April 11, 2022

There were a lot of positives that built up for the market during February and early March, but that multi-week stretch of improving evidence has certainly run into a wall—the market has taken it on the chin during the past couple of weeks, with the major indexes giving up a big chunk of their gains (the brief intermediate-term trend all-clear is gone), and more worrisome to us, nearly every stock that has run into resistance has at least stalled out, if not come unglued. We don’t believe all of the good vibes built up are out the window; this recent action could easily be part of a longer bottoming process for the market. But we never advise ignoring the evidence in front of us, so we’re pulling our Market Monitor down to a level 5.

This week’s list is heavy on some cyclicals but also some dependable growth outfits. Our Top Pick looks to be one of those, a medical firm with a few good-selling drugs on the market and sold earnings growth projections.

Market Overview

A Heavy Tape

There were a good number of positives that built up for the market during February and early March (when the internals of the market were slowly healing even as the indexes struggled), and then the sterling two and a half week rally brought with it a rare blastoff-type green light and recouped a good portion of the market’s losses. But that multi-week stretch of improving evidence has certainly run into a wall—the market has taken it on the chin during the past couple of weeks, with the major indexes giving up a big chunk of their gains (the brief intermediate-term trend all clear is effectively gone), and more worrisome to us, nearly every stock that has run into resistance has at least stalled out, if not come unglued. With that said, we don’t believe all of the good vibes built up are out the window; this recent action could be part of a longer bottoming process for the market. But we never advise ignoring the evidence in front of us, and right now, there’s little doubt that, at best, there’s little money being made, and at worst, the sellers are back at it for another leg down. We’re pulling our Market Monitor down to a level 5.

This week’s list does have a bunch of good-looking charts, mostly due to the dependability of the underlying businesses. Our Top Pick is Horizon Therapeutics (HZNP), which is reasonably valued, has great business trends and is part of the resilient medical group.

Stock Picks & Previously Recommended Stocks

Stock 1

Allegheny Tech (ATI)

Why the Strength

An accelerating recovery in the aerospace industry is driving stronger commercial airline production schedules, pushing Allegheny (covered in the February 7 report) ahead of its own growth schedule. The company’s specialty is producing titanium- and nickel-based alloys, stainless steel and specialty components for the global aerospace and defense markets, as well as for critical applications in electronics, medical and specialty energy. Surging demand for jet engine materials has been the main growth driver of late, with fourth quarter revenue of $765 million jumping to the highest level in over two years, rising 16% and beating expectations. But an additional upside catalyst was provided at a recent investor day event when Allegheny indicated it sees a long runway of growth ahead. Specifically, management said it expects to achieve annual revenue growth of around 10% through the end of 2025, which should outpace growth rates in key end-markets. More important, adjusted EBITDA margins are expected to expand “significantly” (estimated around 20%) as a result of ongoing market recovery, lean cost structures and an enhanced product mix. Allegheny also foresees increased cash conversion rates driven by profitable growth, reduced managed working capital and pension funding needs and sees “rapid improvement” in return on invested capital, leading to increased opportunities to enhance shareholder value over time. On the financial front, analysts expect the bottom line to mushroom this year off a near-breakeven 2021 and see lots of upside from there, and estimates keep rising for this year (93 cents today vs 66 cents estimates three months ago) and 2023 ($1.47 vs. $1.16). Earnings are due out May 4.

Technical Analysis

ATI’s post-crash recovery petered out near 25 last May and led to a long, tedious decline that took shares down in nearly a straight line until early December. January brought a very nice rally, but it was the February earnings report that really changed the landscape, with shares gapping up and they’ve been respecting their 25-day line since. We’re not dead set against a nibble here, but given the environment, we’ll set our buy range lower, thinking a shake to the 50-day line is possible.

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Stock 2

CNX Resources (CNX)

Why the Strength

Oil prices are easing (though most oil stocks remain fine), but natural gas is super-strong, with the combination of buoyant domestic demand and the prospects for huge shipments to Europe as they wean themselves off Russian supplies has the buyers in control. CNX Resources is one of the leading plays in the group, operating mostly in Appalachia (Marcellus and Utica shales) with north of 3.8 million acres and proved reserves of nearly 10 trillion cubic feet of gas; it also has a solid midstream operation (which, after going public, it swallowed back up a couple of years ago). Like so many energy plays, the firm struggled for years, but got its cost structure in order and lowered breakeven prices, and even before the latest bull run, it saw good things ahead: Back in 2020, it released a seven-year plan that called for modest production growth, consistent free cash flow and lots of debt reduction, and now that prices are up, those goals are proving to be very conservative. Last year, CNX cranked out $506 million of free cash flow (about $2.50 per share), about half of which was used for debt reduction (no maturities until 2026 at this point) and half to buy back what the top brass believed was a very undervalued stock (the share count was down nearly 8% at year-end compared to a year ago), and there’s more where that came from, with the firm’s February update aiming for nearly $3 of free cash flow this year, and that was at prices much lower than what we see today. Now, to be fair, 80%-plus of CNX’s expected output this year was already hedged, so the higher prices won’t help all that much near-term, but it’s a good bet the firm is layering on higher-priced hedges for 2023 and beyond at this point. Despite the stock’s big run, CNX and many natural gas plays look seriously undervalued. The Q1 report is due April 28.

Technical Analysis

CNX wasn’t on many radar screens the past few months, and for good reason—shares peaked near 16 last March, corrected sharply, and even after a lot of repair work, were still hanging around that same level in late February of this year. But now CNX’s character has changed, with five weeks up in a row to new highs, followed by two tight, calm trading weeks. We’re OK nibbling here, but given the environment, we’d prefer to grab shares on a dip of a few dimes.

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Stock 3

Horizon Therapeutics (HZNP) ★ Top Pick

Why the Strength

Horizon has one blockbuster therapy ($1 billion-plus in sales), Tepezza, which generated $1.66 billion in revenue in 2021. The drug treats thyroid eye disease (TED), a rare autoimmune disorder that results in bulging, red eyes and a painful deterioration of vision. Success of the therapy – which turns off the signaling that progresses the disease – seemingly came out of the blue: When it rolled it out in 2020, management estimated annual sales would start at $30 million and then it sold $820 million. As many as 20,000 people suffer from TED in the U.S. Management is now seeking approval for the drug in Japan, a TED market about a quarter the size of the U.S. With that and other international markets to come, sales could eventually peak north of $3.5 billion. Better yet, management sees two more drugs that are working their way to blockbuster status. One is Krystexxa, the only U.S. approved drug for uncontrolled gout. Horizon acquired it in 2015 when it generated about $60 million sales, and has built it to $566 million last year, with a peak over $1 billion seen. Another drug, Uplizna, treats an autoimmune inflammatory disease that attacks the optical nerve and can lead to death. FDA approval came in 2020, sales tripled last year to $61 million with a yearly global market over $1 billion eventually. For this year, Horizon revenues are seen rising 22%, led by Tepezza, while analysts see earnings up north of 20% both this year and next. Horizon sees itself as an expert commercial developer of drugs, so it prefers to buy or partner with research specialists to develop therapies. With its $1.6 billion in cash, more M&A is possibility.

Technical Analysis

HNZP hit an all-time high of 120 in October, but sold off as very good quarterly earnings didn’t beat consensus by enough, and then the market’s wipeout took the stock even lower into January. But after sinking to 83, the stock formed a higher low (88) a few weeks later and has taken off since, rallying into the mid 100s with just brief pullbacks and shakeouts along the way. There is old overhead to chew through, so we’ll set our buy range down a bit.

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Stock 4

Marathon Oil (MRO)

Why the Strength

Oil prices have been sagging since their early-March spike into the $130 area, with prices today nearly sinking to multi-week lows in the mid $90s—yet many leading energy stocks, like Marathon Oil, remain near or at new highs. What gives? It’s all about expectations: Most names never priced in those super-high oil prices, figuring things would soon normalize (indeed, the futures are pricing in lower oil when looking out a ways), which means that, if anything, perception continues to increase as prices remain generally elevated. (It doesn’t hurt that natural gas and liquids prices have been advancing strongly, too.) When it comes to Marathon Oil, they’re latest update in February said that, even at $80 oil and $4 natural gas, well below where the market is now, the firm’s free cash flow would be around $3 billion this year (nearly 16% of the current market cap) while the minimum shareholder returns would total $1.8 billion this year (9.4% of the current market cap)! There’s a modest base dividend (0.8%), but the main form of returns is from share buybacks so far, and they’re coming fast and furious—from October through mid February, the firm bought back 8% of its outstanding shares (!), there’s little doubt at least another couple of percent has been repurchased since then. Moreover, management sees this as a multi-year opportunity, with free cash flow averaging $2.3 billion a year through 2026 even at $70 oil and $3.50 natural gas. To be fair, the firm still has a swath of debt ($4 billion), so it’s retaining some of that cash flow to pay off maturities as they come, but there’s little doubt Marathon is going to be paying out boatloads of cash and buying back stock for a long time to come. Q1 earnings are due May 5.

Technical Analysis

As with many peers, MRO really changed character at the start of the year, breaking free of a two-month rest period and embarking on its latest run. Since then there’s been a couple of tests of the 50-day line (both held), with the 25-day offering support during more mild rest periods, including the one that started three weeks ago. We’re OK starting a position here, though as with most names, we prefer to get in on dips.

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Stock 5

Pacira Biosciences (PCRX)

Why the Strength

Prescription pain treatment is a large market that remains unsettled by the addiction and legal problems surrounding opioids—but that’s good for Pacira, which specializes in non-opioid pain management administered by doctors. Its primary product is Exparel, the only long-lasting local analgesic that isn’t an opioid and is used for orthopedic treatments, for c-sections and general surgery. The drug sold over $500 million in 2021, and its market is likely just starting to be tapped. Exparel is approved for children ages six and over, and the past year has shown the start of excellent traction among pediatric hospitals. In particular, use of the drug by spinal surgeons for children is leading to application with adults. Another non-opioid, Zilretta, is a long-lasting treatment for knee osteoarthritis that is expected to be approved for shoulders later this year’ it sold $100 million in 2021., A third treatment, Iovera, is a handheld applicator in cryotherapy – localized pain treatment. It’s much smaller sale-wise, but has potential applications in spasticity, a potentially large market now dominated by Botox, which is expensive – up to $2,400 a treatment and has a dose limitation, whereas Pacira suggests it could enter the spasticity market with a $500 treatment of Iovera. Consensus estimates are for $721 million sales this year and $3.90 EPS – both increases of more than 30%. Still, management isn’t providing official guidance due to the pandemic uncertainties – and it has some manufacturing troubles with Zilretta it says will be ironed out this quarter. All in all, though, it’s clear big investors expect good things.

Technical Analysis

PCRX peaked in early 2021 and began a long, steady decline into October before turning around a bit. After tightening up in February, shares got going after the Q4 report and rallied all the way back to their old high near 80 last week. However, in this environment, testing new highs usually leads to selling, and that’s what we saw with PCRX today, with a big dip on elevated volume on no obvious news. We’ll set our buy range above the market, thinking a rebound would tell us today’s move was a big shakeout.

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Stock 6

Paychex (PAYX)

Why the Strength

As business evolves from the traditional workplace to remote work or hybrid, fast-growing companies are turning to software providers to increase productivity and keep abreast of changing laws and regulations. Paychex is a leader in this niche, providing human resource software and services and offering technologies designed to streamline everyday functions for small- and mid-sized firms, including payroll, administrative and risk management outsourcing and insurance services. The company’s most popular offering is Paychex Flex, a cloud-based SaaS platform that allows customers to manage the full employee lifecycle from recruitment all the way to retirement (including payroll and benefits). Paychex has experienced a growth spurt in recent years, which management doesn’t see ending anytime soon. In the company’s fiscal Q3, Paychex saw double-digit growth in both sales and earnings while delivering a record quarter in new sales and seeing high levels of customer retention. Revenue of nearly $1.3 billion was 15% higher from a year ago, driven by more clients across the firm’s human capital management (HCM) offerings and growth in checks per payroll for HCM solutions. The company’s professional employer organization and insurance solutions segments saw revenue jump 21% due to an increase in the number of average worksite employees and growth in average wages per worksite employee. Per-share earnings of $1.15, meanwhile, beat estimates by 10 cents and were up 20%, while free cash flow for the first nine months of the fiscal year was 36% higher. Growth is expected to slow a bit in the quarters ahead, but we’ll see if that happens, as earnings estimates have consistently been trickling higher for months. It doesn’t hurt that this growth story is solid and reliable, which big investors crave these days.

Technical Analysis

PAYX hit a record peak at 100 at the end of 2020 and spent the first five months of last year chopping around just under that level before taking off in June. The stock has since established a fairly steady pattern of higher highs and lows, with a sharp correction in January (down 20%) providing the only meaningful downside during that time. The latest run (bolstered by earnings on March 30) looks solid, though we suggest aiming for dips if you want in.

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Stock 7

Quanta Services (PWR)

Why the Strength

America’s move toward a carbon-neutral economy is expected to require hundreds of billions of investment spending in the next several decades, a significant portion of which will be diverted to renewable energy generation and electric transmission. Quanta is already seeing growth from this and related trends as the private and public sectors launch more energy-transition and infrastructure initiatives. The company mainly provides end-to-end solutions in the electric power sector, building generating stations, substations and transmission lines for pipeline, industrial and telecom customers. However, Quanta is increasing its presence in alternative energy, recently acquiring Blattner Holdings, one of North America’s largest and leading utility-scale renewable energy infrastructure solutions providers; Quanta believes the acquisition provides it with access to the “most attractive areas” of the electric infrastructure complex. A big Q4 earnings beat (reported late February) is the reason for the latest strength, with EPS jumping 26% from a year ago to $1.54, 13 cents above consensus, while revenue of $3.9 billion soared 35% and beat estimates by 7%. By segment, Electric Power Infrastructure Solutions sales grew 23% while Renewable Energy Infrastructure Solutions soared 113% and Underground Utility and Infrastructure Solutions rose 25%. Even better, the year-end backlog of $19.3 billion was up 27% from a year ago. Looking ahead, management expects a good 2022 (earnings up nearly 30%), and at its recent Investor Day, Quanta sees a runway for earnings to nearly double by 2026.

Technical Analysis

PWR launched out of a long-term base at 44 in late 2020, leading to a massive, persistent run and taking the stock to the century mark by last May. A three-month correction followed (down 17%), then shares roared back to a record peak of 120 in November. This time a bigger shakeout followed, with the stock briefly dipping below the 40-week line late January, but the snapback since earnings has been outstanding, with a move to new highs and a controlled dip to the 25-day line last week. We’re OK starting a position around here or on weakness.

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Stock 8

Shockwave Medical (SWAV)

Why the Strength

Growth stocks never really got going during the three-week rally, and the latest action has been poor, with most of the names that tested new high ground being soundly rejected. However, one area that (so far) has held up well are medical names, especially those with unique new products with years of growth ahead. Shockwave Medical fills that bill: The firm has a better mousetrap when it comes to treating calcified arteries, which is obviously a growth market as the population ages; current treatments (like balloons and atherectomy’s) do OK but aren’t super effective and, in some cases, carry risks of perforations and bad outcomes. (It also doesn’t help that these procedures are relatively hard for doctors to learn, too.) Shockwave uses a proven technique called lithotripsy, which has been used to safely do away with kidney stones for decades, to get rid of calcium in a similar manner, with a catheter inserted and sound waves used to crack apart the calcium (hence the company’s name). Tons of trials and real-life evidence suggests it’s better and safer than current treatments, and the potential market is in the billions of dollars if approvals for use in more types of arteries come. Even now, though, there’s tons of upside; Shockwave’s products for peripheral arteries doing well, but the big market of coronary arteries (approved early last year) has driven business through the roof—sales more than tripled each of the past two quarters, and profits are big and growing, too (a rarity among these small medical outfits), and with reimbursement levels improving and international expansion on tap (U.K. and France sales just started in Q4), there’s no reason the firm won’t get a lot bigger going forward. Analysts see sales up north of 70% this year with earnings booming, both of which should prove conservative.

Technical Analysis

SWAV had a massive run in 2020 and 2021, which, combined with its deep 50% correction from its November high to its January low (deep retreats often take time to heal), might mean the stock is going to need more time to consolidate. That said, it’s hard not to be very impressed with the action, as the low in January came ahead of the market, and the action since the March market bottom has been superb—including great resilience in recent days even as the market takes another turn for the worse. If you want in, start small and aim for dips.

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Stock 9

U.S. Steel (X)

Why the Strength

On top of lockdowns in China and war-related sanctions, steel consumers face another hurdle in the form of skyrocketing energy costs that are crimping an already tight supply situation and pushing prices higher worldwide. But all of this is good news for U.S. Steel, one of the nation’s oldest and biggest integrated steel makers, and whose blast-furnace mills typically require enormous volumes in order to be profitable. The problem for U.S. Steel historically is that once booming demand for steel wanes, so do its profits, but now it’s working on becoming more efficient. Specifically, the firm is by installing electric arc mini-mills (like the ones used by the firm’s leaner competitor, Nucor), which will enable U.S. Steel to reduce risk from the highly volatile steel price cycle by allowing it to utilize more steel scrap (and less iron ore), while also providing it with the flexibility to reduce operations in times of diminished demand. U.S. Steel recently updated its first-quarter earnings guidance; at $3 per share, the figure was well beneath Wall Street’s prior expectations of $3.77. But the focus here is that (a) earnings are still huge and up big from a year ago (nearly triple last year’s Q1 figure), and (b) with steel prices elevated, U.S. Steel’s bottom line should be, too, with analysts seeing a whopping $10-plus of earnings this year. Additionally, the company said it was experiencing its longest backlog at its Arkansas-based Big River Steel operations since October, indicating that with spot business was “accelerating” exiting the quarter. Earnings are due April 28.

Technical Analysis

X has usually been a feast or famine stock, with big swings up and down depending on the environment—and now it’s definitely in an upswing, recovering from a massive shakeout in January to storm back to new highs (including a streak of seven up weeks in a row, which usually bodes well when seen early in an advance). X’s dip of the past few sessions could go further, but we think the dip to the 25-day line looks very orderly so far—we’re OK snagging some here or on dips, and using a loose stop.

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Stock 10

Wheaton Precious Metals (WPM)

Why the Strength

One of the best ways for a precious metals company to leverage rising metal prices is by engaging in streaming, which involves making an upfront payment, plus a fixed payment per ounce of metal (often 20% of the spot price), allowing the firm it to retain the right to a percentage of a mine’s future production. Wheaton is the world’s largest silver streaming company, with 14 silver purchase agreements, as well as gold and palladium agreements. The company’s main focus is on high-quality, high-margin operations with a goal of returning a minimum of 30% of cash flow to its shareholders. Wheaton produced a record year in 2021 as measured by several key metrics, driven by a strong fourth quarter and resulting in record annual revenue, cash flow and earnings. While Q4 revenue was 3% lower from a year ago and per-share earnings of 29 cents missed estimates by 2 cents (due to lower realized gold prices), full-year revenue increased 10% to a record $1.2 billion on higher prices for several key metals. Per-share earnings for the year were also 17% higher, while operating cash flow rose to a record $845 million (up 10%) due to higher commodity prices. Other highlights included production of over 186,000 gold equivalent ounces (GEOs) in Q4, for a total of 753,000 ounces in all of 2021 (up 6%), thanks to a significant increase in silver production among its investments, allowing the firm to disperse $218 million in dividend payments last year (current yield 1.2%). Further, Wheaton has added eight new streams in the past 15 months, bringing immediate production and growing its mineral reserves by 13% on a consolidated basis. For 2022, management guided for total production of between 700,000 and 760,000 GEOs, while analysts see top- and bottom-line growth of around 8%. With major leverage to higher prices and huge margins (after-tax margin of 47% in Q4!), Wheaton is a direct play on the health of silver and gold.

Technical Analysis

Like most of its precious metal mining peers, WPM boomed between April and August 2020 as gold demand soared. After that year’s peak at 58, the stock spent the next seven months drifting lower and hitting its nadir last March at 35. It took almost an entire year for WPM to make any meaningful headway, but the last two months have shown a definite improvement, including a strong six-week rally starting in early February, and a reasonable rest period since. We think dips of a point or two would be tempting.

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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 April 18, 2022.