Cabot Top Ten Trader Issue: October 24, 2022

No Rush

The market and many stocks staged a nice bounce last week, and what’s interesting if you look at the charts of the major indexes is that, despite many ups and downs and news-driven moves (including last night’s plunge in Chinese stocks), they’ve all stopped going down for the past three to four weeks—and that means you should keep your eyes open, as believe it or not, as a few good days could actually produce an intermediate-term green light. Still, as has been the case for weeks, we need to see it before taking any big action: Until proven otherwise, the onus remains on the buyers to show up for more than a day or two (and to have things head up as opposed to just “not go down”), which means keeping plenty of cash on the sideline and making only small new buys when you decide to put a little money to work. As has been the case for a while, our Market Monitor remains at a level 3, though we’ll let you know if that changes going forward.

This week’s list is heavier on commodities than it has been in a while, though there are a few nascent earnings winners in there, too. One that fills both bills is Steel Dynamics (STLD), which is our Top Pick—shares are picking up steam after their Q3 report following a 13 month period of no progress.

STOCK 1

Amylyx Pharm (AMLX)

Why the Strength
The Ice Bucket Challenge craze of recent years wasn’t just for show: Money gathered by the effort to boost awareness of amyotrophic lateral sclerosis – ALS – helped fund research for, and lobby for approval of, Relyvrio, Amylyx’ oral treatment that dramatically reduces the deterioration of muscles seen in adults with ALS. The drug was green-lighted by the Food & Drug Administration last month, after clinical trials partially funded by Ice Bucket Challenge grants showed that Relyvrio takers had a median survival period of 23.5 months, 4.8 months more than those on placebo. ALS is a fatal disease, with about half of those afflicted dying within two years of diagnosis. Some 300,000 people worldwide live with ALS, including about 62,000 in North America and the European Union. The drug is approved in Canada under the brand Albrioza and is nearing approval in the E.U. Until now, Amylyx has been a developmental stage company, posting revenue of just $285,000 in 2021, all from grants, and a net loss of $88 million. Rollout of Relyvrio has been planned for some time, and will be the main driver of revenue going ahead. It could be significant since, while Amylyx has priced the drug below the levels of other ALS treatments, Relyvrio will still command $158,000 for a year’s treatment. The key will be getting doctors who treat ALS patients to prescribe the drug as it becomes available in the next couple of weeks. Management says they have a plan to get some 500 doctors specializing in ALS to prescribe the drug early on, which would cover two-thirds of expected prescriptions, a number that hasn’t been publicly disclosed. Analysts see revenue of $185 million next year, but that’s likely a shot in the dark.

Technical Analysis
AMLX began to get going in May after a huge decline, though nervousness about the approval caused a big shakeout in early September. That’s behind the stock now, of course, with AMLX gapping up to 30 after the news, forming a base around there for a while and pushing higher in recent days, moving out above its post-IPO highs. It’s an interesting speculation—if you want to take a swing at it, look for a pullback into the 25-day line.

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STOCK 2

Axon Enterprise (AXON)

Why the Strength
Axon Enterprises has a story that’s become increasingly easy to love over time, which is one reason the stock has made good progress in recent years (and has appeared in Top Ten a handful of times). The firm used to be known as Taser, and its electrical weapons (basically fancy stun guns) are still a big part of the business, with law enforcement agencies using them to avoid accidental deaths/shootings. But the reason investors have warmed up to the stock over time is that (a) the product line-up has broadened out a ton, and (b) most of those products include subscriptions (even lots of the weapons are sold via bundles that include training, etc.), which replaces the lumpy, one-time sales model and instead has produced an ever-increasing tally of recurring revenue. Axon now is big into body and in-car cameras (both of which reduce violent confrontations), real-time operations management (far better than getting on the horn) and, maybe most importantly, its Evidence.com cloud platform, which allows video and other data to easily be inputted, stored and shared, taking many departments away from inefficient paper-based methods. The long-term trend of on earnings has certainly been solid because of these changes (44 cents per share in 2017 to $2.35 last year; EBITDA should be up double digits this year despite the earnings dip), but more impressive to us are the sub-metrics: In Q2, annualized recurring revenue came in at $368 million, up 42% from the year prior, while total contracted future revenue (which, granted, includes things that might not be paid for a few years) totaled $3.33 billion, which was up 63%. Both of these figures have been steadily cranking higher for many quarters in a row, and there’s no reason to think that will change going ahead.

Technical Analysis
AXON didn’t escape the bear phase earlier this year, with a double top in the 200 area in November and a slide into the low 80s by May. The brief bottoming area and rally that followed was decent (nosed above the 200-day line), but what’s caught our eye is the action of the past two months—AXON has etched a proper launching pad while the market retested its lows, And today the stock moved out to multi-month highs! We like the move, but given that breakouts have been very iffy for months, we’ll set our buy range down a bit.

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STOCK 3

Diamondback Energy (FANG)

Why the Strength
Among the bigger cap oil plays, Diamondback Energy (which focuses on the Midland and Delaware basins) might have the best set of acreage, the best management team and the best cash flow profile—and given that, as of July, the firm had finally hit its debt reduction target, Diamondback now plans on returning (dividends or share buybacks) a full 75% of its free cash flow starting in Q3, which is obviously going to keep many investors interested. That’s certainly an underpinning for the stock, as are still-resilient oil prices (north of $80 per share) despite an aggressive Fed and pervasive recession worries. But what’s interesting here is that the top brass isn’t just harvesting cash flow but remains on the offensive: In August, it swallowed up its own MLP (Rattler Midstream, which was spun out just three years before), bringing that highly profitable operation back under its wing. And then, two weeks ago, the company announced a good-sized buyout in the Midland basin, costing around $1.7 billion of cash and stock that will add 350 drilling locations and 68,000 acres nearby their current acreage, including many wells that are so economic they could be drilled right quick; the buyout should be accretive to all metrics (including shareholder returns) starting in 2023, though management also separately announced a target of $500 million of non-core divestitures to help keep the balance sheet strong. Stepping back, before the Midland proposal, Diamondback cranked out $1.3 billion of free cash flow in Q2 (when prices where higher) and, looking ahead, should see north of $20 of free cash flow next year even if oil is in the $70 range.

Technical Analysis
FANG topped with the oil group in June, pulled back about 35% into July, with the rally after that just OK and leading to another dip in late September (again, with the sector)—shares dipped clearly below their 200-day line on both retreats, which wasn’t ideal. But now the stock seems to be changing character, being one of the first to take out its August/September highs and racing toward the June peak. We like it, but favor looking for dips if you want in.

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STOCK 4

Interactive Brokers (IBKR)

Why the Strength
A bear market should be bad for brokers because most aren’t inclined to start trading or load up cash into an existing account. But the headwinds for Interactive Brokers don’t blow as strong as they do on competitors. In the third quarter, which was reported last week, the company managed a slight gain in commission revenue and posted active account numbers up 31% over 2021 – meaning accounts now number more than two million. Management says that even if the negativity continues, it expects a 30% growth in accounts by this time next year due to expanding broker relationships that more than offset the ebbing tide of Mom-and-Pop traders. Interactive Brokers has long benefitted from what Barron’s says is a 20-year run of being the lowest cost broker in the business, with lower fees and margin rates – and higher interest paid on cash balances – compared to competitors like Charles Schwab and Fidelity. Part of the business’ advantages are because, while most online brokers are retail trader focused, Interactive Brokers also serves as a prime brokerage to other Wall Street firms. It expects to be the fourth largest next year, just behind Morgan Stanley. That means hedge funds – which trade a lot of assets frequently – are using the platform more. The business is also much more global than others, with a plurality – 39% – of accounts in Asia-Pacific and the rest roughly equal between North America and Europe, thanks to a system that allows easy pricing and trading in 150 stock markets. Higher interest rates are also helping, too: Commission revenue was up 3% in the quarter (again, solid relative to the market), while net interest income came in at a whopping $4.70 per share, up 73%. Thus, it seems like the firm has a solid balance here—should rates rise, earnings should perk up despite tough times for trading, while if the Fed calls off the dogs, customer activity could ramp. Analysts see excellent earnings growth in 2023.

Technical Analysis
IBKR has rounded out a very nice-looking base for the past many months, with a solid bottom in the May-July time frame, and excellent relative strength since August, with the 50-day line holding firm during corrections and every thrust higher (including last week’s post-earnings move) taking the stock to new recovery highs. Hold on if you own some, though pullbacks of a couple of points are likely, so wait for that if you want to enter.

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STOCK 5

Northrop Grumman (NOC)

Why the Strength
Northrop Grumman is one of the world’s largest defense contractors, providing military aircraft and unmanned aerial vehicles, missile defense technology and rocket launch systems. Northrop has a leading position in aerial drones used in military applications, including the remotely piloted RQ-4 Global Hawk and manned battle management planes like the E-2D Advanced Hawkeye. While the firm’s aeronautics segment has historically been a revenue leader, space systems (30% of total revenue) are now Northrop’s fastest-growing segment, accounting for nearly half its current backlog of $80 billion. Indeed, management noted that while the the Pentagon’s budget has increased by around 5%, NASA’s proposed 2023 budget is up nearly twice that amount, and a major investment bank has said space could be a $1 trillion industry by 2040 (thanks in part to the costs of launches dropping as much as 95%). To that end, Northrop bought rocket maker Orbital Sciences in 2018 to expand its space systems division, and more recently partnered with Firefly Aerospace to provide an American-built, first-stage upgrade for Northrop’s Antares rocket along with a new medium launch vehicle to serve commercial, civil and national security space launch markets. (The move was prompted by U.S. sanctions against Russia, as that country supplied Northrop with rocket engines.) Wall Street was impressed, and several institutions upgraded shares after the announcement (a reason for the strength). Q3 earnings (due Thursday, October 27) are expected to be lackluster, but analysts expect growth to pick up in Q4 and beyond, supported by the growing backlog.

Technical Analysis
NOC has been a standout in an otherwise lackluster market environment. The stock spiked after the Russian invasion (war fears), and then hacked around with a slight upward tilt during the next many months. But every time it’s approached its 200-day line (including its dip two Friday’s ago) the buyers have returned, with NOC popping to new highs last week. We favor aiming to enter on dips after earnings if you want in.

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STOCK 6

NOV Inc. (NOV)

Why the Strength
A sharp drop in drilling activity during the Covid pandemic—along with supply-chain setbacks—were major obstacles for oilfield equipment providers like NOV. But as global rig counts rebound, the company is seeing increased demand for its offerings as the global supply crunch abates. NOV provides equipment and components used in drilling and production operations for the upstream oil and gas industry, as well as oilfield services and supply chain integration offerings. The company’s latest strength was in part due to a major Wall Street outfit upgrading its shares based on an improving oilfield services outlook and supply-chain situation (the bank sees significant improvement in NOV’s EBITDA margin over the next two years). Sales and earnings have seen steady improvement in recent quarters, driven by what the company sees as “improving execution, customer demand and pricing.” Additionally, years of underinvestment in the drilling industry has resulted in lower global oil inventories and productive capacity, which along with geopolitical risks, should keep capacity tight and prices elevated for a while, All of this played into Q2 results, where revenue of $1.7 billion rose 22% from a year ago, while per-share earnings of 18 cents obliterated the consensus by 11 cents. Additionally, new orders totaled $670 million and orders exceeded production for the fifth straight quarter—a key indication that industry-wide activity is picking up steam. NOV believes it’s in the early stage of a new up-cycle in oilfield spending and both peers (Schlumberger had a great report last week) and analysts seem to agree, with earnings expected to surge to north of $1 per share next year. NOV’s Q3 report is due out Thursday, October 27.

Technical Analysis
NOV ran to two-year highs in March as energy prices spiked following the Russian invasion, but that began a big correction and consolidation—shares are now 32 weeks into a 42%-deep rest period. But the past month certainly has seen some buyers show up, with NOV seeing above-average buying volume in three of the past four weeks, including last week’s pop (aided by SLB’s earnings report). Reasonable dips would be tempting.

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STOCK 7

Petrobras (PBR)

Why the Strength
Petrobras (covered in the August 1 issue) is one of the world’s largest oil and gas producers, with expertise in deep and ultradeep water exploration and production. Global oil market tightness continues to feed strong revenue per barrel for the company, which has seen net profits north of $10 billion per quarter so far this year. Aside from high commodity prices and supply tightness (which is expected to intensify with OPEC’s recent decision to cut production starting in November), Petrobras’ strength is also driven by its South Atlantic assets, which allow the firm to produce high-quality oil that brings premium prices in global markets. On the financial front, Petrobras reported revenue of $32.5 billion—a 46% increase from a year ago—while recurring EBITDA jumped 34% from the prior quarter. Free cash flow generation has also been very strong of late, as highlighted by the whopping 61% sequential increase in Q2, to $13 billion, with annualized cash flow of around $50 billion. Possibly most important, the company’s profitability has allowed it to be generous with shareholder distributions, including a record $17 billion payout to shareholders in Q2; U.S. shareholders got a dividend of nearly $1.30 per share for that quarter alone! Management said it expects the company’s high refinery utilization rates to continue through the rest of this year, likely averaging 86% in the second half. More recently, the stock has benefited from the closer than expected Brazil election, which investors view as pro-growth. Earnings are due November 3, with analysts seeing elevated earnings and payouts for many quarters to come.

Technical Analysis
PBR broke out last December and had a great run for the next few months, moving up above 13 in May before pulling back to the 200-day line. Then came another surge to new highs (to nearly 15.5), followed by another sharp dip (23%) into the end of September. But now PBR is at it again, surging last Friday to another fresh high … but today’s selloff in emerging markets (especially China/Hong Kong) took the stock back down. We look at this as a potential shakeout–if you want in, consider a nibble on a move back into the upper 15s.

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STOCK 8

Prothena (PRTA)

Why the Strength
Prothena is a late-stage clinical company with expertise in protein dysregulation and a growing pipeline of novel investigational therapies for rare peripheral amyloid and neurodegenerative diseases, including Alzheimer’s. Prothena’s leading Alzheimer’s candidate, PRX012, is currently in Phase I and targets amyloid beta, a sticky protein commonly found in the brains of Alzheimer’s patients (the idea being that the protein’s removal would slow the cognitive decline associated with the disease). Last month, rivals Biogen and Eisai released clinical results that showed their amyloid-targeting Alzheimer’s drug, Lecanemab, slowed cognitive decline in early Alzheimer’s patients by 27%. The optimism the news generated sent Prothena’s shares soaring based on the Wall Street’s realization that PRX012 works similarly to Lecanemab, but potentially allows for subdermal (instead of intravenous) delivery, lower dosing and better binding potency. The bullish Alzheimer’s news prompted a major Wall Street bank to upgrade Prothena’s shares (a reason for the strength), calling it a “a big milestone in the treatment” of Alzheimer’s that’s expected to benefit the company by extension, adding that while Prothena’s amyloid-targeting therapy may not be the first to market, it has best-in-class potential. PRX012, meanwhile, was recently granted a fast-track designation by the FDA, with top-line data expected next year, while Phase I data for another Alzheimer’s candidate, PRX005, is expected by year-end. It’s speculative, of course, but any good news should keep the buyers active.

Technical Analysis
After dragging along a multi-year low of 7.50 for several years, PRTA turned a corner in early 2021 on the back of general sector strength, with shares mushrooming as high as 80 by September that year. PRTA then round-tripped most of that move during next few months, hitting bottom around 22 in June, which was followed by a three-month bottoming process. Lift-off came in late September after the Biogen trial news, with shares tagging 64 before resting normally the past three weeks. Dips toward the recent lows would be intriguing.

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STOCK 9

Steel Dynamics (STLD) ★ TOP PICK ★

Why the Strength
Despite hot-rolled steel prices being 60% below their highs from last year, demand for the building material remains strong, which is keeping Steel Dynamics’ business in fifth gear. The company, which is one of America’s largest producers of carbon steel, reported surprisingly upbeat results for Q3 last week: Strength in the firm’s steel fabrication business “meaningfully” offset lower sales from its flat-rolled operations, with total steel shipments hitting a quarterly record of 3.2 million tons, thanks to steady steel demand from the construction industry and complemented by the automotive, industrial and energy sectors. The firm also reported records in steel fabrication operating income (bolstered by higher prices) and shipments, as well as record cash flow from operations of $1.5 billion (up 138%). Total revenue of $5.7 billion improved 11% from a year ago, while per-share earnings of $5.46 beat estimates by 5%. Management said customer order activity continues to be “healthy” across all business segments, but expects seasonally moderated volume for steel and metals recycling operations in the coming months. However, it also sees strength down the road, while both input costs and competitive imports expected to fade—in turn supporting steady-to-expanding metal margins. Moreover, the company’s steel fabrication operations order backlog is “historically high” (stretching well into 2023) and this, along with recently announced expansion initiatives, are anticipated to be “firm drivers” for Steel Dynamics’ bottom line in the coming years. Earnings should slip next year, but remain elevated, and even those estimates are moving much higher—to north of $11 per share today from $9.60 three months ago.

Technical Analysis
Like most commodity names, trading action in STLD has been extremely choppy in recent months. The stock hit a peak near 100 in April, then plunged 38% before bottoming in early July. A strong rebound into August followed, but shares were unable to recover to the April high, stopping short around 89 and resulting in another big drop, this time to 70. The move higher in October definitely has more power, though, helped along by the end-of-week rush of buying after earnings. There’s likely resistance in the mid 90s, so if you want in, aim for weakness.

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STOCK 10

United Airlines (UAL)

Why the Strength
The new travel boom has been in effect for a couple of quarters now, and United Airlines is one of the beneficiaries, as its sales and earnings have catapulted out of the weak pandemic period. In Q3, reported last week, everything went bananas as prices were high and people traveled anyway—not only did revenues leap 66% over the prior year, they were also up 13% from the pre-pandemic 2019 Q3, with revenue per seat mile up a big 25% from 2019 (capacity was actually down 10% versus three year ago). And earnings went crazy, totaling nearly $3 per share and coming in more than 20% above expectations. That’s certainly a reason for the strength, but we think there’s something more that could be shaping up, too: Management expects a very strong Q4, stating that operating margins should beat the comparable 2019 quarter (that would be the first time that’s occurred since the pandemic), and sees durable uptrends for air travel due to the Covid recovery, hybrid work and overall supply challenges (which is keeping capacity in check and prices elevated); indeed, analysts think earnings could rise to $6 per share next year, and even that could prove conservative given recent trends. However, due to the bear market and fears of recession, it seems like big investors have mostly looking past those likely good times of late (i.e., expecting the recession to quickly cut into business next year), as the stock trades at just 6x to 7x next year’s (possibly conservative) earnings estimates. Thus, part of the attraction here is something we’ve seen a bunch since the pandemic—investor perception starting to rise as fears of an earnings stumble in the quarters ahead fade. It’s obviously cyclical, but we’re intrigued by travel stocks in general, and United Airlines in particular.

Technical Analysis
With all of that said, we can’t say UAL is free and clear on its chart, but it does appear to have put in a solid bottom and is now finding buyers. Shares found support in the 30 to 35 area in March, June and again in October, and now the stock has rallied solidly back above its 40-week line. It’s not a classic setup, but a nibble here or on minor weakness would be tempting, with the idea of adding more if the market gets healthy and UAL continues higher.

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Previously Recommended Stocks

Below you’ll find Cabot Top Ten Trader recommended stocks. Those rated HOLD are stocks that traded within our suggested buy range within two weeks of appearing in the Top Ten and still look good; hold if you own them. Stocks rated WAIT have yet to dip into our suggested buy range … but can be bought if they do so within the next week.

Those stocks rated SELL should be sold if you own them; they will no longer be listed here. Finally, Stocks in the DROPPED category are those that failed to trade within our buy range within two weeks of our recommendation; that’s not a bad thing, we just never got the price we wanted. Please use this list to keep up with our latest thinking, and don’t hesitate to call or email us with any questions you may have. New recommendations each week are in bold.

The next Cabot Top Ten Trader issue will be published on October 31, 2022.