Cabot Top Ten Trader Issue: March 25, 2024

Quick note before we get into it today: Join me and my fellow Cabot analysts Tom Hutchinson, Tyler Laundon and Carl Delfeld next Tuesday, March 26 at noon ET for a FREE special event in which we will discuss the state of the market, how to maximize profits in this bullish environment, reveal our top stocks to buy now, and answer any questions you may have. To join us, simply click here.

Buyers Reappear, Leaders Pop

There was definitely some churning in the leading areas of the market from early February into last week’s Fed meeting, but there wasn’t much abnormal action (mostly selling on strength, rather than a bunch of breakdowns), and the past few days have seen the buyers back at it, helping many leading stocks of all stripes pop. Now, we don’t consider the action as a brand-new buy signal—everything we’ve written during the past few weeks still holds true, including the fact that you have a lot of tech names that have enjoyed big, prolonged runs without much of a pullback, which raises the risk of some near-term air pockets; thus, we’re mostly focused on fresher names when it comes to new buying. But the major evidence of the market (trends are up for most indexes and sectors) never wavered, so we’re holding most of our winners and looking to increase exposure in names that are enjoying big-volume accumulation. We’ll nudge our Market Monitor up at level 8.

This week’s list is a bit of a hodgepodge, with different types of names from varying sectors. For our Top Pick, we’ll go with the strongest name this week that comes from the strongest sector—Micron Technology (MU) is cyclical, but business has turned up in a major way, and last week’s earnings gap looks like a major change in investor perception. Keep it small and/or aim for dips.

Stock 1

Celestica (CLS)

Why the Strength
The boom underway in artificial intelligence spending is widely expected to broaden to multiple industries across virtually the entire value chain in the coming years. This is just one of the key factors driving the favorable sentiment for electronics manufacturing and supply chain solution specialist Celestica (covered in the February 5 issue). The Canadian firm partners with leading companies in the aerospace and defense, communications, enterprise, healthcare, industrial and smart energy sectors, while also teaming with large cloud service providers—lately, this has been a key growth driver for Celestica while providing significant exposure to the AI boom. In Q4, free cash flow of $84 million doubled from a year ago, while revenue of $2.1 billion increased 5% and earnings of 76 cents per share handily beat estimates (all reasons for the stock’s strength). The sanguine results were helped along by enterprise end market revenue that jumped 46%, which was “meaningfully above” the firm’s expectation of a high-20s percentage increase; the growth was driven by strengthening demand for AI and machine learning (ML) compute programs from Celestica’s hyper-scale customers. Going forward, to meet what it described as persistent demand from clients in the communications and enterprise markets, the company is expanding its capacity in Thailand and Malaysia, with both capacity expansions expected to be up and running later this year. For Q1, management guided for revenue to be up in the high-60s percentage range year-over-year in the enterprise end market, driven by anticipated demand growth in AI and ML customers, while the aerospace and defense business is expected to significantly contribute to “solid” results (which Wall Street pegs at 10% for sales and 20% for earnings) for the full year. It’s a solid down-the-food-chain story with bright prospects and a reasonable valuation.

Technical Analysis
We missed getting into CLS after our write-up last month, but the latest rest may provide an opportunity. The stock decisively broke out last July and advanced over the next few months, with only a couple of minor pullbacks along the way. The upmove accelerated in late January, with CLS running in short order to round number resistance near 50 before backing off. Since then, the dip to the 25-day line has looked normal and the stock has bounced in recent days—we’ll set our buy range down a couple of points, thinking more of a rest is likely near term.

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Stock 2

Gap (GPS)

Why the Strength
Consumer discretionary companies collectively posted their best sales performance last year since 2009, thanks to a combination of strong travel demand and increased restaurant and apparel spending (especially in the U.S.). The latter market is currently one of the largest industries of the sector, valued at about $1.4 trillion, with retail apparel giant Gap (covered in the November 20 issue) clearly one of the major players—it’s America’s fourth-largest clothing company by revenue. And the stock is strong today because results, while hardly showing huge growth, are coming in miles better than expectations—indeed, in Q4, the company blew away Wall Street’s earnings expectations (and topped views for many key metrics), driven by improving comp sales trends for the Gap (up 4%) and Old Navy (up 2%) segments, largely due to accelerating demand for women’s active wear. Total revenue of $4.3 billion rose 1% year-on-year, with store sales increasing 4% and online sales (40% of total sales) decreasing 2%. Even so, the Gap brand gained market share in Q4, which the company said was “noteworthy” given the weaker backdrop in some segments of the apparel market. Gap also ended the year with nearly $2 billion in cash—up 54% from 2022—while full-year free cash flow of $1.1 billion compared favorably to a $78 million outflow a year ago, putting Gap on a “strong financial footing.” Management emphasized the focus on boosting cost savings and margins going forward, as well as the stability of revenues; to that end, it delivered a gross margin improvement of 5% for Q4 and 4% for the full year, and it sees smaller but continued upside in margins this year thanks to a variety of moves. Most likely, analyst estimates will prove conservative (Q4’s 49 cents beat by 26 cents!), and the reasonable valuation and dedication to a solid dividend (2.1% yield) should keep investors interested.

Technical Analysis
GPS re-tested its bear market low in May last year and started on the comeback trail, though progress was choppy at first. But things began to pick up in October, and November’s quarterly report blew the roof clean off, allowing the stock to surge above 20 (to two-year highs). The consolidation after that was modest but lingered for a while, as shares meandered just south of the 50-day line for many weeks. But the Q4 report has led to a stampede of huge-volume buying for two weeks, leaving no doubt about GPS’ major trend. We’ll set our buy range down a bit, though we’re not expecting a giant retreat given the overwhelming volume.

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Stock 3

KKR Inc (KKR)

Why the Strength
The S&P 500 has rallied a whopping 27% in the past 21 weeks—and looking back over the past 50 years, the only other times something similar has happened has seen the market up north of 20% a year (on average) after those events, i.e., strength begets even more strength. If anything like that transpires this time around, it’s a very good bet that Bull Market stocks will do well—and so far, KKR is one of the leaders of that group. The firm finished last year with $553 billion of assets under management (mostly private equity and credit-related), $446 billion of which are fee-based (which provides recurring income), while new capital raised in Q4 came in at $31 billion, a solid acceleration compared to the $38 billion raised in the prior three quarters combined as the markets took off. But the bigger Q4 news came near Thanksgiving, when KKR gobbled up the 37% of insurer Global Atlantic it didn’t already own; the partnership had been very successful in boosting originations for Global Atlantic and thus boosting KKR’s asset management business, and now the top brass thinks the full combination will drive distributable earnings per share nicely higher this year. When you combine that move with what could be a far more favorable (and easier money) environment going ahead, there’s no reason KKR’s asset base (including from new money raised), fee-based earnings and the like can’t boom from here—indeed, following the Atlantic buyout, the top brass boosted its fee-based earnings target to $4.50 per share in 2026, up from $2.68 per share in 2023, and even that could prove conservative if big-picture investor sentiment really turns up. It’s not a hot AI stock, but all signs are pointing higher for KKR.

Technical Analysis
KKR hasn’t gotten too much attention during the bull run, but it’s action has been fantastic—after dipping just below its 40-week line near the market low, shares took off on the upside, bolstered by the insurance acquisition, rising seven weeks in a row and testing its all-time highs from 2021. Then came a brief, tight rest, before the stock motored up to the century mark. And now, after another tight period, KKR is attempting to resume its advance. We do think the 100 level could be sticky-ish, but we like the risk/reward of buying here or on minor weakness.

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Stock 4

Krystal Biotech (KRYS)

Why the Strength
A surprise $0.30 per share profit for Q4 sparked a huge rally for Krystal Biotech the past four weeks, vaulting the Pittsburgh-based biotech up 50%. The reason for the encouraging results is its recently approved treatment named Vyjuvek, which produced sales in the period of $42.1 million—all of Krystal Biotech’s revenue. The drug treats a rare and serious skin disorder called dystrophic epidermolysis bullosa (DEB), which causes serious blisters on the skin (and sometimes even on the linings of internal organs) after even the mildest of agitation like scratches or heat. It’s a type of herpes simplex virus that often appears shortly after birth and which can display moderate to severe blistering. As many as 3,000 people in the country suffer from the affliction, with roughly a third of those showing moderate to severe expressions of DEB that make them likely to receive Vyjuvek. The drug more than doubled up on Wall Street’s sales expectations for 2023 (a few weeks of sales in Q3 means Vyjuvek sold more than $50 million last year). At a cost of up to $900,000 per patient in the U.S., investors expect the drug to generate $254 million sales this year, with earnings per share well into the black given Vyjuvek has a gross margin of 90%. With six months of sales in the U.S., management sees a clear path toward getting to market in Europe and Japan, saying the drug will reach blockbuster status one day, implying $1 billion-plus in global sales. Krystal has good potential to not be just a one-drug shop: It has six drugs in trials that treat other rare genetic disorders, including one for cystic fibrosis which had a problem-free first trial last year. The company also has a series of drug developments under its Jeune Aesthetics division, pursuing skin treatments to reverse the normal effects of aging.

Technical Analysis
KRYS looked like it might be getting going a year ago, when the stock popped to new highs near 130. But with real results still months away and the market running into trouble, shares chopped sideways to down for many months—until Q4 results caused a buying panic, with shares soaring to 160 after the report and above 190 in the days after. now the stock has calmed down for a couple of weeks, and the digestion looks normal thus far. It’s obviously not for the rent money, but a small position here or on minor weakness with a stop near the 50-day line is fine by us.

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Stock 5

Micron Technology (MU) ★ Top Pick ★

Why the Strength
The long-awaited start of a new upcycle in the memory chip market appears to be underway, with memory prices surging in recent months. This is very good news for memory and storage solutions giant Micron, which just posted stellar results for fiscal Q2 (ended February) thanks to a confluence of factors that included strong artificial intelligence server activity, a healthier demand environment in most end markets and supply reductions across the industry. The company saw revenue of $5.8 billion soar 58% from the year-ago Q2, led by DRAM sales that increased 50% and NAND revenue that leaped 77%. Per-share earnings of 42 cents beat estimates by a country mile (a reason for the share price strength), roaring back into the black for the first time since mid-2022. Also contributing to the excitement was the explosive growth in the demand for Micron’s high-bandwidth memory (HBM) and storage solutions for AI applications, including its industry-leading HBM3E product (which will be a part of Nvidia’s H200 Tensor Core GPUs for supercharging AI workloads). In fact, Micron announced last week that its HBM products have been sold out for 2024, with most of next year’s supply already having been allocated, too, a sign that demand is going wild. To that end, a major investment bank just boosted its target price for Micron while proclaiming it the next big beneficiary from the AI revolution. Management said AI server demand is driving rapid growth in HBM and data center solid-state drives, resulting in a positive ripple effect for pricing across all memory and storage end markets and putting Micron on track to generate several hundred million dollars of revenue from HBM in fiscal 2024. The firm also sees DRAM and NAND pricing levels rising further throughout this year and expects record revenue and “much improved profitability” this year and in 2025, further guiding for Q3 sales and EPS of $6.6 billion (up 76% if realized) and 45 cents, respectively—with earnings booming from there.

Technical Analysis
MU finished rounding out a 14-month-long bottoming process in November, breaking out above a key resistance at 75. That said, it wasn’t one of the big chip leaders, making some upside progress but then chopping sideways under 90 for two months. However, after a shakeout under the 50-day line, MU bounced back nicely in late February, and then last week’s quarterly report gapped the stock to all-time highs, with further strength seen today. Yes, it’s extended, but MU has a history of big moves when the environment is right—we’re OK with a small position here and a loose stop.

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Stock 6

SharkNinja (SN)

Why the Strength
SharkNinja makes household electronics under two brands, Shark and Ninja. Ninja is the larger of the two, with 55% of sales, focusing mainly on food-related small appliances like air fryers and waffle makers as well as cookware, bakeware and cutlery. The Shark brand got established with a line of vacuums, but has expanded to cover the rest of the home outside the kitchen, with gear including air purifiers and hair stylers. Management promotes the lines through aggressive multichannel marketing including TV commercials, social media placements and plentiful media stories. The business sells through multiple channels, too, including direct-to-consumer, web retailers and brick-and-mortar stores including Ulta, Lowe’s and Sephora. Growth is fueled by a strategy to expand into adjacent categories–for instance, it recently introduced in-home carbonation systems–while not letting up on the push in its current 27 categories. Management is now looking to get into product lines that appeal to younger consumers, including beauty and outdoor cooking. In each, it’s looking to be able to put its own spin on a product that enables it to charge a premium without pushing into luxury price points. There’s no one thing that that makes SharkNinja work with consumers (though its rapid product innovations are a plus), which makes it a tough target for competitors to knock off. The holiday season was strong, capping off a $4.2 billion sales year that brought net income per share of $3.23. SharkNinja’s management think they can push earnings north of $3.50 per share this year on a revenue increase of around 8%, to $4.54 billion. A move to manufacture all of its U.S. supply outside China by next year is well underway and will help SharkNinja avoid tariffs to stay price competitive.

Technical Analysis
Following a wild first few days, SN has enjoyed a relatively steady advance—not flashy, but with modest pullbacks and consolidations leading to renewed upside. The stock’s latest rest took place during January and most of February, centered on the 50 area, but the buyers have been at it since earnings in mid-February, with SN up seven weeks in a row to new highs. Aim to enter on dips closer to the rising 25-day line.

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Stock 7

SM Energy (SM)

Why the Strength
Four years ago, many thought SM Energy was likely to go bust as oil prices tanked and the pandemic dampened hopes and demand while a bunch of debt weighted on the balance sheet—but today, SM is a thriving small oil firm with a straightforward story of extremely efficient operations and gushing free cash flow. The firm is focused on Texas, with 111,000 net acres in the Midland basin (where this year’s plan is to operate four rigs and two completion crews) and another 155,000 acres in south Texas (two rigs and one completion crew), and the inventory is as good as any out there: The top brass thinks the firm has north of 10 years of drilling inventory, and even at $70 oil and $3.50 natural gas prices, it sees its average well return north of 65% (!), partly thanks to far better output than nearly all of its peers (#2 well productivity in the Midland). So from there, it’s just about drilling and keeping things on track, which the firm has done a great job of: Last year, SM Energy cranked out $509 million of free cash flow (up from $156 million the year before), which it used to pay down debt (just $380 million or so of net debt left and no maturities this year), pay dividends (1.5% yield) and buy back shares (Q4 share count down 5.5% from the year before). Moreover, SM isn’t hedged all that much (about one-quarter of production this year), so the latest bump in oil prices (hanging around $80 per barrel) will mostly fall to the bottom line and lead to greater shareholder returns in the quarters ahead. All in all, it’s a solid oil play that should continue to see buoyant free cash flow even if oil prices remain modest—and could be one of the bigger beneficiaries should prices really get moving on the upside.

Technical Analysis
SM topped out for most of 2022 and early 2023 before sliding sharply to a low near 25, more than 50% down from its peak. Shares enjoyed a nice rally last summer (up 11 weeks in a row) that brought them back to the lower 40s, but that began another tedious slog, with shares correcting 22% over four months and testing the 40-week line multiple times. But now SM has changed character: It’s up seven weeks in a row, including four on above-average volume, as it tests its highs from 2022. A dip or shakeout from this persistent uptrend would mark a solid opportunity to get in.

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Stock 8

Toast (TOST)

Why the Strength
Most payment firms have been iffy performers during the bull run, but Toast has always had a good story and solid sponsorship—and now we may be seeing investor perception finally turn up. The firm’s offerings are developed and targeted specifically for the restaurant industry, which is gigantic, with 860,000 locations in the U.S. that bring in over $1 trillion of revenue, and that says nothing of the overseas opportunity that is many times that. And while point-of-sale offerings are a huge part of business, the company is really a one-stop shop for much of a restaurant’s operations and infrastructure, with offerings for table service, counter service, mobile order, deliveries (including from third parties) and drive-thrus; managing gift cards, loyalty programs and multi-location management; and even getting into the people aspect of the business via payroll, scheduling, managing tips and much more. The firm sells its wares on a subscription basis, and growth has been solid for a while now—in Q4, the company’s annualized recurring revenue totaled $1.2 billion (up 35%), while gross payment volume last year came in at $126 billion (up 38%) and Toast served 106,000 locations by year-end (up 34%) as clients continued to expand with them (17% same-customer revenue growth rate). And underlying it all are solid economics, with the payback for getting new clients around 14 months last year, partly thanks to one-fifth of new customers coming via referral. While growth may slow some as Toast grows, cash flow should crank ahead this year: While accounting earnings remain in the red, EBITDA came in at $61 million last year and management’s early outlook is for that to grow to $210 million in 2024.

Technical Analysis
TOST crashed during the bear market after a hyped IPO, but it’s spent more than a year and a half essentially attempting to bottom out, as it’s thrashed around the 14 to 25 range. The last test of the lows came in November, with the stock starting to repair the damage soon after that—and TOST’s bullish earnings reaction in mid-February has led to a push back to the top of this giant range. If you’re game, we’re OK starting small here or on dips with a stop near 20, with the idea of buying more should the stock finally let loose above resistance near 26 on the upside.

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Stock 9

Weatherford (WFRD)

Why the Strength
After a big spike in petroleum production in 2021 and 2022, the U.S. oil and gas rig count dropped 20% last year due to factors like lower energy prices, higher labor and equipment costs and soaring inflation. But the early year resilience and rebound in crude prices is expected to lead to improved exploration and drilling activity in the coming months, which is a likely reason for Weatherford’s recent strength. The Houston-based outfit is one of the world’s largest oilfield service and equipment providers in support of the drilling, completion and production of oil and natural gas wells. Its segments include Drilling and Evaluation (DRE), Well Construction and Completions (WCC) and Production and Intervention (PRI, including production automation, pressure pumping and sub-sea services). Also contributing to the recent strength is Wall Street’s recognition that Weatherford is successfully executing a multi-year initiative to fundamentally change its manufacturing, sourcing and repair platform in order to drive revenue growth and lift margins, while offsetting inflationary pressures from suppliers as well as labor costs. In fact, a major institution just initiated coverage of Weatherford with an “overweight” rating based on the firm’s improvement in free cash flow and margins (up 15%) since 2020, in large part due to a cost-cutting strategy and supply-chain overhaul. Weatherford’s Q4 financial performance was another cause for celebration, as revenue of nearly $1.4 billion increased 13% year-on-year, earnings of $1.90 a share beat estimates by 42% and adjusted EBITDA of $321 million jumped 21% (up 45% for all of 2023—the highest in 15 years). Looking ahead, the top brass believes the industry is in the third year of a long-term upcycle and sees demand for new oil and gas projects continuing through the end of the decade. Of course, we wouldn’t bet the farm on long-term forecasts in this sector, but Wall Street expects earnings growth north of 20% this year and next, with a low valuation (5X forward EBITDA) serving as an added attraction.

Technical Analysis
WFRD is in the fourth year of a major fundamental turnaround, with buyers showing increased enthusiasm of late. The stock shrugged off last year’s broad market weakness with a solid performance during the summer months, rising very nicely between late June and mid-September before hitting resistance. It spent the next five months see-sawing in a lateral range between 85 and 100, but after a shakeout to the 40-week line, last month’s earnings report caused buyers to pounce. Aim to enter on modest dips, but we’re not looking for a major retreat.

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Stock 10

XPO (XPO)

Why the Strength
Last year’s shutdown of freight shipping giant Yellow created havoc for the firm’s former customers, but a massive opportunity for other less-than-truckload (LTL) transportation providers. XPO (covered in the February 12 issue) is one of North America’s largest LTL players, with coverage spanning the U.S., Canada, Mexico and the Caribbean thanks to a fleet of more than 38,000 semi-trailer trucks across 562 locations. XPO is making major strides toward filling the gap left by Yellow, recently boosting its network capacity with a just-announced plan to integrate 28 recently purchased former Yellow truck terminals into its operations, as well as expediting dozens of real estate investments it had planned to make over the next several years. The expansion amounts to 2,000 doors of new capacity and, thanks to its Yellow assets, XPO has already seen an 8% annual increase in its shipping count. More recently, a major institution has pointed out that LTL shippers continue to see pricing gains and tonnage improvements in the wake of Yellow’s bankruptcy, with XPO seeing a 6% year-over-year increase in shipments per day for February and a 4% tonnage per day improvement. What’s more, the company sees an opportunity for double-digit price increases over the next three years, prompting an industry analyst to proclaim a “pivotal moment in the firm’s growth trajectory.” Basically, the Yellow bankruptcy was a boulder dropped into a lake, with the ripples likely to be felt for years in the sector as competition has taken a step-function move lower even as demand grows. In Q4, XPO’s revenue was just shy of $2 billion, up 6%, with per-share earnings of 77 cents beating estimates by 15 cents, driven by higher rates (excluding fuel), an increase in tonnage per day in the North American LTL segment and a fourth straight quarter of improved labor hours per shipment. Looking ahead, XPO has “strong” expectations for record metrics 2024, with Wall Street estimating a 20% EPS improvement this year and an acceleration of growth into 2025.

Technical Analysis
After an earnings-related move to new highs in October, XPO quickly met resistance and spent eight weeks bouncing around in a zone between the 80 to 90 area through January. Bullish Q4 results helped slingshot the stock out of that range and up to 130 in early March, followed again by some profit-taking. However, the sellers haven’t been able to do any damage, with XPO basically marking time as its moving averages catch up. If you want in, we’re OK starting a position here or on dips.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on April 1, 2024.

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