Cabot Stock of the Month Issue: March 9, 2023

Market Review

A new day, and maybe a new term for some of us. That is, “rolling recession.” After expectations of a hard landing, then soft landing, then pushing a possible recession further down the line, economists have now decided we may just be having a rolling recession, which affects just a few industries at a time.

So, I guess, currently, that could possibly mean that the following sectors which are negative so far in 2023 may be in a recession:

Personally, I think it’s too early to tell.

Everyone continues to talk about the bad housing market. But pending home sales were just reported—up 8.1% compared to the 0.9% forecast. And home prices are mitigating; According to the S&P Case-Shiller home price index, they rose just 4.6%, compared to the estimate of 5.2%. Jobless claims are still at a good level. And consumer confidence remains healthy. The unemployment rate for February will be announced on Friday, but most economists are not expecting any major moves.

As to the market, let’s just say volatility continues. Here at Cabot, we‘re not forecasting smooth sailing ahead, but we’re seeing signs of optimism, encouraged by the pullback which has left plenty of buyable stocks, like the tech company I am recommending for you this month.

Feature Recommendation: Shift4 Payments, Inc. (FOUR): A Rising Payments Star

My recommendation today comes from Mike Cintolo, Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader.

Growth stocks have taken the lead so far this year with mid-caps up 9.77%, small caps gaining 9.59% and large caps rising 9.41%. With that in mind, I asked Mike for some growth ideas for our newsletter.

His reply: “Well, I only have a few names, and to be fair I’m not advising people to pile in here, waiting for the market to get right. But I am very optimistic about and Shift4 (FOUR).”

“Shift4 looks to me like the new payment leader—at least in market terms—sort of the next in line after Block and PayPal and, before them, Visa and MasterCard, of course. It’s been around for a while, and it’s taking share in its core restaurant and hospitality areas, but it’s also entering many new verticals that should contribute to growth. Despite the economic uncertainties, the firm just posted a very solid Q4 and 2023 outlook.”

In his original recommendation, Mike had this to say about Shift4:

“Growth stocks continue to bring up the rear of the market for the most part (with lots of rotation and selling on strength), but Shift4 continues to look like an exception, with the stock continuing to test multi-month highs even when the market and growth stocks hit the skids.

“And we think there’s good reason for it: Shift4’s integrated payment solutions have had a big following for years (over 200,000 clients), starting with the restaurant and hospitality area but expanding rapidly of late to include many newer growth sectors like gambling, sports and entertainment (including stadiums; its offering is great for large areas and campuses), travel, non-profits and more, and is attractive bigger fish in the process (average merchant spending is three times the size compared to 2019).

“Shift4’s new cloud-based SkyTab point-of-sale system (new as of September) could be big, offering not just payment processing but front-to-back operations management for restaurant owners and free loyalty, online ordering, and marketplace modules. it’s useful in many non-restaurant settings, too.

“Even better, though, is the potential of its new sectors, with Shift4 inking tons of seemingly big deals (biggest theme park in the U.S.; biggest casino in the world; multiple stadiums including NRG Stadium in Houston; St. Jude Children’s Hospital and more than 2,000 non-profits; up and running with Allegiant Airlines as of Q4) that should goose volume going ahead.

“There is competition, but Shift4 is certainly gaining share, with the only worry being the economy—a big recession could crimp spending and profits, of course. But the momentum of the business looks powerful: Not only are sales, payment volume, earnings and free cash flow kiting higher, but estimates have moved up nicely during the past year (unlike most peers) and management believes revenues can rise nearly 60% during the next two years (2023 and 2024) while payment volume more than doubles. It’s a big story.

“While most payment peers languish, FOUR bottomed in July and rallied nicely after earnings in August, and it held up well (albeit with a lot of hacking around) during the market’s fall plunge, with the stock “only” seeing a brief shakeout in November before snapping back. And now, while still choppy, FOUR is nosing to higher highs—the RP line hit a new peak just before year end, and FOUR continues toy with multi-month highs.”

Shift4 is a company that just turned a profit for the first time two years ago. Since then, the picture has continued to brighten. In 2022, EPS grew by 223% annually. In its fourth quarter (2022), Shift4 posted EPS of $0.46 on revenues of nearly $538 million. Looking forward, Shift4 is anticipating that its end-to-end payment volume will rise to $109 billion, and EBITDA to reach $435 million, with $200 million of adjusted free cash flow.

Better yet, the company is expected to grow earnings 47% in 2023 and 42% in 2024, per FactSet estimates.

Liking the report as well as the forecasts, Wall Street analysts raised their price targets to $85 per share, with Piper Sandler saying they “think Shift4 could potentially double sales over the next three years while boosting its margin.”

The future looks stellar for the company. Analysts now are forecasting that over the next three years, Shift4’s revenues will rise by 24% annually—and that’s extremely healthy, compared to the estimated 10% growth for other infotech companies.

Certainly, the company’s shares are trading at a lofty P/E, but like with all fast-growing tech companies, my evaluation gives more value to growth forecasts than current valuation, and Shift4’s growth prospects are very tasty, so I’m not too worried about the P/E. However, I will keep a close watch on it, as I consider this stock Aggressive. Having said that, I would recommend that you place a 30% trailing stop-loss on the shares when you purchase them.

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About the Analyst: Mike Cintolo, Cabot Growth Investor and Cabot Top Ten Trader

A growth stock and market timing expert, Michael Cintolo is chief analyst of Cabot Growth Investor and Cabot Top Ten Trader. Since joining Cabot in 1999, Mike has uncovered exceptional growth stocks and helped to create new tools and rules for buying and selling stocks. Perhaps most notable was his development of the proprietary trend-following market timing system, Cabot Tides, which has helped Cabot place among the top handful of market-timing newsletters numerous times.

Nancy: In a recent issue of Cabot Top Ten Trader, you wrote: “Ideally, this three-week dip leads to a resumption of the January rally—but the next few days should tell the tale. Right now, given the late-Friday firmness and today’s bounce, we’ll leave our Market Monitor at a level 6, but we’re watching closely.”

Would you please update your thoughts on the market, and explain what “Market Monitor level 6" means?

Mike: Level 6 is on a scale from 1-10, with 10 being fully bullish. In a sense, you could look at it similar to 40% cash/60% invested, though it’s not exactly like that. Mostly, we’re slightly leaning bullish but, really, we’re near the cusp here, intermediate-term: Much more weakness would probably have me paring back a bit more (level 5, etc.), though frankly, a really good week or so could have me flooring the accelerator, as I see a ton of stocks that want to go up if the market lets them. For now, though, still mostly waiting, with a good chunk of cash but also a few stocks.

Nancy: Many tech stocks have seen a nice bounce since the beginning of the year. I note that your CTT portfolio includes quite a few technology companies, but I also see that you don’t have any FAANG stocks in your holdings.

Will you elaborate on your current “tech” sector thinking, giving my subscribers a peek into your ideal tech sectors right now, and why you may be avoiding the FAANGs?

Mike: I’m definitely thinking the FAANG days could be over—not that they’ll be “bad,” but that they won’t lead the next upturn. In fact, many of the mega-cap names seem to be the main thing dragging the indexes down of late, while some fresher names are peppier. That said, leadership is still very much in the development stage. I expect there to be a lot if a new bull emerges here, but to this point, it’s a bit of a smattering of new chip leaders, some retail and some things like aerospace and cyclicals like construction.

Nancy: Your portfolio for Cabot Growth Investor is nicely diversified. Is that intentional or just that the specific stocks in the portfolio look to be the best ideas (regardless of industry)?

Mike: I am not a huge diversification guy, so it’s basically random. However, I won’t own, say, three chip stocks, or three medical names. I will try to home in on the one (maybe two) leaders. Realize that, when fully invested, I will only have something like nine to 12 stocks, so it’s pretty concentrated.

Nancy: Growth companies appear to be taking over from Value firms at this moment. Do you think there’s a case to be made that Growth will become increasingly important this year? If so, why?

Mike: Well, I’m a growth guy, so you know I’ll say yes, right? But seriously, I would say that growth underperformed in 2021, and of course was nailed in 2022, so some rebound I think makes sense. Really, though, I don’t predict these things, just stay in gear with the market’s trends and the action of leading (and potential leading) stocks.

Nancy: With the Federal Reserve continuing to raise rates, companies with a lot of debt may see significant pressure on their earnings in 2023. If the rate extensions continue throughout this year, which sectors do you think will be most adversely affected?

Mike: This is a bit of a macro question, which to me is like kryptonite. I make it a point to (a) be aware of what’s going on, of course, but (b) to just stick with what I see. That said, maybe surprisingly, I think the fact that many defensive areas (consumer staples, utilities) held up so well last year has left them vulnerable. And indeed, even as the major indexes pulled in during February/early March, we’ve seen those areas lead the way down. No real predictions, but the debt-heavy REITs, staples, utilities, etc., could see earnings and yields stagnate for a while, which might lead people to look elsewhere.

Nancy: Are there any sectors or sub-sectors that you currently see as oversold?

Mike: I’m not big into oversold, honestly. Right now, I’m focused on stuff that’s holding up well. I will say, though, there are many areas that have (a) fallen off of late for 3-4 weeks, but (b) are still well above prior bear lows and near support. We’ll see how it plays out.

Nancy: What are the 3-5 most critical challenges to growth of the stocks in your portfolio right now?

Mike: Well, honestly, the biggest challenge is the market, and most aren’t exactly super liquid (well-traded). But I know you meant challenges fundamentally—I would simply say the risk of the Fed breaking the economy by going too far. Clearly, some things have been pulled in, but each firm I look at has something special (or at least I think they do), so it’s a matter more if the rug gets pulled out from under them.

Portfolio Updates

The Miller Value Deep Value Strategy fund recently gave a shout-out to our M/I Homes, Inc. (MHO), noting, “During the quarter, we initiated a new investment in M/I Homes, Inc., what we deem as a significantly misplaced homebuilder. M/I Homes’ share price is 40% below its recent highs, at valuation levels near/below 2008-09 and 2020 industry troughs. Homebuilders in general have been under pressure due to marketplace concerns on the potential impact from higher mortgage rates and lower housing affordability. However, we believe the positive demographics and lack of housing supply over the page 10 years provides a very favorable long-term supply/demand picture for the industry that should shorten the current downturn.

“M/I Homes is nicely diversified covering multiple home-type categories, with properties in valuable local communities in the Midwest and Southeast (#2 in the Jon Burns Real Estate Consulting Submarket Desirability Index). The company appears well positioned with a strong land portfolio and a backlog that remains higher than 2019 levels. M/I Homes also has a strong balance sheet, with net debt to capital near 25% and no debt maturities through 2028.

“With their strong backlog, management still sees potential for Return on Equity to remain above 20% which, if achieved, would lead to strong tangible book value growth over the next couple of years. With market expectations and valuation near historical troughs (EV/Revenue <0.5x, EV/EBIT near 3x and deep discount to tangible book value), the share price is already discounting a deep and extended industry trough. M/I Homes’ attractive asset base, strong balance sheet and deep valuation discount to peers should provide an attractive long-term reward/risk investment opportunity.”

Currently, the shares of M/I Homes are in 26 hedge fund portfolios, up from 23 in the previous quarter.

If you have not yet purchased shares of M/I Homes, you could add a few here. For subscribers who are already owners, Continue to Hold for now.

In his latest update on Qualcomm Inc. (QCOM), Tom Hutchinson, Chief Analyst of Cabot Dividend Investor, had this to say: “It’s been a rough market for QCOM. The stock is down over 26% for the last one-year period. But the longer-term prognosis remains bright, and the stock is also showing signs of having perhaps bottomed out. Qualcomm reported lousy earnings for the last quarter, and it appears that next quarter won’t be much better. Yet the stock remained quite resilient after the report and is still up 12% YTD. That suggests that this news was already factored into the stock price, and the market is looking towards improvement in the second half of the year. HOLD”

Investor Place had some nice comments about QCOM, saying, “This fabless model means that Qualcomm does not have to invest large amounts of cash for capital expenditures, which results in a high free-cash-flow conversion. This, in turn, means that Qualcomm has more flexibility when it comes to shareholder returns and acquisitions.

“Qualcomm also has a large patent portfolio that includes 3G, 4G and 5G tech. This generates high-margin royalty payments for the company that it can use for shareholder returns and investments in other areas.

“Qualcomm has increased its dividend for 20 years in a row. Additionally, there is a lot of room for further dividend growth, as the dividend payout ratio is below 30%. This makes the dividend very safe and should allow Qualcomm to offer sizeable dividend increases for many years to come.

“Between the dividend yield of 2.4%, forecasted EPS growth of 7%, and substantial tailwinds from multiple expansions, a mid-teens total return seems achievable.”

In other news, Qualcomm announced that it was working with a group of Android smartphone companies—Honor, Lenovo-owned Motorola, Nothing, OPPO, Vivo and Xiaomi Corp—to add satellite-based messaging capabilities to their devices. Some of these devices are expected to be released by the second half of this year.

The company also reported that its new Qualcomm Aware, a paid cloud software service, will help companies that use its chips keep tabs on shipping containers, pallets, packages and other parts of supply chains to help companies track them as they move through the supply chain.

Let’s continue to Hold.

Devon Energy (DVN) continues to suffer from declining oil prices. The IEA expects oil supplies to grow by only 1.2 million barrels per day in the near future, while demand continues to grow, giving a boost to oil prices.

For the fourth quarter of 2022, Devon missed EPS estimates, posting earnings of $1.66 per share (estimate was $1.75). Revenue was up 1%, to $4.3 billion, and operating cash flow came in at $1.9 billion, up 18% from the prior year. The good news was that free cash flow reached its all-time high for 2022, up to $6 billion.

Hedge funds have been upping their stake, with 55 now holding Devon’s shares. The average broker recommendation is “Buy.”

I’m disappointed in Devon’s performance, but am going to hold on just a bit longer, as the stock has a historical pattern of rebounding. But let’s change our recommendation to Hold for now.

Bruce Kaser, Chief Analyst of Cabot Undervalued Stocks and Cabot Turnaround Letter, updated his thoughts on Citigroup (C), saying, “Citi estimated that its wind-down of operations in Russia would cost about $190 million. This equates to about $0.10/share, pre-tax. Citi shares trade at 62% of tangible book value and 8.6x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.

“When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield (4.0% vs 3.9%) and considerably more upside potential (about 70% according to our work vs. 0% for the Treasury bond). Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation, Citi shares would seem to have a remarkably better risk/return trade-off. BUY”

I agree. Buy.

Curaleaf (CURLF) is still a buy for Michael Brush, Chief Analyst of Cabot SX Cannabis Advisor. In his most recent update, Michael commented, “States continue to make progress on legalization, cannabis sales, and tax revenue growth. States that could legalize cannabis in 2023 include Delaware, Hawaii, Maryland, Minnesota, Ohio, Oklahoma, Pennsylvania, South Carolina, and Wisconsin, says cannabis sector expert and reform advocate Tod Harrison.

“As for the third quarter, Curaleaf reported 7% year-over-year sales growth on November 7, and 1% sequential growth to bring in $340 million in the third quarter. Retail sales (76% of revenue) increased by 16% to $260 million, driven in part by store openings. Curaleaf posted its 19th consecutive quarter of retail sales growth. Wholesale revenue decreased 14% to $79 million, as the company continued to reduce its wholesale business in lower-margin states. Curaleaf losses declined to $51 million compared to $55 million in the third quarter of 2021.

“Note that this company is founder-run, which can be a plus in investing. Board chair Jordan and board vice chair Joseph Lusardi founded Curaleaf. The company has a price/sales ratio of 2.1, among the highest in the group. BUY”

Curaleaf will report fourth-quarter earnings on March 28. Analysts expect a loss of -$0.04 on $354.43 million in revenues. Recently, the consensus EPS estimate has been rising a bit. If you have not yet bought shares of CURL, know that it is a speculative stock, but looks pretty undervalued at this level. Buy.

Tyler Laundon, Chief Analyst of Cabot Early Opportunities and Cabot Small-Cap Confidential, updated his thoughts on Huron Consulting (HURN), saying, “Huron reported after the close yesterday, and results came in well ahead of expectations. Revenue of $313.7 million (+26.3%) beat by $31.3 million while adjusted EPS of $1.12 beat by $0.13. Guidance for 2023 revenue of $1.22 - $1.28 billion (+10% at the midpoint) is also ahead of expectations for $1.21 billion. EPS guidance of $3.75 to $4.25 straddles consensus of $3.98.

“Digging a little deeper, revenue in the digital capability (44% of total revenue) rose 37% to $130.1 million. Management said healthcare (+18%) and education (+44%) remain very strong markets as well. Management sounded very positive on the conference call. Huron is not followed by a lot of analysts; however, Benchmark does follow it and increased its price target from 90 to 95 this morning. Shares of HURN are up about 15% to 81. BUY”

Our shares in Huron are up a bit more than 11% today. Continue to Buy.

Our newest recommendation, Kraken Robotics (KRKNF), was updated by Carl Delfeld, Chief Analyst Cabot Explorer, who noted, “Kraken Robotics is probably the most speculative of Explorer stocks, but it is a well-run company and a prime takeover candidate in the growth defense sector, coupled with a strong management team. Based in Newfoundland, Kraken Robotics is a marine technology company providing ultra-high resolution, software-centric sensors, and underwater robotic systems. Kraken was up marginally this week as well as so far in 2023, outperforming the broader market. This maritime and defense stock remains a buy for aggressive investors. Buy a Half.”

Kraken Robotics Inc. had a nice press mention as the company was named a 2023 Top 50 by the Toronto Venture Stock Exchange, placing first in the technology category.

Continue to Buy.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

ETF Strategies

I’m not making any changes to our ETF portfolio this month. Currently, First Trust Water ETF (FIW), iShares US Energy (IYE), and ALPS Medical Breakthroughs ETF (SBIO) remain positive.

I’ll most likely be making some changes/additions to the allocations in the next few weeks; I’m just waiting to see if the market steadies out.

*Aggressive (A), Moderate (M), Conservative (C)

The Global Payments Market Has Nowhere to Go but Up!

As with most technology, I was slow to “get with the program” of mobile and online payments. And while I’m still constantly worried about fraud and the safety of my personal information, I also can’t tell you the last time I actually wrote a check for something!

Certainly, I’m not alone. The growth of digitization, e-commerce, internet penetration, and rapid adoption of mobile payments is expected to spark annual expansion of 8.2% in the global payments marketplace over the next five years.

The shift from cash was reinforced during the COVID-19 pandemic, as stores shut down leading to massive rises in e-commerce, the decline in cash usage, adoption of instant payments, and adoption of digital payments.

And it’s not just in America. EUROSTAT reports that the number of online shoppers in Europe increased from 60% in 2017 to 73% in 2021.

Mordor Intelligence reports that the Asia Pacific Region is expected to see annual growth of 22.4% in the payments business through 2028.

The major global players include Mastercard Inc., Visa Inc., UnionPay International, and PayPal Holdings Inc., AliPay (Alibaba Group), and UnionPay International.

Recent innovations in the market include:

• Sokin, a new-generation fintech payment firm, will use Mastercard’s digital-first banking solutions and card services to launch its next-generation card programs for consumers and businesses.
• Airwallex launched the Airwallex Borderless Card, a virtual multi-currency Visa business debit card that enables businesses to easily make online card payments anywhere that Visa is accepted.
• Mastercard and CRED, a leading Indian FinTech, will enable Mastercard credit card holders to make simple, secure tuition and rent payments for housing expenses using the CRED application.

Tearsheet.co/payments recently published a list of 10 Trends that will Shape the Payments Industry in 2023:

1. B2B 3.0; a new frontier of global B2B commerce is digital, secure, fast, and flexible. We’ll see a rise in B2B mobile payments as the preference for businesses to pay and be paid by phone increases, and B2B payments digitization will fuel increases in B2B e-commerce purchases.
2. More investment in payment choice to meet consumer needs.
3. More use cases for real-time payments.
4. Fraud adapts to a “hybrid” world—our new world of increasing remote workers as well as a return to traveling and eating out.
5. Increased M&A activity.
6. Every smartphone will (eventually) become a POS terminal, already evidenced by the 3 billion smartphones that are NFC-enabled (used as payment terminals).
7. Consumers will demand more sustainable payments, such as the Visa Eco benefits and carbon-neutral flight tickets.
8. More reliance on digital wallets, especially with the younger generations.
9. Businesses will move their payments data to the cloud.
10. Next payments tech focus: the automotive industry, where fintech will leverage financial innovation by “creating a universal experience across their brand from dealership to website to app to car dashboard (including one-click accessory, subscription, and charging payments).”

It’s surely a new world, as our parents and grandparents and those before them would say. And the digitization of payments is permeating almost every activity we do. And that’s a good thing for companies like Shift4, which is not only gaining market share in its core businesses but also in industries new to the company.

The next Cabot Money Club Stock of the Month issue will be published on April 13, 2023.