 in mid-October. From there the stock’s character changed and it established a series of higher peaks over the next few months. The advance temporarily halted at 540 in February, with a period of tightness following into May and culminating with last week’s breakout, which came on four straight days of great volume. We’re fine grabbing a few shares here.

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Stock 8

Li Auto (LI)

Why the Strength
Li is a luxury plug-in hybrid car maker in China, the world’s largest market for EVs. The L7, its newest model that started being delivered to customers this spring, sold 10,000 units in April, its first full month on the market; that made it the leading model in the large SUV segment of the Chinese market. Li has been focusing on extended-range hybrid SUVs, with batteries powering the car with a small gasoline engine kicking in to give its vehicles range up to about 500 miles, an appealing characteristic to consumers fretting over China’s vast distances. Its other models, the L8, L9 and the last of its earlier Li ONE offerings, combined to sell 52,584 units in its most recent quarter, which places Li among the top 3 automakers of new energy vehicles selling for over RMB 200,000 (about $28,500) in China. The strength in the period helped Li beat consensus estimates for the period, with RMB 18.79 billion, or $2.74 billion, and net income of RMB 930 ($133 million), both up huge from the year before. The appeal of its vehicles has management saying it will boost sales significantly in the quarters ahead, predicting it will be delivering 30,000 vehicles a month starting in June. That should get Q2 deliveries to around 79,000 units, which would be a 170% increase over the same period last year. There has been some gross margin pressure from the sales ramp, something the company says will reverse now that all the lower margin Li ONEs have sold, and as plans develop for premium services owners can pay extra for, such as autonomous driving features. Li also plans to roll out a line of battery-only EVs that will boost its lineup to 11 models by 2025. The battery EV lineup will be supported by a company fast-charging network that will cover 90% of China’s highways. Analysts see big growth ahead, with China’s reopening also helping.

Technical Analysis
LI was very strong last summer, but the bear market (and China’s lockdowns) caused the ensuing meltdown. After bottoming last October, LI began a stairstep recovery to 27.5 in February, then built a fairly tight, controlled launching pad for the next three months. The earnings reaction caused the breakout, and shares have held up since then. If you’re game, you can start here with a loose stop in the mid-20s.

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Stock 9

Monday.com (MNDY)

Why the Strength
Based in Israel, Monday.com offers shared workflow and automation software it markets as a “work operating system,” designed to be easy to use by non-tech types, such as marketers, salespeople and human resources professionals. While the business has been growing quickly for a couple of years now, the first quarter this year was exceptionally strong, with revenue jumping 50% to $162 million in the period, thanks in part to strong reception to its new customer relationship management software for salespeople. With record free cash flow also in the period, management said it now expects to be profitable for full-year 2023, about two years ahead of schedule. Monday.com streamlines team communication with instant synced messaging, while adding the ability to customize project management and data sharing as needed. The system offers features users find familiar, like the ability to drag and drop columns and events around a virtual whiteboard. The software’s utility comes, too, from serving as a connective layer for apps like Gmail, Zoom and Salesforce, enabling automation of alerts and tasks to be pulled from those into the whiteboard. Monday offers a free tier of its software for up to two people with the aim of upselling into four different pricing tiers depending on company size and complexity. The strategy is working, with clients spending more than $50,000 annually with the company rising 75% in Q1, to 1,683. The company is rolling out a new version of its database to all its customers over 2023 that speeds up load times and will be able to offer advances the company is making in AI capabilities, too. Analysts see revenues up 35% this year while earnings move into the black.

Technical Analysis
MNDY crashed from 450 in November 2021 to below 90 last summer, where the bottoming process began—it did briefly sink to a new low under 80 in October, but that was a shakeout, with shares eventually moving back to 170 or so in February. The market’s bank-induced retreat did hit MNDY hard, but we’re impressed with the recent pre- and post-earnings comeback, including the big-volume earnings gap last Monday. Volatility is extreme, but a nibble here or on dips and a loose stop is fine by us.

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Stock 10

Take-Two Interactive (TTWO)

Why the Strength
Video game maker Take-Two offers titles through its labels Rockstar Games, 2K, Private Division and Social Point, and its industry-leading portfolio includes top sellers like the Grand Theft Auto, NBA 2K and Red Dead franchises. Most of Take-Two’s legacy games are outperforming in an otherwise weak video game market with plans to release 16 new titles this fiscal year. But next year (fiscal 2025) is when Take-Two expects to enter a “new era” of “greater levels of success.” That’s when it plans to release “several groundbreaking titles” it believes will set new standards in the video game industry and enable it to achieve over $8 billion in net bookings and over $1 billion in adjusted operating cash flow. Moreover, the company expects this momentum will be sustained with even higher levels of operating results in fiscal 2026 and beyond. These plans were revealed in last week’s fiscal Q4 (ended March 31) results; although EPS was in the red and missed estimates by four cents, Q4 featured an eye-catching 56% year-over-year revenue increase and net bookings of $1.4 billion (up 65%), while full-year net bookings exceeded $5 billion (up 47%). Bookings from recurrent consumer spending more than doubled in 2023, rising 115%, and digitally delivered net bookings rose 76% and accounted for 97% of the total. The latter metric is significant given the industry’s increasing shift away from physical sales, with Take-Two predicting its business will eventually be entirely digital. For fiscal 2024, the company guided for net bookings of $5.5 billion at the midpoint, with 79% of console games expected to be delivered digitally. Wall Street sees a nominal top-line bump this year, followed by a 45% revenue jump and booming earnings in 2024 as the company’s new offerings drive business higher.

Technical Analysis
After the Covid-era gaming boom ended in early 2021, TTWO fell out of favor along with the rest of the gaming industry and hit the skids for almost two years. After shedding 60%, the stock bottomed at 90 last November on more than 10 times average daily volume (looks like a climactic selloff at this point). Shares climbed above the 50-day line in January and began a multi-month advance, with some very tight action followed by last week’s earnings gap. Weakness should be buyable.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on May 30, 2023.