May 2, 2022

There’s been a lot of action of late, mostly on the downside, and this week’s news flow (Fed meeting, jobs report, etc.) is sure to create more. But, really, nothing much has changed with our view: There remain many secondary-type indicators that are at intermediate-term (if not multi-year) extremes, so we’re keeping our eyes open should the buyers show up for more than a day or two. But we have to actually see it to believe it, and to this point, any bounce has been soundly rejected. We’re lowering our Market Monitor to a level 3.

There are still a couple of decent-looking areas, mostly either slow/steady growth firms or special situations. Our Top Pick this week is one of the latter, with an almost hard-to-believe cash flow story.

Market Overview

The Story Remains the Same

There’s been a lot of action of late, mostly on the downside, and this week’s news flow (Fed meeting, jobs report, etc.) is sure to create more. But, really, nothing much has changed with our view: There remain many secondary-type indicators that are at intermediate-term (if not multi-year) extremes, including the fact we’ve now seen 23 straight weeks of more new lows than new highs (one of the longest streaks in 40 years), yet those figures have actually been decreasing since late January despite lower index values. Thus, we’re keeping our eyes open should the buyers show up for more than a day or two—but, again, we have to actually see it to believe it, and to this point, any bounce has been soundly rejected and 70% (NYSE) to 85% (Nasdaq) of stocks are buried below their 200-day lines. We continue to advise plenty of cash and only small new positions on the buy side. We’re lowering our Market Monitor to a level 3.

There are still a couple of decent-looking areas, mostly either slow/steady growth firms or special situations. Our Top Pick this week is Arch Resources (ARCH), which has an almost hard-to-believe cash flow story that should persist for at least a few quarters.

Stock Picks & Previously Recommended Stocks

Stock 1

Arch Resources (ARCH) ★ Top Pick

Why the Strength

Most investors know the commodity theme at this point, but even with big runs, some still look very under-appreciated. Arch Resources is one of those, as it’s spinning off cash flow numbers that are hard to believe and things should actually improve from here. The company has a legacy thermal coal segment for electricity that it’s going to wind down over time—but ironically, demand there is exploding as natural gas prices soar and Europe looks to lock-in supply, and with little CapEx obligations, that business is simply spinning off cash at this point. But the main focus is the metallurgical coal operations (used to make steel): The company has a handful of leading, low-cost mines, and the supply/demand dynamics there are through the roof, with pricing near $470 per ton, compared to $256 recognized in Q1 and just $94 in Q1 2021! Management doesn’t expect these prices to last forever, of course, but it also sees volumes ramping, partly because rail shipments should finally pick up after being a bottleneck in recent months. The results, as mentioned above, are out of this world—in Q1, earnings came in at nearly $13 per share, and Arch used that money to pay off more debt (it’s now net-debt free), and due to its capital return program (paying back 50% of cash flow after CapEx and some other stuff), will be paying a quarterly dividend of $8.11 per share (payable June 15; ex-dividend date May 27), and with the other 50%, there should be lots of buybacks and further balance sheet strengthening going forward. Just as important is the future—Q2 should be even stronger than Q1, but even if things do ease into 2023, most now see the bottom line still remaining in nosebleed territory (analysts see earnings of $28 per share!) as Russian supplies remain crimped and other export markets (Australia) are lagging. The numbers here should be huge for many quarters at least.

Technical Analysis

ARCH has been rallying nicely for the past year, but it still looks to have gas left in the tank. Shares built a nice-looking launching pad from October through January, broke out and soared to 160 in early March after Russia invaded. There were ups and downs after that, including a huge shakeout two weeks ago with the market, but the Q1 report brought in the buyers, with ARCH soaring on its heaviest weekly ever back to its highs. Expect volatility, but we’re OK nibbling on the retreat of the past couple of days.

Weekly Chart

Daily Chart

Stock 2

Autonation (AN)

Why the Strength

Many of the remaining resilient stocks in the market are either out-and-out defensive (and even some of those are starting to come in) or those with unique and likely durable (for at least another year or two) cash flow stories. AutoNation fills the second bill: The company is the country’s largest auto dealership, and it also has a good aftermarket (parts and service) business; the firm has always been well run and has a solid growth history (it just entered two new markets and should grow its store base by 20%-plus by 2026). However, those results have taken a step-function leap in recent quarters, thanks mostly to the tight supply seen in the auto industry that has boosted sales prices—revenue and earnings have gone through the roof, especially with its new car business; importantly, in its recent Q1 call, management said it hasn’t seen any waning of demand for new vehicles despite all the bad news going around. All of that is to the good and has resulted in a bargain basement valuation (five times earnings!), but what makes this story attractive is what AutoNation is doing with a bunch of its cash: Just this year, the firm has bought back about 8% of all shares outstanding, and this comes after many quarters of similar repurchases. The end result is that there were 58.3 million shares outstanding as of mid April, compared to 65.5 six months ago and 80 million a year ago (a 27% decline), with more on the way. And that means last year’s earnings boom ($18 per share) is likely to stick around even if business eases (analysts see ~$23 this year and $21 in 2023), which of course gives the top brass a lot of room to eventually pay dividends (none yet) or do some other shareholder friendly actions. There’s nothing revolutionary here, just a well-run company that’s hitting it big right now, and using that money aggressively to effectively boost future results.

Technical Analysis

As AN’s numbers began to soar last year, so did the stock, moving from a pre-pandemic high near 55 to 125 last August. That was basically the top, and shares sagged into January, and after a bottoming attempt and rally, there was a dip to new lows in early April. But that may have been a shakeout, with AN rallying from that point in spite of the horrid market. There’s obviously a ton of overhead above here, but there should be good support not too far down, too. If you’re game, you can start a small position here or on weakness.

Weekly Chart

Daily Chart

Stock 3

Bristol Myers (BMY)

Why the Strength

In this environment, boring is good, and Bristol-Myers Squibb is a giant pharma outfit with an excellent history of reliable results. The firm’s big money-making drug, Revlimid (acquired when it bought Celgene a few years back), which treats a cancer of plasma cells called multiple myeloma, is facing increasing generic competition. Given throttles on generics volume in the U.S. and various agreements in Europe, Revlimind sales should “only” gradually decline into 2026, when generic restrictions end. That’s actually good news, putting the company in the position of being able to roll out new drugs over time to make up lost Revlimid sales, which likely peaked last year at $12.8 billion. For investors, it could be a chance to buy into Bristol-Myers at value, with shares trading hands around 10 times last year’s earnings, compared to the current pharma stock PE of 30. Just being cheap doesn’t make a stock a buy, but Bristol-Myers believes it has two just-approved drugs that should be contributing more than $8 billion in sales by decade’s end: Opdualag, a fixed-dose combination drug to treat unresectable or metastatic melanoma in people 12 and older; and Camzyos, for treating symptomatic obstructive hypertrophic cardiomyopathy. Management says there are another two drugs in its pipeline that will generate $4 billion in sales by 2030, including Opdivo, which may end up being the biggest—it treats a number of different cancers that may allow it to top $10 billion in annual sales down the road. Bristol-Myers’ pipeline was refreshed by the aforementioned $74 billion buy of Celgene in 2019, which should continue to give it new medicines involving blood cancers for years to come. Earnings should advance at mid-single-digit rates this year and next, with the 2.9% dividend yield adding to the attractiveness.

Technical Analysis

BMY isn’t the fastest moving stock, but it could be entering a long-term leg higher. Shares broke over resistance in the highs 60s in February, cracking a ceiling that has blocked BMY since the 2018, and it’s now testing all-time highs from 2016. Moreover, after the persistent rally since the November low, BMY has leveled off a bit, including a little shakeout after last week’s earnings report. We’re OK taking a swing at it here with a relatively tight stop.

Weekly Chart

Daily Chart

Stock 4

Delta Air Lines (DAL)

Why the Strength

With Covid testing requirements on the wane and cabin fever at a peak, travel bookings are surging, prompting airlines to predict a record summer travel season. Delta is one of the world’s oldest passenger airline operations, with up to 15,000 daily departures. In an industry plagued by setbacks in the last two years, Delta’s outperformance is partly attributable to its high ranking in terms of having the fewest cancellations and the most on-time departures of any major airline (according to the U.S. Transportation Department). And despite raising ticket prices and offering 10% fewer seats, customer demand has remained strong this year, with Delta reporting its best March ever for cash sales, outpacing its prior record from the (pre-pandemic) spring of 2019. (March was also Delta’s first month in two years of positive unit revenue, and the company achieved record co-branded acquisitions and cargo revenue.) The company further indicated long-haul international travel is growing as restrictions lift across the globe heading into the peak summer season. Revenue of $9.3 billion in Q1 increased 125% from a year ago, and while EPS remained in the red, it beat estimates by 4 cents. More important, though, is the future, and on that front the news is very bullish: Delta said that consumer demand accelerated throughout Q1, as shown by a solid spring break performance, while business travel demand has also picked up in what is an overall stronger fare environment. The stellar results prompted several major Wall Street institutions to upgrade their share price outlook for Delta (another reason for the strength). As the company returns to profitability, management is focused on increasing free cash flow while reducing debt and expects a “meaningful full year profit.” Analysts agree and see the bottom line ramping from here. It looks like an intriguing group move could be underway.

Technical Analysis

DAL had a mighty run-up from its Covid crash low on optimism that 2021 would witness a full economic reopening. But last March saw the stock peak at 52 when those hopes faded, with shares spending the next full year on the slide. Shares finally found bottom at 30 this past March after the oil price spike, and have since shot up to multi-month highs. The 45 area is resistance, but the recent buying volume is encouraging—we’re OK with a nibble here and a loose stop.

Weekly Chart

Daily Chart

Stock 5

EQT Corp. (EQT)

Why the Strength

While the market’s in shambles, many energy names are still hanging in there due to amazing cash flow profiles, and some of the best today can be found in the natural gas sector, where prices were in the dumps for years but are now elevated, with supply/demand dynamics very supportive. EQT Corp. is the largest producer of natural gas in the U.S., with more than a million net acres in the Marcellus and Utica shales (mostly in Pennsylvania and West Virginia) and 15-plus years of drilling inventory, as well as an investment grade balance sheet that it’s continuing to improve. After years of belt-tightening, the firm is set to do very well even at prices that were common in recent years; in Q1, the firm’s realized price (after money-losing hedges) was just $3.19, yet with constrained CapEx and operating costs, the firm cranked out a whopping $580 million in free cash flow (~$1.50 per share), which allowed it to repay $569 million of debt, buy back 9.9 million shares (nearly 2.5% of outstanding shares) and pay a decent base dividend (1.3% yield). In fact, EQT thinks it will have plenty of money to pay the base dividend, repay another $600 million-ish of debt and buy back another $700 million of stock, all by the end of next year—even at $2.85 natural gas! At current strip prices, it sees north of $2.5 billion of free cash flow this year (more than $6.50 per share), and if this holds into next year, that figure could be more like $10 per share, which would lead to massive special dividends, shares buybacks and the like. (EQT already doesn’t have any debt maturities until 2024.) While the plan is to keep production flat, it’s possible some new LNG deals could change that, but either way, EQT is poised to spin off huge amounts of cash for years to come, even assuming natural gas prices fade back toward the levels of the past few years.

Technical Analysis

EQT had a gradual ascent after the March 2020 crash recovery, eventually hitting a wall at 23 in the spring of last year and moving mostly sideways for the better part of a year. But the breakout in March was solid, and EQT went vertical after, basically doubling in just a few weeks! Impressively, the stock’s latest pullback, while sharp, has found support near the 25-day line—we think further dips are likely, and if they come, we think a small buy would be worthwhile.

Weekly Chart

Daily Chart

Stock 6

MasterCard (MA)

Why the Strength

Mastercard (covered in the February 7 report) needs no introduction, as it’s the world’s second-largest credit card network, with some 2.5 billion cards in circulation. Unlike last year’s false start, it looks like 2022 will finally be the year when travel and leisure spending makes a full comeback, with Mastercard’s blowout first-quarter earnings report offering support for that outlook. Revenue increased 24% to over $5.1 billion in Q1, while operating expenses were just 13% higher. Earnings per share rose 46% to $2.76, thanks in part to share buybacks, beating the consensus by 58 cents. Gross dollar volume (the total value of all card transactions) grew 17% to almost $2 trillion, while cross-border volume growth (which offers insights on travel recovery trends) jumped 53% on a currency-neutral basis. Mastercard said it’s seeing “strong traction” in consumer and small business payments, including increased use of Mastercard Installments (a zero-interest buy now, pay later program for consumers). The solid results were immediately followed by several upgrades by some big institutions, including one which raised its EPS target for Mastercard based on “overwhelming positives” for the card provider. Mastercard just completed its acquisition of Dynamic Yield, which increases its range of consumer engagement and loyalty services. It also teamed up last month with Nexo and DiPocket to launch a cryptocurrency card in select European markets (the card allows users to spend without selling their cryptos). Going forward, management guided for revenue to increase at a high-teens rate for both Q2 and the full year; analysts see earnings up 20%-plus both this year and next.

Technical Analysis

After hitting a record high of around 400 last April, MA entered a gradual decline and ended up correcting 24% before finally hitting rock bottom at 306 in December. The stock looked like it was out of the woods, retesting its high near 400 after that, but the market yanked shares down one more time in March. MA then rallied with the market in March, and more important, held its own last month, including a positive reaction to earnings last week, though it’s quickly been pulled back in due to the market’s weakness. There’s risk, but if you want in, you can start small here.

Weekly Chart

Daily Chart

Stock 7

Suncor Energy (SU)

Why the Strength

Energy companies that mine from oil sands enjoy a significant cost (and longevity) advantage over traditional oil extraction techniques, including fracking. This is where Suncor, a leading integrated energy firm specializing in the production of synthetic crude from Canadian oil sands, comes into play. Industry experts are sanguine on the Canadian oil patch outlook based on its high operating leverage and competitive fiscal advantages, which are expected to drive cash flows for Canadian producers and could even allow them to outperform global competitors. While Suncor’s oil sands mining segment is big, refining makes up around half its business, and the firm also supplies and trades oil products to mid- and large-sized businesses. All together, the firm’s businesses are doing great: Revenue of $11.1 billion in Q4 was a whopping 69% higher from a year ago, driven by refinery utilization averaging 96% and crude throughput that was 2% higher; earnings of 89 cents per share (Canadian dollars) were up from a loss last year. Moreover, a well-known Wall Street activist hedge fund just took a 3% stake in Suncor (a reason for the strength), stating that it sees significant upside in the share price. (Many observers believe the fund’s presence on the board will lead to increased shareholder returns and possibly a management shakeup.) On the capital returns front, Suncor’s dividend has returned to its pre-pandemic level (3.7% yield) and management plans to allocate half of free cash flow to debt reduction (returning to 2019 debt levels in Q4) and half to buybacks (it has repurchased nearly 6% of the float in recent quarters). Analysts see earnings booming to north of $5 per share this year, though next week’s quarterly report (May 9) will be important to watch.

Technical Analysis

Like most oil stocks, SU hit a peak in the early to middle part of last year (26 last June) and entered a fairly steep correction (down 34%). It bottomed at 17 in August, slicing through the 40-week line and shaking out the weak hands in the process. From there it rallied to 27 in November and then had another (shallower) pullback, this time finding support above the trend line. The breakout came in February and, while not a shooting star, SU made solid progress—and last week’s brief shakeout below the 50-day line was quickly reversed after earnings. If you’re aggressive, you could pick up a few shares here or (preferably) on further weakness.

Weekly Chart

Daily Chart

Stock 8

U.S. Silica Holdings (SLCA)

Why the Strength

A domestic energy boom is underway with oil and gas fracking making a big comeback; in March, the state of Texas issued nearly 1,200 new well drilling permits—up an eye-opening 47% from a year ago. With drilling on the rise, sand used in fracking is in high demand, a key reason for U.S. Silica’s strength. The company is a leading producer of sand used in a wide range of industrial applications, including high purity sand and fracking sand, as well as diatomaceous earth, perlite (used in a variety of applications) and engineered clays. While its other specialty products help reduce the volatility related to its heavy exposure to the energy sector, there’s no question that rising oil prices are responsible for the company’s recent growth. In Q1, U.S. Silica saw revenue of $305 million (up 30% from a year ago), led by the oil and gas segment, as sand and logistics were effectively sold out due to strong well completion demand—particularly in West Texas. Industrial and specialty products were also strong across end markets, supported by a “robust pipeline” of new products. The firm posted a 2-cent EPS loss (related to a supplier contract termination and acquisition-related expense), but saw adjusted EBITDA jump 38%. Management sees the strong market conditions persisting and expects to deliver even stronger financial results in Q2, forecasting increased drilling and completion spending growth of around 23% versus 2021, thanks in part to “very supportive commodity prices.” (It’s implementing price hikes for many of its end products that aren’t contracted yet.) Going forward, the company is focused on free cash flow and debt reduction and says it will be operating cash flow positive this year. Wall Street sees Q2 top- and bottom-line growth of 20% and 33%, respectively, both of which will likely prove conservative.

Technical Analysis

SLCA mirrored the rebound in oil prices into last March, but then SLCA spent the rest of 2021 in a rut, falling from its March high of 15 to 7 by September, and it was still sitting near 10 in early February. This was the stock’s turning point, however, with shares exploding higher as it became clear drilling activity was going to pick up. The last few days have been all over the place, but shares have so far found support near the 50-day line. It’s volatile, but we’re not opposed to a nibble in this area.

Weekly Chart

Daily Chart

Stock 9

Ulta Beauty (ULTA)

Why the Strength

In the highly fragmented beauty segment, Ulta Beauty is as close to a dominant player as can be found. It’s the largest beauty retailer in the U.S. with 1,300 stores and about a hundred more store-within-a-store concepts in Target locations. Its appeal is its wide selection of 600 brands and 25,000 individual items selling at price points that appeal to all types of buyers, who can test cosmetics, fragrances, skin care and hair care products from a generous selection of testers in store. Ulta aims to make itself the resource for ‘all things beauty’ adding more luxury brands and continually finding new product launches while expanding Black-owned brands and its Conscious Beauty platform, for customers wanting products “made without” specific ingredients. Remarkably, 95% of the chain’s $8.5 billion in 2021 sales were by the 37 million members of its loyalty club. It’s a simple club where spending earns points to be redeemed against products and services. It’s free, but Ulta supercharges it for high spenders who can pay $500 or $1,200 a year to get more points per dollar. Beyond selling goods, Ulta also offers a ton of services at its stores, which generates money and traffic; customers can get a free consultation with a hair or skin care specialist and then opt to pay for services on hair, eyebrows, lashes as well as skins services and ear piercing. Management sees the business growing sales 5% to 7% annually the next few years while raising earnings per share at a low double-digit rate. Should consumer spending slow, Ulta seems well-positioned to weather any sluggishness, with no long-term debt, $422 million cash and a consistent share buyback program. It’s a defensive-type company with a decent growth angle. Earnings are due May 26.

Technical Analysis

ULTA is a more mature name, so you’re not going to get huge swings, but it’s also showing some solid relative strength of late. The stock did top out over many months in the 420 area then dove in January with the market, but it has since worked its way back, actually moving to new highs a few days ago before selling off with the market. It’s not going to be a home run, but there should be solid support in this area if you want to roll the dice.

Weekly Chart

Daily Chart

Stock 10

Valero Energy (VLO)

Why the Strength

The oil price boom is boosting the outlook not only for oil companies, but for renewable fuels producers as well. Valero is a major player in both industries; it’s the world’s largest independent petroleum refiner and is the second-largest corn ethanol producer, as well as manufacturing and marketing other petrochemical feedstocks and specialty products. After a couple years of pandemic-related setbacks, Valero’s refining segment is experiencing a strong rebound, as was evident in Q1, which saw total revenue of nearly $39 billion, up 85% from a year ago. Specifically, Valero’s refining segment delivered around $1.5 billion in operating income during the quarter (compared to a loss a year ago, and up 15% from Q4). Meanwhile, bio-fuels, ethanol and renewable diesel generated a combined $150 million in operating income in Q1 (up 140% sequentially). All in all, per-share earnings of $2.31 obliterated estimates by 62 cents as margins kited higher. Looking ahead, the company sees strong industry fundamentals continuing in Q2, providing a “positive backdrop” for refining margins. Management further said refinery optimization projects that are expected to lower costs and lead to margin capture are progressing on schedule, with the Port Arthur (Texas) coker project (designed to increase turnaround efficiency) expected to be completed in the first half of 2023. Valero also returned over $500 million to stockholders in Q1, with $400 million paid as dividends (3.5% yield) and the rest as buybacks. Management is focused on reducing balance sheet debt and is targeting an annual long-term payout ratio of around 45% of adjusted net cash from operating activities. More important for investors is that this year should see a massive increase in earnings, and while 2023 should back off, the bottom line is expected to remain elevated for a while.

Technical Analysis

VLO looks like a lot of big/mega-cap energy outfits, with a nice recovery rally in late 2020/early 2021 but a long consolidation beginning in the spring of last year—from the stock’s March 2021 peak, it made no net progress for 13 months. But now VLO is running, with a nice move to 110 in the middle of April, a quick shakeout to the 10-week line and a strong recovery before and after earnings. We suggest aiming for dips if you want to grab a few shares.

Weekly Chart

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 bold.

The next Cabot Top Ten Trader issue will be published on May 9, 2022.