September 20, 2021

A Change in Character

Current Market Outlook

Our intermediate-term trend model has effectively been neutral for months, with the big-cap indexes acting pretty well but most other areas chopping sideways. Today, though, the sellers got their act together, with the S&P 500 decisive diving below its 50-day line and small caps actually falling below their 200-day line! That’s certainly a change in character and, for the first time in months, turns the intermediate-term trend down. Of course, the evidence hadn’t quite lined up for a while now, so we’ve been playing it more cautiously than normal, but now it’s time to step carefully and see how this plays out. As for positive tidings, there are some: The bad news out there (Chinese real estate) is obvious, and looking at individual stocks, many growth titles are now holding up far better than the Dow or S&P 500 (a marked change from earlier this year). Thus, we’re still holding our resilient names and are OK doing a little buying as stocks pull in to support, but it’s not time to be a hero, with the focus shifting more toward preserving capital. Our Market Monitor has moved to a level 5.

If you are aiming to put a little money to work, you want to look for names that have recently shown good-volume buying. Happily, this week’s list has many names in this club, and our Top Pick is Lululemon (LULU), which is emerging from a long rest and has held its recent earnings gap despite the market’s dip.

Align Technology (ALGN)

aligntech.com

Why the Strength

Most people have some form of malocclusion – misalignment of the teeth, and about 15 million people annually use braces to fix the problem. Align Technologies sells clear retainers, called aligners, that fit over teeth and help pull them into proper position. Usually, these are recommended by orthodontists after braces come off. But that’s not the only situation they can be used in–Align estimates some 500 million people could benefit from just an aligner and the company has been busily targeting those customers on social media and apps that evaluate smiles and prod users toward treatment. The company’s product, Invisalign, is a simple-looking product with a vast system of technology behind it, including special materials that apply different pressures to teeth within the aligner, sequencing how teeth move into position. Align also focuses on selling dentists scanners and software to evaluate teeth, products which produce data exclusively for high-margin Invisalign aligners. The company recently introduced intraoral scanning – a touchless tool inside a patient’s mouth that digitally scans the contours of the teeth and uses that data to create the aligner mold. The technology is far less uncomfortable than the traditional physical mold, and supposedly more accurate, too, saving patients and dental offices time. The pandemic seems to have sparked more consumers to focus on their teeth and an embrace of digital dental services –Invisalign shipments were up 200% in Q2 and full-year EPS should more than double, to nearly $11 per share, with more growth expected ahead. It’s a simple story, but it’s a mass market and Align has a better, more desirable mousetrap compared to the current standard.

Technical Analysis

ALGN fell into a two-year slump in late 2018 after raising costs for customer and doctor acquisition. Those investments paid off, however, with shares blowing out of the downtrend in October on sterling earnings, and management has handily beaten quarterly expectations since. The most recent leg up came after Q2 results sparked a breakout from a multi-month, mostly sideways rest. Like everything else, upside progress has been slow since then, but the stock hasn’t done anything wrong and is still holding up above support. You can start small here with a tight stop.

ALGN Weekly Chart

ALGN Daily Chart

Catalent Inc (CTLT)

www.catalent.com

Why the Strength

Catalent has played an outsized role in the race to produce Covid vaccines. It’s a contract manufacturer that helps pharmaceutical customers develop biologic drugs and gene therapies, from small-volume clinical trials to large-volume commercial sales, and has deals with giants Johnson & Johnson and Moderna to produce vaccines. Catalent is well equipped for its pandemic role: As one of the world’s largest drug manufacturers, it makes 73 billion doses of drug and health products annually, with 83 of the world’s top 100 drug companies as its customers. Catalent spent much of last year scaling its capacity to meet the massive demand for the production of Covid vaccines and treatments (it’s on track to deliver well over a billion vaccine doses this year!) while also continuing to manufacture a broad range of other medicines (including 139 products in its development pipeline). This demand was highlighted in fiscal Q4, in which revenue lifted 26% to $1.2 billion, while per-share earnings jumped 29% to $1.16. Adjusted EBITDA came in at record levels, driven by “robust growth” in its biologics segment, which accounted for 48% of net sales. Catalent has also been on an acquisition spree of late, buying Juniper Pharmaceuticals, Paragon Bioservices and MaSTherCell among others in a bid to cement its position as a leading biologics and gene therapy manufacturer. Most recently, it acquired Bettera Holdings to expand Catalent’s manufacturing capabilities for vitamins and supplements (by making them in gummy form). Moving forward, management guided for full-year fiscal 2022 (started in July) revenue of $4.4 billion at the midpoint (up 12% from the prior year) and expects continued growth from work on newer gene-based Covid vaccines.

Technical Analysis

CTLT enjoyed a solid advance for most of last year and early this year, but peaked in February with many names in the broad market. The correction wasn’t particularly fierce (23% from high to low), but it did take until late August for a fresh breakout to occur, with CTLT moving to new price (though not RP) highs on two straight weeks of good volume. The pullback since then has been relatively tame, and a bit more weakness could offer up a nice entry point.

CTLT Weekly Chart

CTLT Daily Chart

Chesapeake Energy Corporation (CHK)

www.chk.com

Why the Strength

A year and a half ago, Chesapeake Energy was circling the drain; with a too-heavy debt load, an elevated cost structure and leverage to dirt cheap natural gas prices, the firm filed for Chiapter 11 last June. However, for people looking at the stock today, that move has proven to be a great thing—the debt load is now one of the lowest in the industry (0.6x EBITDAX), costs have been slashed and cash flow should be enormous in the years ahead, especially if the recent rally in gas prices sticks. As for the asset base, Chesapeake has operations in a few areas, though Appalachia and the Haynesville shale are the focus, with more than three-quarters of output natural gas, and even with prices much lower than present in Q2, the company still cranked out nearly $3 per share in free cash flow. And the story should get even better going ahead: Chesapeake is buying Vine Energy, making it the #1 producer in the Haynesville and the buyout should be immediately accretive to all key metrics—once the deal goes through (expected near year end), the company has said it will hike its already solid base dividend by 27% (current yield 2.3%; after the hike, 2.8%), and like some of its peers, it will institute a variable dividend of 50% of its free cash flow at the start of 2022. Moreover, just to give you an idea of the potential here, the top brass sees $6 billion of free cash flow during the next five years given pricing as of a month ago, equal to the current market cap! Obviously, those forecasts can easily change, but the point here is that Chesapeake could be one of the higher-yielding energy stocks in the market even if natural gas prices come back down to Earth. It’s a solid turnaround story.

Technical Analysis

CHK emerged from bankruptcy in February of this year and, after a few weeks of seasoning, took off on the upside, getting to 57 in June before topping out. The correction after that wasn’t too bad (18% deep), and while there were some volatile moves in August, CHK got going again in recent weeks, soaring as high as 65 last week (when natural gas prices went vertical) before pulling back. It’ll be volatile, but you can start small around here or preferably on dips.

CHK Weekly Chart

CHK Daily Chart

Cloudflare (NET)

cloudflare.com

Why the Strength

Nobody is going to argue that Cloudflare (or any stock for that matter) is the next Cisco Systems, which was one of the stock market’s biggest winners of all time. But in terms of fundamental positioning, we see a lot of similarities here—back in the day, Cisco had the right products to help interconnect people and companies just as the Internet was hitting the mainstream, while today, Cloudflare has the “new” kind of network that helps firms (from small to giant) speed up (supposedly websites load twice as fast and use 60% less bandwidth) and protect their websites, content delivery, apps and teams, while being the best platform for app development. Effectively, then, Cloudflare is providing the core infrastructure to the cloud- and app-based world, with a network that spans 250 cities worldwide in more than 100 countries, interconnects to 9,800 other networks directly and is just 50 miliseconds from 95% of the world’s Internet-connected population. Many can use the offering for free (to, say, protect and accelerate a couple of small websites), but the company is continually coming out with new products that are enticing more and more customers (126,000 paying in total) and big users to pay; at the end of Q2, 19% of the Fortune 1,000 are paying customers (and they’re buying more—same-customer revenue growth was 25% in the quarter), and we see no reason that figure can’t double or triple in the years ahead. Revenue growth has been both rapid and reliable in the 50% range for many quarters, and while earnings are slightly in the red, that’s because management is focused on investing to capture what it believes will be a $100 billion opportunity within a few years. It’s a big idea.

Technical Analysis

NET has had a big run over the past year, so it’s not in the first inning of its overall advance. Still, we see solid upside if growth stocks hold together—shares effectively took nearly six months to rest (December-May), and after tagging their 40-week line, have embarked on an excellent run, with just three down weeks since then. Lately, progress has been tougher, but NET bounced off its 10-week line last week and held its 25-day line on today’s dump. If you want in, start small and aim for weakness.

NET Weekly Chart

NET Daily Chart

Entegris (ENTG)

Why the Strength

Entegris is a down-the-food-chain stock in the semiconductor industry, but we don’t mean that in a negative way—the company offers a lot of specialized products, has carved out a great business for itself (20% after-tax profit margins) and has a bright future. The firm operates in three roughly equal-sized categories: Micro-contamination control is the largest (40% of revenues, 24% growth in Q2), followed by specialty chemicals and materials (31% of revenue, up 24%) and advanced materials handling (29% of revenue, up 36%), the latter of which includes the firm’s high-purity Aramus bags, which are used in Covid vaccine handling and should have applications in non-Covid biologics going forward. Overall, sales and earnings easily topped estimates in Q2, and management sounded increasingly bullish going forward as chip demand remains strong thanks to big-picture trends in mobile phones, high-performance computing, Internet of Things (IoT) and automotive end markets. Most important for investors, Entegris’ order book was at a record level at the end of the quarter and management expects to outperform the industry, guiding for 2021 sales to grow nearly 22%, up from the prior expectation of 18%. The company also sees demand for its materials process and purity capabilities benefiting from accelerated digitalization, 5G and high-performance computing trends. And with 70% of its revenue recurring in nature, it believes business will be resilient even after the chip sector hit a snag. Analysts see Q3 top- and bottom-line growth of 21% and 30%, respectively, while the bottom line should expand another 18% (likely conservative) in 2022.

Technical Analysis

ENTG had an excellent and well-controlled advance for much of last year and early 2021, rising as high as 126 in April. A relatively shallow (only 20% deep) five-month period of base-building followed, which should serve as the launching pad for another bull move, assuming the market can find its footing. Last week’s breakout to new highs came on a nice three-day volume cluster, with the RP line also notching a new peak. We’re OK stepping in on this dip.

ENTG Weekly Chart

ENTG Daily Chart

KKR & Co. L.P. (KKR)

www.kkr.com

Why the Strength

Low interest rates and easy money policies have led to a boom in leveraged buyouts, with private equity (PE) hitting records for multi-billion M&A deals this year, as well as an overall levitation in asset values; throw in a long-term move toward alternative investments and it all plays into the hands of KKR. The firm’s total assets under management have been soaring, coming in at $429 billion, up 93% from the year before thanks to both fundraising and also asset appreciation, while fee-paying assets under management were $319 billion, up 99%. Indeed, one of the big attractions for big investors is the company’s move (similar to Blackstone’s) into more predictable growth; fee-related earnings came in at 53 cents per share in Q2, up 68%, a figure that takes out a lot of lumpiness in the results based on private equity investments and liquidity events. Of course, as mentioned above, the environment is key: KKR was able to raise $59 billion in the second quarter alone (compared to $44 billion raised in all of 2020!), a clear sign the money spigot remains wide open. Private equity is still the biggest driver here (55% of investment holdings), though again, the top brass has been emphasizing so-called long duration assets under management, which should insulate KKR a bit from any wobbles in the environment. Looking ahead, analysts see the top and bottom lines growing 21% and 87%, respectively, in Q3. With an expanding client base across all its channels, along with new strategies and fund raisings, management sees a big runway ahead for further growth. A modest regular dividend (0.9% yield) and the potential for special payouts puts a nice cherry on top of this Bull Market story.

Technical Analysis

KKR reached record highs by last July, though that effectively led to a long rest through January. The stock kicked into a higher gear starting in February and kept above its 50-day line for months ... until today, when KKR fell sharply with all financial stocks. Is this is a shakeout, or the start of a real correction? We’ll handle it uniquely, setting our buy range above the current price, thinking a strong rebound would indicate the weak hands are out.

KKR Weekly Chart

KKR Daily Chart

Lending Club (LC)

Why the Strength

LendingClub (covered in the August 9 issue) is the world’s largest peer-to-peer online lending marketplace and has become the only full-spectrum fintech marketplace bank in the U.S. thanks to its recent acquisition of Radius Bancorp. LendingClub’s main business involves originating unsecured personal loans for refinancing credit card debt or to make major purchases. Owning Radius now means the firm no longer has to rely on third-party banks for loan origination and can instead cheaply fund those loans with low-cost deposits, which should fuel future growth. But what sets LendingClub apart from other lenders is its ability to leverage data and artificial intelligence (AI) to facilitate loan approvals that have a good shot at being paid back. The company further offers lower rates than most credit card issuers, and while it’s able to resell its loans to other banks and financial firms, it now intends to keep 15% to 25% of those loans on its balance sheet—mostly from higher-quality borrowers—in order to collect monthly payments (a strategy management believes will prove far more profitable than reselling loans, while also encouraging more client trust). That more borrowers are turning to LendingClub was seen in Q2 when the firm crushed estimates of between 15% and 28% loan growth in Q2 with loan originations that were up 84% from the prior quarter, while revenue was up 93% sequentially (406% higher from a year ago). This prompted the firm to raise its full-year loan origination guidance to $10 billion at the midpoint, from previous midpoint guidance of around $7 billion—the big reason for the strength. LendingClub also guided for Q3 revenue to be nearly 200% higher than a year ago (up 9% sequentially) at the midpoint, in line with expectations.

Technical Analysis

After a year of wild volatility, LC turned the corner with a huge gap up from 16 to 24 on record volume following its Q2 report at the end of July. The stock went on to post new highs for the next five weeks before the recent pullback—while the recent haircut has come quickly, it’s far from abnormal given the prior run. With the market again iffy, further wiggles wouldn’t shock us, but if you don’t own any, we’re OK starting small as shares pull in toward their 50-day line.

LC Weekly Chart

LC Daily Chart

Lululemon Athletica (LULU)

lululemon.com

Why the Strength

Lululemon is well known for its “athleisure” apparel for yoga, running and working out, based on a “Science of Feel” platform that focuses on creating a distraction-free and weightless sensation for the wearer. The company caught a big tailwind from the pandemic when suddenly home-bound workers began wearing its ultra-comfortable clothing (especially leggings) around the house. A combination of extended work-from-home and laxer dress codes at work have further resulted in booming sales for the company, allowing the brand to expand at an eye-opening 28% compound annual growth rate (versus 19% in the years before the pandemic), led by soaring e-commerce sales. Now that Covid restrictions are loosening, its brick-and-mortar outlets are seeing improved business as well, providing momentum on both fronts and allowing Lululemon to surpass its 2023 sales target by the end of this year (a reason for the strength). Revenue in Q2 increased 28% on a two-year basis (which the company uses to smooth out last year’s volatility), led by a 43% increase in international sales and a 26% bump in North American sales, with e-commerce making up 41% of total revenues. Per-share earnings of $1.65 beat the consensus by a huge 46 cents and were “significantly ahead” of the firm’s expectations. Lululemon also noted that productivity in stores has already returned to pre-pandemic levels, with 95% of stores reopened by the end of Q2, plus 11 new stores opened during the quarter, bringing the total to 534. Management believes the firm is in the early innings of growth and repurchased $171 million in shares during Q2 alone. Wall Street, meanwhile, has been raising price targets and sees earnings not only surging 59% this year but another 21% next.

Technical Analysis

Unlike many of its apparel retail peers, LULU broke quickly out of the gate following last year’s crash and reached new highs just two months after the March low. Shares continued to surge higher into September, but that turned into a lasting top—as of two weeks ago, the stock was still hanging around that peak. But earnings may have changed things, as LULU popped on big weekly volume after that news and has held relatively firm since despite the wobbly market. If you want in, you can start a small position here.

LULU Weekly Chart

LULU Daily Chart

Natera (NTRA)

natera.com

Why the Strength

Cell-free DNA (cfDNA) are fragments of DNA freely circulating in the bloodstream. They can be captured in a simple blood draw and examined for indications of diseases and abnormalities ranging from signs of cancer to whether a fetus has a genetic condition. Natera has built a fast-growing business out of cfDNA testing for women’s health, oncology and organ health. Specifically, it has a widely used non-invasive prenatal test called Panorama, with which fetal problems can be identified through the mother’s blood. It also produces a cancer test, Signatera, that can identify specific cancers, and Prospera, a test to determine odds of kidney transplant rejection. Natera tests can be as sensitive as identifying one target molecule in a vial of blood, accuracy that is helping the company win market share. Recently the company improved its Prospera test to be 20% more accurate by tallying both the percentage of targeted DNA in a sample as well as the absolute amount of it found in a vial–information doctors use to eliminate false-positives. The same method is being rolled out into its other tests and also to expand applications for Prospera; Natera is developing a heart transplant test, a $100 million annual market where there is just one competing test. Business recently got a big boost with Signatera being awarded “ADLT” status by Medicare, which means it now receives $3,500 reimbursement per standard monitoring blood test, up from $750. Natera is still a young company (it IPO’d in 2015) and has yet to turn a profit, with net losses projected to be $4.65 a share this year. The financials are shifting in the right direction, however – its women health arm just reached cash flow positive and management suggests 2021 revenue could hit $620 million, 20% stronger than they offered at the start of the year. Long term, there’s a revolution going on in testing, and Natera looks like one of the leaders.

Technical Analysis

NTRA has had a choppy 2021, topping out in the mid-120s multiple times and seeing bears push shares into the 80s in May, beneath its 40-week moving average. The stock began repairing the damage in June and looked prepped for a “real” breakout late last week, though the market’s plunge yanked NTRA back down today. Still, the setup looks solid—you can either nibble here or wait for a decisive upmove.

NTRA Weekly Chart

NTRA Daily Chart

Wingstop (WING)

wingstop.com

Why the Strength

Wingstop is a relatively small outfit, with an annual run rate of just $300 million in revenue and a market cap ($5.5 billion) that’s near small-cap territory. But the company has about as clear a multi-year runway of growth as you’ll find, while the move to more digital ordering is playing right into the firm’s hands. The story is simple: Wingstop offers customers wings, tenders and even thighs in 11 different flavors, along with some other bar-type grub (dips, fries, shakes). The big long-term attraction here was and still is the cookie-cutter story: The firm ended June with just over 1,600 locations (most franchised), but management believes there’s the potential for 6,000 worldwide—it sees Wingstop as a top 10 global restaurant brand down the road! (2021 should see a very solid 12% increase in the restaurant count.) But another big factor in its favor is that the business has always been takeout oriented, and that’s been even more prominent since the virus came on the scene—in Q2, a whopping 65% of the firm’s orders came online, and it has an aspirational goal of getting 100% of orders digitally. And that means the economics of its locations are greatly improved. Get this: In 2019, new locations averaged $900k in revenue in their first year, but in recent quarters, that’s bumped up to $1.2 million, all while the initial opening cost ($400k) has remained the same. Near term, growth may slow due to tough comparisons, but there’s no doubt business remains strong (same-store sales up 2% in Q2 on top of a 34% gain a year ago!) and that the company will get much bigger over time.

Technical Analysis

WING did very well after last year’s March low, but it effectively topped out in August—there have been some multi-month downmoves and multi-month rallies, but a year after that peak, the stock was unchanged. But while WING hasn’t decisively broken out, the action has been much calmer in recent weeks and shares have staged a modest move to new highs last week. The market environment is an issue, of course, but snagging a small position on dips is fine by us.

WING Weekly Chart

WING 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 September 27, 2021.