June 22, 2020

Very Strong, but Keep Your Feet on the Ground

Current Market Outlook

After three weeks of rotation, where cyclical stocks took the reins and growth stocks rested (and some broad selling pressure showed up June 11-12), the reverse occurred last week, with the leaders again ramping up and cyclical stocks sagging. Still, while the endless rotation isn’t ideal, it hasn’t changed the big picture—most of the evidence remains bullish, so we’re still optimistic the path of least resistance is higher. That said, it’s important to keep your feet on the ground, too; looking for solid entry points and not hesitating to book some partial profits on the way up are still good ideas, as some selling pressure or another bout of rotation isn’t out of the question. We’re leaving our Market Monitor at a level 8.

This week’s list has a bit of a secondary feel to it, but many are showing solid setups; ideally some of these will be the next wave of names big investors focus on. Our Top Pick is Restoration Hardware (RH), which has a strong story and is resting nicely after a very strong run.

Big Lots (BIG)

biglotscorporate.com

Why the Strength

In what came as a shock to many, some brick-and-mortar retailers actually did quite well during the shutdown. Big Lots emerged as one of the winners in the locked down economy, keeping all its stores open during the pandemic and reporting strong online business (+45%) and higher comparable store sales in April. Last week, it provided an optimistic update after completing a previously announced sale and leaseback transaction worth $550 million (the proceeds of which are expected to improve its liquidity and boost shareholder value). The closeout consumer goods retailer said comparable-store sales were “up strongly” in the current quarter and have exceeded the firm’s expectations through mid-June; it also saw its biggest e-commerce volume ever in Q1. Management attributed recent growth to increased demand for home furnishings during the shut-in, though it warned that sales will likely slow this summer. But analysts anticipate more good things in their furniture and online businesses (the firm recently partnered with Instacart to provide same-day delivery from nearly 1,400 stores in 47 states), with revenues expected to rise 13% in Q2. While Big Lots hasn’t transformed into a growth company, analysts see earnings taking a step-function leap higher this year and holding most of those gains going forward. Helping the cause is the fact that Big Lots is set to resume a $348 million stock buyback program in the coming months, and it recently announced a cash dividend of 30 cents per share (payable on June 26). As an off-price retailer in a rebounding economy, we think Big Lots can do well.

Technical Analysis

BIG had been the dog’s dinner for years, but the action after the market’s low has been stunning, with shares ripping higher eight of nine weeks and tagging multi-year highs in late May. The stock has finally begun to pull in, which is normal, and so far the selling has been orderly, allowing the 50-day line (now nearing 29) to begin to catch up. If you don’t own any, we’re OK taking a swing at BIG around here.

BIG Weekly Chart

BIG Daily Chart

Immunomedics (IMMU)

immunomedics.com

Why the Strength

A few weeks back, we told you Immunomedics was making great strides with Trodelvy (sacituzumab govitecan-hziy). After a couple of years of disruptions due to the manufacturing issues, in late April the company received accelerated approval from the FDA for use of the drug for the treatment of adult patients with metastatic triple-negative breast cancer (mTNBC), which affects more than two million people every year. Trodelvy is the first antibody-drug conjugate approved by the FDA specifically for previously-treated mTNBC, and the drug’s commercial launch has begun. Immunomedics is also working with the Dana-Farber Cancer Institute to conduct two phase II studies to evaluate the safety and efficacy of combining Trodelvy with a specialized protein antibody from Merck (dubbed Keytruda) in patients with mTNBC and a specific form of breast cancer. It’s not all good news, though: Citing the disruption from COVID that halted clinical trials, both CEO Harout Semerjian (who had just become CEO in April) and chief medical officer Rob Iannone both tendered their resignations; no new management announcements have been made. But trials are resuming now, with patient enrollment into the Phase 3 TROPiCS-02 study of Trodelvy at approximately 20 clinical sites ramping up as of mid-May. Bottom line, the drug approval is the motivating factor here, and the potential is enormous, with sales expected to reach $70 million this year and north of $200 million in 2021.

Technical Analysis

IMMU has completely changed character since late March, when the stock exploded higher off the market bottom and then got another boost on news of the FDA approval. Shares made it all the way to 35 before finally taking a breather, and we like the look of that consolidation; IMMU pulled in a relatively modest amount, found support near the 50-day line and has surged higher. You could start a position here if you’re not yet in, but we’ll set our buy range down a touch from here.

IMMU Weekly Chart

IMMU Daily Chart

LGI Homes (LGIH)

lgihomes.com

Why the Strength

Housing was thought to be an industry that would be crushed by the virus, with open house cancellations seeming likely for months. But it really hasn’t been that bad. Housing permits did slip 30% over three months, but this comes after a tripling in the past decade and May’s bounce (up 14%) is certainly encouraging. LGI Homes is a mid-sized homebuilder ($2 billion of revenue over the past year) that mostly focuses on faster growing markets (southeast, southwest and Texas) in the U.S.; all in all, it’s in 34 markets and has 115 active communities, with a goal of becoming a top five homebuilder in terms of closings per year. Growth has been solid for a while, and that continued in the first quarter, with sales and earnings booming in the first three months of the year. That doesn’t mean it’s completely escaped the COVID situation, though—in April and May, home closings were down single digits from the same period a year ago, and analysts see sales and earnings growth in the red during the current quarter, and the third quarter might not be much better. Of course, there’s risk in some of these areas of a second wave of the virus (North Carolina, Arizona, etc.), which could always change things, but (a) the odds still favor improvement going forward, and (b) even if there are hiccups, it’s unlikely the business is going to grind to a halt. As it stands now, analysts see 2020 earnings as relatively flat with growth getting back on track on 2021—and we think those figures could prove conservative given the data we see now.

Technical Analysis

Relative to the overall market, LGIH actually hit a peak back in early 2018 and of course plunged with everything else during the COVID crash. The initial bounce wasn’t anything to write home about, but like most cyclical stocks, it picked up steam in late April and had a huge run right through May before beginning to chop around. We think the next big move is up, but given the resistance in this area (and recent light buying volume), we suggest targeting dips for entry.

LGIH Weekly Chart

LGIH Daily Chart

MercadoLibre, Inc. (MELI)

mercadolibre.com

Why the Strength

As every investor is aware of by now, COVID-19 and the stay-at-home orders have given e-commerce a huge boost around the world. And while U.S. digital sales (accounting for some 11% of total sales) are booming, the opportunities in Latin America may be even better. Right now, consumers in South America only spend about 4% of their shopping dollars online, but that’s changing in a hurry; last quarter, 13 million Latin American shoppers made their first purchase online, with 68% of them coming from Brazil. And e-commerce provider MercadoLibre was the clear winner, as it’s a hybrid eBay/Amazon/PayPal in that neck of the woods (it has customers in 18 countries and is by far the dominant player), offering a huge platform for merchants and payment solutions, too. In the beginning, the company modeled its payment system after PayPal (an investor in the company) and it now allows its customers to add money to their accounts at a network of convenience stores, as well as other locations. Well before COVID, the company was on a growth streak, and the stock remains strong because growth is still in high gear: In the first quarter, MercadoLibre’s revenues in local currency surged 70%, with gross merchandise volume up 34% and total payment volume (through its MercadoPago payment offering) surging 82%. Currency movements will impact results, but the combination of the e-commerce boom worldwide and this firm’s dominant position has big investors getting in.

Technical Analysis

MELI was one of many stocks that topped out in mid 2019 (around 700) and had two big corrections after that (to 470 last November and to 422 this March) to shake out the weak hands before exploding to new highs. The breakout came after earnings in early May, and MELI has steadily marched higher since then, including a good-volume push higher last week. Dips of a few percent would be very tempting.

MELI Weekly Chart

MELI Daily Chart

Mersana Therapeutics (MRSN)

mersana.com

Why the Strength

Ovarian cancer is the fifth leading cause of cancer-related deaths among U.S. women and is regarded as the deadliest of all gynecologic cancers. Thankfully, advances are being made in the treatment of this disease, and Mersana—a clinical-stage biopharma that develops antibody-drug conjugates (ADC) that target cancers—has made progress on this front. The firm’s drug design approach begins with a “fleximer backbone” to improve drug solubility and delivery, in turn facilitating the creation of novel drug candidates. Using this approach, Mersana achieved promising interim results in a Phase I study of XMT-1536, its ADC designed to treat ovarian cancer patients. The study found that 10% of patients saw total remission after taking the drug, while 35% experienced partial tumor reduction (further study details will be released in coming months). Mersana also has a growing pipeline of candidates, including XMT-1592 (for ovarian cancer and adenocarcinoma), B7-H4 (for multiple solid tumors) and a targeted STING ADC anti-tumor drug, which the firm will release data on in the second half of this year. It boasts a $78 million cash position, including $15 million available from a credit facility, which will support development activities going forward. It’s obviously speculative, but Mersana could have something special both in XMT-1536 and its overall approach.

Technical Analysis

MRSN came public in June 2017, rallying from its 14 IPO price to a high of 23 in May 2018 before commencing a slide all the way down to 2 last September. The stock rallied back to 9.5 in February of this year and built an acceptable launching pad in the months after before exploding higher on the Phase I trial results. Just as encouraging, MRSN has traded relatively tightly in recent weeks, a good sign after such a big move. If you want in, you could nibble here.

MRSN Weekly Chart

MRSN Daily Chart

Nuance Communications, Inc. (NUAN)

nuance.com

Why the Strength

Nuance is known for its artificial intelligence-driven (AI) voice recognition software, dubbed Dragon Naturally Speaking, which allows for vocal control of computer programs. The company serves the finance and auto industries (more than 200 million cars use the company’s voice-enabled AI), as well as client engagement centers. So ubiquitous are firm’s AI solutions that when you call a customer support line and get a robotic response, chances are it’s Nuance’s technology. Another driver these days is the firm’s healthcare business, an industry that’s racing to digitize patient records, and that’s boosted Nuance’s business. It serves around 600,000 physicians daily, alleviating the administrative burden with compliance support and documentation assistance; the firm’s technology allows them to recapture the patient-physician interaction by removing keyboards from the note-taking process and letting voice AI do the “grunt” work. Nuance’s overall numbers look mundane, but that’s in large part because of its transition to the cloud, similar to what Adobe and Autodesk did years ago; the Dragon Medical cloud platform saw 46% growth in the most recent quarter, plus the firm reported a 77% increase in free cash flow and bought back 3.8 million shares while paying down $170 million in debt. Looking ahead, it expects near-term headwinds as hospitals reprioritize projects to deal with the needs of virus patients—it cut 2020 expectations due to these factors—but management made a point of saying it stands by its 2023 targets that it revealed at last December’s Analyst Day ($685 million of healthcare annualized recurring revenue by that year, up from $299 million last year). COVID hiccups aside, this remains a solid growth story.

Technical Analysis

NUAN was looking very good before the crash, with a solid breakout in October/November, tightness in December and a super-bullish earnings reaction in February. Shares got crushed during the four-week crash, but NUAN has enjoyed a fairly persistent advance since then. Most recently, the stock paused nicely in the 22 to 24 area before leaping to new highs on big volume. We advise aiming for dips, possibly toward the rapidly rising 25-day line.

NUAN Weekly Chart

NUAN Daily Chart

PagSeguro Digital (PAGS)

investors.pagseguro.com

Why the Strength

A recent survey found that as many as 45 million Brazilians (1 in 3 adults) lacked access to a bank account as of 2019. PagSeguro, a Brazilian fintech operation, is looking to fill this gap. The firm was created to provide merchant solutions to Brazil’s many unbanked small businesses, and it’s focused on providing a digital link between merchants and credit card companies. The firm’s digital bank business, PagBank, offers banking through a smartphone app and facilitates bill payments and cash transfers, including services for top-up prepaid mobile phone credit, prepaid credit and cash cards, loans, investments, QR code payments and other digital banking services. Growth for PagBank has been explosive, with 4.6 million active users in Q1, an increase of one million users from the prior quarter and more than double the year-ago number! (It tops Google searches for digital banks in the region.) The company also recently created PagPerto, aimed at helping small merchants sell online. On the financial front, the company beat expectations in the latest quarter—in local currencies, the top line increased 27%, while most sub-metrics impressed, including total payment volume rising 30%, active merchants up 25% while the take-rate lifted 6%. Net income also rose (15%), and the big picture is super-bullish, with the company having less than 1% of the potential market for its services. Foreign companies have some risk given currency shenanigans, but there’s no question Pagseguro is a great growth story.

Technical Analysis

PAGS had a nice breakout in May 2019 that took the stock from 32 then to 53 in August, but that was the top; it was down around 37 in February and crashed as low as 14 during March. Like everything else, it began rallying soon after that, but the real action has been since mid May, with the stock booming over a four-week stretch. The two-week rest since then has been normal—we’d be more favorable to entering on dips.

PAGS Weekly Chart

PAGS Daily Chart

RH Inc. (RH)

restorationhardware.com

Why the Strength

Restoration Hardware has been an interesting company in recent years, driven in equal parts by solid execution, some business model changes and aggressive moves by management to boost shareholder value. The company is one of the top brands in the luxury home furnishings market, and it made waves a few years ago by refocusing its efforts away from small, mall-based locations that featured just a small fraction of the firm’s offerings, to giant galleries, outlets and even restaurants (featuring all the firm’s furnishings), massive catalogs (don’t hurt your back picking one up) and a move into adjacent areas (luxury baby and child furnishings, etc.). Management also made the bold move a couple of years ago of repurchasing half of all shares outstanding when the stock was low, which drastically boosted earnings per share. As for the here and now, the stock is strong because the early-June quarterly report was far better than expected (earnings of $1.27 were down 36% from a year ago, but were above the $1.04 estimate) and management relayed positive comments, saying the second quarter has seen a strong rebound as things reopened (74% of its galleries are open); the core furnishings business was up 7% in May from a year ago (with better margins, too) and up 11% in early June despite civil unrest crimping sales in many places. Long-term, the top brass thinks the firm can more than double revenue in North America alone as it captures market share. It’s a good story.

Technical Analysis

RH is known for making wild moves, and it’s been no different during the past couple of years, with a drop from 161 to 84, a rally up to 256, a plunge to 73 during the crash and now a push back to its old highs since the market bottom. Digging into the recent action, what we like is the big acceleration in buying from mid-May to early June, followed by a normal hesitation given the prior run and the stock’s early-year highs. You could nibble here or (preferably) on dips toward the rising 25-day line.

RH Weekly Chart

RH Daily Chart

Teradyne (TER)

www.teradyne.com

Why the Strength

Before the coronavirus, semiconductor companies were posting their best results in years. But the virus sent both supply and demand reeling, and it’s expected that global semiconductor revenue will be down 0.9% overall in 2020 compared to the previously forecast rise of 12.5%. But it’s likely that forecast will either prove too conservative, or that the air pocket in demand has already been factored in, as spending is beginning to rebound. Teradyne sells advanced testing equipment for semiconductors and wireless devices. And while the chip market can be very volatile—with big up and down cycles—the equipment market is much more stable; the advent of the cloud service providers is pushing up demand both near- and longer-term. In the first quarter—despite COVID-19—Teradyne posted EPS of $1 per share, handily beating estimates of $0.86, and coming in 85% higher than a year ago. Sales were up 43%, also beating estimates by a few percent. Revenues are split as follows: semiconductor testing platforms (69%), System Tests (17%), Industrial Automation (9%) and Wireless Tests (5%). As demand continues to increase, analysts see sales and earnings up nicely in Q2 with more on the way down the road. It’s not changing the world but Teradyne is doing good business and looks like a big-ish cap leader in the chip space.

Technical Analysis

TER had a very nice run from its breakout last July near 50 to a high around 80 in January of this year. It plunged and snapped back with everything else, eventually consolidating in a reasonable range (~55 to 65) for six weeks. Since mid May, though, the buyers have been in control, with TER pushing to new closing higher earlier this month and stretching higher in recent days. If you want in, we advise aiming to enter on weakness.

TER Weekly Chart

TER Daily Chart

Yeti Holdings (YETI)

yeti.com

Why the Strength

Summertime and Yeti go hand in hand, with more and more people using their tumblers, coolers, waterproof bags and the like to keep their beers cold and coffee hot when they hit the beach, lake or camp. This is basically a brand name and distribution story (both wholesale and direct-to-consumer), and as both have risen in years, so have the firm’s results. And that continued in the first quarter—total sales were actually up 21% in Q1 through mid-March, but the virus caused sales to fall 25% in the final portion of that month. Like many, the company responded quickly with some cutbacks, and when management released results in early May, they noted thatQ2 overall will be a stinker because of virus-related issues (mainly a drop in corporate-related sales). But there are bright spots, too; in its conference call, management said it saw “extraordinary” growth from Yeti.com in April as well as positive trends in other online distributors of its wares (like Amazon). Analysts do see Q2 earnings slipping 61%, but the company regularly trashes estimates (usually by 10% to 20%, though in Q1, EPS of 11 cents topped by a full four cents). Bottom line: this is all about the future—Yeti is clearly a best-in-class name in what’s been an entirely new industry in recent years (high-end drinkware and coolers), and as the world turns right side up, there’s no reason business trends won’t return to their prior bullish trends.

Technical Analysis

YETI came public in late 2018 and had a nice post-IPO run in early 2019 before topping out; from 37 in April of that year, the stock fell all the way to 15 at this year’s market lows. The 200-day line was resistance on the bounce through early May, but the stock’s action since then has been encouraging, rising persistently despite a couple of share offerings (sold by existing owners; YETI got none of the proceeds), even kissing new high ground last week. Dips of a couple of points would be tempting.

YETI Weekly Chart

YETI Daily Chart

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 green.

The next Cabot Top Ten Trader issue will be published on June 29, 2020.