Cabot Top Ten Trader Issue: May 30, 2023

Definite Flaws, but also Definite Improvement

For the first time in a while we started to see big investors floor the accelerator last week, with some names (many AI-related issues in the software and, especially, the chip group) really letting loose on the upside. Moreover, even the “non-AI” nascent leaders that perked up earlier in May are acting fine, with most digesting gains in normal fashion. All of that is to the good—though the top-down flaws that we’ve written about are all still out there, too, with relatively few stocks hitting new highs (some improvement here, but still lackluster), a good number of blowups each week and most areas of the market (the equal-weight S&P 500 hit two-month lows last Thursday) still struggling. Right now, we’re keeping our Market Monitor at a level 5, but we’re watching things closely—if more leaders emerge, it would certainly add to the bullish side of the ledger, but let’s see how the market reacts from here.

This week’s list has a bunch of solid growth and earnings-related plays from a variety of industries (including some tangentially connected to AI). Our Top Pick is practically a blue chip name—ServiceNow (NOW) won’t double in a month, but it has a pristine track record of growth, a bit of an AI angle and a suddenly powerful chart.

Stock 1

ASML Holding (ASML)

Why the Strength
Dutch firm ASML makes equipment that uses extreme ultraviolet light (EUV) lithography for printing highly advanced semiconductors, which are in growing demand for many of the fastest-growth end markets out there. EUV uses a lower wavelength of light to print finer circuitry on very small chips; it’s the next step in continuing to advance processing power, an evolution that has reached its limit with traditional ultraviolet light processes. ASML is the unquestioned leader in making chip-imprinting equipment, considered well ahead of competitors Canon and Nikon, and in fact, has a monopoly in the highest-end systems out there. The company’s first-quarter results showed the benefit of its market-leading position, with revenue coming in 5% beyond the most bullish estimates at €6.76 billion, with EPS up more than 180% from a year-ago at €4.95 a share. (The figures in the table below have been converted into U.S. dollars.) Market enthusiasm for the results was clipped somewhat by bookings falling, as ASML’s clients are seeing some softening in demand. But the dip is just cyclical and exacerbated from prohibitions on exporting its systems to China, with the Netherlands recently joining with the U.S. government in banning the sale of advanced chip-making equipment to that country. But there’s little doubt plenty of customers will come to take orders that would have gone to China – ASML’s backlog of orders covers two years of its production – and the long-term future is very bright: Management says sales in 2025 and beyond seem like they will be better than projected earlier, while continuing revenue from installed users should grow at 15%, also more optimistic than they had been. Analysts see the bottom line soaring to new highs this year and continuing a solid (not explosive) growth trend in 2024.

Technical Analysis
ASML’s off-the-bottom bounce from last October into February of this year was a solid one, but then shares got roped into the market’s rope-a-dope action in the spring. Even so, the base-building effort was shallow (a good thing), and after some tightness early this month, the chip stock rally helped shares leap to their highest level since January 2022. We’re OK snagging a small position (dollar-wise) here or on dips.

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Stock 2

Canadian Solar (CSIQ)

Why the Strength
In a sign of the times, U.S. wind and solar combined produced more electricity than coal in this year’s first quarter (partially due to a plunge in coal production, but still), with experts predicting renewable energy will provide over a quarter of the nation’s electrical generation in 2023 (a record if realized). Moreover, the International Energy Agency forecasts global solar power investment will surpass oil investment this year for the first time ever. The rapid growth in renewables has been driven largely by solar photovoltaic (PV) technology both on rooftops and via utility-scale deployments. Canadian Solar focuses on the latter, supplying utility-scale solar projects, and is one of the world’s largest providers of solar PV products, with customers in more than 160 countries; it also boasts one of the industry’s largest pipelines of future business and enjoys a leading position in battery storage manufacturing. The company’s large modules are used mainly for solar farms which operate like power plants and have become key drivers for the industry. This trend was highlighted in Canadian Solar’s latest earnings (a reason for the strength), which saw solar module shipments soar 66% in Q1 from a year ago to over six gigawatts (GW), of which 90 megawatts (MW) were shipped to the firm’s own utility-scale solar power projects. Total revenue of $1.7 billion jumped 36%, while per-share earnings of $1.19 crushed estimates by 46 cents. Canadian Solar’s project pipeline stands at 25 GW for solar and 47 GW for battery storage projects, which should fuel continued growth in the coming quarters; all-in, management expects shipments to increase 60% this year. Also interesting, the firm looks set to have a carve-out IPO in Shanghai in June (the initial pricing was announced this morning), raising proceeds that will help the firm expand.

Technical Analysis
CSIQ’s bear market started in February 2021 and technically ended in May 2022, with shares falling by about two-thirds during that time. The summer rally last year was nice but fell flat on its face, and the early-year spike back above 40 also didn’t stick. But instead of going through the wringer again, CSIQ then tightened up, with a nice base built between 35 and 43 (ballpark). And now we see a strong post-earnings reaction off that low, with six straight days of solid buying volume. There’s still some resistance near 45 (which capped the stock today), but we’re OK buying here or on modest dips.

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Stock 3

Confluent (CFLT)

Why the Strength
Confluent is a database developer that focuses on data flow, rather than the traditional view of data silos connected to specific applications. Think of this data streaming like a central nervous system, allowing corporations’ disparate systems and devices to access and synchronize data sets quickly. Speed is a big selling point as the end users of Confluent’s clients demand near-instantaneous abilities on mobile phones and web apps. This year Confluent should see sales rise 30% to around $760 million while getting its operating margin to breakeven by year’s end. Most of the business comes from two product offerings, Confluent Platform and Confluent Cloud. Platform, also called Kafka, is sold to customers as a self-managed system, meaning Confluent needs just five engineers on call at any time to assist customers, giving Confluent vastly better labor costs than competitors. The downside is that clients bear the brunt of staffing to manage Platform, raising their costs, especially for very large businesses that want to use Platform globally. For that reason, Confluent is now focusing more on Cloud, which slashes labor costs for clients while providing the same level of speed and synchronicity as the original system. This year, Platform will generate half of total revenue, down from 65% two years ago, while Cloud rises to 42%, nearly double two years ago (service contracts contribute the balance). Cloud is helping Confluent secure more large enterprises, with the number of clients contributing more than $100,000 in sales a year now at 1,075, roughly 20% of the client base. Confluent says its Cloud system is one-third cheaper than using competitors’ or open-source, which is helping with sales traction as companies have become more total-cost conscious. Big investors like the story and have been buying in, with 437 funds owning shares now, up from 324 nine months ago.

Technical Analysis
CFLT came public in the summer of 2021, had a good few months and then crashed with other high-flyers, falling to 17 last May. But over the past year, it’s been rangebound, mostly holding between that low and 30 or so (with one poke above that last summer). Early May’s better-than-expected Q1 report helped the stock push back to resistance near 30, and today it topped that figure on some solid volume. Even so, we’ll set our buy range down a bit, thinking a short-term exhale is likely.

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Stock 4

DoorDash (DASH)

Why the Strength
DoorDash is one of the leaders in the delivery sector, where there is plenty of competition (UberEats and Grubhub, among others) but where there’s also plenty of growth—in fact, a recent report sees restaurant delivery services growing at a 14% annual rate through 2027, and in the U.S., the growth wave could be stronger and longer lasting given that online delivery stands at just 12% of all restaurant sales, compared to 22% in Britain and 30% in Canada. However, DoorDash isn’t content just with restaurants; in recent years it’s moved into new verticals like grocery and convenience stores with success—the firm isn’t releasing many numbers from these areas yet, but said growth is faster in these newer areas compared the business as a whole, that’s it’s taking market share (as it is in restaurant delivery) and is seeing improved margins as well. As for the stock, it’s setting up nicely today because business is solid, the competitive landscape is easing, cash flow is improving in a big way and, of course, the stock had previously come back down to Earth: In Q1, revenues were up 40%, though that overstates things a bit; excluding an acquisition, total orders were up 17% and gross order volume rose 20%, while contribution profit margin (as a percent of order volume) was 3.3%, up from 2.6% a year ago; EBITDA was the star, totaling $204 million, up from $54 million last year and up nicely from the prior two quarters. There really isn’t anything hugely game-changing here—just a leader in a steadily growing field, with a few newer avenues that should keep growth in fourth gear for a while.

Technical Analysis
DASH hit a double top near 260 in November 2021, which kicked off its toboggan slide to a low of 41 (!) last October. There was a bit of an earnings-induced rally after that, but the momentum didn’t really stick, and shares again ran into a wall in late January with many stocks. However, since then, we see improvement—DASH has held north of its 40-week line for many weeks, shown a few areas of tightness and, now, is set up just shy of multi-month highs. Today’s action was a bit sloppy, so we’ll set our buy range up from here, thinking a snapback will lead to good things.

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Stock 5

DoubleVerify (DV)

Why the Strength
DoubleVerify looked done for a few weeks ago, but that dip now looks like a shakeout as the underlying story attracts more big investors who see years of growth ahead. It’s not hard to see why: With the boom in digital advertising across many mediums, as well as the uptake of programmatic ad buying (pre-set, computerized bidding for slots), the need for ad verification is soaring—firms want to avoid fraud, which is a growing problem (a tripling in bot fraud since 2000; unprotected advertisers can see fraud rates north of 10%); they want to protect their brand, making sure their ads aren’t shown next to potentially objectionable content; they want to make sure the ads are actually seen (the industry standard is at least two seconds; 30% of digital ads don’t meet these criteria!); and that the ads are shown in a valid geography, not in place the firm doesn’t want to reach. Oh—and firms also want this across various outlets, including ad-supported connected TV, social media, e-commerce websites and more. Enter DoubleVerify’s platform, which, effectively does all of this and more—it’s the only platform, in fact, that covers all of the top ad-supported connected TV providers, and all in all, clients get a single place to manage and track their ads. The system works, and while there’s competition, there’s some moat here given DoubleVerify’s 5.5 billion measured transactions last year alone, providing great data and insight. That’s why the client list is chock full of blue-chip names in tons of different industries, and is why it wins more than 80% of the contracts it’s bidding for and all of its top 75 clients have stuck around—yet it’s still early days, with two-thirds of new clients usually not having any prior ad verification offering at all! To be fair, growth isn’t out of this world, but if management pulls the right levers, there’s no reason sales and EBITDA can’t rise 20%-plus for a long time to come (revenues expected to rise 24% in 2023).

Technical Analysis
DV’s dip four weeks ago on a short seller’s report hit the stock hard (and knocked us out), but shares did hold their 200-day line and started to bounce back after earnings. It wasn’t smooth, but DV gained strength starting a couple of weeks ago, leapt above resistance near 31 after that and has continued higher since. We would note that the relative performance (RP) line (not shown) is still shy of its old high, which usually (not always) leads to some more wiggles. Thus, we’ll take another swing at DV, albeit with a buy range down a bit from here.

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Stock 6

ServiceNow (NOW) ★ Top Pick ★

Why the Strength
Investment in artificial intelligence (AI) is booming across all segments of the economy, as businesses are aiming for a huge round of productivity boosts from the AI revolution and fear being left behind. Underscoring this theme was a recent statement from chip firm Nvidia’s CEO, who predicted that companies that don’t embrace AI could “perish.” Digital business platform provider ServiceNow is partnering with Nvidia to use the latter’s GPU software to train proprietary, generative AI algorithms for its digital workflow management platform. ServiceNow, whose software automates repetitive tasks and helps customers streamline workflows, sees AI chatbots and text-based prompts as being excellent tools to help clients fix workflow problems and train employees and believes its partnership with Nvidia will result in the development of “powerful, enterprise-grade generative AI capabilities that can transform business processes.” To further strengthen its AI position, ServiceNow just announced the launch of its Generative AI Controller and Now Assist for Search to improve automation, while expanding its strategic partnership with Microsoft to connect the Now Platform to Microsoft’s Azure OpenAI Service. The company also just agreed to acquire AI-powered platform G2K, which will enable ServiceNow to add G2K’s smart IoT technology to the Now Platform in an effort to help retail and other industries improve operational efficiency. Underlying all of the AI buzz, though, are great long-term growth numbers that remain strong: ServiceNow saw Q1 revenue of over $2 billion improve 22% from a year ago, thanks to a 24% increase in subscription revenue. Current remaining performance obligations (RPOs) grew 23% and per-share earnings of $2.37 beat estimates by 33 cents, prompting management to announce its first-ever buyback authorization of $1.5 billion. For Q2, the firm expects subscription revenue to increase by 24% while earnings continue to plow ahead.

Technical Analysis
From a November 2021 peak at 700, NOW entered the doldrums in 2022, falling steadily through most of the year before catching a break last October after a 55% drop. A successful retest of that low in early January led to a quick pop toward 500, which in turn led to a tidy three-month bottoming base. And now the stock has broken out on the upside on solid (not amazing) volume. Given the recent spike, look for dips to enter.

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Stock 7

Toll Brothers (TOL)

Why the Strength
There’s no question the housing market is feeling the effects of the prior multi-year ramp in prices and the backup in mortgage rates (which are still holding above 6.5%)—but homebuilders are doing well anyway, partly because the drop isn’t turning out as bad as feared, partly because the earnings power of the group has been greatly underappreciated, and partly, in Toll’s case, likely due to the resiliency of higher-income home buyers, where the firm focuses. In the quarter ending in April, Toll did see new orders and backlog slip in the high-20% range from a year ago, but the absolute dollar levels were still elevated given the ramp in recent years. And the here and now remains fantastic, with revenues and home deliveries both up nicely from a year ago, while home sales gross margin was up more than two percentage points, helping earnings to leap 54% and annihilate estimates by about the same amount! (An active share buyback program during the past year also helped, with the share count down nearly 6% from a year ago.) More important was management saying what many are seeing: Supply of existing homes remains hugely limited these days, as few are eager to give up their cheap (sub 3%) mortgages if they don’t have to, and that means demand for new homes should remain strong in general (and certainly stronger than many expected a few quarters ago) as the country is underbuilt in general. When you put it all together, nobody expects big growth from here, but as mentioned above, Toll’s earnings power looks big even in a so-so environment—analysts now see earnings of $10 per share this fiscal year, up from an estimate of $8.76 before the report, partly because the top brass sees home deliveries of about 9,200 this fiscal year, up from an outlook of 8,500 just three months ago (and at slightly higher than expected prices, too). A modest 1.2% dividend puts a nice bow on the story.

Technical Analysis
TOL ramped nicely from its bear market low last year into the end of January, and like many peers (and strong stocks today), it built a tidy launching pad for the next two-plus months before breaking out on the upside. The run from there was solid, but unlike most peers, TOL didn’t succumb much to the recent rise in interest rates, holding its 25-day line the entire time—and then popping to new highs after earnings on Thursday. Dips that bring shares closer to that 25-day line would be tempting.

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Stock 8

Urban Outfitters (URBN)

Why the Strength
Despite a challenging environment for many types of retailers, Urban Outfitters, which operates Anthropologie, Free People and FP Movement, along with its namesake stores, posted record sales and earnings in fiscal Q1 (ending April 30). The lifestyle retailer specializes in fashion apparel, footwear and accessories for younger adults, and its digital sales strategy continues to pay dividends, as evidenced by first-quarter results that featured a “significant improvement” in gross margins. Indeed, while Q1 saw a 5% year-over-year comp sales increase in the company’s retail segment and a modest 6% total sales bump, per-share earnings of 56 cents topped estimates by 20 cents and were up a huge 70% from the year-ago quarter. The Free People and Anthropologie brands witnessed sales spikes of 17% and 13%, respectively, driven by stronger spend among the higher-income consumers the brands target. By contrast, Urban Outfitters sales were 13% lower, while wholesale revenue decreased 11%, due in part to lower storefront sales. The standout performer, however, was Nuuly—Urban’s online, subscription-based premium clothing rental business—which is still very small but saw a whopping 150% sales increase, to $51 million, thanks to continued subscription growth (over 150,000 in three years) and increased interest. The company expects Nuuly to generate over $200 million in sales for this fiscal year which, if realized, would be a 54% improvement from last year; yes, it’s a drop in the bucket of the total, but the top brass also adding that the digital business “continues to make fast and steady strides towards profitability.” Back to the overall picture, management indicated that total retail segment comps for Q2 “could look very similar to Q1,” with retail sales so far in May in line with first-quarter results. After a tough year, Wall Street sees Urban’s bottom line roaring back to nearly $3 per share this year, leaving the stock with a very reasonable valuation (~11x estimates, which are likely conservative).

Technical Analysis
URBN has shown consistent relative strength versus the retail sector in the past year, including a more than 50% jump between October and December. The stock encountered strong resistance near 29 last year, but it led to several months of tight trading within a narrow, range. Last week’s earnings were the catalyst that finally shot URBN out of the holding pattern on extremely high volume (third heaviest weekly volume since late 2020). We’re OK taking a stab here or (preferably) on dips.

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Stock 9

Vaxcyte (PCVX)

Why the Strength
Vaxcyte is a clinical-stage biotech focused on overcoming the limitations of conventional, cell-based vaccine approaches using advanced chemistry to create difficult-to-make proteins that deliver benefits. The company’s pipeline is mainly focused on diseases that afflict both children and adults, including invasive pneumococcal diseases (IPD), Group A Strep and periodontitis. Positive mid-stage results for Vaxcyte’s lead candidate, VAX-24— targeted for the prevention of IPDs such as meningitis and bacteremia—is the reason for the stock’s recent show of strength. Data from a Phase II study in adults aged 65 and older found the vaccine candidate demonstrated robust immune responses and safety profiles across all doses studied. The results prompted a major Wall Street institution to initiate coverage of Vaxcyte with an “outperform” rating, noting that VAX-24 compares favorably to Pfizer’s Prevnar 13/20 (which dominates the $7 billion-plus market, a figure that could reach $13 billion by 2027) and Merck’s Vaxneuvance pneumococcal vaccines, while using a different technology that prompts cells and tissues to provoke a potentially better immune response across many strains compared to the current treatments. Now, with that said, any launch is still likely years away—Phase III safety and immune response data arent’t likely until 2025—so there’s a lot of hope here. On the financial front, a recent equity offering generated about $545 million in net proceeds, which the company said will allow it to expand manufacturing capabilities as it advances its PCV franchise (comprised of VAX-24 for adults and kids, and VAX-31, plus a 31-valent PCV candidate). Some see a $6 billion peak revenue figure for VAX-24 in the years ahead. It’s an interesting speculation and likely has some M&A attraction, too.

Technical Analysis
Like all clinical-stage biotechs, PCVX is very news driven. It spent 17 months laying the foundation for the vigor the stock has shown since late October, when positive data from its lead vaccine candidate exploded the stock 125% higher in less than two weeks. Shares did stall out in the weeks after that and pulled in with the market—but they held the 40-week line and then gapped higher following the latest batch of VAX-24 data in April. After soaring to 55, the recent dips to the 25-day line looks orderly—we’re game grabbing a few shares here or on weakness if you want in.

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Stock 10

Workday (WDAY)

Why the Strength
Workday was one of the pioneers of cloud-based software many years ago and remains so today; it offers solutions for finance, human capital management (HCM), planning and spend management, including applications for analytics, reporting and more. Thanks in part to a “healthy pipeline of opportunities,” the company got off to a solid start in 2023, with demand for the firm’s software increasing across organizations, industries and all geographies. Workday reported earnings per share of $1.31 that blew past consensus estimates by 19 cents. Revenue of $1.7 billion rose a respectable 17% from a year ago, including over $1.5 billion from subscriptions (up 20%). Meanwhile, total subscription revenue backlog jumped 32% to $17 billion, underscoring the long runway of growth that’s coming down the pike. Commenting on the bullish results, management emphasized that artificial intelligence (AI) and machine learning (ML) are a big part of Workday’s platform, with the company committed to infusing more generative AI and ML into its products to drive more business value for its clients. Specifically, Workday said it’s exploring the use of AI for multiple content generation use cases within its talent management, recruiting, financial management and core HCM applications. On the ML front, the firm recently unveiled a predictive forecasting capability within its Adaptive Planning software solution that creates forecasts with the ability to add additional datasets. Even more promising, Workday is using ML to develop “low-code/no-code” tools that allow developers with no code writing skills to create apps with a simple drag-and-drop user interface. For 2023, the company raised its subscription revenue forecast to just over $6.5 billion, with Wall Street seeing upper-teens revenue and faster earnings growth going ahead.

Technical Analysis
Shares of WDAY were slashed in half during last year’s bear market, but the stock found strong support at 130 in early November and quickly turned the corner after that, catapulting above the 50-day line on earnings later that month. The February through April period was generally sideways (one fakeout on the upside, and one on the downside), but WDAY rallied nicely early this month and gapped to 13-month highs last Friday. We advise aiming for weakness if you want in.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on June 5, 2023.