October 21, 2019

Earnings Will Tell the Tale

Current Market Outlook

The market had another decent week, with the major indexes finishing above key moving averages, though all are still stuck in multi-month ranges. But the calm action hid another round of vicious rotation beneath the surface, with most growth-oriented stocks at least taking on water, if not unraveling altogether. With few stocks in sustained uptrends and the major indexes effectively trending sideways, we continue to advise a mostly cautious stance, with small new positions and plenty of cash on the sideline. That said, you shouldn’t stick your head in the sand, either—we continue to see a good number of setups out there, and we believe a lot will come down to earnings season. A spate of breakouts would be encouraging, but as usual, we have to see it first.

This week’s list is mostly full of the steady growers and special situations that the market is favoring these days. Our Top Pick is Tempur Sealy (TPX), which looks like a solid turnaround situation, with surprisingly big growth numbers to boot.

Arconic (ARNC)

arconic.com

Why the Strength

Arconic is a mid-cap company that makes lightweight manufactured goods from aluminum, titanium and nickel, serving the aerospace, construction, transportation and automotive industries. There’s nothing overly sexy here, but business is good and a restructuring plan that’s focused on the sale of non-core businesses is providing an added boost. In September, Arconic agreed to sell its forging business in the U.K. and take a $40-$50 million restructuring charge in Q3. Then today, the company announced that it will curtail operations at its global rolled products plant in San Antonio and transfer operations to its other mills, resulting in another $4 million of charges But as usual with restructuring moves, investors are taking these as positives—indeed, consensus earnings estimates keep rising, with Wall Street expecting earnings to grow 50% in 2019 and another 16% in 2020 (likely conservative). In recent weeks, a rash of big investment firms significantly raised their price targets on the stock, likely helping the October surge in the shares. Strength in the commercial aerospace end market is contributing to strong growth at all three business segments, two of which (engineered products, where it makes gas turbines, fasteners and the like; and Rolled Products, which includes differentiated aluminum sheet and plate for aerospace applications) it’s the clear global leader in. Arconic is expected to reported third quarter EPS of $0.52 on the morning of November 5. Structurally, Arconic will be separating into two companies in the second quarter of 2020 in order to unlock shareholder value, something that should keep buyers interested.

Technical Analysis

ARNC got hit very hard in 2018, but shares enjoyed a nice, persistent recovery from its lows through June of this year. The consolidation since then has been tricky (two big shakeouts with the market in early August and early October), but overall reasonable, and the latest run to new highs bodes well. If you want in, you can nibble here or on pullbacks toward the 50-day line.

ARNC Weekly Chart

ARNC Daily Chart

Cabot Microelectronics (CCMP)

www.cabotcmp.com

Why the Strength

Cabot Microelectronics (no relation to us) is technically a chip equipment name, but that’s not really what it does. The firm doesn’t provide equipment, per se, but it’s the world’s largest supplier of polishing slurries, the top supplier in U.S. and Europe of electronic materials and the second leading global maker of polishing pads—all of which allow semiconductors to be etched properly, cleaned and dried so that they function properly and operate at peak performance. (About 20% of business is high performance materials for things like pipelines, but the chip-related products are the driver here.) The company is still cyclical to some extent, riding the sector’s ups and downs, but because its products need to be reordered as foundries crank out chips (revenues are closely linked to wafers produced), there’s more reliability here than your average chip outfit. Revenues have been surging recently, but that’s because of a good-sized acquisition, and while earnings have fallen off, cash flow hasn’t (EBITDA was actually up 6% in the most recent quarter, despite the group’s slowdown). Analysts see business turning up nicely next year, and management believes it can grow revenue at high single-digits rates annually in the years ahead, with faster earnings and (especially) cash flow growth. Earnings are due out November 7.

Technical Analysis

CCMP had a nice run through March 2018, but then began to underperform the market and form a huge consolidation through August of this year. And now the buyers are back in control—CCMP had a nice, persistent advance in September, a modest dip to the 10-week line in early October and, recently, a good-volume push back to its highs. We’re OK with a small buy here or on dips.

CCMP Weekly Chart

CCMP Daily Chart

Fastenal (FAST)

www.fastenal.com

Why the Strength

The current market environment is putting an emphasis on dependability and yield, and Fastenal offers both. The company isn’t going to win any beauty contests, but it’s one of the largest distributors of construction, industrial, safety and other widgets, offering hundreds of thousands of different products to customers of all stripes--it’s a key supply chain partner to thousands of customers. The slowdown in the U.S. industrial sector has been seen in the firm’s recent results, but management has done a good job of cost controls (profit margins hit an all-time high in Q3), which is keeping cash flow strong (20% larger than net income in the most recent quarter), and the company is still inking a ton of new deals (installed base of vending devices and onsite locations are growing at a good clip) and building out its e-commerce operation (sales up 28%). The stock is strong today because, despite the tough environment, Fastenal eked out an estimate-beating report in Q3, and while growth isn’t likely to zoom from here, a reasonable valuation (24 times projected earnings) and solid yield (2.4% annual yield) means big investors are comfortable building positions.

Technical Analysis

FAST will never be confused with a great growth stock, but it tends to have solid multi-month runs after breaking out from big consolidations, and that’s where the stock is today. Shares topped in April of this year at 36, fell as low as 28 in August and was still sitting around 31 two weeks ago. But the Q3 report saw FAST gap to new price highs on six times average volume and stretch even higher today. If you want in, you can grab a small position on dips.

FAST Weekly Chart

FAST Daily Chart

Kansas City Southern (KSU)

www.kcsouthern.com

Why the Strength

More than 70% of the nation’s coal is moved by rail in the U.S. Trains also carry some 58% of raw metal ores, 1.6 million carloads of wheat, corn, and other agricultural products, and 13.7 million intermodal containers and trailers that transport consumer goods, so the sector is directly tied to the heartbeat of the U.S. economy. Kansas City Southern (with about 14% market share) is the smallest of the Class 1 railroads in the country, which are responsible for 68% of rail traffic. Fundamentally, there are two trends that are changing the railroad industry: The reduction in the use of coal (a decline of 35% between 2010 and 2018) and precision-scheduled railroading (PSR), and both trends are giving this company a boost. First, this railroad doesn’t carry that much coal, and secondly, KSU has successfully implemented PSR, which has reduced its operating costs and fattened its bottom line. Replacing the old system of hub-and-spoke, where railcars enter a hub and are then attached to a train en route to its final destination, PSR emphasizes consistently running trains between two points on a network at a specified time. The stock is strong today because of the firm’s great quarterly report last week—earnings rose 24% to $1.94 a share, beating analysts’ estimates by $0.15, and registering its strongest growth rate in several years. And company’s revenue was up 7% to $748 million, the best in the last seven quarters. The company benefited from a 21% increase in chemicals and petroleum shipped to Mexico (where the company has rights to operate 3,300 miles of track) and a 15% rise in agriculture and minerals-related revenues. Throw in optimism that economic growth will pick up going forward and investors are in a buying mood.

Technical Analysis

Like most cyclical stocks, KSU got walloped in 2015-2016 and has slowly been working its way back since. The action this year has been solid, with a run to 125 in April, a four-month rest, a breakout in September and, after a quick shakeout, a powerful earnings gap late last week. We like the chart, but given the market environment, we advise aiming for dips.

KSU Weekly Chart

KSU Daily Chart

Nike (NKE)

www.nikeinc.com

Why the Strength

Nike is the world’s biggest sportswear maker, competing head-to-head with Adidas. After a series of drops in consensus earnings estimates that rattled Wall Street’s confidence in Nike’s outlook and strategy, Nike reported a fantastic first quarter in September, which is one of the main reasons the stock is moving higher—strength in the core sportswear products and solid cost controls (gross margin surged) contributed to a large earnings beat, causing analysts to revise and upgrade their expectations for Nike’s 2020 outlook. As for specifics, sales in China rose 22% year-over-year, continuing a five-year trend of double-digit revenue growth. And the Nike Direct strategy, which is focused on app and website commerce, delivered a 42% revenue increase; the new app has launched in 20 countries so far, with further expansion planned. Whereas the trade war kept a lid on investor perception for a while, Nike is successfully managing their tariff burden through a variety of strategies, including vendor negotiations and sourcing product from other countries. On the tail of blowout quarterly results, analysts immediately began hiking price targets well over 100, with one Wall Street firm setting their eyes on 150. Of course, it’s not a rapid growth outfit, but Nike’s e-commerce traction and competitive global performance are expected to fuel revenue and profit growth for years to come. Watch for an annual dividend increase to be announced in mid-November.

Technical Analysis

NKE had a big run from late 2017 through September of last year, but then basically went on to build a huge base, including the incessant ups and downs during the spring and summer of this year. But the late-September earnings report brought a decisive, big-volume breakout, a chart event we never overlook in big, liquid stocks. Dips of a couple of points should provide a solid buying opportunity.

NKE Weekly Chart

NKE Daily Chart

Taiwan Semiconductor (TSM)

tsmc.com

Why the Strength

Taiwan Semiconductor (now called TSMC) is the world’s largest dedicated semiconductor foundry, as well as an industry-leading chip supplier to Apple, Qualcomm and Huawei. Thus, you won’t get a more direct play on the healthy of the chip sector as a whole, and today, that’s a good thing. The firm is benefiting from new launches of smartphones, year-end shopping and demand for 5G and AI technologies. The company reported a strong third quarter last week, resulting from increased sales to smartphone makers including Huawei, which also announced huge third quarter and bullish year-to-date sales. TSMC quarterly revenue rose 11% year-over-year to $9.4 billion, beating company guidance by a couple hundred million. Even better, Taiwan Semi delivered their best profit growth in more than two years, beating analysts’ estimates. TSMC did hike their outlook for 2019 capital expenditures from $10.5 billion to $14.5 billion, but they also forecasted a 9% increase in fourth quarter revenue and rising gross margins compared to a year ago. CEO C.C. Wei stated, “5G smartphone growth momentum is stronger than we expected ... we have good reasons to increase our capex this year and next year.” After a slow patch, a period of accelerating growth appears to be here.

Technical Analysis

TSM has a great chart, with a persistent run-up through the start of 2018, a tedious up-and-down correction through August of this year (19 month base), and now a strong move to new highs before and after earnings last week. The stock did see some heavy-volume selling late last week after the breakout, but the action looks normal following the big run. We’re OK buying here or on dips.

TSM Weekly Chart

TSM Daily Chart

TAL Education (TAL)

www.100tal.com

Why the Strength

One of the best secular (very long-term) growth stories out there involves education in China—while the one-child policy has been tossed aside, the amount of time and monetary resources spent by parents (and grandparents) on education of their children continues to grow, especially as China requires various “entrance” exams as students move to higher grades. TAL Education is one of the two leaders in the group (New Oriental Education (EDU) is the other), providing K-12 education in a variety of fields (math, English, Chinese, and for high schoolers, physics, chemistry and biology) through small classes (78% of revenue), personalized tutoring (8%) and online courses (15%). The firm now operates in 57 cities and has 725 total learning centers (up 7.2% from a year ago), and encouragingly, it does great business outside the largest areas (42% of class revenues comes from outside the largest five cities). And enrollment trends remain excellent; 1.72 million students were signed up with TAL at the end of May, up 41% from a year ago. Earnings are beginning to lag as the company’s investment spending picks up (especially in its online offerings) this year, but the core trends here remain intact and analysts see the bottom line rebounding nicely next year. The next update will come this Thursday (October 24) morning, which the next quarterly report is released.

Technical Analysis

TAL peaked with most Chinese stocks in the middle of 2018 (near 48) and had a huge plunge (to 21 at the low) before rebounding in the spring of this year. Since May, though, the stock has etched a decent-looking base, with TAL showing some solid accumulation this month as it approaches resistance. If you’re aggressive, you could nibble here, though waiting for the reaction to earnings (a decisive breakout above 40 would be bullish) is fine as well. It’s a nice setup.

TAL Weekly Chart

TAL Daily Chart

Target (TGT)

www.targetcorp.com

Why the Strength

It’s beginning to look a lot like Christmas—at least in the eyes of retailers. According to the National Retail Federation, holiday sales in November and December are estimated to be 4% higher than last year’s, totaling around $730 billion or so. Compared to last year’s tepid 2.1% increase over 2017, that’s a positive acceleration expected for sellers. And the online segment continues to outpace brick-and-mortar sales growth, with forecasts of 11% to 14% growth, or some $164 billion. The #8 retailer in the U.S., Target’s in great position to be one of the biggest beneficiaries of the expected spending spree. The stock has changed character in recent weeks after a great Q2 earnings report, which topped analysts’ forecasts by 12%, while revenue walloped estimates by more than $100 million. Same-store sales growth also beat, coming in at 3.4% versus the 3% analysts had expected. And earnings forecasts are calling for a 14% hike in earnings this year. The back story here is that, over the past two years, the company has remodeled itself with successful private label brands and alliances with high-end designers, with management pulling all the right levers. On that front, investors (and consumers) are hopeful regarding Target’s announcement last week that it will handle the digital platform and fulfillment of the resurrected online presence of Toys “R” Us, including the online operations of two new Toys “R” Us stores that will launch later this fall in Texas and New Jersey, which fits in nicely with the firm’s new specialized in-store space dedicated to online sales and pick-up.

Technical Analysis

TGT’s coming out party occurred in mid August, when it gapped out of a very long consolidation. And despite the market’s ups and downs and repeated bouts of rotation, the stock has held up well—pausing in 105 to 110 range through early October and recently stretching to new highs. Buying on dips is recommended.

TGT Weekly Chart

TGT Daily Chart

Tempur Sealy (TPX)

www.tempursealy.com

Why the Strength

Tempur Sealy is one of the top dogs in the mattress, bedding and pillow business, and it’s on pace to crank out around $3 billion of sales this year. With that kind of profile, you’d figure Tempur’s stock is strong for defensive reasons (reliable business, low valuation, etc.). But instead, buyers are in control because there are some real positives going on here. First and foremost, management is pulling the right levers, especially on the sales side—whereas most revenue still comes via wholesalers, the company’s direct-to-consumer business (both via company-owned stores and e-commerce) is growing like gangbusters. In Q2, direct-to-consumer revenue grew a combined 55% year-over-year, yet it makes up just 10% (North America) and 23% (internationally) of their respective totals. Going forward, improved web operations and reach and an increasing store count (from 150 today to 225 to 250 over time) should keep the trends pointed up. A second big driver on the sales side involves three distribution pacts the firm recently inked with Mattress Firm and Big Lots in the U.S. and Better Bed Holdings in Europe—when fully ramped up, Tempur Sealy sees these partnerships bringing in an additional $400 million in annual revenue and, even more impressively, $75 to $100 million of EBITDA (by comparison, EBITDA this year should total $465 million). Sales and earnings growth are both accelerating, and analysts see the bottom line up a strong 50% next year. We think this is a good, company-specific story.

Technical Analysis

TPX was a nothing burger through the end of last year, but this year it’s completely changed character, with shares enjoying a persistent advance from its lows near 39 last year to as high as 82 in July. The stock then began a rest period, but that’s gone about as smoothly as can be given the market—TPX consolidated in a tight zone (72 to 82) for 12 weeks with no big-volume selling and actually moved to new highs last week on solid volume. You can nibble here or on minor weakness.

TPX Weekly Chart

TPX Daily Chart

TJX Co. (TJX)

www.tjx.com

Why the Strength

Discount retailer TJX Companies—like Target—is breaking out the eggnog in anticipation of the coming holiday sales season. Deloitte estimates that retailers will sell some $1.1 trillion between November and January, a rise of nearly 5% from a year ago. While consumer confidence has recently sunk a bit, that hasn’t shown up in retail sales, which rose 4.1% in September, year-over-year. And economists expect confidence to bounce back, on the strength of a very low unemployment rate which should prop up holiday spending. But this is more than just a general industry play— TJX, which owns and operates Home Goods, T.J. Maxx and Marshall’s—has delivered positive same-store sales growth for 23 years. The company has beaten Wall Street’s earnings estimates the last two quarters, and TJX is set to report its third quarter results on November 19, with analysts expecting earnings per share of $0.66, an estimate that has edged up a bit in the last month. Revenues are forecasted to come in at $10.3 billion. Wall Street analysts are positive on the shares, citing TJX’s investment in its e-commerce presence, the increase of in-store traffic (up 20 straight quarters, which is impressive given industry-wide trends), and the company’s ability to turn its fast-fashion inventory into rapid sales. A modest 1.6% yield puts a nice bow on the overall package.

Technical Analysis

It’s not thought of as a fast mover, but TJX can make up ground in a hurry when it wants to. Shares had a big run last year, rallying from around 35 to a peak near 55 before the market pulled it lower. That started what ended up being a year-long consolidation for the stock, but now TJX is freewheeling—after a shakeout in early October, the stock has decisively lifted to new highs on good (not great) volume. Nibbling here or (preferably) on weakness makes sense.

TJX Weekly Chart

TJX 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.

“new”