Cabot Top Ten Trader Issue: September 25, 2023

The Correction Continues

The Fed’s latest hawkish stance prompted an upside breakout in Treasury rates and a big late-week selloff in the stock market, with just about everything getting whacked—at the end of last week, more than 80% of stocks were south of their 50-day lines as the big-cap indexes tested their August lows and broader indexes fared worse. That action puts to bed the rally attempt from late August, of course, and reinforces our overall stance—the intermediate-term trend remains down, and with the broadening of selling pressure, we’re pulling our Market Monitor down to a level 5. To be fair, though, we’re not sticking our head in the sand: Yes, there are many worries (interest rates, government shutdown, auto strikes, etc.), but the longer-term trend of many leading stocks and indexes is still up, and there’s plenty of evidence suggesting a resumption of the post-bear rally is coming at some point. Even so, it’s best to wait to see the bulls arrive first than to catch falling knives—right now, we advise holding plenty of cash and being very discerning on the buy side until the selling storm passes.

While there aren’t many super-strong stocks out there, this week’s list has many that have taken the selling in stride thus far. Our Top Pick is Alpha Metallurgical (AMR), which is helping to lead a group move in coal stocks that got underway a few weeks ago and could be starting its first pullback—further weakness would be tempting.

Stock 1

Abercrombie & Fitch (ANF)

Why the Strength
Retail sales this summer were less than stellar as Americans grappled with inflation, but fashion apparel sales were surprisingly strong. While shoppers slashed spending on a wide variety of goods, clothing store sales increased 1% month-over-month in August, making it the top-performing category in the latest U.S. retail sales report, continuing a bullish multi-month trend. Among the leaders in this space is Abercrombie & Fitch, which operates 760 stores worldwide and owns the Hollister and Abercrombie brands that are popular with teenagers. More recently, the company has broadened its appeal to an older crowd—mainly aged 22 to 45—while expanding its offerings to include office, special occasion wear and active apparel. The stock is strong because business is picking up while margins take off: Last month, the company reported Q2 sales of $935 million, which rose 16% from a year ago (the fastest growth rate in years) and was led by a 16% total comp sales increase, plus earnings of $1.10 a share that beat estimates by a head-turning 95 cents as after-tax margins lifted to 6.1%. The stellar comp sales were led by a 26% jump in the Abercrombie brands and an 8% rise in Hollister, with both brands being helped by lower freight costs and inventories. The latter is significant as management noted a major improvement in Hollister’s positioning and assortment, which allowed it to return to positive growth for the quarter. Going forward, store expansion is part of Abercrombie’s growth strategy, with around 35 new locations planned for 2023 (including a just-opened store on New York City’s famed Fifth Avenue), and the firm emphasized its “critical” long-term investments on the digital front. For Q3, Abercrombie guided for sales to be up by low double-digits, with Abercrombie brands continuing to outperform Hollister. Analysts see full-year earnings soaring and the valuation looks very reasonable (11.5x this year’s expected earnings, which are likely conservative).

Technical Analysis
ANF broke free from a multi-month downtrend in late May on a huge earnings gap, continuing to soar to new highs into the summer. A brief correction in July found support above the 50-day line, and after more upside the stock gapped again in August after the blowout Q2 report. The recent dip to the 25-day line looks normal so far—further weakness could provide an opportunity to nibble.

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Stock 2

Alpha Metallurgical (AMR) ★ Top Pick ★

Why the Strength
In spite of a sluggish real estate market in China (the world’s largest steel consumer), the appetite for iron ore—one of the main ingredients for making steel—is picking up as its economy recovers from last year’s Covid restrictions; that country’s steel output has increased in the last few months and has already surpassed 2019 levels every month in the year to date. And that’s welcome news for Tennessee-based Alpha Metallurgical (covered in the August 21 issue). The company is America’s largest producer and exporter of metallurgical, or “met,” coal used to make steel, accounting for 20% of total U.S. met coal production. Encouragingly, though, this isn’t just a China-based story: Even if China’s economic rebound sputters, India is fast becoming another dominant player in the global steel market and is currently the world’s number-two producer of the industrial metal. India also happens to be a growing part of Alpha’s export strategy and accounts for a third of the firm’s overseas sales in the last five years. Additionally, three separate U.S. infrastructure and industry spending bills passed in the last two years—all designed to support the building of semiconductor plants and alternative energy production equipment—should provide a further demand boost for the domestic steel sector, in turn enhancing the outlook for Alpha’s met coal. Despite production-related setbacks earlier this year at two of Alpha’s key mines (which have since been fully restored), the company’s cash from operating activities increased 80% sequentially in Q2. What’s more, some analysts expect Alpha will end up generating an eye-popping $750 million in free cash flow for 2023 ($50 per share, give or take), a lot of which is being used to buy back shares (share count down a whopping 22% from a year ago). Earnings and cash flow should continue to fall from nosebleed levels but remain elevated (~$20 per share in 2024) for a long time to come.

Technical Analysis
We missed getting into AMR in August after the stock never pulled back into our recommended buy range. Instead, shares kept motoring higher with barely a rest along the way, hitting all-time highs in the process. But after reaching a peak last week around 250, the market’s weakness is finally bringing in some profit-taking—though, so far, the dip has been modest and come on very low volume. We do think further dips are likely near term, so we’ll again look to enter on weakness.

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Stock 3

Braze (BRZE)

Why the Strength
The need for better marketing is always around, especially as the digital realm continues to increase and change the ways consumers can be contacted by various brands. Braze is small outfit with a top-notch roster of clients (Pizza Hut, Venmo, HBO, CVS, DraftKings, Fanduel, 1-800 Flowers, Etsy, the NBA, Shake Shack, Taco Bell, Burger King, Turbo Tax, Weather Channel, GoFundMe, Nascar, Gap, IBM, Sophora, Proctor & Gamble, Peloton, etc.) that has a platform built to allow firms to engage in a cross-channel marketing with the customer as the focus—gone are the days of honing in on a single channel (just email, etc.), replaced by real-time alerts, texts, notifications, emails and even WhatsApp messages (a new channel recently added) to boost activity, loyalty and sales. HBO, for instance, could welcome a new subscriber via email, send emails and notifications on a phone about new just-released content, and have a few ways to get in touch to get you to re-up your subscription, if necessary. The advantages here appear to be Braze’s broad applicability (no one industry represents more than one-quarter of its revenue), real-time capabilities and use across channels, with single-channel solutions rapidly losing share—and it doesn’t hurt that management is aggressively integrating AI to boost marketer success rates and improve the tone, structure and grammar of sales efforts. Business trends have been solid despite some softness in tech spending, with revenue growth (nearly all of which is subscriptions) of 34% in Q2 actually accelerating a bit last quarter, same-customer revenue growth of 20%, customer growth of 22% (to 1,958) and a 28% gain in remaining performance obligations. The bottom line and free cash flow are still just underwater, but that could change quickly given the strength seen in the top line. All in all, it’s a solid growth story and the top brass is executing well.

Technical Analysis
BRZE was one of the 2021 IPOs that came public at a huge valuation before being taken apart in the bear market, losing more than three-quarters of its value from top (99) to bottom (23). The stock was still languishing in May (back down to 26) when it rallied off its lows and then gapped up on earnings in June. To be fair, it’s been a bumpy road since then, but BRZE did hit 12-month highs a couple of weeks ago before pulling in on light volume toward support. We’ll set our entry range above here, looking for a strong round of buying off support.

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Stock 4

Crinetics Pharma (CRNX)

Why the Strength
Acromegaly is a rare hormonal disorder that causes the enlargement of bones and facial features, as well as soft tissues and other organs. It has a global incidence of around 32,000 new cases each year (including over 1,300 in the U.S.), and if untreated and associated with diabetes and heart disease, life expectancy is reduced by 10 years. Crinetics is a clinical-stage biotech that develops therapies for patients with rare endocrine diseases and endocrine-related tumors, and its lead drug candidate, paltusotine, recently reported positive Phase III trial results in treating acromegaly (the reason for the stock’s strength). The results suggested that Crinetics’ once-daily oral pill, which can be taken from the patient’s home, is as effective as the existing standard of care (delivered via injection) in treating the disease. Crinetics plans to announce top-line data from a second late-stage trial for paltusotine early next year and also plans to submit a regulatory request to commercialize the drug in 2024. What’s more, the firm is set to release Phase II results for its oral ACTH antagonist CRN04894, which could generate proof-of-concept for treating Cushing’s disease and congenital adrenal hyperplasia. Of course, there’s not much to report on the financial front as the firm is still basically in the pre-revenue phase, but a major Wall Street institution has raised its rating on the stock (another reason for the strength), noting that a marketing application for paltusotine next year could pave the way for up to $250 million in peak sales for the company—a conservative estimate given that many analysts see the drug’s peak sales approaching $500 million. The company also just announced a $350 million capital raise, with plans to use the proceeds to fund development of paltusotine and CRN04894. It’s an interesting, niche biotech story.

Technical Analysis
CRNX rallied choppily in 2021 but then took a hit and essentially entered a long, tedious bottoming phase after that, with support in the 15 to 17 area for months on end. The stock looked ready to crack to new lows recently, but the recent trial data changed everything—CRNX gapped up on the news and rallied even more the next day (testing multi-month highs), and it’s held very tight since despite the market and the good-sized share offering mentioned above. It’s aggressive, but some market-induced weakness could provide a chance to nibble.

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Stock 5

Mobileye (MBLY)

Why the Strength
Mobileye’s autonomous driving system (dubbed SuperVision) is in the hands of its first beta users, customers of the Chinese luxury EV marque Zeeker. Testing has gone so well that, at the start of the month, Zeeker expanded SuperVision capability from 1,100 customers to 110,000. That has Israel-based Mobileye thinking it can ride the wave of Chinese adoption into the global market, with Chinese automakers aiming to sell vehicles beyond their homeland and Western automakers showing more interest in the system, which uses AI and car-produced video recordings and scans of roadways to learn how to navigate safely. While autonomous driving in the west may still be a few years away, Mobileye benefits from the migration of semi-autonomous technologies it develops into current models in the form of driver assistance, awareness and guidance products; about 800 models produced by some 50 manufacturers worldwide use one or more of Mobileye’s products today. The key to supporting such growth is the company’s EyeQ system-on-a-chip architecture, which allows Mobileye to pump out chipsets that can support a wide variety of automaker applications, meaning that car manufacturers can offer unique applications even while buying the same hardware. One analyst thinks there could be a string of catalysts for the firm going ahead, with investor perception boosted by new order announcements, possibly from some big automakers (a reason for the recent strength). As it stands now, 2023 remains something of a transition year, but next year should see the top and bottom lines back on a growth track as its semi- and full-autonomous products are integrated into more models.

Technical Analysis
MBLY was spun off by Intel just over a year ago, with its IPO priced at 21, and the next few months saw a solid run to 48 in February. But that was the top, and a mix of mundane quarterly reports and an offering from Intel (which still owns a bunch of shares—that’s one of the risks here) kept a lid on the stock. Last week, though, MBLY saw its first above-average volume week since April following the aforementioned analyst comments. There’s plenty of overhead to chew through, but shares look like they’re starting to round out a launching pad—if you’re aggressive, you could nibble here with a stop in the mid-30s.

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Stock 6

Neurocrine Biosciences (NBIX)

Why the Strength
Neurocrine develops treatments for rare and under-addressed diseases with a focus on neurological, endocrine and psychiatric disorders. Its approved medicines include Ingrezza and Dysval, for treating tardive dyskinesia (a disorder that causes muscle spasms in the face, neck, arms and legs), along with Ongentys, an adjunctive therapy for Parkinson’s disease patients. Neurocrine garnered a lot of attention from Wall Street earlier this month when a Phase III trial for another drug, dubbed crinecerfont, met its primary endpoint in adults with classic congenital adrenal hyperplasia (CAH), a group of genetic disorders. The study found that 63% of participants experienced a reduction in their daily glucocorticoid (GC) dose with androgen control while using the drug compared to just 18% for those on a placebo (!) after six months (the study also met its key secondary goals). The news sent the stock soaring and was followed by even more good news when the company announced that the FDA has accepted for review a New Drug Application for an oral formulation for Ingrezza. (The new formulation of oral granules is designed for sprinkling on soft foods as an alternative for patients who prefer not to take capsules.) On the fiscal front, Neurocrine is in very solid shape—it generated $1.4 billion in net product sales from Ingrezza for patients with tardive dyskinesia last year, and management’s latest estimate calls for $1.8 billion of sales in 2023, though it regularly nudges those figures higher as sales have outperformed. More recently, the company achieved Q2 revenue of $453 million that increased 20% year-on-year, due mainly to a 26% increase in Ingrezza sales, plus per-share earnings of $1.25 that beat estimates by 13 cents and were up 49%. Wall Street sees a long runway of steady, 15%-ish top line growth and some booming earnings in 2024 and beyond.

Technical Analysis
Biotech stocks have been awful this year, but NBIX is putting up a fight in recent months. Shares had a good run in 2022 but topped in December and headed south earlier this year even as the market found its footing—eventually falling 31% from its peak by the end of May. Since then, though, NBIX has turned up, with a steady advance that hasn’t set any records but has remained persistent despite an iffy market, and it showed some real power after the trial results. More of a pullback toward its moving averages could provide an opportunity to start a position.

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Stock 7

Remitly (RELY)

Why the Strength
Remitly has a very attractive story, where it’s taking a big, old, inefficient sector, bringing it into the 21^st century and growing rapidly as a result. The story is all about the humongous remittance sector (some conflicting numbers, but anywhere from $600 billion to $1 trillion is transferred each year), where people working and living overseas send money to (presumably) relatives back home. For decades, doing so has required someone to go to a physical location (usually a bank), wait in line, fill out lots of paperwork and, importantly, pay some exorbitant fees (averaging 8%, according to Remitly). By contrast, this company brings this process into the digital world: Via a vast disbursement network in more than 170 countries and territories, Remitly users log onto their website or app and can transfer money to around four billion bank accounts, 1.2 billion mobile wallet accounts and north of 400,000 cash pickup locations; more than 92% of client transactions are disbursed within an hour, it often costs just a couple of percent in fees and the firm emphasizes customer service (available in 15 languages) to help in case of a question or snafu. The business model looks great—lifetime value of a new customer is north of six times the acquisition cost!—and while the U.S. (two-thirds of revenue, up 36% in Q2) is the main pull, non-North American revenue is now 20% of revenue and grew a huge 120% in Q2, showing the appeal of the service all over the globe. Long term, there’s plenty of room for expansion in its current markets, and Remitly is aiming to expand beyond just remittances (into other financial products), too. Revenue growth is strong here, and EBITDA was in the black in Q2, should be positive this year and expand from here. There is some competition, but the market is so big there’s plenty for everyone.

Technical Analysis
RELY came public in late 2021 and proceeded to plummet to 7 in the middle of 2022 and then spend months bottoming out in the 10 to 12 area. The change of character came in February, with a big gap up on earnings that led to a powerful, persistent advance to 20 in June. After a short rest, another gap in early August got RELY going again—and the stock has remained in great shape since, with the market-induced pullback looking reasonable thus far. If you’re game, dips toward the 50-day line would be tempting.

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Stock 8

TechnipFMC (FTI)

Why the Strength
Industry analysts expect global spending on offshore oil and gas exploration will rise more than 20% this year compared to last, with the growth continuing well into 2024 as offshore activity experiences what some are calling a “renaissance.” TechnipFMC (covered in the July 3 issue) is a leader in traditional and renewable energy solutions, providing design, engineering and manufacturing of the systems used to access energy resources offshore and onshore—including what are regarded as the world’s most advanced remotely operated vehicles and exploration submarines. A sizable increase in subsea activity has led to a steady improvement in the fundamentals here, with Q2 continuing that trend: Surface Technologies (onshore) revenue increased 17% and rose 7% from Q1, while “strong” inbound orders of over $4 billion for the firm’s Subsea division led a 15% increase in total revenue of almost $2 billion. And while earnings of 10 cents a share missed estimates by six cents, the strong sales performance drove an adjusted EBITDA increase of 40%, along with a massive improvement in free cash flow (FCF) to $103 million, or about 23 cents per share (the company has pledged to return over 60% of FCF to investors via dividends and buybacks until at least 2025; Q2 share count was down 3.2% and the dividend yields 1%). Total backlog, meanwhile, increased 25% sequentially to a gigantic $13 billion, so the writing is on the wall for a big pickup in business ahead; indeed, management raised Subsea order intake guidance to $9 billion for the full year—up 13% from prior guidance. TechnipFMC also announced a month ago a “significant” subsea contract from an offshore project in Angola and said its two-year subsea opportunity remains “robust” with an opportunity set of more than $23 billion based on the midpoint value of those developments. Wall Street sees sales rising in the mid-teens and earnings and cash flow surging in the quarters to come.

Technical Analysis
FTI based out from late February to mid-June, broke out nicely at that point and really hasn’t suffered much adversity since then—there were a couple of wobbles in July after earnings, but the stock essentially went straight sideways for four weeks, waiting for the 10-week line to catch up, and then ramped on good volume in early September. The latest dip looks normal, though could go further—if you’re game, dips of a few dimes would offer a decent risk/reward trade.

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Stock 9

Universal Display (OLED)

Why the Strength
Universal Display makes organic light-emitting diodes – OLEDs – which are next-generation LEDs that allow for brighter, more energy-efficient phones, monitors and TVs. The difference is technically complex but simply stated: OLEDs are tiny individual lightbulbs that can be any color and can combine to create an image, while LEDs provide the light for the images created on the LCD screen; the result is that OLEDs make for much more vibrant, detailed images. For that reason, they’ve had great success in the premium, hotly competitive smartphone market, with OLEDs as a category now seeing 50% market share in phones. That obviously means the industry is dependent on overall phone sales, but there’s also a lot of space to expand into TVs, computer monitors, tablets and elsewhere, as OLEDs have just 2% to 3% of the market in those categories. Next year is expected to see the first adoption of OLEDs in the tablet market by Apple (which makes it owns screens), which should mean Universal Display’s largest customer, Samsung, will follow suit. (Longer term, some see laptop and tablet OLED demand growing 30%-plus a year for the rest of this decade, so the opportunity is big.) All of that has investors expecting a big year in 2024, with sales (up 19%) and earnings (up 21%) expected to rise nicely next year after muddling through a current year that’s been mired by remnants of supply chain troubles from the pandemic and weaker economic activity. For the last two quarters of this year, Universal Display should produce sales around $155 million each period, ending the year at $560-$600 million with earnings per share of $4 or so, both down modestly compared to 2022. But the focus at this point is on 2024 and beyond, when growth is expected to pick up steam.

Technical Analysis
OLED fell from 260 in early 2021 (when most growth and glamour names topped) to a low near 90 a year ago and then rallied back to 155 at the end of March. Since then shares have etched some higher highs and higher lows, but effectively, it’s been one big launching pad under construction. Now things are getting interesting—OLED gapped up on earnings in August and has traded tightly (and above the 50-day line) since, even during the latest market plunge. We’ll set our buy range higher, thinking a strong upmove will lead to good things.

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Stock 10

Vertiv Holdings (VRT)

Why the Strength
AI stocks have been under distribution for a few weeks now, with some of the more speculative ones really getting hit and even well-situated infrastructure names (AVGO, NVDA) taking on water. But Vertiv has held in there better than any of them, and it’s not hard to understand why, as business is already humming, should get stronger with any AI boost and the valuation remains reasonable. The company is a big player in data center products, with battery management offerings, racks, switchgear, power offerings and thermal offerings, the latter of which are increasingly needed as more powerful chips operate at higher temperatures, which can in turn affect the performance of other IT equipment. (Vertiv has a good business in standard cooling solutions, and as liquid cooling offerings likely come into favor, Vertiv’s leading position should allow it to thrive.) Of course, this kind of equipment has been in demand for years, but supply chain issues hampered results in 2021 and into 2022—but now those issues are easing, leading to solid organic growth and margin expansion, just as AI demand is starting to pick up. So far, the AI numbers are small, as in the Q2 conference call AI-related orders are in the “tens of millions of dollars,” but more important is that Vertiv said it’s having “conversations with very relevant market players around security capacity not just over the next few quarters, but well into 2024 and beyond.” Now, that doesn’t mean Vertiv is about to start growing triple-digits; management’s outlook is for 20% top-line growth this year and analysts see just 7% sales growth in 2024. However, (a) that’s likely conservative, (b) even with those assumptions, earnings are likely to expand at 20% to 30% rates going ahead and (c) the valuation (23x this year’s earnings, <20x 2024 numbers) indicate that not a ton of expectations are priced in despite the stock’s massive run. All in all, Vertiv looks like one of the top tech infrastructure plays out there.

Technical Analysis
VRT has had a huge, huge run, kicked off by earnings in April and, after a non-stop advance, it went wild again after earnings in early August. Such action usually causes us to shy away from new buys until we see a fresh correction and base-building effort, as gains tend to be given back. But the difference now is that the market is trashing everything—and yet VRT, at least to this point, has retreated normally and on light-ish volume despite having every reason to cave in. Of course, it’s still possible the sellers eventually come around for it, but the resilient action sticks out like a sore thumb—further dips would offer a solid risk/reward situation.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on October 2, 2023.