March 8, 2021

Growth Cracks, Rest of the Market Holds

Current Market Outlook

The selling pressure that we saw emerge two weeks ago really picked up last week, with the vast majority of leading growth stocks cracking intermediate-term support. That said, the rest of the market has refused to follow the Nasdaq’s lead; there’s been some damage and plenty of wobbles, but so far the broader indexes have held up, and buying in many cyclical areas has picked up. Just going with the evidence, we’d be shying away from growth stocks while looking for opportunities in the strong sectors should they rest or shakeout. Our biggest thought, though, is that making money has become much harder during the past month and a half, with wild moves, rotation and volatility, so now’s a time to go slow and give some thought to capital preservation until we see the buyers really flex their muscles. We’re moving our Market Monitor to a level 5.

As expected, this week’s list is heavy on cyclical and re-opening themes, with many names showing excellent action. Our Top Pick is Marriott Vacations (VAC), which has soaring earnings estimates and a stock that just lifted out of a three-year base on huge volume.

Abercrombie & Fitch (ANF)

abercrombie.com

Why the Strength

Even as a growing number of retailers reopen for business, some have pivoted to digital sales to boost profitability. Based on recent results, Abercrombie can be counted among the early digital transformation success stories. The nationwide casual wear retailer closed 137 brick-and-mortar locations last year, including eight flagships and 129 non-flagships, resulting in a whopping 17% reduction in its square footage. But a renewed focus on digital sales has begun producing robust results, while the much smaller store base has lowered operating expenses; operationally, Abercrombie is like an entirely new company. In the fourth quarter, online sales increased 34% to $639 million, making up a huge 57% of quarterly revenues (for the year as a whole e-commerce represented 54% of sales). Although revenue declined 5% in Q4 (as the company previously guided for), per-share earnings rose 15% to $1.50, which was the highest level in years. Abercrombie continued to see significant improvements in app and website traffic, resulting in the best-ever quarterly digital sales and highest gross margin rate in eight years. And while Q4 wasn’t without its challenges—including renewed lockdowns in some of its global markets and reduced store productivity—the company anticipates that Q1 sales will be up around 35% from a year ago thanks to its online business. As alluded to above, an improving gross margin and operating expense performance outlook has caused Wall Street to reevaluate Abercrombie. It has recently received ratings upgrades based on expectations that digital sales will only increase from here. Management reaffirmed its commitment to putting cash to work, including launching or acquiring new brands to expand its portfolio, as well as share repurchases. Analysts see earnings ripping higher this year.

Technical Analysis

Unlike many stocks, ANF was slow coming out of the gate after last year’s pandemic crash. It bottomed out last March at 8 but took its sweet time gaining any meaningful traction. It wasn’t until September that ANF really took off, rallying first to 15, then kissing the 50-day line before buying pressures accelerated. Shares have respected that trend line ever since as the advance continues unabated. Aiming for pullbacks is preferred.

ANF Weekly Chart

ANF Daily Chart

Affiliated Managers Group, Inc. (AMG)

amg.com

Why the Strength

After years of being threatened by so-called “robo-advisers,” traditional actively managed investment accounts are back in style, thanks to the historic bull run in stocks and increasing interest among the public as a whole. Benefiting from these trends is Affiliated Managers, an investment group with stakes in several boutique asset management, hedge fund and specialized private equity firms (including some of the best-known alternative investment management shops). Although the company experienced net client cash outflows in Q4 (mainly from quantitative strategies and seasonal redemptions), it reported strong customer demand in the alternative investment, wealth management and specialty fixed income categories. Collectively, these three strategies accounted for around a third of its earnings in the quarter and contributed to per-share earnings of $4.22, which surpassed expectations by 15%. Revenue of $554 million, meanwhile, was 9% above estimates. Affiliated also reported that three-quarters of its fundamental equities and alternatives strategies outperformed industry benchmarks on a five-year basis. More important for the stock, the firm repurchased a whopping 10% of its outstanding shares in 2020, with most of those repurchases taking place in Q4; management also upped its repurchase authorization so there’s likely more buybacks ahead. Looking forward, the top brass sees increased long-term growth prospects in light of its clients’ heightened risk appetites, with additional plans to deploy “significant capital” across its new investment pipeline. Analysts share this optimism, forecasting top-line growth of 10% in Q1 along with a 34% bottom-line bump—very attractive given its forward P/E of 8.5.

Technical Analysis

After hitting a long-term peak around 220 in 2015, AMG entered a five-year bear market. The stock finally bottomed last March at 45 and turned a corner just as the retail trading renaissance was getting started. AMG took its time setting up an extended base before exploding to a 52-week high in November and continued to surge into February. Shares were overextended at that point, but we’re impressed with its resilience during the past three weeks, with the stock giving ground only grudgingly. We’re OK starting a position here or (preferably) on dips.

AMG Weekly Chart

AMG Daily Chart

Applied Materials (AMAT)

appliedmaterials.com

Why the Strength

One of the only growth areas that still looks halfway decent is chip equipment, and for good reasons—the general sector is a beneficiary of the acceleration of the digital transformation and the reopening of the economy, both of which are boosting demand in key end markets. Applied Materials, of course, is a granddaddy of the sector, and it’s strong today mostly because of the underlying demand trends as well as its own top-notch execution. The firm’s early-February quarterly report was outstanding (sales up 24%, earnings up 42%, both topping expectations), and the top brass talked about many major trends that are likely to continue for years to come—adoption of 5G handsets, increasing investments in data centers, higher chip content in automobiles and even greater OLED adoption outside of smartphones. All of that is leading to strong chip equipment sales in all of Applied’s segments (logic, flash, DRAM), with the firm’s services segment providing a steadier backdrop (revenues there increased even through the pandemic thanks to longer-term contracts). And possibly best of all in this cyclical area, buying doesn’t appear to be out of control, with the ratio of fab equipment revenue to total chip sector revenues well below prior industry peaks. As Applied’s CEO said, “digital transformation touches every sector of the economy and is non-discretionary for many industries. All of this adds up to a very strong demand environment for wafer fab equipment and we believe this strength is sustainable well beyond 2021.” Translation: Rapid, foreseeable growth should remain here for at least the next few quarters, which should keep big investors interested. The next big event will come sometime in early April when the firm hosts an Investor Day.

Technical Analysis

AMAT broke free from a multi-year base in November and had a great run to 91 before finally pulling back. Then came another ramp to 111 before its second pullback, and a third run to 125 before the recent market-induced hiccup. Still, AMAT is still north of its 50-day line (very resilient compared to most growth stocks), and the overall pattern (three pullbacks, three higher lows) is known as an ascending base, which is a type of launching pad. That doesn’t guarantee anything, but overall, we like the action—if you want in, you can start small here with a stop under the 50-day line.

AMAT Weekly Chart

AMAT Daily Chart

Diamondback Energy (FANG)

diamondbackenergy.com

Why the Strength

Diamondback Energy was out of favor during the energy sector’s doldrums, but the company kept fine-tuning operations (cutting costs, greater efficiencies) and was actually a buyer during the downturn, and all of that is set to pay off in a big way. The company came into the year with 347,000 acres in the Midland and Delaware basins (within the larger Permian basin), and that’s now up to 380,000 (after the buyout of Guidon) and will expand another 50,000 when the firm completes its acquisition of QEP Resources; both buyouts are likely to be accretive, especially after synergies and at current oil prices. That said, while Diamondback Energy has always been growth oriented, one of the reasons for its strength is that it (like many of its peers) is now a cash cow—the firm is aiming to keep organic production steady in 2021 (overall output will rise due to the buyouts) as CapEx declines 22%, which is expected to lead to about $4 per share of free cash flow (after all CapEx) at $40 per barrel; at $50 per barrel, that figure will rise to more than $6 per share and $7.50 per share or so at $60. Such cash flow not only funds Diamondback’s solid dividend (1.9% annual yield) but will lead to debt reduction and tons of flexibility; if the current elevated energy prices persist, there’s no reason the company can’t ramp up output to take advantage of it. As always, if oil prices hit the skids, all bets are off, but after such a long bear phase in the sector (and associated cutbacks), we think the odds of upside surprises in the months ahead are far larger than the other way around.

Technical Analysis

FANG was at nearly 140 in early 2018, fell into the teens last March and was in the mid 20s in November when the vaccine announcement kicked the stock (and its cyclical peers) into gear. The run since then has been dramatic, but shares are still miles short of its all-time highs, and the way these things usually work, the stock will eventually get back there (and beyond) in this new bull phase. As for the here and now, FANG saw increased buying pressure last week which looks like a mini-blowoff move in the short-term; we’re not expecting a huge retreat, but a shakeout of a few points would be tempting.

FANG Weekly Chart

FANG Daily Chart

Lyft (LYFT)

lyft.com

Why the Strength

After slumping for most of its first two years as a publicly traded company, Lyft is finally starting to live up to its hype. The mobile app-based ridesharing company suffered significant losses in 2019 and the first half of 2020 before staging a turnaround in the latter part of last year. While ridesharing in Q4 was still down from a year ago, it’s continued to rebound on sequential basis—indeed, the company reported a 14% sequential revenue improvement, beating estimates. And most important, that business momentum has kept up: rides continued to improve each week in January, and in February, average daily rides increased 4% from the prior month and (during the week ending February 28) reached their highest level since the start of the pandemic. (Management sees average rides in Q1 exceeding the Q4 average.) Though analysts expect the Q1 top line will be 42% lower from a year ago, they predict an eye-opening 101% sales bump for Q2, followed by several quarters of high double-digit growth. Going forward, Lyft anticipates a strong rebound in demand across its entire transportation network as vaccination rates increase throughout this year, likening its position to a “tightly coiled spring.” As for innovation, Lyft is also introducing autonomous vehicles (AVs) to millions of riders; it has already facilitated more than 100,000 paid AV rides on its platform since 2018 with its driverless technology partner, Motional. (It has plans to deploy additional AV vehicles in multiple cities in 2023.) All in all, Lyft is a solid re-opening story, and analysts see profitability next year.

Technical Analysis

LYFT came public in late March 2019, hit a peak around 90 then declined for a year and a half. The slump climaxed last March when the stock hit rock bottom at 15, and like many cyclical names, shares were still languishing (low 20s) in October. But it got going after the vaccine news (plus a positive election result in California) and, after hesitating near 50 in December and January, it’s been very strong, surging into the low 60s on heavy volume last week. Pullbacks should be buyable.

LYFT Weekly Chart

LYFT Daily Chart

Marriott Vacations (VAC)

marriottvacationsworldwide.com

Why the Strength

With vaccinations picking up in a big way (up to 30.7 million fully vaccinated in the U.S. through Sunday) and with wintertime cabin fever at its peak in much of the country, millions of Americans have begun to plan their next vacation. Not surprisingly, companies like Marriott Vacations, a timeshare and rental business spun off by Marriott International in 2011, are seeing increased business. Marriott offers vacation properties in several (mostly tropical) locations in the U.S. and around the world, including Florida, Hawaii, the Virgin Islands and Aruba. The company’s primary segments are vacation ownership (timeshares) and third-party management (hotels and rentals), and it’s considered to be one of the industry’s best upscale timeshare options. While the top-line numbers remain a horror show, Marriott’s latest strength is largely the result of returning demand for getaways—contract sales for vacation ownership (a reliable leading indicator) rose 27% sequentially in Q4, continuing a trend which began last summer. Not all was sunshine and roses in the latest quarter, as revenue dropped 35% from a year ago (though it did beat expectations by 4%). The loss per share, meanwhile, came in at 5 cents and missed the consensus by 3 cents. However, as with all the re-opening stocks, the past is meaningless—economically, 2021 is shaping up to be a 180 of last year, and Wall Street sees Marriott Vacations returning to the black by Q2 and earning $4.52 per share this year with plenty of growth beyond that. Management, by the way, agrees, saying they have more reservations on the books for the second half of this year than they did in in pre-pandemic 2019. We like it.

Technical Analysis

VAC was hard hit by last year’s pandemic, cascading from a late 2019 peak of 130 to a trough of 30 last March. The rebound from that crash low was steady, though it wasn’t until November that the stock took flight, when it became clear that reopening would become reality as the vaccines rolled out. The latest rally to new highs was launched from a three-month base and recent volume trends are encouraging. As with most names, we’d try to buy on weakness.

VAC Weekly Chart

VAC Daily Chart

The Middleby Corporation (MIDD)

middleby.com

Why the Strength

Shutdowns forced the restaurant industry to rethink the way they do business, including a renewed focus on delivery, drive-through and curbside pickup. But the retail food industry quickly adapted to the new paradigm and the success is already evident. It certainly showed in the latest results for Middleby, a leader in the global foodservice equipment industry, offering cooking, refrigeration and beverage solutions for top restaurants and institutions, as well as appliances for the home kitchen market. Although the company’s Q4 top line fell 7% to $729 million and earnings declined from $2.00 per share a year ago to $1.62, those results were significantly better than what most analysts expected (a big reason for the recent strength). All three of the firm’s operating segments reported sequential revenue growth, including a 15% increase in residential kitchen and outdoor appliance sales, a 15% rise in commercial food service revenue and a 9% sequential sales jump in food processing. Further proof that restaurants are roaring back to life was seen in Middleby’s jaw-dropping order backlog, which stood at a record $523 million at the end of 2020 (up 70% from a year ago). Additionally, strength was evident in the company’s record free cash flow of $504 million for the year, which it used to pay down debt, buy back stock (over $85 million worth) and make over $100 million worth of acquisitions and investments. Though Middleby expects Q1 sales to be slightly under Q4 levels due to seasonal factors, the backlog points to great things ahead; analysts see sales up 14% this year with earnings leaping more than 30%, both of which should prove conservative.

Technical Analysis

MIDD fell from an all-time apex of 150 in 2017 to its lowest point in seven years (at 45) a year ago. But the bleak outlook following the pandemic-led crash quickly dissipated and the share price recovered, hitting 90 in June and continuing to grind higher from there. The latest action was even more encouraging, with MIDD etching a very tight pattern for three months before emerging on heavy volume ahead of earnings. We’re OK taking a swing at the stock here or (preferably) on dips.

MIDD Weekly Chart

MIDD Daily Chart

Nucor Corporation (NUE)

nucor.com

Why the Strength

Steel demand in the U.S. has been surging recently thanks to rebounding manufacturing and construction sectors, and Nucor is a prime beneficiary as the largest mini-mill steel producer in the country. The company is also the most diversified steel producer in North America, manufacturing steel mostly from recycled scrap using state of the art electric arc furnaces and fully automated rolling mills. Last year alone Nucor recycled and reprocessed 17.8 million tons of scrap steel. Steel mills represent about half of Nucor’s sales, producing plate, sheet and structural steel, while 20% of sales comes from steel products like joists and fasteners and 30% of sales is from raw materials, mostly iron. Nucor has invested heavily in recent years to boost production and diversify its product lineup. That’s paying off in spades now as American industry rebounds from Covid-19, leading to soaring demand for steel and higher prices. In February, Nucor said it expects first quarter net earnings to exceed $900 million, nearly double the consensus Wall Street forecast that called for just $487 million. That would mark a new record for quarterly profit that beats the previous high-water mark set in 2008! For full-year 2021, analysts expect $25.3 billion in sales (up 15%) and earnings per share are expected to soar 54% to $5.09. While Nucor will never sport a huge valuation, the shares trade at just 13 times this year’s earnings estimates, which is pretty reasonable for what could be an early-stage cyclical situation.

Technical Analysis

NUE had a steady but unremarkable rebound from its March lows a year ago, making progress over time but with plenty of rests along the way. And, after stretching into the upper 50s in December, shares slumped, falling all the way to its 40-week line in January. But NUE has been a different animal since then, rallying five weeks in a row (four on great weekly volume) to multi-year highs with little desire to pull in. Aim for dips, but we’re not expecting a major correction.

NUE Weekly Chart

NUE Daily Chart

PDC Energy (PDCE)

pdce.com

Why the Strength

PDC Energy is yet another energy firm that hasn’t just turned the corner but, thanks to a change in strategy (from growth at any price, which led to tons of debt, to cranking out tons of free cash flow) and higher energy prices, has investors re-pricing shares. PDC operates out of both the Wattenberg field in Colorado (180,000 net acres, 33% of output is oil) and the Delaware basin in Texas (25,000 net acres; 39% oil), though the Wattenberg is where the vast majority of output is, and is also where the company has successfully cut costs (lease and G&A costs are down 25% to 40% per barrel of output during the past two years!) and increased efficiencies. And now that energy prices are back up the company is set to throw off mountains of cash. Management is targeting mid-single digit production growth annually for the next three years (though Q1 production will likely fade some, mostly due to the horrid weather in Texas), but even after some reinvestment, that should leave north of $400 million annually (more than $4 per share) of free cash flow, some of which will be used to initiate a decent dividend (1% to 2% annual yield; payments starting in the middle of this year) and buy back stock. Plus, as we’ve seen with many others (like Diamondback, written about earlier in this issue), these figures are based on conservative assumptions (for PDC, $45 oil), so if the current elevated prices persist, PDC’s free cash flow could mushroom! Either way, the stock looks cheap even based on the official outlook, and there’s always the potential for the top brass to boost output as prices rise. It’s a solid cash flow story with many potential opportunities to outperform expectations.

Technical Analysis

PDC has had a giant run since the November lows, and since early February, the stock has gone nuts, nearly doubling during that time! Thus, short-term, we wouldn’t be chasing the stock here—given its volatility, a pullback of a few points is certainly on the table. That said, bigger picture, such strength after a few years in the doghouse (outhouse?) looks like a kickoff as opposed to a blowoff; if you’re game, starting a position on dips into the mid 30s is fine by us, but be sure to use a loose stop.

PDCE Weekly Chart

PDCE Daily Chart

Texas Roadhouse (TXRH)

texasroadhouse.com

Why the Strength

Texas Roadhouse is a growing casual dining restaurant chain best known for its hand-cut steaks and ribs. The company operates over 610 restaurants in 49 states and 10 foreign countries. Like so many casual dining chains, Texas Roadhouse was hard hit by the Covid-19 pandemic with widespread closures and plunging sales and profits. However recent results tell us the company has turned the corner and Wall Street expects a sizeable rebound in both sales and bottom-line profits in the year ahead. Indeed, at the end of 2020, 82% of company restaurants had their dining rooms open subject to some capacity restrictions, though that’s likely going to be a distant memory within a few months. Texas Roadhouse has likewise succeeded in pivoting to an enhanced To-Go operating model including curbside pick-up, which accounted for 25% of the company’s total weekly sales as of February. Top line sales fell 12% in Q4 (same-store sales off by 15% or so) while earnings were off by more than half, but the company has already begun seeing a turnaround (the first seven weeks of the year saw same-store sales down just 2% and 2021 should bring a huge bounce back—analysts see revenues up 25% and earnings rebounding to $2.36 per share (basically back to 2019’s level), with a lot more upside in 2022 thanks to cost cuts, digital sales and a general lower level of competition. Beyond the re-opening theme, Texas Roadhouse is also still on the growth path, restarting its store count expansion, aiming for 25 to 30 new openings this year.

Technical Analysis

TXRH has been trending nicely higher since early July of last year, perked up to multi-year highs in October and briefly spiked above 80 in November before resting. And that rest was a beauty, with shares trading relatively tightly, and the late-January shakeout led to the current buying spree—TXRH has enjoyed three straight big-volume buying weeks as it’s powered to new highs. A dip of a couple of points would probably mark a solid entry.

TXRH Weekly Chart

TXRH 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 March 15, 2021.