December 13, 2021

The market’s action last week, while far from perfect, was about as good as you could have hoped for given the prior damage. But in our view, what happens from here will tell the true tale: The overall market’s intermediate-term trend is still down (or at least not up), and while there has definitely been some improvement, many stocks remain in poor shape—especially in growth land, where a lot of names have failed to bounce at all. To reflect the bounce, we’ll nudge up our Market Monitor to a level 6, but the bulls still have more to prove.

This week’s list is a hodgepodge of stocks and sectors, with everything from infrastructure to lumber to transportation included. Our Top Pick, though, is part of the strong networking theme and staged a powerful breakout last week.

Market Overview

Solid Bounce, but Now What?
The market’s action last week, while far from perfect, was about as good as you could have hoped for given the prior damage—all the indexes raced higher by 2.5% to 3.5%, with the big-cap ones testing their prior highs and the broader indexes pushing back toward their 50-day lines. The bounce is certainly welcome, and we do think the string of broad buying days off the recent lows is a decent sign that things aren’t going to completely implode. But in our view, what happens from here will tell the true tale: The overall market’s intermediate-term trend is still down (or at least not up), and while there has definitely been some improvement, many stocks remain in poor shape—especially in growth land, where a lot of names have failed to bounce at all. To reflect the bounce, we’ll nudge up our Market Monitor to a level 6, but we’ll see if this leads to a lot of buyable situations … or whether the sellers still have more bullets to fire.

This week’s list is a hodgepodge of stocks and sectors, with everything from infrastructure to lumber to transportation included. Our Top Pick, though, is part of the strong networking theme—Ciena (CIEN) has been dead money for a while, but staged a very impressive breakout on earnings last week. You can start small here or (preferably) on dips.

Stock Picks & Previously Recommended Stocks

Stock 1

Advanced Drainage Systems (WMS)

Why the Strength

Advanced Drainage is a large, independent water infrastructure company focusing on drainage systems, pipes and related specialty equipment for real estate developers, farmers and municipalities. It’s also the second largest recycler of plastic in the country, using more than 550 million pounds of reconstituted plastics as half the feedstock for its products (new plastic is the balance). Focusing on plastic means the firm offers lighter products than metal and cement alternatives, which make them cheaper to install while offering equal or better durability. Other industries are catching up to its strategy of using recycled plastics, which historically are cheaper and less volatile, price-wise, than virgin polymer, and fit with increasing carbon-reduction metrics. That means Advanced’s primary raw material, polypropylene—think yogurt cups—and high-density polypropylene, like milk jugs, are increasingly in demand, hurting margins. Advanced Drainage took a step to retain its margins and secure supply this month by acquiring Jet Polymer Recycling, a large southeastern U.S. firm that is the biggest supplier of recycled plastic to one of its subsidiaries. On the growth side, the boom in the housing market means more demand from builders, while the infrastructure bill’s focus on climate change-related storm and wastewater challenges should be another big tailwind. The cost issues crimped earnings in Q3, but Wall Street is optimistic those are getting under control—analysts see earnings up 50% this fiscal year (ending next March) and 25% in the following year.

Technical Analysis

WMS had a big run through April of this year, but that effectively marked a top, though the sellers never did too much damage—the stock had two corrections within a long sideways phase (15% and 18%), but never dipped below its 200-day line, and earnings and the Jet acquisition caused shares to pop to new highs in November. WMS dipped a bit with the market earlier this month but quickly snapped back last week. If you’re game, you can aim to enter on dips.

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Stock 2

Capri Holdings (CPRI)

Why the Strength

Neither the pandemic nor a 30-year-high inflation rate have dented retail clothing sales, with luxury fashion items flying off the shelf at a particularly fast rate. Capri Holdings is a holding company which owns the well-known luxury brands Jimmy Choo, Michael Kors and Versace, and is seeing strong demand across all three labels. Capri said it added 11 million new customers to its databases over the last year, contributing to sales growth and margin expansion above its expectations. In the September quarter, Capri reported revenue of $1.3 billion, a 17% increase from a year ago, thanks in part to a double-digit increase in e-commerce sales. Earnings per share of $1.53 obliterated expectations by 58 cents, while the firm’s operating margin expanded 19%. The bullish results were also driven by strong domestic demand as stores across the U.S. reopened. And while revenue was flat in Asia due to Covid-related restrictions, revenue in mainland China increased despite greater restrictions. The Versace brand was Capri’s sales leader, with a 45% sales increase in the quarter, punctuated by the launch of a new design series in September; Michael Kors and Jimmy Choo revenue rose 11% and 12%, respectively. Additionally, the company saw double-digit growth in women’s footwear and men’s and women’s ready-to-wear offerings, and reported making “significant progress” in its goal of expanding accessories revenue to $1 billion. Looking ahead, management raised its fiscal 2022 revenue outlook to $5.4 billion (versus the $5.3 billion consensus) and has authorized a new $1 billion share repurchase program. Analysts see further big earnings gains in the next couple of quarters.

Technical Analysis

After a 24% correction between May and July (which found support at the 40-week line), CPRI rallied back to its old high of 60 in August. The sellers came back in at that point and drove shares back toward the lows of its base-building phase, but CPRI refused to stay down and turned up again—this time blasting through the previous high and nearly reaching 70 following the quarterly report last month. The consolidation since then has been tricky (including today’s dip), but we’re not opposed to starting small here and using a tight stop.

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Stock 3

Ciena (CIEN) ★ Top Pick

Why the Strength

One theme we’re starting to pick up on is a “new” networking boom, with the upgrading of mobile networks to handle 5G traffic and the movement toward edge computing (putting content closer to the end user instead of only in data centers) resulting in big demand. Ciena’s gear plays into both trends, leading to a big pickup in growth (and a big breakout for the stock). In the most recent quarter, Ciena reported consensus-beating revenue that exceeded $1 billion for the first time—up 26% from a year ago—while earnings of 85 cents per share were 42% higher (in line with expectations), with both figures marking big accelerations from recent quarters. But the best is yet to come: Ciena’s Q4 orders were significantly higher than revenue for the third consecutive quarter, which management said pointed to “substantial momentum” and provided increased confidence in the demand environment. Indeed, the firm ended the fiscal year (in October) with its highest ever backlog of nearly $2.2 billion, double the year-ago figure! The company added 34 new customers for its premium WaveLogic 5 Extreme network solution and secured a dozen new wins, including significant multiyear deals with two of the largest U.S. Tier 1 service providers. Additionally, Ciena closed a deal with AT&T to acquire its Vyatta virtual routing and switching technology, which will increase its 5G exposure; it also announced a partnership with Samsung to support that firm’s global 5G networks. Moving forward, Ciena sees its addressable market in the edge space soaring 70% in the coming years (from $13 billion) and has authorized a $1 billion share repurchase program. Analysts see relatively tame growth going ahead, but big investors don’t buy it.

Technical Analysis

CIEN had a so-so post-crash rally that petered out near 61 in August of 2020. It collapsed from there, but after bouncing it spent many months hovering in the 50 to 60 range, and then it began to change character in October—CIEN tightened up for a few weeks, popped to 60, then tightened up for another month, all of which told you the sellers had left the building. And last week’s huge breakout is obviously a good sign. We’re OK buying a little here or on dips.

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Stock 4

Civitas Resources (CIVI)

Why the Strength

Civitas is the old Bonanza Creek Energy, which we’ve written up a couple of times this year. The attraction here is that the company has transformed itself into a lean, focused energy explorer through a series of acquisitions this year—Boanza Creek merged with HighPoint Resources, XOG Extraction and privately held Crestone Peak to create the preeminent operator in the DJ Basin, with 525,000 acres, 1,300 gross locations to drill and output that’s 40% oil and 65% liquids in total. (It also has a solid midstream operation with a value of around $300 million.) Like its energy peers, the new Civitas has maneuvered things to have a great balance sheet ($366 million of net debt vs. a market cap of $4.9 billion), and now that it’s spinning off tons of free cash flow, the company is returning a bunch of it to shareholders—in Q3 (right before the final merger went through), the firm cranked out $113 million of cash flow from operations, more than twice capital expenditures, and now it sees better times ahead even at modest energy prices. Indeed, recently, the firm upped its quarterly dividend by a whopping 30% (to 46.25 cents per share; annual yield 3.2%), and expects to pay out half of its free cash flow over and above that base dividend next year. Obviously, the recent slide in natural gas prices will hurt a bit, but oil remains solid in the $70 range and Civitas has hedged a decent chunk of output (34% of oil and 44% of gas) for 2022. All in all, Civitas is another strong cash cow in the energy sector.

Technical Analysis

CIVI’s chart is less meaningful given the adjustments from the mergers, but the recent action is what we like—shares tagged their 40-week line back in August, then enjoyed a persistent advance into the 60 area near Halloween. The four-week pullback last month wasn’t pretty, but as soon as the pressure came off the market and oil prices, CIVI popped on huge volume right back to their old high, and held firm today despite some ugly action in the group. We’re OK taking a stake here.

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Stock 5

Fluor Corporation (FLR)

Why the Strength

Fluor is a good-sized engineering and construction outfit, with revenues of around $13 billion annually—whether it’s technology, supply-chain help, program or construction management or (of course) engineering, the company is a trusted partner to many big clients in the government, energy, technology and life sciences fields. To be fair, Fluor has had some hiccups, including a horrid 2019 and slow recovery that cut the stock off at the knees, but now it’s looking as if the next few quarters (at least) will be very good. First off, in Q3, both sales and earnings topped estimates, management raised guidance and new orders came in at $3 billion (backlog at quarter’s end was $21 billion). The new infrastructure bill should obviously lead to an uptick in orders, but it also looks like the company may have landed a very big fish: Fluor said that the Department of Energy’s nuclear security administration has selected one of its joint ventures to lead a security, plant management and operating contract. And it should be hugely lucrative, worth about $2.8 billion annually, with a contract that runs 10 years (if all options are exercised)! Obviously, a lot of that won’t fall to the bottom line, but given the company’s size and modest market cap ($3.4 billion), it should still be a big deal. Wall Street sees a solid profit this year and 27% earnings growth in 2022, but it’s possible Fluor enjoys a step-function-like boost to its metrics as the deal gets enacted.

Technical Analysis

FLR was north of 60 in 2018, fell to 5-ish last year and made it back to around 25 earlier this year before beginning a big base-building effort. And what a pretty base it turned out to be—the correction was deep (43%), but after a double bottom in the 15 area, FLR raced higher before and after earnings, then tightened up nicely for the past month. And now the stock is attempting to get going as the market finds its footing. It won’t be your fastest horse, but if you want in, you can start small here.

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Stock 6

Knight-Swift Transportation Holdings Inc. (KNX)

Why the Strength

The dramatic expansion of online shopping since the virus showed up has been a boon for companies that deliver large amounts of goods over short and long distances. Knight-Swift owns North America’s largest truckload fleet, providing full truckload services to a broad array of industries. The company is also diversifying to include warehousing and expanded services to third-party carriers, contributing to revenue and earnings growth across multiple segments. In Q3, Knight-Swift’s revenue increased 36% from a year ago and beat estimates by 9%, while earnings of $1.30 per share beat the consensus by 23 cents, lifting 65%. Each of the company’s segments grew revenue and expanded margins in the quarter, resulting in a 63% increase in operating income compared to a year ago. Logistics segment revenue jumped 130%, as load counts grew by 61% and revenue per load increased 43%. Intermodal (truck-and-train) revenue was up 14%, while truckload revenue rose 22% and less-than-truckload (LTL) revenue was 7% higher. As part of its expansion strategy, Knight-Swift just purchased LTL trucking and transportation logistics firms Midwest Motor Express and Midnite Express, which together are expected to generate around $137 million revenue and $27 million in adjusted EBITDA for 2021, as well as adding six cents in accretive EPS next year. The acquisition prompted at least one big institution to raise its share price target (a reason for the strength), citing a “commitment to grow its LTL business and diversify its business mix.” Management expects “unprecedented demand” in the holiday Q4 with similar strength next year; even after a huge earnings leap this year, analysts see more growth in 2022. We like it.

Technical Analysis

KNX has had a smoother ride in recent months compared to the average transportation stock, with its biggest drop being a 13% correction in October. The stock’s uptrend this year has occurred in three stages, with the first being a move from 40 to 50 in the first quarter followed by a consolidation in Q2, then edging higher by a few points in Q3 and, after the decline into early October, pushing to new highs over the last eight weeks. Minor weakness should be buyable, with a stop under the 50-day line.

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Stock 7

Lam Research (LRCX)

Why the Strength

Emerging trends in artificial intelligence (AI), 5G communications and connected devices all rely heavily on increasingly sophisticated semiconductors. Lam supplies wafer fabrication, etching and deposition equipment critical for making advanced logic chips and NAND flash chips to some of the world’s biggest chip companies, and its products have been in high demand this year—especially as foundries address the global chip shortage. Lam is also benefiting from major capital investment increases by some of the world’s biggest foundries, which need the equipment Lam provides. In its fiscal Q1 report (September quarter), revenue of $4.3 billion improved 35% from a year ago and rose 4% sequentially, driven by a 36% increase in system segment sales and a 34% bump in customer support-related revenue. Per-share earnings of $8.36 beat expectations by 13 cents and were 47% higher from a year ago, boosted by capacity additions and conversions by the firm’s NAND customers. (Memory-related revenue represented 64% of Lam’s total in Q1.) The company’s growing dominance in flash memory provides Lam with a major long-term tailwind, with experts predicting the global memory market will double by 2024 as cloud computing adoption increases and hard drive use declines. As a result, a Wall Street institution gave Lam a major rankings upgrade on its top 10 chip company list (a reason for the strength). Looking ahead, analysts see the top and bottom lines jumping 28% and 41%, respectively, in the current quarter, with additional growth in the low-to-mid teens in the two quarters after that.

Technical Analysis

Semiconductor stocks spent the bulk of 2021 making little net forward progress, with LRCX more or less following this trend. Shares rose 40% in the first three months, peaked at 670 in April and then entered a protracted holding pattern, slowly grinding lower before finally bottoming around 535 in October. But since then the buyers have been in control, with a few tight weeks near the lows and a persistent (though not explosive) advance as shares have hit new price peaks. If you want in, aim to enter on weakness.

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Stock 8

Lennar (LEN)

Why the Strength

Housing-related stocks have picked up steam, as the super-strong business trends of the past few months haven’t shown many signs of slowing and the recent virus concerns seem likely to keep mortgage rates under wraps. Lennar is one of the bigger homebuilders out there, and business has gone bananas this year—sales have risen 20%-ish each of the past three quarters, earnings have gone up huge, but the stock is strong because the best is likely yet to come. On the fundamental side of things, Lennar is making a move into larger communities that one analyst believes will support double-digit growth over time as well as boost margins. Moreover, Lennar’s own forward-looking indicators are looking ridiculously good: In the quarter ending in August, not only did new orders rise 19% in dollar terms, but the firm’s backlog was 25,819 homes, up 31% from a year ago, and up a whopping 52% in dollars! Of course, there are continuing shortages (especially labor) in the homebuilding industry that will continue for a bit, but in an odd way, that probably lengthens the demand runway here while boosting margins—in the most recent quarter, deliveries were actually below expectations and Lennar believes its community count will grow 7% on the year (original forecast was 10%), but margins improved a few percentage points. Wall Street sees a huge leap in earnings this year and then a flat performance next, but that’s probably too conservative, as management stated in the last conference call that “we fully expect double-digit growth in sales, starts, closings and community count next year.” Throw in a low valuation and token dividend (0.9%) and there are many reasons Lennar should stay strong. Earnings are due Wednesday, December 15.

Technical Analysis

LEN did well after the March 2020 crash, but that move ran out of steam in October of last year and, while it did make one more brief move earlier this year, it really never got going in a major way—in fact, for a whole year, the stock made little progress. But since the low two months ago, LEN has changed character, with a move to 112, and after a market-induced shakeout, a nice-volume push to new highs. Earnings will be key, but we’ll set our buy range down a bit if you want to try to nibble on a pre-report dip.

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Stock 9

Louisiana-Pacific (LPX)

Why the Strength

With a housing boom in full swing and lumber prices rebounding sharply in recent weeks, affordable, high-quality lumber is in high demand among homebuilders. This is where Louisiana-Pacific, which specializes in producing high-quality siding and engineered wood products, comes in. Louisiana’s proprietary oriented strand board (OSB) technology (a plywood substitute made from compressed wood wafers) cuts board costs by up to half compared to traditional boards. Soaring housing demand contributed to strong third-quarter results for the company, which saw revenue of $1.2 billion increase by a whopping 53% (8% above consensus). Per-share earnings of $3.87, meanwhile, beat estimates by 45 cents. Revenue from its engineered wood products segment doubled from a year ago, setting an all-time quarterly record, while OSB sales jumped 63% and siding sales grew 19%. Despite higher raw material and mill maintenance costs and supply-chain challenges, the company reported stronger pricing power and “robust” product demand, noting that capacity expansion projects at two locations remain on schedule. The firm said it strengthened strategic relations with customers, including being named Partner of the Year by Home Depot for lumber. The South America segment also had a strong Q3, with more stable OSB prices than in North America, as sales increased nearly 70% and EBITDA more than tripled. All in all, business here has taken a step function higher, leaving a very low valuation, which management is taking advantage of; the share count is down 17% over the past year! Analysts see earnings backing off, but remaining elevated, in 2022.

Technical Analysis

LPX started the year on a tear, running up huge in the first four months. But after peaking around 75 in early May, shares entered a 10-week, 34% decline which ended in July when LPX found support at the 40-week line. The stock has trended mostly higher since then, save for a brief hiccup in October (when the 40-week line saved the day again). The acceleration higher in recent days looks good, though we think aiming for a small position on dips makes sense.

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Stock 10

TopBuild (BLD)

Why the Strength

Trupanion is the fastest growing provider of insurance for veterinarian bills in the country. Yet, the company isn’t well known. A big reason for that is because pet insurance has little market penetration–just 1% of North Americans have policies. But the figure has been growing steadily and the future looks bright: A deal recently struck with Chewy makes Trupanion the exclusive pet insurance seller on the site. Starting in the spring, Chewy will market the firm’s plans to its 20 million regular pet supply customers. That’s a big step toward fulfilling management’s belief that Americans will embrace pet insurance as hedge against budget-busting bills for injured or sick pets. Indeed, in other markets, like the U.K., pet insurance policies are held by 25% of owners. In the U.S. and Canada, even a modest step toward European levels could power Trupanion sales for years. More than half of households in the two countries own a dog or a cat, with about 120 million furry friends visiting the vet at least once a year. At the U.K. level of insurance, the market is $34 billion annually, compared to the $2 billion current levels generated for the North American industry in 2020. To date, Trupanion has had success building relationships with vets, who get paid immediately when patients check out with the insurer’s unique point of sale system. Over the last four quarters, the company has grown sales more than 39%, to $647 million, losing 80 cents per share in that timeframe. Trupanion and Chewy haven’t released sales projections for their venture, but Trupanion management was already predicting next year would see a 25% to 30% rise in sales and operating income before the deal was announced.

Technical Analysis

TRUP spent most of the year in a wide range between 70 and 130, with some big downs and big ups during that time, but now it looks like that consolidation period should provide a strong base for higher prices. The stock began to get going in early October, reacted well to earnings in November, and after pulling back sharply with the market in early December, exploded higher last week on the deal with Chewy. Expect volatility, but we’re OK taking a swing at TRUP around here.

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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 December 20, 2021.