Cabot Top Ten Trader Issue: May 28, 2024

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Leadership Acts Well, but Beware the Potholes

All in all, the good-not-amazing environment remains in place, with intermediate-term uptrends intact for the major indexes and a solid amount of good-looking leadership out there, especially among growth titles. (We’re encouraged to see the Nasdaq outperform most other stuff of late, including hitting a new relative performance peak vs. the S&P 500.) That said, there also remain a fair number of potholes and sell-on-strength episodes out there (as we saw on Thursday), and the broad market is sputtering a bit— in fact, most broader indexes (including equal-weight S&P 500 and Nasdaq 100 measures) have stalled out shy of their springtime highs. All told, there are plenty of stocks in a variety of sectors that are working, so we’re bullish, but it’s not a runaway train (at least not yet), so picking strong names, targeting decent entry points and booking a few partial profits on the way up are advised. We’re going to pull our Market Monitor down a notch to a level 7 and remain flexible, as many earnings reports among key names are out this week and next.

This week’s list has something for everyone, and we like how many of these names have shown excellent power of late (sometimes on earnings, but sometimes just on powerful buying). Our Top Pick is GE Verona (GEV), which is one of the “new” GE stocks that looks like an institutional way to play the energy transition trend. Aim to enter on dips.

Stock 1

Analog Devices (ADI)

Why the Strength
Analysts concur that the downturn in analog chips (sensors used in applications ranging from automotive and communications to industrial automation and smart buildings) is bottoming, which has big investors looking ahead to better times. Analog is the global leader in analog, mixed signal and radio-frequency (RF) semiconductors, holds a top position in power management and has always been solidly profitable. Recent quarters have been rough, though, due to industry conditions and inventory buildups, but the company just stated that it’s seeing the inventory problems of recent quarters stabilizing while new orders increase, “clearing a path” for a return to sequential growth in the third quarter and providing optimism that a cyclical recovery is underway. Last week’s release of the firm’s Q2 results was another cause for celebration among investors: Although revenue of $2.2 billion was a whopping 34% lower year-on-year, it topped estimates, while earnings of $1.40 beat the consensus by 11%. Even more significantly, management guided for Q3 revenue to improve to almost $2.3 billion, a 5% sequential increase if realized (the first sequential increase of any magnitude since late 2022), driven by strong consumer and industrial demand. More specifically, the company is seeing exceptional strength in healthcare, led by the rapidly expanding surgical robotics market (where the firm’s precision signal processing and connectivity solutions are critical), and Analog has also won “multiple opportunities” from several customers in the fast-growing continuous glucose monitoring space. Industrial automation and automotive applications also contributed to Q2 strength, where the AI-related and power management needs of both sectors are increasing. The stock has received some positive analyst commentary, as the mainstream view is coming around to the thought that Q1 was the low point of the cycle, with sales and earnings picking up meaningfully from here.

Technical Analysis
ADI rallied 40% from its October 2022 bear market low before hitting a wall around the round-number resistance at 200 starting in early 2023. Despite multiple attempts, it was unable to break out above this benchmark level for more than a year, and the last few months saw the stock go very quiet, with a range between 180 and 200 or so. But now ADI has decisively broken out on the upside, with strength before and after earnings. We’re OK starting a position here or (preferably) on a little weakness.

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Stock 2

ATI Inc (ATI)

Why the Strength
Dallas-based ATI (covered in the April 15 issue) produces high-performance titanium- and nickel-based alloys, stainless steel and specialty components for both the aerospace and defense markets, but it’s also known for its composite fibers that reduce fuel use by replacing heavier metals. Last month the Dallas-based company reported stellar Q1 results that surpassed the high end of its own guidance while turning heads on Wall Street. Touting a “robust backlog” of commercial aircraft orders, ATI posted revenue that, while unchanged from a year ago (due to Q4 production outages), exceeded $1 billion for the seventh consecutive quarter; per-share earnings of 48 cents, meanwhile, beat estimates by 14%. The quarter was led by 7% growth in aerospace and defense sales, as well as accelerating demand for the firm’s advanced specialty alloys segment, which achieved 14% EBITDA margin in the quarter (thanks to double-digit sequential growth in the electronics and medical markets). Equally notable was the record revenue set in the forged products segment, which ATI said sets the stage for strong sequential growth and segment EBITDA margins back above 20% in Q2. In the earnings call, management said Boeing’s widely publicized production slowdown of its 737 MAX and 787 Dreamliner widebody aircraft hasn’t hurt its orders “in any meaningful way,” and it sees strong underlying market conditions counteracting any challenges related to the output reduction. Indeed, while Q1 didn’t show any growth, the writing is on the wall for strong numbers ahead: Citing continued demand in its core markets and increasing production capacity, the top brass said it had a “clear path” for achieving its financial targets going forward, which include views of EBITDA rising a total of 33% from 2023 to 2025, and 57% from 2023 to 2027. Q2 is expected to bring another mixed set of results, but analysts see the numbers accelerating from there with 2025 and beyond looking fantastic.

Technical Analysis
ATI has been in a long-term uptrend (albeit a choppy one) for a couple of years, and when we last wrote about it, shares were trading in a tight range that was sitting on top of a prior 30-week consolidation. The Q1 report, though, brought a decisive breakout (with new relative performance peaks, too) at the end of April, and ATI has since traded very tightly in the 59 to 62 area. We like the action and think new buyers could grab some shares around here with a stop near the 50-day line.

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Stock 3

Cirrus Logic (CRUS)

Why the Strength
Growing momentum in the laptop market, along with the introduction of a slew of new products in the electronic devices market, contributed to a blowout quarter and a share price boom for Austin-based Cirrus. The company, a fabless semiconductor producer of analog, mixed-signal and audio DSP integrated circuits, is well known for its audio and voice processing chips used in iPhones and other Apple products, and it just released results for fiscal Q4 (ended March) that had investors buzzing. Although revenue of $373 million was unchanged from a year ago, earnings of $1.24 improved 35% and doubled Wall Street’s expectations, thanks to the introduction of a third-generation camera controller, the completion of a next-generation custom boosted amplifier and the rollout of the company’s first 22-nanometer smart codec for the smartphone market. A big investment bank initiated a “buy” rating on Cirrus in the wake of the quarterly results (another reason for the stock’s strength) based on the company’s focus on extending its leadership position in the smartphone audio business, but also because of its expansion into so-called high-performance mixed signal functionality in smartphones (improved camera controllers, fast charging devices, and chips that improve power usage), creating “meaningful” revenue streams in new markets. (Audio accounted for 61% of the firm’s Q4 revenue, while high performance, mixed signal accounted for 39%.) Meanwhile, another major bank raised its price target for Cirrus based on the firm’s potential to see “significant growth” when the new iPhone 16 hits the market this fall. That brings up the major risk in this story—that Apple accounts for 86% of sales—so Cirrus is definitely a down-the-food-chain story. Still, the earnings story here is front and center today, with teh bottom line expected to remain elevated in the quarters to come before picking up steam starting in early 2025.

Technical Analysis
CRUS originally hit the century mark back in early 2021 and had been capped by that level (give or take a few points) for the next three-plus years, with some tough drops (to the 60 to 65 range) during that time. However, investor perception has finally changed—shares initially showed signs of life after earnings in February before sagging again, but it held the 40-week line and now CRUS is up and out after the fiscal Q4 report. If you’re game, aim for dips of a couple of points.

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Stock 4

GE Verona (GEV) ★ Top Pick ★

Why the Strength
The old General Electric is now three different outfits—one is focused on aerospace (GE), one healthcare (GEHC), and GE Verona (GEV) is the energy segment that began life as an independent entity in late March. The elevator pitch here is that Verona has the potential to the “safer,” institutional way to play the long-term electrification and energy transition trends: The firm does a huge business in power (gas, steam, hydro, nuclear; about $17 billion of annual revenue, mostly recurring and service-related), wind (onshore and offshore; $10 billion of revenue) and electrification (solar/storage, grid solutions; $6 billion of revenue), and the backlog here is enormous, totaling well over $100 billion and growing as the sectors expand. As of a couple of months ago, about 80% of this year’s revenue is basically booked, as well as more than half of 2025. The sales and earnings numbers are a bit messy because of the spin-off and growth here isn’t going to be as rapid as a smaller outfit, but it should be steady and long-lasting: At an Investor Day in early March, the top brass sees free cash flow totaling about $900 million this year, ramping to $1.5 billion next year (as revenues grow mid single digits and EBITDA margins expand) with continued growth from there right through 2028. Q1 confirmed most of the good tidings, with revenues up 6% and EBITDA moving into the black, while backlog grew, especially in the electrification segment ($18.1 billion, up 55%). There are sure to be other more dynamic alternative energy outfits, but GE Verona has an established position in many steadily growing markets that, with cost controls and rising margins, should produce huge cash flow over time.

Technical Analysis
There’s not much to the chart of GEV, which was just spun-off as part of GE’s reorganization at the end of March. But there a few things we like: First, it’s liquid, trading well over $150 million of volume even on a slow day. Second is the action, as after a wobble with the market in early April it’s been trending up. And third, we like GEV’s low-volume rest for much of May as the 25-day line approached, followed by the latest higher-volume lift. We’ll set our buy range down a bit, thinking a minor exhale is likely.

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Stock 5

Johnson Controls (JCI)

Why the Strength
Johnson Controls is a major player in commercial and residential building supply, energy solutions and next generation transportation systems, with a focus on advancing “smart” and sustainable buildings. Financial results for fiscal Q2 (ended March) were mundane, with revenue of $6.7 billion flat from a year ago and earnings of 78 cents a share beating estimates by three cents. However, orders rose 12% organically in the quarter, while the firm’s building solutions backlog of $12.6 billion increased 10% organically. In the wake of the Q2 report, shares briefly plunged in response to the company’s disappointing earnings guidance for Q3 (which was lower than Wall Street’s consensus). However, the stock came roaring back to life in the days after when a flurry of news announcements pointed to a major restructuring within the company. Reuters reported that Johnson Controls is considering the sale of its ADT security business, a move that has drawn the interest of several private equity funds. Johnson is also reportedly seeking buyers for its $5 billion HVAC segment as part of an effort aimed at divesting non-core assets and streamlining the business (the company inherited its fire and security business after merging with Tyco International in 2016), plus the firm has levered the balance sheet in an aim at increasing share buybacks. More recently, it was announced that a major hedge fund has acquired a $1 billion stake in Jonson, resulting in another wave of buying (the firm’s intention for Johnson haven’t yet been made clear, however). And last week, another hedge fund reportedly took a more than $500 million stake in Johnson! Moving forward, management is investing in capacity to service its accelerated data center backlog, which require cooling for the extreme heat higher-end devices generate. Growth should pick up a bit, but Johnson looks like a special situation, with many possible events driving the stock higher.

Technical Analysis
JCI was dead in the water last October, testing its 2022 bear market lows, when the market began to pull it up. The rally wasn’t impressive initially, but shares did improve in February, starting a string of eight weeks up in a row and moving nicely above the 40-week line. Shares shook out a bit on earnings, but the past three weeks have been solid, with great volume seen last week. It’s bound to be news driven, but we’re OK entering here or on further dips with a stop near the April highs.

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Stock 6

Monday.com (MNDY)

Why the Strength
Monday.com is an Israeli firm that offers shared workflow and automation software designed to be easy to use by non-tech types, like salespeople, marketers and human resources professionals. Monday.com’s Work OS platform streamlines team communication with instant synced messaging and offers lots of customizable project management and data sharing options. The system is designed with features people find simple, like the ability to drag and drop columns and events around a virtual white-board and the software also acts 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.com’s business has been growing fast since the pandemic days and, while growth has slowed a bit, it remains rapid and the top brass has kept costs in check, allowing the bottom line to flourish. Revenue for the first quarter, reported mid-May, jumped 34% to $217 million with net income more than quadrupling to $31.7 million – $0.61 per share, which was 21 cents ahead of expectations. Traditionally the business grows from offering a free tier of its software for up to two people with the aim of upselling as small businesses grow. That still works, but an encouraging sign is that Monday is seeing a lot of traction with larger enterprises of late, which means larger accounts that also are more apt to buy add-ons the business develops. The first quarter is typically Monday’s best quarter for adding customers, so the rest of the year isn’t likely to be quite as robust but should still show strong growth: Management says Q2 will be around $228 million revenue while the full year should come in around $945 million, both representing a 30% rise over 2023, while Wall Street sees earnings growing a bit slower (likely to prove conservative).

Technical Analysis
MNDY has moved up from its bear lows during the past couple of years, but it’s been brutally volatile, with corrections of 37% (last spring), 35% (last summer/fall) and 27% (February through April this year) along the way. However, the latest dip found support at the 40-week line and tightened up for a bit (unlike the prior two) and the recent earnings report may have finally changed investor perception, with MNDY not just gapping up but pushing to new highs in the days since on a string of big volume. We’ll set our buy range down a bit, though shares shouldn’t pull back too much if they’re ready to go.

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Stock 7

NetApp (NTAP)

Why the Strength
Enterprise storage sales declined last year due to shrinking corporate IT budgets, largely driven by recession fears and the after-effects of the post-pandemic tech boom. But as artificial intelligence (and its increasingly complex workloads) hits the mainstream, the demand for all types of storage is rebounding and is expected to continue growing in the coming years. That’s welcome news for data infrastructure provider NetApp, which specializes in unified data storage, integrated data services and cloud operations solutions to enterprise customers. The company offers storage systems and software, including all-flash arrays that support data management and hybrid arrays to deploy the speed of flash storage. Last week, a major Wall Street institution released a research report predicting that NetApp will benefit from improving underlying storage demand trends going forward and opining that at NetApp’s upcoming Analyst Day (June 11), the firm will reiterate its forecast for mid-single-digit revenue growth while maintaining upper-50% product margins despite higher memory component pricing, prompting a target price increase (a reason for the stock’s latest strength). NetApp’s fiscal Q3 (ended January) featured decent revenue growth and record highs across several key metrics. Total sales of $1.6 billion increased 5% year-on-year, led by a 6% rise in hybrid cloud segment revenue, while earnings of $1.94 rose 42% and easily surpassed expectations. Other metrics were equally positive, including all-flash array annual recurring revenue (ARR) of $3.4 billion that increased 21% and billings of $1.7 billion that improved 7% from a year ago. The company reported “good momentum” in AI, with dozens of customer wins in the quarter, including several large Nvidia SuperPOD and BasePOD deployments. Management said its hyperscaler partnerships and natively integrated storage services are positioning the firm to address new and emerging GenAI opportunities in the cloud, as well as in block storage. More will be revealed on Thursday after the close, when the firm will report quarterly results.

Technical Analysis
NTAP turned the corner starting about a year ago, rallying back above its 40-week line and enjoying a nice run into the summer. Since then, shares have largely stair-stepped higher thanks to booming reactions to quarterly reports last November and again in March of this year. Now NTAP is running higher ahead of its quarterly report this week—we’ll set our buy range lower, thinking any normal (not outsized) wobble should prove buyable.

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Stock 8

PDD Holdings (PDD)

Why the Strength
PDD Holdings operates two high-revenue online businesses: Pinduoduo in China and Temu in the U.S. Most of the company’s sales are from selling a wide range of retail goods, including apparel, household items and cosmetics in the U.S. plus, in China, groceries and services. About a fifth of revenue comes from transaction services – the fee it collects from other merchants using its platform for their sales. In China, the company has a lot of success using a social network approach, where consumers can team up to buy goods for group discounts. Pinduoduo also aggressively discounts more expensive goods for customers who haven’t purchased in a certain category before, such as smart phones. Temu, meanwhile, is often the source of the lowest-priced option in a category in the U.S., something it’s able to do both by the low cost of production in China and by exporting into the U.S. via many small packages of low individual value, sidestepping tariffs. There’s some risk to that—the U.S. could apply tariffs to all packages from China, something Congress has discussed (and China is likely to be a political football this election season either way). Still, operating as a cheaper version of Amazon.com has been great for business in both markets: In the first quarter, reported last week, PDD’s revenue rose 131% year-over-year in local currency to RMB 86.8 (about $12 billion) while earnings per ADS nearly tripled to $2.87 per share. Management says they are encouraging increased purchasing through deals, expanding their offerings and investing in technology to improve the customer experience and delivery logistics. Wall Street consensus is for this quarter to break through the RMB 100 billion mark with annual sales hitting RMB 415 billion, up 67%. Net income, meanwhile is seen rising 85% to more than RMB 85 per depository share. It’s a good story, albeit in a still-weak China group.

Technical Analysis
PDD began to get moving about a year ago and kept going until it rallied to near the 150 level last December. Shares stalled out and had some sour action after that, dropping to their 40-week line and seeing an ugly earnings reversal in March that led to some more weakness. But the past month began to see the buyers return—there were two big-volume buying weeks in April, and last week saw another round of heavy buying after earnings. Following today’s dip, we’ll set our buy range up from here, thinking a strong rally would confirm the recent breakout.

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Stock 9

Robinhood (HOOD)

Why the Strength
If this bull market carries on in the months ahead (which the odds favor happening), it’s a sure bet that many Bull Market stocks (firms those business is primarily tied to asset values and trading activity) will see business boom. Robinhood looks like the glamour play in the sector, as it’s leveraged to activity in many volatile areas (including cyrpto and sometimes meme stocks), but the firm has grown up a lot in recent years, too, offering far more in the way of products and services to traders (including index options and futures, though to be fair, there are still limitations, including a lack of mutual funds and things like preferred or closed-end stocks), as well as many interesting company initiatives: Its Robinhold Gold membership ($50 to $75 per year; currently 1.68 million members, up 42% from a year ago) gives users higher cash rates (5% yield), a 3% match on any IRA deposits if you stick around for a while (compared to 1% without Gold), a 1% deposit match (coming soon) and better trading tools and margin rates. (There’s even an upcoming credit card that promises an industry-best 3% cash back on all purchases if you have Gold.) And that’s led to a steady increase in customers and assets, with growth picking up now that the market is strong: In Q1, net deposits totaled $11.2 billion (25% of that came from transfers from other brokerages), more than doubling any other quarter of the past two years, while assets under custody lifted to $130 billion, up a huge 65% from a year ago. (Newer cohorts of customers are depositing larger amounts initially and growing faster over time.) Like many brokerages, a big part of the story is interest income (just over half of Q1 revenue, up 22% from last year), though transaction-based revenues are also surging (up 59%), led by crypto and options-related trading. The market’s correction in April saw trading volumes dip, but net deposits in the month were larger than Q4 2023 and options trading volume actually increased. All in all, if the bulls generally remain in charge, we think Robinhood can get a lot bigger as it takes share in the massive brokerage market.

Technical Analysis
HOOD broke out nicely after Q4 earnings in mid-February, beginning a beautiful gallop up to round number resistance in the 20 area near the end of March when the market took a spill. The correction from there was normal, but then things got a little crazy, with shares spiking and then falling after Q1 numbers came out—shaking us out in the process. However, HOOD’s rebound from there was outstanding, with “over the top” volume (even higher than the prior shakeout week), and shares are now testing their highs. It’s volatile, but we’re OK with a small position here or on dips.

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Stock 10

Starbulk Carriers (SBLK)

Why the Strength
Starbulk is one of the largest drybulk operators out there (moving grains, iron ore, coal and steel products) with 161 vessels on the water, and historically, business has been as cyclical as it gets, with giant boom-bust periods. But there are a couple of reasons why the company is thriving today and has a much sturdier foundation overall. First you have the sector itself, which has seen major under-investment in the past few years; the orderbook is near a historical low (partially due to stricter environment regulations that’s hiking the cost of making ships), net fleet growth has been south of 3% during the past year and new contracts inked in the first four months of 2024 were the lowest since 2017 (not including virus-affected 2020) while demand has been firm—which kept shipping rates from keeling over during the 2022-2023 downturn. Second, Starbulk itself made a big move, gobbling up peer Eagle Bulk Shipping (completed in April; Eagle makes up about 30% of the combined outfit) that should lead to $50 million in annual synergies (as well as some cash from selective ship dispositions) and big economies of scale. And then you have Starbulk’s overall business model, which reminds us of what oil stocks moved to a few years back: The firm has limited spending (expenses per vessel near $6,200 per day in Q1, far less than peers and well below average dayrates north of $19,000 per day!), which has produced a ton of cash that the firm has used to shape up the balance sheet (net debt down 12% from a year ago and 43% from three years ago) and pay solid variable dividends as cash piles up (75 cents per share in Q1). With shipping rates likely headed higher, even better results, cash flow and dividends should be coming.

Technical Analysis
SBLK had a great prior upcycle, but as charter rates finally backed off in 2022, the stock began a long decline, losing more than half its value before bottoming out last summer. There wasn’t any major turning point from there, but the stock gradually gained steam, lifting above its 40-week line last November and trending higher mostly along its 10-week line ever since, save for a few days under there in April. But after that shakeout, SBLK has quickly regained ground, hitting new recovery highs earlier this month and higher highs after the Q1 report. We’re OK entering here or (preferably) on dips.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on June 3, 2024.

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