The Correction Commences
We’ve been writing that the recent straight-up move in leading stocks, combined with signs of speculation in early October, all happening right in front on earnings season, was a recipe for lower prices in the short-term. And voilà! Stocks got hit hard last week and early this morning, as the sellers gained traction. At this point, the major market trends are up, so we believe this correction will eventually lead to higher prices … but we’d still be a bit cautious in the short-term, as selling pressures usually don’t disappear after just one week. This week’s Top Ten contains a few earnings winners from last week (always good candidates for further upside), as well as a few new names. Our favorite of the week is New Oriental Education (EDU), a Chinese firm that gapped up on strong earnings last week, but has pulled back with the market in recent days. It’s a bit thinly traded, and thus jumpier, but we think buying a little here will work out.
| Stock Name | Price | ||
|---|---|---|---|
| ANR (ANR) | 0.00 | ||
| AUO (AUO) | 0.00 | ||
| BIDU (BIDU) | 0.00 | ||
| EDU (EDU) | 0.00 | ||
| ISRG (ISRG) | 0.00 | ||
| LIFC (LIFC) | 0.00 | ||
| LULU (LULU) | 0.00 | ||
| MTL (MTL) | 0.00 | ||
| SA (SA) | 0.00 | ||
| SPWR (SPWR) | 0.00 |
(ANR)
Why the Strength
Alpha operates 62 coal mines in Virginia, West Virginia, Kentucky and Pennsylvania. As a commodity producer, the single biggest determinant of the company’s success is the one it can’t control … the price of coal. And the price of thermal coal has been soft in the past year, a factor that led to negative trends in both revenues and earnings in the past year. Happily, there’s now booming demand for metallurgical coal, which is used in steelmaking, where demand is driven by construction in China and India. What’s interesting about Alpha is that it’s a fairly young company, founded in 2002 by affiliates of First Reserve Corporation, a private equity firm, who joined with current management to buy the majority of Pittston Coal (a subsidiary of Brink’s). In the following year the company added Coastal Coal, American Metals, Coal International and Mears Enterprises. And the acquisitions have continued, with the biggest, the acquisition of the Nicewonder Coal Group, coming in 2005. Bottom line: Alpha is not changing the world, but it might be a big beneficiary of some of the world’s changes. Third quarter results will be released before the market open on October 31.
Technical Analysis
ANR came public in February 2005 at 19, peaked at 33 in September, and then fell all the way to 12 at the end of 2006, when selling power was exhausted. But since then the buyers have been in control. Two weeks ago, the stock touched a high of 28, and since now it’s digesting that gain, trading in a tight pattern at 26 while the 25-day moving average, now at 24, works to catch up. Technically, it’s a nice pattern, and suggests you can confidently buy in our recommended range.
ANR Weekly Chart
ANR Daily Chart
(AUO)
Why the Strength
AU Optronics is one of the largest global manufacturers of liquid crystal displays (LCDs), especially the bigger-sized variety, seen most often in crisp-looking laptop and high definition television displays. The industry as a whole is in a definite long-term uptrend, but the cyclical ups and downs can be brutal – with basically a commodity product, the company’s average selling prices can swing wildly from one year to the next. Thankfully, right now the cycle is trending strongly up; the firm just released a solid third quarter report this morning, with revenues up 96% and earnings of $0.88 per share beating estimates by a few pennies. Management stated that average selling prices for its displays have held steady or even pushed slightly higher, and overall shipments are soaring (up 76% in the third quarter). It’s not a long-term winner, but right now, the wind is at AU Optronics’ back.
Technical Analysis
AUO enjoyed a big rally back in 2003 and early 2004, as demand for LCD displays was going through the roof. (That was about when HDTVs were being adopted by the masses.) However, since then, the stock has been range bound, stuck between 10 and 23, for the most part. During this time, there have been a couple of huge earnings swings that didn’t affect the stock much. But this time around, it appears all the sellers have been worn out – AUO has racked up five straight up weeks on heavy volume, and the stock is approaching its all-time peak. Go ahead and grab shares around here.
AUO Weekly Chart
AUO Daily Chart
(BIDU)
Why the Strength
This is Baidu’s sixth Top Ten appearance, and the fifth consecutive month that the company has been covered here. The story is still intact; this Chinese-language search engine company is the dominant force in the Chinese Internet searching business. In fact, it’s usually called the Google of China because it uses the revenue model that Google pioneered, offering advertisers a chance to bid to have their ads pop up when users search for a certain key word or phrase. Beyond that, the company’s strength is the depth of its understanding of the Chinese language, and its ability to deliver better results from searches. The Chinese internet still has loads of room for growth, which helps to explain Baidu’s daunting P/E ratio of 183. An interesting reality check will come on October 25, when the company reports earnings. There aren’t many bigger stories that Baidu’s; the only question is about the risk/reward balance. Long term, the capacity for advancing is still high.
Technical Analysis
BIDU has shown plenty of performance and plenty of volatility since we first featured it in January. Soon after that first appearance, it dropped from 122 to 93 in three months. But since the big April blastoff, the stock has been on a roll, dipping only when the entire market corrected in July/August. After peaking at 359 on October 11, BIDU has pulled back and traded tight in the 310–320 range. We think it’s a speculative buy at this level, and suggest you keep your stops tight as earnings approach on the 25th.
BIDU Weekly Chart
BIDU Daily Chart
(EDU)
Why the Strength
New Oriental Education is the largest provider of private education services in China, with a network of 35 schools, 130 learning centers, and some 2,400 teachers in 33 cities. The company provides test preparation, foreign language education (particularly English), international study, online education, occupational test preparation, and more. Since its founding in 1993, it has enrolled over 4.5 million students. This is still a fairly small company, with annual revenues (very seasonal, like all schools) of $160 million, but it has enormous growth potential … which explains why it’s valued by the market at $2.6 billion! Revenue growth has averaged about 30% in recent years, and the company seems to be expanding geographically at a pace fast enough to at least maintain that growth. In fact, after hearing the company’s third quarter results last week, analysts increased their estimates for the company going forward. 2008 is expected to see earnings grow 34% and 2009, 41%! It looks good to us.
Technical Analysis
EDU came public at 15 in September 2006 and has been trending up most of the time since. Like all stocks, it retreated this summer, bottoming with the market on August 16 at 43 (and nearly kissing its 200-day moving average in the process). But since then, the buyers have been in total control. It was last featured here on October 1, when it was 65. The earnings announcement last Monday saw buyers gap the stock up from 67 to 78, and today it filled that gap, telling us that in the short term, a little more consolidation is likely. But with the 25-day moving average providing support at 65, we think you can buy the stock here.
EDU Weekly Chart
EDU Daily Chart
(ISRG)
Why the Strength
The amazing growth story of Intuitive Surgical’s da Vinci robot continues. Last week, the firm reported an outstanding third quarter; revenue and earnings growth are accelerating as both robot sales and instrument sales (recurring revenue) pick up steam. And the big-picture story remains very bullish – da Vinci is becoming the standard of care for most prostatectomies, and now the robot is making inroads into a variety of other surgeries (gynecological procedures are a big opportunity). From here on out, the sky’s the limit, as the robot has zero competition and the benefits to both patients (quicker recovery times, smaller incisions) and insurance firms (shorter hospital stays) have proven to be big. Of course, the valuation is equally high ($10 billion market cap!), but P/E ratios are the result of stock performance, not the cause of it.
Technical Analysis
ISRG has now gapped up following its last four earnings reports, a rare feat. Usually, after two or three in a row, expectations become temporarily too high for a company to beat. But so far, this stock is defying gravity – it’s been trending slowly higher the past three of months, with just two down weeks during that time. The earnings gap up is bullish, and if this were a raging bull market, we’d tell you to go ahead and buy shares today. But with sellers taking control of the market last week, we think there’s a good chance they’ll yank ISRG down a bit in the days to come. So keep an eye on the stock, and try to buy on weakness.
ISRG Weekly Chart
ISRG Daily Chart
(LIFC)
Why the Strength
LifeCell is an old favorite, with five Top Ten appearances in 2005 and two in 2006. The company’s product line is based on AlloDerm, human skin that has been stripped of its genetic material, leaving only the structural elements. With no tissue to cause rejection, the body recognizes AlloDerm as skin and grows right back in. From its original use as a component of hernia repair, the product’s usage has spread to burn treatment and general surgical procedures. LifeCell makes many other tissue-based products that are used for reconstructing and reinforcing bone and connective tissue. This is still a small company, and growth may be limited by the difficulty of sourcing as much skin as necessary, but we like that earnings have grown faster than revenues for 14 quarters in a row, and after-tax margins just hit an all time high of 16.0%. LifeCell has been selected as Editor’s Choice of Cabot Top Ten Report three times, which is more than any other stock we’ve covered. This is a tribute to the strength of its story, and the growing number of institutional supporters indicates that the market agrees. Earnings are due on October 25.
Technical Analysis
LIFC caught fire in mid 2005 and has been a strong performer since, with the exception of two significant pullbacks. The first came in September 2005 after a voluntary product recall and the second came in October 2006 on an earnings disappointment. After the latter instance dropped the stock from 33 to 21, LIFC took three months to build a base and then got going again. Other boosts came from news that the stock would be included in the S&P Small Cap 600 and an analyst’s upgrade. The stock’s sharp drop this morning might make LIFC tempting to bargain hunters, but the depth of the plunge and the high volume are yellow flags, especially with earnings coming up. If you’re tempted, the 50-day moving average at 36 is likely to bring a bounce
LIFC Weekly Chart
LIFC Daily Chart
(LULU)
Why the Strength
Lululemon is a “yoga-inspired athletic apparel company” located in Vancouver, British Columbia, that’s growing fast by opening stores throughout Canada, the U.S., Australia and Japan. Targeting active people who want to “live longer, healthier and more fun lives,” it makes its own clothes from a variety of comfortable fabrics, and has been successful at growing fast without appearing too “commercial” to its customers. A company that did this very successfully is Starbucks! And just last week, Lululemon advised Wall Street that its third quarter report, for the three months ending October 31, would be better than previously expected. Instead of same-store sales growth in the mid-to-high teens, it’s suggesting growth will be in the mid-30s! We’re very keen on young companies that exceed expectations; there tend to be few selling pressures on these stocks. We like the cookie-cutter business model common to all mass-market retailers. And we like the growing profit margins here. The valuation is high, at $2.6 billion, but if this growth can continue, that won’t seem high for long.
Technical Analysis
LULU came public July 30 at 18, was higher than that at the August 16 market bottom, and has been climbing ever since. The positive guidance last week from management sparked buying that shot the stock from 40 to 57 in three days, and now the stock is working on digesting those gains. With the 25-day moving average down at 45, you could wait patiently for a lower-risk buy point but you might not get it. We say aggressive investors who can handle the volatility can buy a little on a small pullback.
LULU Weekly Chart
LULU Daily Chart
(MTL)
Why the Strength
Mechel, making its first Top Ten appearance, isn’t a familiar stock to most investors. This Russian giant mines coal, iron ore and nickel and uses them to produce steel and specialty steel products. It’s the second-largest producer of coking coal in Russia, the largest exporter of coking coal concentrate, the second-largest producer of long steel products and the largest producer of specialty steel. The company’s fortunes really turned in Q2 2006, when earnings growth turned positive after four quarters of decline. Since then, earnings have advanced nicely. The big story here is the industrial expansion of Russia, which provides a ready market for all steel products, and its modernization, which requires more higher-margin specialty steel. The stock’s P/E ratio is a calming 11, and a robust 2.7% dividend makes a nice bonus.
Technical Analysis
MTL bottomed in May 2006 at 19, and has enjoyed three phases of progressively steeper advances since. The first phase, from May ’06 to January ’07 had an RP line that matched the broader market. The second phase, from January ’07 to July ’07, featured a much stronger RP line and a price that climbed from 23 to 48. In the third phase, after the market’s July/August dip, the stock took off in a hurry, rising from 34 to 73 in just two months. It has been tightening up around 70 since then. With the 25-day moving average still back at 60, the prudent choice is to wait for a pullback below 65.
MTL Weekly Chart
MTL Daily Chart
(SA)
Why the Strength
Seabridge Gold’s strategy is unusual: in 1999, when gold was out of favor, the company began buying non-producing North American gold mines, ultimately winding up with nine fully-owned properties. It explored its properties thoroughly, enhancing value through discovery of additional assets … and then left the gold in the ground! Crazy as it sounds, Seabridge doesn’t see the actual mining and refining of its gold resources as adding much value. Eventually, the company intends to find producers as partners. But for now, the focus is on turning its investors’ cash into gold rather than attempting to convert gold into cash flow. The attractiveness of Seabridge depends on your attitude toward gold. If you see it as a hedge against inflation and a risk-reducing hard currency in a chaotic world, the stock may be appealing. If, on the other hand, you see gold as a security blanket for the paranoid, its appeal will be somewhat less. In Cabot Top Ten Report, we have no official opinion (we like anything that goes up), but Seabridge’s strategy provides interested investors a higher leveraging to the price of gold than conventional miners, as long as the company’s lack of sales doesn’t bother them.
Technical Analysis
When SA made its one previous Top Ten appearance on August 6, the stock was close to finishing up a run that had doubled the price from 15 in late May to over 30 in mid-August. The stock then dropped along with the rest of the market to bottom on August 16, and spent the rest of the month below 25. Then, after spending most of September idling around 30, the stock took off again on October 11 and 12 and has been sitting at around 37 ever since. At this point it looks set to continue the long-term advance that began in mid-2005 when it was trading at 2. A dip toward the 25-day moving average at 32 would offer a prudent buying opportunity.
SA Weekly Chart
SA Daily Chart
(SPWR)
Why the Strength
Solar power stocks haven’t been grabbing the headlines like they did this spring, but the group as a whole remains healthy. SunPower was the first in the group to deliver its quarterly report, and it was a dandy – revenues and earnings topped estimates, and 2008 should be another year of big-time growth. (Analysts are looking for 66% earnings growth.) To review, SunPower is among the “blue chip” solar firms; the company’s cells are among the most power efficient in the industry (more than 20%), have an all-black aesthetic appearance (better for non-power plant installations), and the firm also has a rapidly-growing division that installs solar cells for itself and others. Management has indicated that the price of silicon, a huge cost for SunPower, should ease in the months ahead, while continued strong demand from a variety of customers should drive profits sharply higher. All told, we’re big fans of the solar sector in general, and SunPower in particular.
Technical Analysis
SPWR has been trending higher since last October, with a few sharp pullbacks along the way. The latest dip came during the market’s July/August meltdown, when the stock fell more than 20 points in just a couple of weeks. But the buyers have returned, driving shares up to new peaks on mild volume. We like the stock’s reaction to earnings last week – it rocketed higher on huge volume – yet realize that, with the market’s choppiness, a pullback is likely in the near-term. Look to buy a little on a retreat to the 90 area.