October 4, 2021

Onus is on the Bulls

Current Market Outlook

For many weeks, we’ve been writing that there’s more good than bad in the market, and indeed, while choppy, many names did work their way jadedly higher. But now the shoe is on the other foot: The intermediate-term trend is now down for the major indexes, and we’re starting to see more and more individual stocks follow suit. It’s not a complete disaster, and given the on-again, off-again environment of 2021, we’re not ruling anything out, including a turn back up in the days or weeks ahead. (Even now, we’re fine sticking with your strong, profitable stocks.) But after a couple of rounds of sharp distribution and some breakdowns among leading stocks, we think it’s simplest to say the onus is on the bulls—we need to see at least a few days of constructive action and some upside power in the indexes and individual stocks to conclude the sellers are losing control. We’re leaving our Market Monitor at a level 5 and, until proven otherwise, would play things cautiously with only small new positions, trailing stops and a decent chunk of cash.

This week’s list has an interesting crop of stocks, ranging from commodity to reopening to legitimate growth outfits. Our Top Pick is CF Industries (CF), which is emerging from a multi-month dead period with a lot of power; as with most names in this market, try to buy on weakness.

Affirm Holdings (AFRM)

Why the Strength

No matter what you think of the Buy Now, Pay Later (BNPL) movement, which is sure to get a few people in over their heads, the fact is the industry is booming as more and more retailers adopt it for their online purchases (an $800 billion market in the U.S. alone). There will be many players in the field, but Affirm is in the lead, partnering with numerous firms (including Adidas, Nike, Best Buy, Expedia and Shopify, which offers it to its massive merchant base) and giving customers customized BNPL offers (with interest!) based on quick “soft pull” credit checks (no impact to a person’s credit score). Affirm makes money by getting a small cut of every purchase that uses its borrowing options, plus collecting the interest on each loan. For customers, spreading out payments over a few months, flexible payment options and never having to pay more than agreed to are all positives. If the economy goes south, Affirm could be on the hook for a lot of late payments/bad debt, but a) growth has been outstanding (Q2 saw revenues up 71% while active users of 7.1 million soared many-fold), and b) two recent deals have boosted perception: First, Affirm signed a (non-exclusive) deal with Amazon, allowing buyers to split up purchases of $50 or more, and after that, Walmart greatly expanded its deal with Affirm, too, with the service available at 4,000 superstores and online too. Moreover, Affirm’s recent Analyst Day revealed a bunch of product announcements, including an upcoming debit card that will connect to consumers’ checking accounts and plans for brand-sponsored promotions. There’s risk, but there’s no question the upside potential is enormous.

Technical Analysis

AFRM got walloped soon after its IPO and then spent months basing in the 50 to 70 area before the Amazon announcement caused a huge rally, followed by further strength on the Walmart news and the Q2 report. And while the stock has definitely come in with the market, it still looks resilient to us, especially compared to its prior move. It’s a hot potato, but we’re OK nibbling here with a loose stop.

AFRM Weekly Chart

AFRM Daily Chart

(SKIN)

Why the Strength

BeautyHealth’s claim to fame is the HydraFacial, a beauty treatment given at salons to clean and revitalize skin. The pitch is that in three steps and 30 minutes it’ll give you the best skin of your life. The company sells a mobile system for salons that uses the company’s one-use treatment tips for cleaning skin, extracting dirt and oils and applying its own liquid treatments. Selling these stands to estheticians generates about half of revenue; restocking the treatment tips and serums (recurring revenue) generates the other half. The HydraFacial is especially appealing to millennials, who account for about 40% of global facial customers and are helping drive skincare growth at spas by low double digits each year. At around $200 a visit, HydraFacial isn’t cheap, but it’s an affordable luxury within reach for many. About 15% of customers get four or more treatments annually, according to the company. The beauty industry likes it too, rating it in 2019 research as the favored treatment at salons, just ahead of Botox and well ahead of other treatments like CoolSculpt and Diamond Glow. Last year was a lost year for sales due to pandemic closures, but in 2019 sales grew at 49% year over year and appear to have more than recovered–over the course of 2021, management has raised its sales projections from $181 million for the year to $230 million. The company is expanding into offering products at beauty care retailers that offer limited in-store skin care too. BeautyHealth was created by the May merger of a special purpose acquisition company and HydraFacial, which had been a private company since its founding in California in 1997, and while SPACs aren’t our favorite plays, this one appears to have a legit niche offering.

Technical Analysis

SKIN shares haven’t suffered the volatile fate of most other SPAC mergers in 2021. That doesn’t mean shares aren’t subject to big moves, it’s just that most moves to-date have been higher. Since closing in May SKIN has more than doubled, including a strong earnings move in August that kicked off a big move to 28. There’s been some resistance up there of late, but given the market, SKIN is holding very well. A small position on dips with a stop under the 50-day line is fine if you want in.

SKIN Weekly Chart

SKIN Daily Chart

Caesars Entertainment Corp. (CZR)

Why the Strength

There are a lot of moving parts with Caesars Entertainment, but we mean that in a good way—the company is strong today as it’s partly a reopening stock, benefiting from declining virus case counts, good news on the therapeutics front and some fundamental improvements at casinos; indeed, Vegas strip gaming revenue in August actually came in 20% above the 2019 level, a strong sign that travel is back. In Q2, the company actually set records for both EBITDA and profit margin, coming in well ahead of expectations, and in the conference call the top brass said that bookings point to further strengthening, especially in group sales (expecting a 15% group sales increase this year vs 2019). Indeed, even with some development going on in a few places, the company is spinning off tons of cash, with a run rate of around $10 per share of free cash flow as of July. But, importantly, there’s also a big growth angle here, as Caesars is making a play to be a leader in the sports betting and iGaming (online casino) market: As of early August, the firm had sports betting operations up and running in 17 states (including 13 with mobile sports betting), and it’s been integrating its bold $4 billion purchase of William Hill (a leading sports betting outfit in Britain). Right now, the online business is small ($117 million in revenue in Q2), but there will be a lot of investment in this area—north of $1 billion over the next two and a half years—and the firm said that, at maturity, it expects its digital operation to crank out cash flow of 50% to 100% annually of any investment they put in! In the meantime, they’re busy expanding (up and running in Arizona in early September) and signing up partners (LSU Athletics and Indianapolis Colts are on board). It’s a good story, and the next quarterly report is due November 2.

Technical Analysis

Many casino and sports betting stocks are acting iffy, but not CZR. Its post-November 2020 rally easily took it to new all-time highs, with shares finally hitting a wall near 113 in June. The correction that followed brought shares below their 40-week line for a few days, but CZR snapped back beautifully in late August and has shot ahead to new highs near 120 in recent days. Given the market, we advise starting small and aiming for dips.

CZR Weekly Chart

CZR Daily Chart

CF Industries (CF)

cfindustries.com

Why the Strength

Nitrogen prices are hitting their highest levels of the last decade as hurricane-related production problems and surging prices for natural gas—the main feedstock for nitrogen fertilizers—are contributing to a global nitrogen supply crisis. While this is troubling for farmers, fertilizer producers are seeing higher profits as a result. CF Industries is the world’s leading producer of the anhydrous ammonia used to make other fertilizers like ammonium nitrate and urea, also producing compound fertilizer products and “clean” fuels like hydrogen. Higher nitrogen demand contributed to a blow-out second quarter, helped also by widening energy spreads between North America and other regions. This led to higher margins for all of CF’s segments, and the combined factors drove a 25% increase in EBITDA compared to a year ago while allowing CF to generate strong free cash flow. Despite lower Q2 sales volumes from a year ago (due to lower supplies), revenue of $1.6 billion was up 32% thanks to higher ag commodity prices across the board. The stronger fertilizer price outlook, moreover, prompted some major Wall Street institutions to raise price targets for CF. Looking ahead, management believes global fertilizer and coarse grain inventories will need to be rebuilt, contributing to what it sees as record nitrogen demand and a “positive pricing environment” for fertilizer until at least 2023. The company further believes this will allow it to lower its gross debt by $3 billion in the next two years, as well as return cash to shareholders through dividends (2.0% annual yield) and “opportunistic” share buybacks. Analysts see earnings catapulting to $4.56 per share this year and actually increasing a bit more in 2022.

Technical Analysis

CF has flown under the radar for most of this year as fertilizer stocks have been largely ignored, but we think this a good thing. After blasting off last November and making good progress into May, CF pulled back into August and made contact with the 40-week line. Three very tight weeks followed (usually a sign that the weak hands are out) and buyers have gone nuts since, with three giant-volume accumulation weeks. We’d prefer to get in on dips, but we’re not wholly opposed to nibbling up here, either.

CF Weekly Chart

CF Daily Chart

ConocoPhillips (COP)

Why the Strength

ConocoPhillips needs no introduction: It’s the world’s largest oil and natural gas exploration company based on production and proven reserves. Its recent strength was prompted by reports that the EPA is mulling major cuts to the nation’s biofuel blending requirements for refiners (which boosted sentiment on the energy sector as a whole). But an even bigger boost came from its announced purchase of the Permian Basin assets of Royal Dutch Shell, placing Conoco firmly in the ranks of other top-tier Permian players like Exxon Mobil and Chevron and making it the second-largest oil and gas producer in the lower 48 states (behind Exxon). The deal is further expected to generate billions in additional free cash flow for Conoco in the coming years and has cemented what has already been a solid 2021 for the firm. In Q2, Conoco saw revenue of $10.2 billion increase 154% from a year ago, while per-share earnings of $1.27 rose from a 92-cent loss in the year-ago quarter and, more importantly, was the highest since 2018. Excluding Libya, Conoco’s adjusted oil production rose 3% to 1.55 million barrels per day, while its total average realized price in the quarter more than doubled to $50 per barrel from a year ago. Third-quarter production is forecast to be around 1.5 million barrels a day, reflecting seasonal turnarounds planned in the Alaska and Asia Pacific region, and Wall Street sees earnings not just exploding higher this year but lifting to nearly $6 per share in 2022. An added bonus is that as part of a 10-year plan to grow its production at a 3% compound annual rate, Conoco plans to return $65 billion to shareholders (fully funded from operations), recently upping its stock buyback authorization by $1 billion for the remainder of 2021. A healthy dividend (2.5% yield) is icing on the cake.

Technical Analysis

Like most energy stocks, COP exploded higher late last year and early this year, doubling in four months and peaking at 60 in March. The going since then has been choppy, with shares spending the last few months stuck in a lateral range between 53 and 63. But COP experienced a character change with last month’s acquisition announcement, and the stock has since taken flight again, with three straight weeks of accelerating buying volume as shares have shot to new highs. It’s not going to double overnight but we think you can enter on dips.

COP Weekly Chart

COP Daily Chart

International Game Technology (IGT)

igt.com

Why the Strength

Casino gambling has staged a huge comeback in 2021, with top gaming state Nevada boasting record gambling levels this summer despite subdued convention bookings. International Game is a big player in this market, producing video slot machines and other gambling technology. Aside from video slots, the firm has a lottery business (which helped it navigate last year’s casino shutdowns) and, importantly, a sports betting platform that powers 50 sportsbooks across 15 U.S. states. This year’s reopening contributed to strong performance in all segments, including lottery, land-based gaming and digital and sports betting activities, all of which drove revenues to an estimate-beating $1.04 billion in Q2, up 74% from a year ago. Broad-based player demand across games and channels drove same-store sales 35% higher in the quarter, driven by lottery growth (up 50%) and new additions to this category. Impressively, while accounting earnings are in the red, the company generated $380 million in free cash flow in the first half of 2021—about $1.85 per share and the highest amount for a first half in company history. The company sees global same-store sales up mid-single digits in the second half of 2021 and up low double digits compared to the pre-pandemic second half of 2019. Management also expects to exceed 2019 levels in several key metrics this year, thanks in part to the high-level performance of its lottery business and “progressive recovery” in global gaming. Wall Street sees the firm’s revenue rising 29% for the full year, with one analyst recently hiking his price target.

Technical Analysis

IGT rallied to 19 in January, etched a nice-looking four-month base and staged a breakout in May. But the market caused that move to fail, leading to another, deeper (35% deep) correction that briefly took shares below the 40-week line. The initial recovery was just OK, but the roof has blown clean off the past two weeks, with the stock powering to new highs on two straight weeks of good volume. We’re OK grabbing some here or (preferably) on dips.

IGT Weekly Chart

IGT Daily Chart

Live Nation Entertainment, Inc. (LYV)

www.livenation.com

Why the Strength

Pent-up demand for concerts that were cancelled during last year’s pandemic is immense, and analysts expect live event ticket sales to boom in the coming year. Live Nation Entertainment (the result of a merger between Live Nation and Ticketmaster) is the leading live music company in the world, providing ticket sales for concerts and festivals in the U.S. and internationally. In its latest earnings report, Live Nation observed that momentum for the return of live events has been building monthly, with ticket sales and concert attendance “pacing faster than expected.” The company also said that 83% of its customers continue to hold tickets for rescheduled events, underscoring the strength of the pent-up demand, and noted that June was actually Ticketmaster North America’s fourth-best month ever for transacted ticket volume. Underscoring the demand, despite ticket prices being 10% higher than 2019, most of its major festivals sold out in record time, with over six million fans expected to attend its festivals during the second half of the year (and with about two-thirds of those festivals increasing their attendance compared to 2019). After experiencing a shutdown-induced revenue collapse last year, Live Nation’s top line soared 677% in Q2, to $576 million. And while the bottom line was still negative, it surprised by 28%, has been galloping ahead all year and is expected to surge into the black in 2022. Looking ahead, Live Nation anticipates a “roaring era” for live events, with concerts and sponsorships for every major venue scheduled for 2022 and 2023 up double digits from 2019, and with tour extension plans underway for 2024. Indeed, analysts see the top line more than doubling in 2022 even after this year’s rebound.

Technical Analysis

LYV rallied in a herky-jerky fashion for much of last year and early this year before hitting a wall in March around 95. Then the stock began a W-looking consolidation, with a dip to 74 in May, a failed breakout in June, and a slightly deeper retreat to 74 in July. Still, LYV held pretty firm, tightened up nicely in early September and has taken off of late. We wouldn’t say it’s completely up and out, but you could start small here and buy more if the attempted breakout gains steam.

LYV Weekly Chart

LYV Daily Chart

Matador Resources Company (MTDR)

matadorresources.com

Why the Strength

The entire energy group acts well, but we’re focusing on those that have raced back toward their highs or have shown huge-volume buying—and Matador has done both. The company is basically a pure play in the Delaware Basin (93% of its total output) and, after a tough Q1 due to weather, Matador came roaring back in Q2, with total production up 26% sequentially (oil output up 28%), which led to a big $156 million in free cash flow (~$1.33 per share) in that quarter alone. Indeed, Matador is planning on some solid output growth this year compared to many of its peers, with production up 10% (oil up 11%) while total CapEx lifts only 9% and it harvests cash flow mostly to pay down debt—its revolving balance has dropped a whopping 45% during the past three quarters alone and its leverage ratio is at its lowest levels since mid-2019. It initiated a small dividend too (0.3% annual yield), a figure that should rise nicely from here. What’s most interesting here (and different from its peers) is San Mateo Midstream, which is a joint venture between Matador and Five Point Energy that’s developing midstream assets in the Delaware to help move Matador’s output. Despite drilling hesitation in general, San Mateo is doing very nicely, with EBITDA from that operation alone expected to reach $140 million in 2021 (about 20% of the firm’s total). And now the goal is to start signing up non-Matador clients, with management hoping to land a “big fish” (in its words) in the quarters ahead. As with every oil play, a plunge in prices would throw a monkey wrench into the story, but analysts see earnings and cash flow growing nicely at least through 2022. It looks like a small/mid-cap leader in the space.

Technical Analysis

MTDR was definitely one of the better oil stocks during the late 2020/early 2021 rally, motoring above its 10-week line for months and reaching 38 in June. The correction after that wasn’t fun (35% deep), but wasn’t abnormal, with support appearing north of the 40-week line and, after a modest initial bounce, the buying pressures have picked up—MTDR has surged the past three weeks on good volume as the stock has raced to new price and RP peaks. We think the stock heads higher over time but, near term, aim for a minor pothole to enter.

MTDR Weekly Chart

MTDR Daily Chart

Palo Alto Networks (PANW)

paloaltonetworks.com

Why the Strength

As the economy reopens, one thing that likely won’t return to normal is how Americans work. Cybersecurity firm Palo Alto (covered in the August 30 report) believes remote and hybrid work setups for businesses will remain in place for years and sees booming cloud growth boosting the need for greater security measures to protect against increased network threats. Palo Alto is meeting this expanding cybersecurity demand through a growing portfolio of next-generation security (NGS) services, led by its Prisma Cloud security platform and AI-based Cortex threat detection platform (allowing the company to address cloud security and automated threat detection markets that are growing at compound annual rates of 23% and 17%, respectively). In fiscal Q4, Palo Alto’s revenue surged 28% as the firm finished the quarter with more than 2,700 Prisma customers (up 47%), while Cortex customers increased a whopping 93%, to 2,900. Its NGS services, meanwhile, brought in $1.18 billion in annual recurring revenue (ARR), accounting for nearly 30% of the top line and beating the company’s guidance. At a recent investor day presentation, management predicted annual revenue would increase by more than 50% in the next two years, to $10 billion in total billings, on the back of accelerating demand for cloud-based security services. For Q1 2022 (ending Halloween of this year), Palo Alto sees NGS recurring revenue rising 42% from a year ago as the firm continues to churn out new NGS offerings (releasing 20 in fiscal 2021 alone!), while forward-looking indicators in the latest quarter (remaining performance obligations of $5.9 billion, up 36%) back up the long-term growth story.

Technical Analysis

PANW broke free from a multi-year base last November and rallied to 400 in February before being taken down by the growth stock correction. The 23% dip wasn’t too bad, but shares ended up making no net progress into late August when earnings changed the landscape—PANW gapped up on huge volume following its report, and it’s acted great since, pushing a bit higher and trading fairly well (even after today’s drop) despite all that’s going on in the market. We’re OK taking a swing at some here if you don’t own any.

PANW Weekly Chart

PANW Daily Chart

Paycom Software (PAYC)

paycom.com

Why the Strength

Paycom Software is a human resources software provider that automates tasks HR departments traditionally handled in-house, from researching if new hires generate work opportunity tax credits to meeting requirements under COBRA regulations for ex-workers. Paycom is generating a lot of interest from a product rolled out this summer called BETI, which puts the work of managing payroll information on employees—through Paycom’s cloud-based app, workers see, review and approve their paycheck before deposits are made. The system works because employees know best if all their hours are logged and if information BETI draws from sister Paycom software suites are accurate, like paid time off claims and compensation changes. Workers can also tweak electives, like 401k deductions, and see the impact on their take-home pay. For employers, BETI allows HR to oversee the process rather than perform it, which Ernst & Young says cost $4.70 per check. As of early August, after just a few weeks of availability, about 1,000 Paycom customers had signed on, and the top brass thinks nearly everyone could be using it down the road. Since Paycom’s big cost is customer acquisition, every existing subscription add-on generates far more subscription revenue than expense. Paycom’s gross margin is in the 80 percent area, with EBITDA margins around 40% after the business spends on sales and marketing. Management told investors in August that 2021 sales should hit $1.04 billion thanks to new customers and products like BETI. Earnings are expected to rise in the 25% to 30% range both this year and next—and that’s likely conservative. It’s a solid, reliable growth story.

Technical Analysis

Q4 earnings enthusiasm helped PAYC bust out on good volume at the start of August, leading to a great-looking five-day volume cluster as it got going. And since then the action wouldn’t lead you to believe that much of the market is in turmoil—a rally to 500 was met with some selling, but that led to another big-volume buying spree, pushing the stock up toward 515 before the latest wobble. We think PAYC is buyable here, albeit with a tight-ish stop should the market really cave in.

PAYC Weekly Chart

PAYC 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 October 11, 2021.