Cabot Early Opportunities 108

While the market has rallied roughly 25% off its closing low from March it’s not exactly a roaring bull market. We are where we are because the Fed and Treasury are lobbing money-filled grenades in all directions. Near-term market fundamentals are weak, but looking out a few quarters (or more) things should improve drastically, and that’s what the market is trying to factor in. On balance, it’s time to be conservative, but to take shots here and there. This month’s Issue of Cabot Early Opportunities offers up five options that look good right now.

Cabot Early Opportunities 108

Stock Name	Market Cap	Price	Investment Type
Adaptive Biotechnologies (ADPT)	$3.6 billion	28.16	Rapid Growth – Immune Medicine
Conmed (CNMD)	$2.11 billion	74.10	Steady, Slow Growth – MedTech
Datadog (DDOG)	$11.56 billion	38.91	Supernormal Growth – Cloud Infrastructure Monitoring
Descartes Systems (DSGX)	$3.30 billion	39.33	Growth – Supply Chain Software
Virgin Galactic Holdings (SPCE)	$3.73 billion	19.03	Disruptive Technology – Aerospace

Current Market Outlook

Off the Ventilator and Into the ICU
What a difference a month makes.

When we published the last Issue of Cabot Early Opportunities in mid-March the market was in the middle of a historic crash. As if fear of the COVID-19 pandemic wasn’t bad enough, there was fear that our financial systems were toppling. Few people were even talking about crisis number three, the utter and complete implosion in the oil market.

A month later we are in the middle of social and public health experiments that will be debated forever. The scale of stimulus spending is mind-boggling. Public and private organizations and governments around the world are throwing everything they can at this pandemic, and it appears to be working.

With economic life support coming in the form of government stimulus the market has rebounded 27% from its lows and, for the moment, appears stable. Perhaps even a little overheated in the short-term.

Stepping back from the day to day, it’s a little hard to tell if we’re still on a ventilator, or just in intensive care. However, one thing is clear: we will get checked out, but once we do it’s going to take a while before the economy will get a clean bill of health.

What to Do Now
This is a challenging time to invest because we don’t know the timeline before a significant portion of the economy can open back up.
On the one hand the market could go lower if the situation worsens and the timeline to reopening is extended. In that scenario the collateral damage will be far greater, and we will need more stimulus, which comes at a cost.

On the other hand, if the virus infection curve continues to flatten and then goes down soon (as is expected), and we can begin to incrementally open up the economy (likely with masks, more testing and maintaining social distancing), the collateral damage could be less than feared.

Thinking big picture, what we know is that massive crises require government intervention. This is often the best time to put money to work. Yes, risks and uncertainties are high, but stock prices and valuations are low.

All things considered, if you have time and liquidity on your side, you must invest, at least a little. It’s really that simple. History has shown these opportunities don’t come by all that often.

I find it encouraging that conversations have turned back to fundamentals. The focus isn’t necessarily on Q1, which just ended two weeks ago, or even Q2, which is sure to be a disaster for many companies. Even Q3 remains somewhat up in the air.

But by focusing more on companies that should get through the next two quarters and be well-positioned in Q4 and into 2021 I think investors can do quite well. At that point the consensus is that we will be exiting a recessionary environment driven by the COVID-19 pandemic, and companies should once again show their true colors.

This isn’t to say it’s time to get super-aggressive. There are still big hurdles to get over. But the trends suggest we could be in the early to middle stages of a market recovery, complete with expected bouts of volatility, and that means continue to average into select opportunities.

On that topic, this month’s Issue of Cabot Early Opportunities features a variety of stocks across the risk spectrum.

We have a company working on immune medicines, including antibody testing for COVID-19, as well as a conservative MedTech stock that’s been punished but should bounce back. The month’s Top Pick is a way to play surging demand for a specific type of cloud computing technology. We also have an economically sensitive software company looking to rebound, and a company that you’ve likely heard of but has out-of-this world potential.

As always, there should be something for everyone. Enjoy!

STOCKS

Adaptive Biotechnologies (ADPT)
Adaptive Biotechnologies (ADPT) is a newly public biotech company translating knowledge of people’s adaptive immune systems into products to diagnose, treat and monitor diseases, including certain cancers, Lyme disease and COVID-19. It has a market cap of $3.6 billion.

Adaptive’s immune medicine platform sequences T-cell receptors (TCR) and B-cell receptors (BCR), maps receptors to antigens, pairs receptor chains, and identifies drug candidates that could be potential therapies. The immune-driven medicines market is large, approaching $50 billion across research ($1 billion), diagnostics ($16 billion) and drug discovery ($31 billion).

Adaptive is generating revenue. ClonoSEQ is used to detect and monitor minimal residual disease (MRD) in bone marrow from both multiple myeloma and B cell acute lymphoblastic leukemia (ALL) patients. It is expected to launch for lymphoblastic leukemia (CLL) later this year.

In diagnostics, Adaptive is developing immunoSEQ for Lyme and Celiac disease. And in drug development the company has submitted a data package to partner Genentech for a TCR candidate that could work in multiple solid tumors.

Finally, Adaptive announced in early April that it’s working with Amgen to develop therapeutic antibodies to treat or prevent COVID-19. How might it work?

After contracting the virus, T cells are the first to respond, with antibody response from B cells following about a week later. These neutralizing antibodies protect healthy cells by binding to the virus, but not everyone makes them. Massive screening is needed to find the best performing antibodies for COVID-19. While there’s been talk of using plasma (containing antibodies) from recovered COVID-19 patients, that solution wouldn’t be as consistent or scalable as a synthetic product made in a lab.

Adaptive’s role with Amgen is to sequence BCRs from hundreds of recovered COVID-19 patients to find the most effective antibodies. Amgen will then select the best antibodies to neutralize the virus then, with a little luck, develop, manufacture and distribute a therapy. The road to developing an antibody-based therapy (months) should be far shorter than that required to develop a vaccine (one year or more).

Additionally, Adaptive is working with Microsoft on a TCR-based diagnostic test for COVID-19. This test could yield highly accurate results as an early detection tool (before antibody response), to help categorize patient risk (by measuring response rate of T cells) and to detect immunity (for those previously infected).

In terms of growth, testing volumes grew by 66% in Q4 2019, driving revenue up 41% to $24.2 million. For the full year revenue was up 53%. The company had an adjusted EPS loss of -$0.56 in 2019. It ended the year with $682 million.

Consensus estimates for 2020 have fallen a little to reflect disruption in existing business from COVID-19. The longer the pandemic lasts the greater the disruption. For now, revenue is seen up around 30% this year, then soaring by 73% in 2021. Adaptive is expected to lose roughly $1.00 per share each year.

The Stock
ADPT came public at 20 in June 2019 and doubled its first day. Shares peaked at 55 in early September then retreated into the mid-20s by October. Trading action was choppy but relatively stable through lockup expiration in December and a secondary offering in January. Shares hit 34.60 before the market crashed in March, at which point ADPT briefly fell back below its IPO price. It has since recovered back into the mid-20s. The area around 24 should provide some support.

Conmed (CNMD)
Conmed (CNMD) is $2.1 billion market cap MedTech company that provides surgical devices and equipment for minimally invasive procedures. The company is primarily focused in orthopedics and general surgery, but also generates sales from thoracic surgery, gynecology, neurosurgery and gastroenterology.

Roughly 80% of revenue is recurring, coming from single-use products that include shaver blades, burrs, and pump tubing. The other 20% comes from capital equipment sales.

While growth isn’t off the charts – in a normal market, investors should expect mid-to-high single-digit revenue growth and double-digit EPS growth – the story here isn’t about growth at a blistering pace. The real attraction is that Conmed is a conservative growth story with market leading products in niche markets where it can do better than both larger and smaller competitors.

This “sweet spot” market positioning is achieved because Conmed is big enough to outcompete smaller companies, but it’s not so big that it gets pulled in all different directions. Rather, management is focused on giving customers what they need. That’s led to a culture of instrument innovation, which has driven loyalty, pricing power and leading market share in core markets.

Conmed has shown an appetite to expand through acquisitions. The most recent was Buffalo Filter, which was acquired in 2019 for $365 million. Buffalo Filter holds a dominant market share in devices for surgical smoke evacuation (getting rid of surgical smoke during surgical procedures) and was growing north of 20% annually when it was acquired.

There are near-term risks. There will be a dip in procedures in the first half of 2020, and hospital capital spending has fallen as the focus has turned to handling COVID-19 patient volume and slashing costs elsewhere. Also, Conmed’s long-term debt is relatively high (but falling) at $755 million, largely due to the acquisition of Buffalo Filter.

In 2019 revenue was up 11% to $955 million and adjusted EPS rose 21% to $2.64. Management pre-announced Q1 2020 earnings on March 10, saying revenue would be up 2% to 4% instead of up 5% to 6% because of COVID-19. Adjusted EPS is seen around $0.60, close to consensus estimates because of favorable tax adjustments.

Actual results could easily be worse than the Q1 guide given what’s happened over the last month. But big picture, Conmed’s steady growth profile makes it attractive for many high-quality mutual funds, many of which are sure to start snapping up shares with the stock roughly 37% off its high.

The Stock
CNMD has been public for a long time. Shares had been trending higher for the last three years. The most recent breakout came last June when CNMD broke out to multi-year highs above 83. Shares ran as high as 116 in November before flattening out. They dipped to 100 before the market crash, which pulled CNMD back near 42 at the worst point. Shares have since rallied back into the low 70s.

Datadog (DDOG)

When applications first began appearing in the cloud over a decade ago those resources were in early stages of development. A hiccup or outage here and there was no big deal.

That’s not the case anymore. As cloud infrastructure from Microsoft, Amazon and Google becomes the backbone of so many computing environments the margin for error on hosted applications is razor thin. If a core solution goes down for even a short spell that could mean disaster, or at the very least, very angry customers.

The rise of cloud computing has led to a surge in demand for cloud infrastructure monitoring to make sure all is working as it should. Datadog (DDOG) is one of the leaders in the market for public cloud infrastructure monitoring and is rapidly expanding into the private cloud and on-premise environments as well. It has a market cap of $11.6 billion.

The company’s supernormal growth rate – revenue was up 83% in 2019 – reflects that Datadog is signing customers left and right. There are probably half a million potential customers out there willing to pay $40,000 to $200,000 a year. Add it all up and you get an addressable market of around $35 billion. In other words, it’s a sizeable market.

Why are they choosing Datadog?

Datadog has what’s arguably the best platform across the three core markets in monitoring, which include infrastructure monitoring (where it is the leader), application program monitoring (APM), and logging. It’s not as strong in the latter two markets where Dynatrace (DT), another of our stocks, and Splunk (SPLK), are the respective leaders. Those companies are attractive investments too. But Datadog’s likely the best positioned to snag customers who want one vendor to cover all three needs across monitoring.

Growth is eye popping. Revenue was up 83% last year and is seen up nearly 50% this year, though it remains to be seen what impact the COVID-19 pandemic has had. The company is not profitable, but not far off either. Adjusted EPS was -$0.04 in 2019 and is seen around -$0.06 this year.

Equally impressive is that Datadog has a dollar-based retention rate near 130%, which means the average customer is increasing spend with the company every year. That’s a great sign and suggests a good deal of resiliency in the business model during any downturn. Shares are trading 22% off their February high and lockup expiration just passed a few weeks ago.

The Stock
DDOG came public at 27 last September and jumped 39% its first day. It pulled back to its IPO price soon after, then blasted off to new highs over 40 after the company’s first earnings report. Another dip then DDOG ran to 50 by mid-February. That was the top. Shares pulled back into the next earnings report then the market crash sent them back near 29. Notably, DDOG never fell below its IPO price. Shares have been grinding higher for the past month.

Descartes Systems (DSGX)
Descartes Systems (DSGX) is a $3.3 billion market cap company that specializes in logistics management software solutions. The company operates the largest multi-modal logistics network in the world. Its range of product offerings and integrations has led to loyal, long-term customers.

Big picture, this company is all about software that helps things get where they need to go. This is something customers need in all times given increasingly complex global trade networks that are often disrupted, which slows down delivery time.

Descartes helps customers overcome these challenges by offering faster deliveries to market. The secret sauce is a proprietary logistics data and an analytics platform that automates and optimizes inefficient delivery processes.

Products range span connectivity and document exchange, route planning, inventory and asset visibility, wireless dispatch, rate management and warehouse optimization.

These solutions help customers manage the flow of data and documents that track and control inventory, assets and people in motion, whether they interact with high- or low-tech partners.

Despite a challenging macro economy heading into the COVID-19 pandemic, Descartes has been a steady grower. Revenue was up 16% in fiscal 2019 and 18%, to $326 million, in fiscal 2020 (ended January 31), while adjusted EPS rose 14% and 13%, respectively.

There’s no doubt the business will be affected by the pandemic. Consensus estimates suggest just 4% revenue growth in 2020. That could bounce back to 12% growth in 2021. Adjusted EPS growth is currently seen accelerating, up roughly 24% this year and next, though all bets are off until management reports, which should be in late May.

Stepping back, this company has been a consistent performer for years. While the pandemic will inflict its damage in the near-term, it will also allow conservative growth investors the opportunity to buy shares in a high-quality and profitable company that should emerge just fine.

The Stock
DSGX had been a steadfast performer for the greater part of the last decade, up until recently. The most recent selloff, which took DSGX well below its 200-day moving average line, was by far the worst in recent memory. Prior to this most retreats reversed near the 50-day line (2018 was the other exception). Going into February DSGX was trading at all-time highs near 47. It crashed to below 30 in early March but has been gaining altitude steadily since. With shares trading around 39 and roughly 17% off their high DSGX looks good now.

Virgin Galactic Holdings (SPCE)
Virgin Galactic Holdings (SPCE) just might be the most exciting stock in recent memory. It is young (just came public in 2019), relatively small (market cap just over $3 billion) and is involved in space tourism. Plus, it’s led by billionaire entrepreneur Richard Branson. What more can you ask for?

The growth opportunity is undeniably attractive for early-stage investors, though the risks are significant. Success depends on Virgin Galactic essentially pioneering two major markets.

The first is space tourism. Virgin Galactic plans to launch its first flight into the upper atmosphere later in 2020, with Branson on board. The trips are expected to take around 90 minutes and cost $250,000 per person. The company has over 600 reservations right now and is seen growing that to over 3,000 by 2030.

The second major market, and the larger opportunity, is the hypersonic point-to-point travel market. This could mean a flight from New York to London in one hour and Los Angeles to Sydney in 2.5 hours. This business relies on transferring “proven” technology from the space tourism business into the high-speed travel market.

Success on this front could upend the multi-trillion-dollar airline market. High-speed travel could be a roughly $800 billion market within the next two decades and Virgin Galactic is positioning itself to be a major player.

The amount of investment required is massive (tens of billions of dollars) but given what Virgin Galactic is already doing and the ability of its founder to knock down barriers (he’s already started commercial airline companies) nothing is off the table.

To succeed Virgin Galactic needs to have technology, reusable spacecraft, infrastructure and cash. It’s well on its way and has been assembling the pieces since 2004, including The Space Company (composite aircraft manufacturing) and Spaceport America (spaceport with personnel and passenger training, aircraft maintenance and flight coordination).

Management believes Virgin Galactic’s space tourism business could grow to 270 flights by the end of 2023, assuming five aircrafts making 54 flights a year. In this scenario revenue could top $500 million in three years.

Virgin Galactic generated $4 million in revenue in 2019 from transporting scientific payloads. It lost $211 million and ended the year with $480 million in cash. Consensus estimates assume zero revenue in 2020, then $110 million in 2021.

There are plenty of risks. One in-flight explosion would be a major problem, two or more could be devastating. There are also regulations and customer demand issues that could arise. Competition is on the rise (Blue Origin, SpaceX) and cash flow is far from a guarantee (breakeven might not be for five or more years).

Still, it’s a hard stock to avoid if you’re even a modest thrill seeker! In terms of when to buy, the honest truth is we don’t know where this is going and what’s a fair price to pay for the stock because so much is up in the air (so to speak). The best advice I can give is to average in.

Just yesterday the stock soared over 20% so we are starting with a half position.

The Stock
SPCE came public on October 28, 2019 after merging with a special purpose vehicle and closed the first day roughly flat, at 11.75. Shares then retreated in November, hitting a low of 6.90, before blasting off and rallying as high as 42.49 by February 20. As the market crashed so too did SPCE; shares fell to an intra-day low of 9.06 on March 18. SPCE doubled soon after, to hit 18.39, then dipped back near 12 in early April. SPCE is now trading around 19. Average in, starting with no more than a half position now.

Previously Recommended Stocks
We have had just a few changes since the March Issue. Yesterday, via Special Bulletin, I DROPPED coverage of both Arco Platform (ARCE) and Endava (DAVA).

Today, I am moving two stocks to HOLD, including Chewy (CHWY) and Sprout Social (SPT). One stock, Axonics Modulation (AXNX), moves to BUY. Please take note of any changes in the table below where you’ll find previously recommended Cabot Early Opportunities stocks.

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.

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

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

^Average of high and low price if published intraday, or closing price if published after 4 PM ET

The next issue of Cabot Early Opportunities will be published on May 20, 2020

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