Cabot Early Opportunities Issue: June 20, 2024

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Stocks in This Issue

What’s up with Apple (AAPL)?

I added Apple (APPL) to our portfolio last month, saying that I saw an emerging opportunity given strategic moves management has made to get growth going again.

Over the last month, shares have jumped 13% and stepped out to a new all-time high.

What’s the deal, and is there more upside ahead?

The simple answer is “yes.”

Pretty much everything that I was looking for when I added AAPL a month ago is on track to play out.

Most importantly, Apple has laid the groundwork for a significant upgrade cycle across iPhones, iPads and Macs, all of which are getting better AI-specific hardware and AI features – called “Apple Intelligence” – with industry-leading user privacy measures.

There is a ton here to unpack that, at the end of the day, could make for a much bigger upgrade cycle than the last one (5G), which boosted device revenue by 44% over three years (2019 – 2022).

The hardware discussion gets technical, so we’ll keep it high-level. The key takeaway is that Apple is using its own silicon, and Apple Intelligence/AI features will mainly run on-device but be capable of using Apple’s Private Cloud Compute if/when accessing server-hosted AI models. Apple’s own chips are used on these servers.

Privacy and protection of user data is a huge discussion point for AI, and Apple’s framework seeks to assure privacy to the consumer. Whether users tap into Apple’s AI models on devices or on Private Cloud Compute, their data will not be stored. If they use third-party AI models, user permission will be required.

It’s not yet clear to me if/how this will limit the robustness of Apple’s models since it seems they would collect far less data than those with fewer privacy measures with opt-in necessary. But I’m certainly not qualified to question Apple’s strategy here.

I suspect that across the company’s massive userbase, many will be fine sharing relatively innocent data (they do on so many other platforms already so who really cares?) and it’ll be the minority working with super sensitive data. As a practical matter, that type of work will probably continue to happen within corporate IT-sanctioned solutions anyway. It’ll be interesting to see how this evolves.

Speaking of AI models, Apple decided to work with ChatGPT, the free version of which will become part of Siri. Users with premium GPT can integrate their account into Apple’s ecosystem too. Use of ChatGPT seems like a wise choice as compared to going with Google’s (GOOG) Bard or something else given relatively widespread acceptance/use/popularity of the AI tool.

So, what can users expect from all this?

Apple Intelligence will help with writing, proofreading, editing, rephrasing content into the desired tone, summarizing emails, etc. I think these are baseline AI tools at this point.

For images, it will help users create custom emojis, create images/sketches/photos/etc. based on a user’s photo library and/or inputs, search for content within a video and help find pictures in a library based on description.

Siri will become a lot smarter, capable of taking actions across applications, responding to voice/text/images and maintaining a conversational context.

None of this will cost users anything. No subscription fees. They’ll just need to fork over the cash for the devices.

In terms of what devices these features will work on, the upcoming (fall time frame) release of iOS 18, iPadOS 18 and macOS Sequoia will bring the goods to users, with iPhone users needing an iPhone 15 Pro model or later to work and iPad and Mac users needing an M1 version or later.

It remains to be seen how well these features will work on the current hardware, with battery life probably becoming a key concern. This is where the upgrade cycle discussion gets interesting.

The release of the iPhone 16 this September will kick off an upgrade cycle that could go on for several years given ongoing hardware improvements.

Over the last five years, the average rate of iPhone upgrades (i.e., users who bought a new device) has hovered around 17%, with 2021 representing the high-water mark at 20%.

Looking back at the 5G upgrade cycle, iPhone revenue climbed by 44% from 2019 to 2022 (pandemic hurt early, then helped later). Sales of iPhones have dipped since 2022 and are likely to come in around $200 billion this year. If we take a best guess of 35% growth over the next two years that gets iPhone revenue to $270 billion in 2026.

It could be less, but also could be a lot more. Adding in other devices plus Services some analysts are forecasting total company revenue of nearly $500 billion in 2026, or roughly 28% higher than this year.

That’s significant, especially if we believe – as many analysts do – that a lot more of revenue will drop to Apple’s bottom line than will for other hardware manufacturers. This is because the company is pursuing partnerships for AI and cloud-based tech while focusing investments on its own devices/hardware.

The bottom line to all this is that the building excitement around Apple’s AI strategy seems entirely logical, as does the recent move higher in the stock.

In short, it’s a buy and still one of my Top Picks right now.

What to Do Now

Same story as last month – lean cautiously bullish, try to let winners ride and add exposure to momentum names that play into the big secular trends of the day (AI, infrastructure, etc.) while picking off some names undergoing normal-looking pullbacks.

Yes, we need to be aware of the potential for a harsh pullback given the relatively poor breadth in the market (i.e., a relatively small number of big companies doing the lion’s share of the hard work). But at the same time, it’s been a loser’s game to ignore strong stocks.

Being relatively simple-minded (buy strong stocks, avoid weak ones) will continue to work, until it doesn’t.

When that happens, and it will, it’ll be time to change tack.

NEW STOCKS

AST SpaceMobile (ASTS)

AST SpaceMobile (ASTS) is a pure-play, low-earth orbit (LEO) broadband communications company. It’s been a fast-moving stock lately and is only suitable for risk-tolerant investors. We’ll start with a half-sized position so we can average down if shares pull back and it makes sense.

AST is on a mission to build the world’s first space-based cellular broadband network that can provide uninterrupted smartphone coverage across the globe.

This is a potentially huge market given that over 40% of the global population lacks cellular broadband and 90% of the earth’s surface has no cellular coverage at all.

AST’s most direct competitor is Starlink, a SpaceX subsidiary that has deals with T-Mobile in the U.S.

The company’s network is called SpaceMobile, and in the not-too-distant future, you may just tap a few buttons on your cell phone to connect. It’s designed so ordinary mobile phones can connect at 4G/5G speeds whether on land, at sea or in flight.

The company’s satellites operate similarly to cell towers, just at a different scale. They have a large surface area of phased-array antennas that work together to electronically form, steer and shape wireless communication beams into cells of coverage.

Mobile phones and other cellular devices connect to the satellites via frequencies that are shared with wireless customers.

AST currently has the BlueWalker 3 test satellite in space. In September of last year, it worked to connect calls from Hawaii to Spain via AT&T (T) spectrum.

The company is working with major mobile network operators and wireless ecosystem players, including AT&T, Vodafone (VOD), Orange (ORAN), Google (GOOG), American Tower (AMT) and Bell.

Its business plan is to work with these operators, which have over 2.8 billion existing subscribers, under a revenue share model designed to allow users to sign up with a simple text message for a day pass, a monthly rate, an emergency connection or an IoT connection.

To date, AST has raised over $1.2 billion. This includes a strategic investment of over $200 million in January 2024 from new investors AT&T and Google, as well as a follow-on investment from Vodafone.

The company has an agreement with AT&T to provide space-based cellular broadband through 2030 under the revenue share arrangement. It also has a contract with the U.S. government.

Just recently (May 29) AST announced a strategic partnership with Verizon (VZ) that includes a commitment of $100 million ($65 million of commercial prepayments and $35 million of convertible notes). Verizon customers will get direct-to-cellular AST SpaceMobile service when needed over 100% of the continental U.S.

Looking forward, AST expects to launch its Block 1 (five BlueBird satellites) from Cape Canaveral shortly after they are delivered in the July – August time frame. This will be an exciting event, hopefully without any explosions. Block 2 satellites are expected in late-2024 to early-2025.

That all said, FCC approval is still needed. While expected, this is clearly a major milestone.

In terms of estimates, things are evolving quickly here so there is a wide range of potential outcomes, largely dependent on getting satellites into orbit. At the moment, it’s reasonable to expect around $50 million in 2024 revenue (was $0 last year) then upwards of $260 million in 2025.

AST won’t be profitable for a while and is likely to need to raise capital. Management has stressed its preference for strategic partnerships over dilutive equity financing. That said, management believes it has enough cash ($212 million at the end of Q1, before the Verizon deal) for the next twelve months.

The Stock
ASTS came public at 10 via SPAC IPO in late 2020 and initially did well, then suffered the fate of many SPAC IPOs (and other stocks) as the bear market took over. Over the next three years, there were lots of head fake rallies that lasted for a few months. ASTS hit a floor near 2 just a couple months ago (April 2) following the Q4 2024 earnings release. The trend changed following the AT&T agreement and Q1 earnings report (May 15). ASTS doubled, then traded between 4 and 6 until the Verizon partnership was announced (May 29), which sent shares to 9. Over the last three weeks, ASTS has climbed to around 12. This story has gone from super speculative to considerably less so given material commercial progress. That said, expect a wild ride with the stock – there’s still a lot of business development to do and the short-term trajectory is very uncertain, despite the massive long-term upside potential. BUY HALF

Celestica (CLS) ★ Top Pick ★

Celestica (CLS) is a Canadian mid-cap stock that offers investors broad-based exposure to the technology infrastructure industry, including data centers, AI, cloud computing, MedTech and defense/aerospace.

It’s a supply chain specialist, serving original equipment manufacturers (OEMs) and cloud-based service providers – including the hyperscalers (MSFT, META, GOOG, AMZN, etc.) – with a full range of product manufacturing and supply chain services.

These range from R&D for infrastructure platforms, hardware and software design solutions, engineering services, component sourcing, electronics manufacturing and assembly, systems integration, machining, order fulfillment, logistics, repair and more.

While not the biggest supplier out there, Celestia provides all the solutions necessary to build out an entire AI data center. That’s a big-picture growth tailwind as more customers look to consolidate the number of vendors on these complex projects.

Celestica reports in two segments.

The Advanced Technology Solutions (ATS) segment is about 42% of revenue and grew by 11% last year but isn’t expected to grow much in 2024 due to macro headwinds. Management says things should pick up in Q4. This segment serves the aerospace, defense, industrial, health tech and capital equipment markets.

The more exciting segment is Connectivity & Cloud Solutions (CCS). This is where the action is (+38% in Q1) given intense demand for servers, storage and networking solutions from hyperscale customers.

Growth of High-Performance Solutions (HPC) is expected to be a particularly strong contributor to CCS segment revenue this year as AI infrastructure is built out. Celestica offers equipment like 400g and 800g switches, one of the main building blocks used in data centers.

Management sees strong CCS segment revenue through 2024 helping to drive full-year revenue growth of 14% ($9.1 billion) and EPS growth of 36% ($3.30).

If you’re looking for a picks-and-shovels-type play on tech infrastructure with a medium-sized company, Celestica should fit the bill.

The Stock
CLS shares have doubled year to date, solid performance following a move from around 11 to 30 in 2023. On the other hand, CLS also had many years of completely unremarkable performance, and these types of infrastructure buildouts aren’t flash-in-the-pan movements. It’s altogether possible there’s a lot of performance left in the tank. Over the last three months, CLS has had a few completely normal-looking pullbacks to its 25- and 50-day moving average lines (biggest drawdown was around 21% in April). The stock is currently recovering from a 16% pullback (61 to 50.9) that began three weeks ago. BUY

Core & Main (CNM)

I added Core & Main (CNM) to our Watch List last month and was glad we didn’t buy. The stock pulled back into earnings then dropped 15% the day after the release.

We’ll take a swing at the name today for three reasons.

First, the compelling growth story remains intact.

Second, Q1 results topped expectations, and management raised full-year guidance.

And third, the stock is recovering, and a $500 million buyback authorization signals a decent vote of confidence from management.

To refresh your memory, Core & Main is from the class of 2020 IPOs and has a nice, clean growth profile and easy-to-digest story.

It distributes products for water, wastewater, storm drainage and fire protection.

Pipes, valves and fittings generate 67% of revenue, storm drainage products make up 15% and fire protection and meter solutions make up the remaining 18%.

Around 42% of revenue comes from municipal projects, 38% is non-residential and 20% is residential. The business is evenly split between new construction and repair/replace projects.

On the Q1 call, management talked about decent activity in residential for the first time in over a year as well as good activity in roads and data centers.

The company is growing organically but acquisitions also play a significant role. This is one of the reasons storm drainage solutions was up 18% in Q1.

Stepping back, revenue was up bigly in fiscal 2023 (+32%) then slowed considerably to just +1% in fiscal 2024 (which ended in January). Things are normalizing this year.

Prior to the Q1 report, we expected 11.3% revenue growth and 14% EPS growth. On the back of management’s raised revenue guidance, we’re now looking for fiscal 2025 revenue growth of almost 12% ($7.5 billion). EPS looks like it will come in a little lower than previously expected ($2.34 versus $2.45 a month ago) given a return to a more normal operating environment with some price deflation and competitive bidding.

The Stock
CNM marched steadily higher from the December 5 earnings report (stock was near 35) until it reached 60 on April 3. A little pullback to 53.3 soon followed, but CNM got back in gear and hit a fresh all-time high of 62.2 on May 15. The stock lost some ground heading into the June 4 earnings report then sank 15% to close at 48 that day. Shares have since recovered to around 52. We’ll take a shot at CNM here and see if we can ride it for a quick double-digit gain. BUY

Nova Measuring (NVMI)

The semiconductor industry continues to recover, and while it’s not red hot across all areas – auto, industrial and personal computers are better characterized as “warm” – the race to develop generative artificial intelligence (AI) models is driving intense demand for technology infrastructure.

This creates a compelling setup for Nova Measuring (NVMI), a mid-cap manufacturer of semiconductor capital equipment. Nova specializes in dimensional and materials metrology (measuring) solutions for process control used in semiconductor manufacturing.

The company is benefiting from intense demand for semiconductor chips for AI, the increasing complexity of manufacturing them (which requires new equipment from NVMI, KLAC, CAMT, etc.) and the movement to bring some semi manufacturing back to the U.S. (reshoring).

Nova offers a portfolio of high-precision metrology tools (78% of 2023 revenue) and related services and software (22% of revenue) that help integrated circuit (IC) manufacturers manage yield through the semi fabrication process.

The company’s solutions are particularly important when the market is moving fast, as it is now, to transition from one complex technology node to the next. Each jump to the next node requires more processes and greater capital investment per wafer.

Nova’s current X-Ray metrology (unique in the marketplace) and exposure to advanced packaging and High-Bandwidth Memory (HBM) are particularly compelling in the current environment.

Management has indicated outsized demand should drive mid-teens revenue from wafer fabrication equipment (WFE) over the next couple of years while services revenue should hold steady at around 10%.

This has analysts calling for total company revenue growth of 16% this year ($601 million) and next, which implies 2024 EPS of $5.47 (+12.6%), potentially accelerating toward 16% in 2025.

Nova also has around $700 million in cash, suggesting it could pick off some smaller acquisitions to boost growth further.

The Stock
NVMI came public in April of 2000, so it’s been through a number of semiconductor cycles. The stock hit a pandemic high of 149 (January 2022) then fell below 80 (October 2022) in the following bear market. Beginning in 2023, NVMI’s pattern has been mostly higher highs and higher lows on the weekly chart. The biggest drawdown was 30% last fall after the stock hit 130, but shares bounced right back in November following earnings. There was a smaller pullback (about 16%) this spring (190 to 158). But once again shares recovered after earnings and have since powered their way to a new all-time high, near 240. NVMI is trading at a premium valuation and has a ton of momentum (maybe too much), so we’ll look for a palatable entry point rather than jumping in today. WATCH

Vertex (VERX)

In the darkness that has enveloped the software space, Vertex (VERX) stands out as an incredibly bright star. Shares of the $5.5 billion market cap company are approaching their all-time high from 2021, which closely followed the IPO.

The company offers tax compliance efficiency solutions that address major pain points to the biggest companies in the world. Customers with extremely complicated tax operations turn to Vertex to automate their end-to-end indirect tax processes.

Indirect tax includes sales tax, seller’s use tax, consumer use tax and value-added tax. It’s the biggest corporate tax category in the world, and the biggest of the big retailers – like Walmart (WMT) and Costco (COST) – rely on Vertex to get the job done and comply with all the ever-changing rules.

The company is also doing more business in Europe, the exit of competitor Avalara (taken private) is opening up opportunities, an SAP (SAP) co-sell partnership is in the early stages of bearing fruit and a new offering, Tax Calculation Service for Microsoft Dynamic, represents incremental upside to growth.

Perhaps most interesting to those of us that don’t get overly excited about tax software, Vertex recently announced the acquisition of a proprietary AI technology that’s mainly used for tax categorization (mapping a customer’s SKUs for sales and use tax purposes).

This is a super time-consuming and manual process that’s as awful as it sounds. So having a tax-specific version of OpenAI’s GPT4 do the work is pretty darn attractive.

Vertex bought the tech from Ryan LLC (a Vertex partner) and has no plans to license it out, so customers can only get it from Vertex, most likely through a separate add-on module with its own pricing.

Turning to financials, Vertex has a solid profile with mid-teens revenue growth and EPS growth near 30%. In 2024 look for revenue to grow by around 15% to $657 million and for EPS to grow 35% to $0.53.

The Stock
VERX came public in July 2020 at 19 and traded as high as 39 in early 2021. Then the bear market took over. Shares finally bottomed out near 10 in the middle of 2022. The recovery was choppy at first but began to smooth out in 2023, though there have been some 15% to 20% pullbacks along the way. There were two such drawdowns this year, first in March (came after a 32% earnings-induced rally), then in early April. The Q1 report on May 8 helped VERX get back in gear, and over the last six weeks, the stock has walked up to multi-year highs near 35. We’ll start by putting VERX on our Watch List. WATCH

PORTFOLIO CHANGES SINCE LAST ISSUE

I’ve been content to sit on rising stocks since the May Issue (a nice situation to be in!) so the only recent sale has been Alamos Gold (AGI), which was sold on June 14 for a gain of 2%.

Today we will take a profit of roughly 11% on GoDaddy (GDDY) which seems to have plateaued for the time being. This sale continues our strategy of taking consistent, modest profits while we have them, which also helps us keep a more targeted portfolio of manageable size.

Turning to our Watch List, today we give the boot to Nutanix (NTNX) due to shaky performance.

An updated table of all stocks rated BUY, HOLD and WATCH as well as recent stocks SOLD, is included below.

Please note that stocks rated BUY are suitable for purchasing now. In all cases, and especially recent IPOs, I suggest averaging into every stock to spread out your cost basis.

For stocks rated BUY A HALF, you should average into a position size that’s roughly half the dollar value of your typical position. We may do this when stocks have little trading history (for instance, IPOs), when there is more uncertainty in the market or with a stock than normal, or if a stock has recently jumped higher.

Those rated HOLD are stocks that still look good and are recommended to be kept in a long-term-oriented portfolio. Or they’ve pulled back a little and are under consideration for being dropped.

Stocks rated SOLD didn’t pan out, or the uptrend has run its course for the time being. They should be sold if you own them. SOLD stocks are listed in one monthly Issue, then they fall off the SOLD list.

Please use this list to keep up with my latest thinking, and don’t hesitate to email with any questions.

Active Positions

Recently Sold Positions

The next issue of Cabot Early Opportunities will be published on July 17, 2024.

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