January 18, 2022

Last Monday’s dramatic selloff and reversal smelled like a short-term low, but the sellers had other ideas—the bounce from that low lasted just a couple of days before the bears were back at it, with today’s decline further unraveling growth stocks. All in all, we remain in the same cautious stance as we have been for a while: Given the extreme selling in growth and choppiness in many other areas, we think holding a good chunk of cash is paramount; we’re not opposed to a little buying here and there in resilient areas, but we don’t advise playing heavily until the bulls step up to the plate. Our Market Monitor now stands at a level 4.

This week’s list is mostly cyclical and commodity names, all of which are acting or are set up well. Our Top Pick is a Canadian copper and coal play that just lifted from a multi-month rest on big volume.

Market Overview

Growth Continues to Unravel
Last Monday’s dramatic selloff and reversal smelled like a short-term low, but the sellers had other ideas—the bounce from that low lasted just a couple of days before the bears were back at it, with today’s decline further unraveling growth stocks. That said, the broad market continues to hold up somewhat well, with most broad indexes more flat-ish than bearish, many cyclical and commodity areas with solid charts and even a positive divergence in new lows on the Nasdaq today. All in all, though, we remain in the same cautious stance as we have been for a while: Given the extreme selling in growth and choppiness in many other areas, we think holding a good chunk of cash is paramount; we’re not opposed to a little buying here and there in resilient areas, especially if we start seeing positive earnings gaps, but there’s not much money being made out there, so we don’t advise playing heavily until the bulls step up to the plate. Our Market Monitor now stands at a level 4.

This week’s list is mostly cyclical and commodity names, all of which are acting or are set up well. Our Top Pick is Teck Resources (TECK), which has huge earnings and just broke out of a big consolidation on huge volume. As with most names these days, try to buy on pullbacks.

Stock Picks & Previously Recommended Stocks

Stock 1

Alcoa (AA)

Why the Strength

Lofty aluminum prices and a transition to environmentally friendly production methods have lifted Alcoa’s prospects. A major Wall Street firm cited those reasons for raising the stock’s price target, along with generous capital returns (including a recent $500 million share buyback authorization) and better-than-expected free cash flows. Alcoa is also capturing interest among environmentally conscious investors for its aggressive efforts to reduce its carbon footprint. Indeed, expectations are high that it can become the world’s first “green” aluminum producer, as already some 80% of its production is powered by renewable energy sources. Further contributing to the bullish outlook is an energy crisis in Europe and Asia that’s should result in production cuts for smelters, which will pressure already-tight inventories for the metal. Indeed, around 600,000 tons of capacity have been cut in Europe, with an additional 900,000 tons at risk of shutting down due to higher power costs, issues that “exacerbate concerns over aluminum shortfalls globally” in the words of a major investment bank. Indeed, Alcoa has announced it will halt primary aluminum production at its plant in Spain (Europe’s second-largest facility) for at least two years. Along those lines, a ban on thermal coal exports by Indonesia has contributed to surging coal prices (used in smelting), in turn adding to the squeeze on aluminum production in the world’s top two producing countries, China and India—ironically, these production cuts will help Alcoa’s bottom line as prices for aluminum should stay elevated. The next big event comes Wednesday evening, when Q4 earnings are due; analysts expect 40% top-line and 670% bottom-line growth, and more importantly, see earnings remaining in the stratosphere ($6.53 per share) in 2022.

Technical Analysis

We wrote about AA just a few weeks ago (December 20) as the stock had raced ahead on big volume as more investors saw the aluminum price rise as sustainable, at least for a few more quarters. That said, the stock missed our entry price, but that’s a sign of strength—shares have essentially meandered sideways (slightly up) since the breakout with no big-volume selling. Earnings on Wednesday are a risk, but we’re not opposed to rolling the dice on a small position here or on minor weakness toward the 25-day line before or after the report.

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Stock 2

ArcelorMittal (MT)

Why the Strength

When we last reported on Luxembourg-based ArcelorMittal in August, the firm had just released some eye-opening results for Q2, featuring its best earnings quarter in 13 years (with EBITDA soaring more than seven-fold from a year ago). The iron ore miner and steel producer also predicted that strong demand for its “smart” steels (which use less energy and hence result in less carbon during production than traditional steel) would carry into the second half of the year. And in Q3, that’s exactly what happened as ArcelorMittal reported its highest net income ever and its best overall quarter since 2008, with revenue of $20.2 billion that rose 52% and per-share earnings of $4.16 that was nearly as large as any year of the past decade. EBITDA, meanwhile, was six times higher than the year-ago quarter (and up 20% sequentially). The stellar results were in spite of a 9% decline in steel shipments from the prior quarter, due to weaker automotive demand, production setbacks and order shipment delays (problems the company said would improve in Q4). ArcelorMittal also anticipates a 12% to 13% increase in global steel demand, even without top consumer China, where a real estate crisis is brewing. Furthering the bullish case for ArcelorMittal is the big-picture outlook for steel prices which are close to record highs, and which management sees being reflected in annual contracts for 2022. The CEO of a major international steel company, moreover, made news recently when he predicted that average prices for hot-rolled coil steel in the coming years would likely exceed $600 a ton—40% above the eight-year average price. As for Wall Street, they’re more conservative, but even with an expected 27% decline in 2022, earnings should come in well above $9 per share. The Q4 report is due February 10.

Technical Analysis

Many steel stocks, including MT, were flying high in the first seven months of 2021 before running into some turbulence in August. Shares peaked around 34 in May, and while there was a brief breakout attempt in July, the stock essentially built a double-bottom base with no net progress during the next seven months. But the action from the December low has been excellent, with a strong-volume initial rally, some tightness, and last week saw a breakout to new highs. Granted, today’s drop wasn’t the best, but in the context of the recent move, looks normal. You can nibble here if you’re interested.

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Stock 3

Eastman Chemical (EMN)

Why the Strength

After experiencing some major demand shocks during 2020’s pandemic, specialty chemical makers like Eastman are seeing brighter days now that things are returning to normal. Highlighting this was Eastman’s third quarter which saw revenue of $2.7 billion that was 28% higher from a year ago and earnings per share of $2.46 (in line with estimates and 57% higher from a year ago). The revenue increase was driven by a 19% hike in average selling prices (vs. easy comparisons during the pandemic), led by chemical intermediates and additives. Additionally, Eastman reported a 9% volume jump that underlined what management described as a continued “strong recovery” in demand across key end markets, especially construction, transportation and consumer durables. The firm’s chemical intermediates business saw sales rise 44% due to higher selling prices, while additives sales were 34% higher, led by higher coatings prices. The lone weak spot in Q3 was in the advanced materials segment, which was impacted by component shortages and reduced auto production. However, the company expects automobile supply-chain setbacks to improve in the back half of this year. Also accounting for the recent strength was a high-profile recommendation from a major Wall Street firm, which picked Eastman as its top materials sector performer for 2022. Looking ahead, Eastman continues to implement price increases across its specialty chemicals portfolio and plans to use its ample free cash flow for dividends, bolt-on acquisitions and share buybacks. An attractive dividend yield at 2.4% is an added bonus, as is the reasonable valuation. Earnings are due out January 27.

Technical Analysis

EMN started off last year well enough, rising from around 98 in January to 130 in early June. But then the sellers took control and had their way with the stock until September, when EMN was forced back down to 98. From there, shares staged an impressive comeback and have etched out a bowl-shaped launching pad; better yet, the stock has seen big-volume buying in recent weeks as it approaches its old high. If you want in, start small and aim for dips ahead of next week’s report.

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Stock 4

EOG Resources, Inc. (EOG)

Why the Strength

Most energy firms changed course in 2019-2020 as business slowed and then the pandemic crushed business, focusing on cutting debt and costs and harvesting free cash flow. But EOG Resources (a big, diversified explorer with stakes in many of the leading basins in the U.S.) began that move way back after the 2016 bust—back then, it promised to focus on “premium” wells that delivered returns of 30% at $40 oil and $2.50 natural gas, and that move helped the firm be consistently cash flow positive even during the dry times of the next few years (about $6 billion worth from 2016-2020!). Then, last year, the firm moved to “double premium” wells for the most part, which (thanks in large part to cost cuts and efficiencies) return 60% at the same energy price metrics. And now those moves are really paying off: EOG should be net-debt free by early this year, allowing it to spin off a ton of cash flow to investors, and as opposed to the highly variable payouts of others, EOG is more reliable—in November, the firm upped its dividend significantly (now a 2.9% yield), and it can afford to pay that out and fund maintenance CapEx at just $40 oil! Moreover, it wasn’t shy about paying out special dividends last year ($3 per share worth), and there should be a lot more where that came from (and/or further base dividend boosts) given that EOG was on pace to crank out $8 of free cash flow per share in 2021 at just $65 oil—a figure that should be higher in 2022 even at the same modest oil price level. Obviously, the $80-plus oil level of early 2022 is helping the cause, but even if things normalize somewhat, EOG could be an Altria-like cash cow in the energy space. Earnings aren’t out for a bit but should come February 25.

Technical Analysis

EOG had a great run into June of last year before finally hitting a wall near 90 and pulling back slightly below its 40-week line. The September rally brought it to marginal new highs, but it also led to another dip to the 40-week line; net-net, the stock made no progress for about six months. But now EOG is freewheeling again, with the stock and relative performance (RP) line hitting new highs as shares leapt over the century mark. We like it, but think dips of a couple of points would make for better entries.

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Stock 5

Halliburton (HAL)

Why the Strength

The big energy story of the past year is that explorers, having slashed costs and debt, didn’t take the bait when it came to quickly expanding production; despite healthy prices, virus and other fears (plus the winter storm Uri a year ago) had big players holding production somewhat flat. But with oil again north of $80 despite various economic worries, Wall Street is starting to sniff out an upturn in fracking-related capital spending, with one brokerage firm seeing a 20%-plus bump in spending industry-wide. Halliburton is one of the biggest and broadest oil service outfits out there, with various products and technologies that help clients with reservoir evaluation, well construction and completions, production and more. Impressively, even in the worst of the pandemic the company was solidly profitable, and despite most clients keeping their powder dry, sales and earnings have been gradually picking up of late; cash flow, in fact, has been quite strong, totaling nearly $1 per share in the first nine months of 2021, including north of 50 cents a share in Q3 alone. And now analysts see 2022 as something of a boom year, with earnings rising 61% and free cash flow likely to advance at a similar pace. (It’s also believed that the firm will embark on a meaningful shareholder return plan in the new year; current dividend yield is just 0.6%.) Management doesn’t see this as a one-year thing, either: Halliburton’s CEO believes the under-investment by the industry since 2014 has led to scarcity that should keep demand and pricing for its wares healthy for a long time to come. Earnings are due January 24.

Technical Analysis

HAL’s post-crash recovery stalled out in May of last year as business, while improving, never really took off. Shares bobbed and weaved after that, with three 20%-plus corrections that led to a nine-month period of no progress. But the stock’s character has clearly changed since the turn of the year—HAL has surged two straight weeks on great volume, moving out to new price highs (the relative performance line is close). We advise aiming for dips, though given the buying volume, we’re not expecting a major retreat.

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Stock 6

KB Home (KBH)

Why the Strength

KB Home has been building homes for 65 years, though it’s on the small side in the industry, operating in “only” 47 markets in the U.S. and with a market cap south of $5 billion—but it might have the best metrics and near-term outlook of any firm in its industry. The stock has turned strong after a blowout Q4 report promised good things for a while to come: In Q4 (ending November), sales lifted 40% while earnings of $1.91 were up 71% and beat estimates by 14 cents, thanks to a 28% rise in homes delivered and a 9% hike in average selling price. It’s the forward-looking metrics that really impressed, though, as the firm’s unit backlog ended the quarter up 35% and (more importantly) the value of that backlog totaled $4.95 billion, up a whopping 67% and nearly as big as last year’s entire revenue total ($5.72 billion)! Indeed, while many are worrying about rising interest rates or housing prices that seem out of touch with reality, KB’s top brass remains very optimistic—they guided for fiscal 2022 revenues to rise nearly 30%, and despite all the cost pressures and supply-chain issues out there, they see housing-related operating margin actually lifting three percentage points, all while it expands its community count by up to 25%. (Some of that margin outlook is thanks to the firm’s build-to-order strategy, as opposed to spec building.) Analysts now see earnings up a huge 71% this year and more in 2023. Of course, if the housing market really slows, KB Home will feel it, but there’s no question KB Home’s business and prospects are super strong.

Technical Analysis

KBH got up to around 50 last May before taking a hit, with investors thinking the housing market (and the company’s business) was likely to take a hit in the months ahead. Shares fell a maximum of 27% but mostly languished sideways between 37 and 45 for many months. But last week’s earnings reaction was encouraging, with a massive-volume move (11x average as the stock leapt nearly 17%). That said, today’s drop on rate fears tells us the sellers are still hanging around; we’re going to set our buy range up a bit, as a good rebound will imply today was a shakeout.

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Stock 7

Nexstar Media Group (NXST)

Why the Strength

The U.S. midterm elections are still 10 months away, which is too far to predict most outcomes but one: A lot of money will be spent on political ads. Nexstar is the largest independent television broadcaster in the U.S., setting it up as one of the major beneficiaries of wall-to-wall political pitches that come with competitive federal and state races. Nexstar owns 200 stations in 118 markets reaching about a third of the population and it typically takes 12% to 15% of all the broadcast spending in each election. This year, about $3.8 billion of money is projected to be spent, larger than any other year but the 2020 presidential election. More than 80% of the races considered competitive occur in one of its markets! But politics isn’t the only tailwind. The company is in four out of every five legalized or soon-to-be sports wagering markets. Bookies spend very heavily in new markets to acquire customers, with about half a billion of ad dollars expected to be spread across sports content, like Nexstar’s local sports reports and affiliated broadcasts of pro games. Already Nexstar is an impressive money machine, as sales are seen hitting $5.2 billion this year with a more than 40% EBITDA margin. This year EPS should surpass $25, meaning shares look cheap even near all-time highs. A healthy dividend (1.6% yield) that’s grown 25% annually for the past few years and a share buyback program should boost returns, too. Helping the cause is the fact that Nexstar renegotiates the majority of retransmission fees it collects from networks in coming months; right now, it gets paid well less in fees than it should given its ratings, so a bump is all but guaranteed, which should boost results in 2023 and beyond.

Technical Analysis

NXST just went through the quietest period its shares have ever seen, a nine-month stretch where it largely traded in a tight range between 141 and 155, but for a handful of excursions by bulls and bears. Such tightness usually results in a solid launching pad, and now shares are lifting off: NXST lifted nearly 15 points last week on huge volume, just shy of its November high. We like the action, though we wouldn’t be surprised if today’s dip went a bit further.

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Stock 8

Taiwan Semiconductor (TSM)

Why the Strength

There may not be a better pure-play business for the semiconductor shortage than Taiwan Semi. That’s because the Taipei-based company seems to make semiconductors for everyone, including Apple, Intel and Nvidia. Taiwan Semiconductor has more than 500 customers for whom it makes some or all of their chips as a contract manufacturer, crafting more than 10,000 distinct chip designs. Sales in the most recent quarter, reported last week, rose more than 20% and EPS lifted in the high teens with management guiding current-quarter results to exceed prior estimates, including revenue of at least $16.6 billion that would be up 31% from a year ago—its fastest growth rate in a year and a half. While the global semiconductor shortage has led to improved prices, Taiwan Semi indicated it’s holding off a bit there in the interest of long-term relationships. It’s not just the pandemic and move of everything online behind Taiwan Semi’s strength: The company is on a massive capacity binge, spending more than $40 billion in 2022 to meet future demand for chips sparked by 5G, Internet of Things and AI. Even then, expect chip supply to be tight, which in turn will keep prices strong—it’s not a certainty that the new capacity will put Taiwan Semi in a glut later on, as making sophisticated chips is hard, and the company is focusing on new lines for 300 millimeter chips, which are needed for more advanced computing efforts. Bottom line, Taiwan Semi’s business is strong and getting stronger.

Technical Analysis

An ADS listed on the NYSE, TSM spent much of 2021 consolidating around the 155 area after a rip-roaring 2020 that saw the stock nearly triple. That long, drawn-out dead period surely wore out many weak hands, so when the bullish earnings announcement and forecast came, TSM went vertical—the move actually started the first two days of the year, and following a pre-report pullback, the stock lifted to new highs late last week. We’re OK starting a position on today’s market-related weakness.

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Stock 9

Teck Resources Limited (TECK) ★ Top Pick

Why the Strength

Strong global demand for key industrial metals has given increased pricing power to firms like Teck (covered in the October 11 report), a copper- and zinc-focused company which sees these metals as pillars of the “green” economy; indeed, one brokerage house last year said copper’s roll in electric vehicles and wind turbines could boost demand more than China did back in the 2000s when the metal’s price was galloping higher. To that end, Teck is giving high priority to its Chilean QB2 copper growth project (one of the world’s largest undeveloped copper resources) and expects production to begin there in the second half of this year. Management has high hopes for the low-cost project, which is expected to double (!) Teck’s consolidated production by 2023. In the third quarter, Teck’s sales improved significantly from a year ago, driven by higher prices for its output: Revenue of almost $4 billion jumped 73% from a year ago, due mainly to higher seaborne coal prices and a 43% increase in realized copper prices, while per-share earnings of $1.88 beat the consensus by 34 cents. Bitumen prices nearly doubled from a year ago, while production rose 10%. The company’s steelmaking coal business is also turning heads, with average realized prices more than doubling from a year ago, while production increased 17%. Teck says its steelmaking coal supply-chain transformation is contributing to higher efficiency, and with current record coal prices, Teck expects this business to significantly contribute to profitability going forward. Wall Street sees sales doubling in Q4 and earnings growth of nearly 500% (report due February 24), with the bottom line rising further in 2022 after last year’s boom.

Technical Analysis

After a huge rally, TECK hit a wall last May around 26 and began what turned into a seven-month, base-on-base formation. The first launching pad was etched through September, but the breakout didn’t last long; then came a calmer, tighter consolidation during the fourth quarter of the year. And now the buyers are back, with TECK hitting new price and RP peaks on good volume. The chart looks great, but we’ll set our buy range lower, aiming for a pullback given the market environment.

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Stock 10

Webster Financial (WBS)

Why the Strength

Webster Financial is the holding company for Webster Bank, a mid-sized outfit that operates mainly in New England and New York. With more than $33 billion in assets, Webster serves over three million customers through retail and commercial banking (including commercial real estate and small business loans), as well as through wealth management services. Additionally, Webster’s HSA Bank division is one of the nation’s largest providers of Health Savings Accounts (HSA). Last year, Webster combined with Sterling Bancorp in a “merger of equals” in a move designed to cut costs and enhance scale and growth in Webster’s HSA and consumer banking business. The $10 billion merger, which will close on February 1 and operate under Webster’s name, is also expected to unlock a multi-billion-dollar opportunity in commercial lending and real estate, as well as foster new clients in sponsor and specialty loans. Webster’s revenue grew to $314 million in Q3 (up 3% from a year ago) on the back of 3% linked-quarter loan growth and 4% deposit growth, while per-share earnings of $1.08 were 44% higher. The bank noted that credit quality and economic conditions continue to improve, and management sees more of that coming in the quarters ahead. Another positive was the $230 million in net interest income Webster earned in Q3, a 5% improvement from the year-ago quarter—and there should be upside down the road with anticipated higher interest rates this year. Asset quality also improved, with nonperforming loans (less than 0.5% of total loans) declining 37% from a year ago and 16% sequentially. Earnings are due Thursday morning, January 20.

Technical Analysis

WBS is yet another cyclical stock that had a huge post-vaccine rally that topped out in the early part of last year (near 64 in March), took a good-sized hit for a few months (down a maximum of 29% into the fall), began shaping up after that and, in recent weeks, has lifted off—WBS has been very strong since the mid-December low, with a string of good-volume buying that’s driven the stock to new highs. If you want in, target a modest post-earnings dip for entry.

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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 bolded.

The next Cabot Top Ten Trader issue will be published on January 24, 2022.