Cabot Top Ten Trader Issue: February 26, 2024

Getting Volatile, but Trends Remain Up

One tool that we’ve long used is, after a big move (either up or down), if the market starts to get very volatile (lots of up-down-up-down action with little net progress), it’s often a sign that the buyers and sellers are fighting it out—and could lead to a character change. That’s similar to the action we’ve seen of late, as volatility has picked up in a big way in the indexes as leading stocks have thrashed around. That said, we’re mentioning that more as a heads up than as any major red flag—at day’s end, the trends of the major indexes and most leading stocks are up, and the recent selling waves may have shaken out some weak hands ... and it’s possible that Nvidia’s (NVDA) quarterly report cleared the air last week. All told, we’re bullish but we also think the odds favor more tricky trading going ahead, with rotation, ups and downs and news-driven moves … though a few days of calm trading could change our thinking. We’ll leave our Market Monitor at a level 7 while keeping a close eye on the post-NVDA action.

This week’s list has some tech leaders, but it also has more than a few names outside of the AI field, both smaller and larger. For our Top Pick, we’re going with Eli Lilly (LLY), ideally on weakness—it’s not in the first inning of its run, but it’s a liquid leader and we think investor perception has a lot farther to run on the upside as its weight loss treatments penetrate a giant market.

Stock 1

Allison Transmission (ALSN)

Why the Strength
A post-Covid era rebound in commercial truck demand, plus soaring purchases for defense-related transportation equipment, are contributing to record sales for one of the world’s biggest players in both industries. Allison is a leading manufacturer of fully automatic transmissions for medium- and heavy-duty commercial, as well as defense vehicles, and a leader in electrified propulsion systems (used in electric hybrid and combat vehicles). Allison just released the best fourth quarter results in its history, leading to a record year driven by strong demand in its biggest end markets. Total revenue climbed 8% to $775 million in Q4 (full-year sales of $3 billion also reached a record), and earnings of $1.91 beat estimates by 32% (the main reason for the stock’s strength). The quarterly results were driven by a 14% sales increase in the North America on-highway end market, thanks largely to continued strength in customer demand for Class 8 vocational and medium-duty trucks; a 34% sales bump in the defense sales driven by increased demand for tracked and wheeled vehicles; and a 31% increase in the international off-highway end market driven by higher mining sector demand. Management said it remains committed to shareholder returns going forward (it repurchased $260 million, or 6% of shares outstanding last year, and it still has $1 billion or so of authorization left) and expects another record revenue year in 2024 while expanding its addressable markets. Growth here isn’t likely to be rapid, but the big free cash flow, share buyback plan and modest dividend (1.3%) make the current valuation (10x earnings) look cheap.

Technical Analysis
ALSN had a solid, albeit choppy, 2023, with some fits and starts early on before gliding higher to the 60 range in the summer, where it stalled out. The Q3 report in October took a chunk out of the stock, but the 40-week line held and ALSN ending up forming a decent-looking launching pad for the next few months. The breakout two weeks ago was powerful and shares extended higher after some wobbles last week. You can enter here or (preferably) on a normal retreat.

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Stock 2

Armstrong World Industries (AWI)

Why the Strength
Inflation and higher interest rates continue to create uncertainty for the overall construction sector, but major infrastructure projects around the country are proving to be a boon for commercial builders. Armstrong is a leading manufacturer of ceiling, wall and suspension systems for both commercial buildings and residential spaces, operating under two major segments: Mineral Fiber (soft and mineral fiber ceiling systems) and Architectural Specialties (commercial ceiling and wall manufacturing). The good news today is that most of Armstrong’s revenue comes from commercial structures, making the company an infrastructure spending play—a very good thing right now. Despite facing softer demand in the commercial office space (vacancy rates are high nationwide thanks to the remote work trend), Armstrong posted a solid Q4 report last week. Much of the firm’s financial strength was due to increasing activity in airport projects across the country, helped by the $15 billion in federal funds recently earmarked by Congress for airport infrastructure development (with $9 billion allocated through 2024). Management said the Mineral Fiber segment (its largest portfolio) is “uniquely positioned” to capture the opportunities provided by larger, more complex infrastructure projects that are currently being built. Total Q4 revenue of $312 million increased 3% from a year ago, while per-share earnings of $1.22 beat estimates by 17% and full-year free cash flow jumped 19% and came in ahead of earnings (at nearly $6 per share). Q4 sales in the Mineral Fiber segment rose 2% due to better-than-expected market conditions, while Architectural Specialties delivered 4% sales growth in the quarter, with contributions from recent acquisitions also helping the cause. Armstrong expects the momentum from 2023 to continue in 2024 and guided for 5% full-year revenue growth; analysts are even more sanguine and expect 8% growth this year and 12% next year, both of which are likely to prove conservative. A token dividend (0.9%) and modest share buyback program (share count down 3% from a year ago) put a nice bow on the package.

Technical Analysis
AWI didn’t hit its bear market low until last June near 62, and the stock was trading under 70 and below its 40-week line in late October—but then the buyers took control. The first wave up saw nine weeks of rallying, thanks to expectations of an easier Fed this year. After a tight digestion phase in January, AWI sneaked above the century mark for a few days before exploding higher on earnings last week. The stock is a bit thinly traded, so we’ll set our buy down from here.

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Stock 3

Celsius (CELH)

Why the Strength
Florida-based Celsius is known for its energy drinks—both sparkling and non-carbonated—which contain no preservatives or artificial colors, and which are shown to accelerate metabolism and, of course, boost energy. Its beverages have fewer calories than competitors like Monster Beverage, and it comfortably fills a niche for drinks that fall somewhere between flavored water and traditional soda. The company’s products are further aimed at health-conscious consumers who love energy drinks but want to avoid the “crash” and jitters that often accompany them (some have called Celsius the “new Red Bull”). Along with its popularity, the firm’s reach is growing, and in recent years has secured distribution agreements with big names like Costco, CVS Health, Target and Amazon, where it’s consistently a leading energy drink seller. But a distribution deal with PepsiCo, struck in 2022, has been the biggest reason for Celsius’ ability to expand its distribution. With the deal, Pepsi is now the drink’s official domestic and global distribution partner, and thanks to its assistance, Celsius now controls an estimated 10% of the worldwide energy drink market. That market share is certain to grow from here, and to that end, Celsius just announced an expansion plan into new international markets, including Canada, Ireland and the U.K. (a reason for the share price strength)—indeed, the top brass talked a lot about international growth being a big 2024 story a few months ago so there should be plenty more to come. The news prompted a major Wall Street institution to call the company the “best growth story in the consumer sector” with a “long runway of momentum” still ahead of it. Growth is the operative word here as Celsius has seen a huge acceleration of late on the sales front, with triple-digit growth the past two quarters (and likely for Q4, too, which will be released on Thursday). The top line is expected to slow to “only” 40% growth this year, but if history is any guide, that should prove conservative. Simply put, Celsius is very likely to get much, much bigger in the years ahead.

Technical Analysis
After etching out a gigantic base-on-base formation between 2022 and early 2023, CELH broke free and took flight last May on earnings. The rally continued four more months before hitting resistance near 69 in September, with sellers pulling shares down to 50 in October—and it repeatedly tested that area in the months that followed. The final test looked ugly, but CELH has pulled itself up nicely this month despite the up-and-down market. The stock is set up well ahead of earnings; if you’re aggressive, you could nibble here or on dips ahead of the report, or look for an upside gap after earnings.

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Stock 4

Coinbase (COIN)

Why the Strength
If you’re a believer that cryptocurrencies will advance over the long-term and become a major asset class, than Coinbase is a name you should be interested in. The firm is aiming to be something of a mix between the NYSE and Charles Schwab of the crypto world—Coinbase is the main way individuals and institutions trade the various digital currencies, and it’s just not bitcoin anymore; 34% of volume comes in the most popular cryptocurrency, but 15% is Ethereum and the rest is spread out among stablecoins (those linked to something, usually the U.S. dollar) and other currencies. When crypto prices move around a lot, trading volumes spike, and transaction revenue is usually the largest piece of the pie here—in Q4, for instance, trading volumes mushroomed as prices went wild, leading to a near-doubling of transaction revenue in Q4 vs. Q3! Long-term, that figure should rise, but it’s bound to be hugely volatile, so a growing piece of the pie (~40% to 50% of revenues) is subscription and service revenue, which is more stable and generally lifts over time: It includes stablecoin revenue (becoming big as it gives crypto investors a safe haven and allows people to earn interest), blockchain rewards (when users “stake” their coins, which makes it easier for farms to “mine” more crypto) and, like many brokerages, interest income from higher rates and larger customer balances. (The company also has a $30/month subscription service that offers cheaper trading fees and more.) Another big part of what’s going on here, though, is simply cost cutting, with the top brass slashing operating expenses by 45% last year and vowing to keep them relatively contained (up a few percent this year) going ahead. If you’re looking for stability, Coinbase is not it—business will swing up and down wildly with trading volumes—but if you’re bullish on crypto, this stock will surely do very well, and early Q1 results (through mid February) looked promising.

Technical Analysis
As with cryptocurrencies themselves, COIN is about as volatile as it gets among big, liquid stocks, and it generally follows the movement of crypto prices. Lately, that meant a monstrous, persistent advance from late October through year-end, followed by a very sharp pullback (39% from high to low!), with yet another romp toward the highs before and after the Q4 report. The latest dip has (you guessed it) been sharper, but it was well controlled on the chart, and of course today’s strong move is a good sign. It’s not for the faint of heart, but a small position on a little weakness has good potential.

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Stock 5

Confluent (CFLT)

Why the Strength
Confluent has a very good story, and now it’s possible the stock is starting to get moving that after the Q4 report. The firm is all about data, specifically putting it “in motion” in the firm’s words—which is a fancy way of saying there can have access to real-time, actionable data throughout an organization; called streaming data, think of it as the evolution from databases (static queries of what’s going on) to having constantly updated data sets that can be used for more timely (and often automated) decisions and offerings, whether it’s personalized recommendations for clients, dynamic pricing of goods, supply chain optimization alerts or fleet management—the applications are pretty much endless and range across many huge sectors. The firm has a legacy on-premise, self-managed offering that still makes up 48% of revenue and sports modest growth (up 17% or so in Q4), but the big draw is Confluent’s cloud offering, which leads to a lower total cost of ownership and is quickly taking share and seeing add-on buys; in Q4, the cloud offering make up 47% of revenue and grew 46% from a year ago. Both services are subscription-based (subscription revenues up 31% in Q4), and the top brass thinks it’s playing in a $60-plus billion market, so there should be lots of upside ahead. The trick here is competition—there’s lots of it, especially from the huge public cloud operators in part—and whether the recent slowdown in growth has been discounted: Management forecast just 22% top-line growth for 2024, though that’s probably conservative and is being weighed down by the on-premise solution. Like we wrote above, it’s a solid story, and if management pulls the right levers, Confluent could go far.

Technical Analysis
CFLT looked like a possible fresh leader last spring, as shares romped ahead on good volume and touched 15-month highs, but the summer/fall correction dragged the stock back down—and then the Q3 report caused a selling maelstrom that briefly pulled the stock to new bear market lows! However, the repair work started right away, and after a brief (but tight) base in December and January, CFLT stormed back to its summer range after the latest Q4 results. There’s overhead here, but we like the change in character and think most of the weak hands could be gone. If you want in, consider a small position on dips (and possibly adding a bit more if the stock heads higher from there).

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Stock 6

Eli Lilly (LLY) ★ Top Pick ★

Why the Strength
The anti-obesity drug market is projected to increase from $6 billion last year to an astounding $100 billion by 2030. What’s more, a widely publicized research report just made the case that the popular GLP-1 class of weight-loss drugs could boost U.S. GDP by 1% in the coming years as it leads to all sorts of side economic benefits. Both projections help explain Wall Street’s excitement over the latest developments at pharma giant Eli Lilly. Analysts see the company’s recently approved weight loss drug, Zepbound (tirzepatide), as being a key driver for revenue in 2024 and beyond. The once-a-week injectable prescription drug is a direct competitor to Novo Nordisk’s blockbuster Wegovy, but there’s certainly room for both. And it’s just not weight loss, either, as the same core compound is used for diabetes: Marketed under Mounjaro, the treatment is the first and only GIP and GLP-1 hormone receptor agonist approved for controlling blood sugar in Type 2 diabetes patients. Demand has been so strong for tirzepatide that capacity is limited, but Lilly is working to boost output and drive sales and earnings much higher in the years ahead. Indeed, the massive boost both drugs are forecast to contribute to business prompted a major investment bank to suggest the company could become the world’s first trillion-dollar pharma stock (one reason for the latest share price strength). And with food price inflation a key concern for millions of obese consumers, that same bank also just made the case that GLP-1 weight-loss drugs could cut grocery bills by up to 9% (a potential selling point for both Zepbound and Mounjaro). In Q4, Lilly reported total revenue of $9.4 billion, up 28% year-on-year and led by strong Mounjaro and Zepbound sales ($2.38 billion, up from $280 million a year ago), while EPS of $2.49 beat estimates by 5%. For 2024, the firm expects sales to increase 21%, led by Zepbound, while Wall Street expects earnings to reach $12.50 this year and $18 in 2025.

Technical Analysis
LLY broke out last April and exploded higher again in August before finally hitting some resistance near 600 in October—and while the market got going in November, this stock played possum, toying with that round number resistance through year-end. But 2024 brought a character change, with a move to marginal new highs in January, and then this month, a big run before and after the Q4 report. With some near-term distribution last week, we’ll set our buy range down a bit, thinking a normal exhale could be coming and provide an excellent entry point.

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Stock 7

Hyatt (H)

Why the Strength
Hyatt isn’t a true blue growth stock, but the travel boom continues (both in the U.S. and overseas), and as one of the “smaller” big hotel chains (market cap of $15.5 billion vs $52 billion for Hilton and $73 billion for Marriott), Hyatt is still expanding organically and room rates remain very strong—all while the top brass is bolstering shareholder returns. In Q4, revenues improved 5% from what was a strong year-ago quarter, while EBITDA was up 4%, but investors liked many of the sub-metrics more, including revenue per available room (RevPAR) leaping 5.9% in the quarter, while room growth was also up 5.9% from a year ago. And after lagging for a while, it looks like the overseas business is finally kicking into gear, with Q4 franchise EBITDA for Asia Pacific (up 77%) and Europe/Middle East (up 20%) small but lifting nicely. More important, 2024 should keep the momentum going, with another 6%-ish growth in total rooms and RevPar expected to lift 4% while EBITDA leaps 17%. One underappreciated fact of the hotel business is the tremendous free cash flow that can be spun off when things are good—last year, Hyatt cranked out $600 million of free cash flow (about $5.80 per share) and the firm’s early 2024 look sees that growing by 8% or so (probably conservative), with a lot of it being returned to shareholders (the firm bought back about 4% of shares outstanding last year; it expects to return about $5.50 per share worth of dividends and buybacks this year, too). It’s not a buy-and-hold-forever name, but Hyatt’s post-pandemic business trends have been outstanding and show no sign of slowing.

Technical Analysis
H actually rallied to new all-time highs in March of last year, but that was it for a while, as the stock kept running into resistance from there before finally giving way to a retreat with the market last fall. The upmove starting in November was persistent (up seven weeks in a row) and took shares to marginal new highs, and then the action got very interesting—H traded tight as a drum for nine weeks, and then this normally less-volatile stock went bananas on earnings last Friday. We don’t advise chasing it here, but the eye-opening strength should prove bullish down the road.

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Stock 8

JFrog (FROG)

Why the Strength
A rundown of JFrog’s software applications is a dive into byzantine IT terminology, with the company providing services like DevOps, DevSecOps, MLOps and MLSecOps for clients focused on “the binary” and “artifactory” uses. What’s more important to grasp is that JFrog specializes in software development systems that can span the whole of a client’s enterprise and help build secure and increasingly interoperable applications. A driving force is that IT heads at large businesses want to move their operations to having one single source of records, compared to today where many different software development and security systems often each have their own siloed data, which makes it a slog to figure out what’s up when something goes awry. Basically, clients use JFrog’s software to build more secure software while providing better visibility about the operations as a whole. For example, the company recently inked AT&T as a client to top become its single source of records and provide application security. AT&T has tens of thousands of individual developers working for its business; using JFrog will allow the company to wrangle them to both ensure data security and give the visibility its tech chiefs need to decide how to evolve the firm’s technology offerings. Providing such services is a booming business: JFrog’s revenue grew 25% in 2023, to $350 million, with 51 cents per share of earnings per share, up from 4 cents in 2022. Much of the growth comes as businesses decide they need to move to the cloud and elect to shift a lot of internal management to JFrog. That trend should raise Q1 sales about 23% to $99 million, says management, with full-year revenue seen coming in around $426 million (up 22%) with earnings per share of $0.60.

Technical Analysis
FROG came public in late 2020 and basically skied downhill from the jump, falling from 95 to 16 by mid-2022—and while that was technically the bottom, shares really never got much going on the upside (though last spring/early summer was encouraging), with the stock still sitting at 21 last October. But like most growth titles, FROG changed character after that, lifting to two-year highs by December, resting for a while as the 10-week line caught up, and then surging before and after earnings the past two weeks. Volatility is high, so we’ll set our buy range down a bit.

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Stock 9

Lam Research (LRCX)

Why the Strength
Lam is a major provider of the equipment used by manufacturers of memory chips—including advanced DRAM and NAND flash chips—but it also has strong exposure to the white-hot artificial intelligence trend. Memory equipment spending was down almost 50% last year (due to an oversupply of memory chips), which impacted Lam’s bottom line, as nearly half its revenue is from memory equipment sales. Even so, while the memory equipment market isn’t completely out of the woods yet, analysts expect a big improvement starting this year as a new chip upcycle gets underway, driven largely by AI-related demand. In the December quarter, Lam said it secured some big advanced packaging wins for high-bandwidth memory, which is “critical for enabling advanced AI servers.” In 2024, moreover, the company expects its high bandwidth memory (HBM)-related DRAM and packaging shipments to more than triple year-on-year and outpace wafer fabrication equipment growth in this segment by a “significant margin.” On the financial front, fiscal Q2 (ending in December) revenue of $3.8 billion came in 29% lower from a year ago due to the broad chip market slump, but was 9% higher from the prior quarter as signs of recovery emerged. Per-share earnings of $7.52 were 10% higher sequentially, and both the top and bottom line handily beat Wall Street’s expectations (the reason for the strength). Lam indicated that its specialty technology markets are opening up new opportunities, including the recent delivery of pulse laser deposition technology for some of its high-volume micro device manufacturing customers; plus, the firm is investing more in digital capabilities like virtual twinning, advanced simulation and, of course, AI. For fiscal Q3, Lam guided for earnings to increase 5% sequentially, while analysts expect EPS to turn the corner in the second half of the year and accelerate higher in fiscal 2025 (starting in July).

Technical Analysis
LRCX bottomed in 2022 and set up nicely in early part of 2023 before breaking out in May and running to near 725 in July. Then came the market correction, which yanked the stock down to its 40-week line in October, but LRCX has been strong since, with one test of the 10-week line at the start of January and a nice push higher in recent weeks. Like most tech names, there’s been a lot of up-down-up-down action of late after a big run, so if you want in, aim for dips.

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Stock 10

Vertiv Holdings (VRT)

Why the Strength
Since WWII Vertiv has been a specialist in cooling systems for computing systems and infrastructure, something it remains a leader in today. The business also sells other mission-critical technological infrastructure products like uninterruptible power supplies and racks and enclosures for servers. About three-quarters of its sales are to individual corporations and the rest to server farms that have multiple corporate clients. It’s been a fine business, but the explosion of energy-hungry AI applications has opened up Vertiv to a new phase of growth. Revenue for 2023 of $6.86 billion, announced last Wednesday, came in a sliver short of heightened expectations after a bullish November investor conference, but earnings per share of $1.77 per share still topped Wall Street’s outlook for $1.75. The use of AI in the Americas is driving the business, and it should result in Q1 sales rising 5% overall to around $1.62 billion with margins widening thanks to cost improvement and tailwinds from easing inflation. The first quarter is usually a slower one, so overall 2024 revenue should see an organic bump of about 10% to $7.6 billion, a little higher than management first suggested in November and that figure could rise if the firm uses its burgeoning cash flow to make any minor acquisitions. Any improvement in Asia (China especially has been in a slump) would only help Vertiv. Longer term, management says the combination of AI and a desire of companies to save energy, for both cost and environmental reasons, should provide for consistent 10% annual sales growth in the next five years. Partnerships for cooling system development with NVIDIA and Intel will help too. A just-started $3 billion share buyback to occur through 2027 along with growing margins should see earnings growing much faster than revenue for years to come.

Technical Analysis
VRT was one of the best performers in 2023, with shares rising from the dead and continuing higher throughout year-end. Thus, the stock isn’t in the early stages of its advance, but shares continue to act as they “should”—after a test of the 10-week line in early January, VRT raced nicely higher, and the intra-week wobbles of late haven’t stuck, with the stock actually closing the past three weeks tight and in the upper parts of its range, before today’s move to new highs. We took a good profit ahead of earnings, but now that we’ve seen some consistent support, we’re OK re-entering on dips, with a stop near last week’s low.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on March 4, 2024.

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