June 7, 2021

Now the Real Test Begins

Current Market Outlook

The holiday-shortened week was a relatively quiet one, with most indexes and sectors mostly meandered in tight ranges. After the prior two and a half weeks of constructive action, we consider the lack of selling a positive; to this point, the bears haven’t really come around for many names despite some decent rallies and a few breakouts. But now the real test will begin—if the former leaders that have run right into some tough resistance can hold firm, if recent breakouts can build on their gains and fresh breakouts can emerge, this rally could gain steam ... but if the sellers return, things could go back in the soup within a few days. Right now, we’re still in the trust-but-verify mode of the rally, slowly increasing exposure but also keeping a close eye to see if cracks show up.

This week’s list has a wide array of stocks, including a few cyclical names that are pushing up after a few weeks of consolidation. Our Top Pick is Marathon Oil (MRO), which showed some real power last week as oil stocks came to life.

Apellis Pharmaceuticals (APLS)

apellis.com

Why the Strength

PNH is a rare, life-threatening disease characterized by the destruction of red blood cells, blood clots and impaired bone marrow function, with treatment typically including bone marrow transplants and blood transfusions. Previously, just two drugs were approved to treat PNH in the U.S., both owned by Alexion Pharmaceuticals. But a recent FDA approval win has made Apellis Pharmaceuticals a top entrant in the $4 billion PNH market. Apellis is a clinical-stage biopharma company focused on developing novel C3-targeted gene therapies for the treatment of a broad range of debilitating rare diseases through the inhibition of the complement system (part of the body’s immune system). The C3 protein is essential for activating the complement system, and Apellis’ FDA approval for Empaveli marks the first and only targeted C3 therapy for the treatment of adult PNH patients. The company said 85% of patients treated with Empaveli were transfusion-free after 16 weeks (compared to just 15% of patients on Alexion’s Soliris treatment!). Results also showed a significant reduction in fatigue (a common symptom of PNH) compared to Soliris. Analysts estimate Empaveli could achieve annual sales in excess of $400 million per year, while capturing up to a 30% global market share. On the financial front, there’s nothing much to report yet, but Apellis has a cash position of $724 million, which should provide a runway into the second half of fiscal-year 2022. And while revenue is expected to be just $25 million this year, the top line is forecast to boom 400% next year on the back of Empaveli sales, followed by low triple-digit increases in 2023 and 2024.

Technical Analysis

APLS staged a good-looking breakout last November, but the advance only lasted until early January before the sellers showed up again. The stock pulled back to the 40 level a couple of times, finding support near the 40-week line before bouncing. The real change in character came three weeks ago, with a huge-volume rally, a quick shakeout and further upside two weeks ago. If you’re game, aim for a dip of a couple of points.

APLS Weekly Chart

APLS Daily Chart

Callon Petroleum (CPE)

callon.com

Why the Strength

Energy stocks were strong last week, supposedly because oil prices perked up after the OPEC meeting, but we think it had more to do with big investors believing the odds of a major decline in oil was fading—which means firms like Callon Petroleum should be hugely profitable for the foreseeable future. Like its peers, Callon (which operates mostly in the Delaware, Midland and Eagle Ford basins in Texas) has put aside growth considerations—it plans on production coming in under 2020 levels this year—while keeping costs in check (all-in cash costs in the $15 per barrel range). And that means the firm is harvesting a ton of cash: From 2021-2023, Callon thinks it can produce $500 million (at $50 oil) to $800 million (at $60 oil) of cumulative free cash flow, and that’s including a fairly active hedging program (about 60% hedged in the second half of this year; already 25% hedged for 2022). For the next few quarters, that cash flow (along with the $40 million proceeds of the sale of some non-core acreage in the Delaware basin) will be used to cut debt; the company has no maturities until 2023, but the overall debt load could use some downsizing. Moreover, all of this is based on $50 to $60 oil—if energy prices can stick up here or rise further, there’s no reason the company can’t outdo its own forecasts (via either higher realizations or selling hedges at higher prices). The prospects for payouts seem a ways off, which is the one negative here, but investors are willing to pay up for giant profits, free cash flow and debt reduction in the quarters to come.

Technical Analysis

CPE ran up to around 42 in March and then built a nice base for the last two and a half months—the consolidation featured three waves down and had one fake-out (in early May), which isn’t unusual in a tricky market. But after that selling, CPE tightened up nicely, and last week’s breakout looks good, with solid (not blowout) volume and new relative performance peaks (not shown on chart). Given the group strength, we’re OK taking a swing at it here if you don’t own any.

CPE Weekly Chart

CPE Daily Chart

Discover Financial Services (DFS)

discover.com

Why the Strength

Americans used their stimulus to pay down their credit card balances a whopping 14% in the first quarter compared to the year prior. At first glance, that’s bad for card issuers who make much of their money when customers carry balances and accumulate late fees. But there are signs of consumers returning to old habits, which should be a boon for banks like Discover. In April, its customers’ ending balance was slightly higher than average balance, an early indication people are starting to build up monthly carryovers. Discover should be able to expand its margins, too, thanks to a steep (39%) drop in delinquent loans, which will take some time to get back to their typical levels. In the latest quarter, Discover crushed expectations, posting $5.04 EPS compared to $2.83 consensus, in great part due to unleashing reserves it had set aside in expectation of worsening delinquency. Wall Street is eying additional 2021 reserves it expects Discover won’t need. But Discover’s story is more than accounting windfalls: The combination of lower write-offs, rising card balances and generally strong consumer credit put the bank in a sweet spot as long as it can grow its loan portfolio. Even though it’s the fourth-largest credit card company in the U.S., Discover has been the best at generating shareholder returns, and Wall Street sees $13.41 EPS in 2021, almost 50% higher than 2019’s peak before backing off a bit next year. Management’s side hustle in getting folks into online savings/checking accounts (which generate interest income for Discover) has been good enough to offset a notable amount of the interest cost of funding credit lines, positioning it well for a rising interest rate environment.

Technical Analysis

DFS spent the first four months of the year building a base after a racing recovery from the pandemic lows. Now that the stock has lifted off, that means the 105 area should be strong support. The latest little rest south of 120 has given way to another move to new highs, though volume’s been a bit light—if you’re game, we prefer aiming for dips.

DFS Weekly Chart

DFS Daily Chart

General Motors Company (GM)

gm.com

Why the Strength

Automakers have been forced to cut vehicle production in recent months due to the global semiconductor shortage, but General Motors is bucking the trend with plans to boost production of its best-selling automobiles this summer, which is a big reason for the stock’s renewed strength. Last week, GM said it will increase deliveries to its North American dealers to meet strong demand for Buick, Chevrolet, GMC and Cadillac models. Production of the popular Silverado HD and GMC Sierra HD full-size pickups will increase by about 1,000 trucks per month beginning in mid-July thanks to production line efficiencies at its Flint, Michigan plant. Meanwhile, shipments of its top-selling mid-size pickups will increase by about 30,000 units through the first week of July. What seems to be turning most of the heads, however, is GM’s foray into the electric vehicle realm, with a goal of more than a million battery electric vehicle sales by 2025 (and with further plans to make more than 20 models with hands-free driver assistance by 2023). Additionally, the firm’s autonomous Cruise subsidiary recently became the first to be permitted to test driverless cars in San Francisco, winning financial backing from Walmart and Microsoft. Q1 revenue of $33 billion for GM was down slightly from a year ago, due to chip shortage-related production constraints, but per-share earnings of $2.25 more than doubled estimates thanks to strong U.S. retail sales (up 19%) and China deliveries (up 69%), as well as the launch of its high-margin full-size SUVs. Going forward, the company is leaning on its “build shy” strategy of producing as many vehicles as possible without chips. Analysts see top- and bottom-line improvements of 9% and 11% (respectively) for 2021.

Technical Analysis

GM actually got going in October, before most cyclical stocks, running from 34 then to around 60 by March. The consolidation since then has been solid and relatively tight, with selling volume on the weekly chart easing nicely. And now the bulls are flexing their muscles again, with huge-volume buying on May 27 and June 3 as GM tests its prior highs. We’re OK buying some here or (preferably) on dips.

GM Weekly Chart

GM Daily Chart

Jabil Inc. (JBL)

jabil.com

Why the Strength

Jabil is arguably the world’s most important company you’ve never heard of; when you order something online, for instance, Jabil was likely involved with the packaging. Jabil is a contract manufacturing solutions provider with 100 plants in 30 countries, making a huge variety of products and offering design engineering and consulting services for several industries including healthcare, defense, automotive, computing, consumer goods and networking. Its two main segments are diversified manufacturing services (DMS) and electronics manufacturing services (EMS), with DMS segment revenue soaring 26% from a year ago in Q2, to $3.6 billion, on strength in connected devices, healthcare, automotive and mobility. Apple is one of its biggest DMS customers, accounting for an estimated 22% of Jabil’s total sales, and the firm’s mobility business is humming this year thanks to high demand for Apple’s iPhone 12; Jabil should benefit from this tailwind, and expects DMS segment sales to jump 19% in fiscal Q3. EMS segment revenue was $3.2 billion, also reflecting strong broad-based demand across several verticals including 5G, cloud and networking. Looking ahead, management sees a big opportunity in its connected packaging solutions business on the back of huge increases in global e-commerce sales. Jabil also plans to return capital in the form of a $254 million stock repurchase program in the months ahead, and Wall Street predicts 10% top line and 181% bottom line growth for Q3. Any movement on a Federal infrastructure deal could also boost investor perception. Earnings are due out June 17.

Technical Analysis

JBL broke out of a low-level base with so many other stocks last November and has basically stair-stepped its way higher since then, with a sideways rest in January and February, a strong rally to the mid 50s and then another month-long pullback to the 10-week line. The bounce since then has been persistent (up 12 days in a row coming into today), which is generally a good sign. We advise aiming for dips if you want in.

JBL Weekly Chart

JBL Daily Chart

Logitech (LOGI)

logitech.com

Why the Strength

Logitech excels at making premium hardware that much of the computing industry began treating as commodities long ago: Keyboards, mice, headsets and webcams. It’s been a good strategy for the Swiss firm, with its stock doubling about every three years since the dotcom days. The pandemic accelerated the adoption of high-quality video, as working from home and long-distance relationships made people want the superior quality that Logitech offers in its lines of $50 (entry level) to $1,500 (conference room) webcams. The company’s video-related sales growth of 248% last year correlated with Zoom usage, which helped total revenue surge in its fiscal 2021 (ended in March) by 76% to $5.3 billion. This year won’t see nearly as dramatic a rise, but the persistence of mobile work and equipment upgrades from companies seeking to please the ones grudgingly returning to the office leads management to project a 5% gain (likely conservative). The next stage of Logitech’s growth is coming from the boom in video gaming. How strong is the potential market? The final of a League of Legends video game competition was watched by more people worldwide than the Super Bowl, in excess of 1 billion viewers! As more people play games themselves and spend their time watching others play, it opens up demand for Logitech’s gamer line of headphones, mice and trackpads–and, yes, more webcams. Management thinks it can grow sales as much as 10% a year in the long term while pushing its margins up. Analysts see earnings well above $4 per share this year and nearing $5 next year, but given recent earnings beats (Q1 beat by 70%!) those are almost surely too low.

Technical Analysis

The pandemic jolted LOGI out of a three-year range between 27 and 48, with shares rallying strongly until the tech stock retreat that started in February. But while many high-growth stocks are still suffering four months later, this name immediately found buyers—LOGI perked back up near 120, and after a final shakeout in May, have soared to new highs with a very persistent rally. Minor weakness should offer a nicely buying opportunity.

LOGI Weekly Chart

LOGI Daily Chart

Marathon Oil (MRO)

marathonoil.com

Why the Strength

Marathon Oil is yet another energy explorer that’s starting to throw off mountains of cash, and with oil prices perking up, the prospects for a crazy-huge cash flow is looking like a real possibility. The firm operates in four of the better basins in the U.S. (Delaware, Eagle Ford, Bakken and the Stack/Scoop in Oklahoma) as well as in Guinea, and like nearly all of its peers, it’s content to keep CapEx in check (one of the lowest CapEx rates per barrel of production in the industry) and cut costs elsewhere (G&A costs down 23% last year) while production remains relatively flat. And that’s leading to some of the best cash flow outlooks in the entire energy sector—even at $50 oil and $3 natural gas, Marathon believes it will crank out $1.1 billion of annual free cash flow (about 10% of the current market cap), with that figure lifting to $1.6 billion (about 15% of the market cap) at $60 oil! (It sees its breakeven price at less than $35 oil.) Indeed, in Q1, the company cranked out more than $440 million (about 56 cents per share) of free cash flow, which it used to pay off more than $500 million of debt; the top brass is targeting another $500 million of debt reduction by year end, but it’s also intent to reward shareholders directly—Marathon recently hiked its modest dividend (annual yield now 1.2%) and intends to return more than 30% of its cash flow to investors over time. (There’s a big share buyback authorization, though it’s not being used too much yet, with the share count down only 0.6% year-on-year.) And now it’s looking like even the $60 oil cash flow prediction ($1.6 billion of cash flow) could prove conservative, which is likely to accelerate dividend hikes and share buybacks going ahead. We like it.

Technical Analysis

MRO rallied from an oversold low of 4 last November to 13 in early March before beginning its consolidation. The correction was sharp (27% from high to low) but more than reasonable given the prior advance, and volume really dried up nicely (usually a sign the sellers have been worn out) near the end of May. Last week brought a good-looking breakout (up 14% on Tuesday) and it held those gains for the rest of the week. You can start a position here or (preferably) on dips.

MRO Weekly Chart

MRO Daily Chart

SeaWorld Entertainment Inc. (SEAS)

seaworldentertainment.com

Why the Strength

SeaWorld Entertainment is one of the flagship reopening stocks in the market—the firm operates many theme parks including SeaWorld (three locations), Busch Gardens (two locations), Aquatica (three locations), Discovery Cove (one location) and Sesame Place (the only U.S. theme park based on Sesame Street), and obviously business dried up to next to nothing during the worst of the shutdowns (revenues of just $18 million in Q2 of last year!) but it’s all about the recent recovery and the prospects for a travel boom now that the pandemic is mostly in the rearview mirror. Of course, there’s already been a solid uptick in business of late as things open up, though interestingly, a lot of that is due to higher revenues per customer—attendees in Q1 were still down 4.5% from the year before, but revenues were up 12% thanks to much higher ticket prices (up nearly 11%) and in-park spending (up 26% per customer). Moreover, while earnings were deep in the red, they crushed expectations (per-share 57 cent loss vs. loss of 78 cents expected) and adjusted cash flow was around breakeven, which gives you a sense of the earnings power as the world turns right side up and as attendance limits are lifted. Indeed, management said Q1 attendance would have been “notably higher” if not for limits that were in place and said trends vs 2019 were improving as of early May. Analysts have been ratcheting up their estimates, with 81 cents of earnings now expected this year and $2.61 next, compared to estimates of a loss of 24 cents and a profit of $1.97 (respectively) two months ago. It’s likely even those figures will prove conservative as Americans make up for lost time on the travel front.

Technical Analysis

SEAS has certainly already had a big recovery during the past year, so you can’t rule out the fact that the boom times that are coming have already been discounted. But the stock certainly isn’t acting like the sellers are gaining traction—SEAS has built a base-on-base formation since early March, with next to no selling volume on the weekly chart, and shares stretched to new highs today on good (not great) volume. We think it’s buyable around here.

SEAS Weekly Chart

SEAS Daily Chart

United Parcel Service (UPS)

Why the Strength

The post-Covid e-commerce boom has translated into strong sales growth for United Parcel Service, which has seen a huge increase in both domestic and overseas package volumes in recent quarters. Driving growth for UPS are ground-based package deliveries and international export deliveries (with the latter more dependent on global trade and economic conditions). The ground transport business is relatively low margin, but UPS aims to expand margins through its “better, not bigger” transformation strategy by focusing on high-growth end markets such as global e-commerce deliveries and key industries like healthcare and the small- and medium-sized business (SMB) sector. That strategy is paying off, as shown by 22% growth in domestic shipping revenue in Q1 and a rising trend in domestic revenue per piece over the past year. Also in the quarter, UPS reported record profits and a double-digit operating margin in its domestic segment, record quarterly profit in the international segment and record operating profit and margin in supply chain and freight. Its digital access program (providing e-commerce discounts and shipping logistics) grew by nearly 150,000 accounts in the quarter, putting it in line to achieve a goal of $1 billion in digital revenue for 2021. International revenue rose 36% with all regions growing sales over 20%. These successes led to a top-line increase of 27%, with earnings more than doubling to $2.77 (beating expectations by 61%). Analysts see earnings booming 34% this year before growth slows in 2022, while a 1.9% annual dividend adds a nice cherry on top of this story.

Technical Analysis

UPS hit new highs last summer but failed to follow through, essentially going sideways from early October to early April despite some accelerating growth trends. Fears existed that business would slow as the pandemic eased, but that’s not happening—the Q1 results caused a huge gap up and follow-through in UPS, and now shares have meandered sideways for nearly four weeks. We’re OK grabbing shares here with a stop under the 50-day line.

UPS Weekly Chart

UPS Daily Chart

Vale S.A. (VALE)

vale.com

Why the Strength

With the world economy on the mend and steel consumption from China accelerating, raw materials essential to steel production are in high demand. Vale (covered in the April 19 report) is one of the world’s largest iron ore and nickel miners, as well as a diversified producer of other industrial and precious metals. Accounting for the recent strength was management’s announcement of an ambitious plan to reach 400 million tons of iron ore production by next year, which, if realized, would be a 33% increase from 2020’s total production. Given the firm’s first-quarter financial performance, that goal looks to be obtainable. While copper production was lower in Q1, Vale more than made up for it with iron ore production that was equal to that of last year’s Q2 in spite of the quarter’s seasonal weakness. Adjusted EBITDA of $8.5 billion was the highest in Vale’s history for Q1, while revenue rose 81% to $12.7 billion. The biggest driver was China, where Vale’s operating revenue more than doubled to $7 billion as demand for iron ore surged. The company’s iron ore production increased 14% in the quarter, while total ore sales were 15% higher from a year ago. Analysts believe Vale’s production of premium iron ore should help maintain strong demand from China, with its focus on buying the best-quality ores. Additionally, Vale’s outlook got a recent boost from the White House’s proposed $6 trillion budget for fiscal year 2022—a budget that would dramatically expand fiscal spending for roads, water pipes, EV charging stations and other infrastructure, in turn necessitating higher steel production volumes. Analysts do expect earnings to back off in 2022, but estimates are rising rapidly for both this year and next.

Technical Analysis

VALE’s progression since the early 2020 disaster has been steady, yet measured. Unlike most of the stocks covered in Top Ten, its rallies over the past year have been interspersed with multi-month tightening periods that have kept shares from becoming overheated. The latest breakout saw the stock run from 18 to 23, with the dip toward the 10-week line two weeks ago bringing in lots of buyers. Some further wiggles are possible, but we’re OK snagging some shares around here.

VALE Weekly Chart

VALE 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 14, 2021.