Cabot Top Ten Trader Issue: May 6, 2024

More Steps in the Right Direction

Last week was another constructive week, with the major indexes surviving some early volatility to finish the week higher—and with more leading (and potential leading) stocks perking up as they round out multi-week launching pads. That’s all to the good and, when you include some positive action from the broad market (few stocks are hitting new lows), it’s pretty obvious the intermediate-term evidence has improved during the past couple of weeks. That said, we also wouldn’t say it’s all clear out there—the major indexes and growth measures are moving into the thick of resistance, there’s still lots of selling on strength and this week brings an avalanche of earnings reports from key stocks, so it’s still very much a day-by-day process here. Even so, we always go with what’s in front of us, and while it’s not 1999 out there, the tenor of the market has improved—we’ll nudge our Market Monitor up to a level 7 and could go higher if more individual names kick into gear.

This week’s list has a bunch of recent earnings winners, some of which are out to new highs, while others are setting up. Our Top Pick is Carpenter Technology (CRS), which has a great near- and longer-term outlook in the aerospace and defense area, with the stock exploding higher after earnings.

Stock 1

Carpenter Technology (CRS) ★ Top Pick ★

Why the Strength
Thanks to both escalating military conflicts and increasing air travel demand, the world’s biggest aircraft engine maker, GE Aerospace, recently forecast that engine deliveries will grow by around 25% this year, with engine services revenue likely achieving low double-digit compound growth between now and 2028. That’s welcome news for Philadelphia-based Carpenter, which is a major player in both markets and is a global provider of specialty metals like titanium, stainless steels, powder metals, as well as additives and metal powders and parts. The company serves numerous end markets, with around 60% of its sales coming from the aerospace and defense market, as its alloys and products (including engine parts, fasteners and structural components) are widely used across that industry; the industrial and consumer (20%) and medical (15%) markets account for most of the rest of the revenue pie. In last week’s fiscal Q3 (ended March) earnings call, Carpenter noted that aerospace and defense customers were “very active” in view of ongoing world events, resulting in the firm prioritizing critical defense orders (which were up 30% year-on-year and 28% sequentially). Although total revenue of $685 million was basically unchanged from a year ago, per-share earnings of $1.19 more than doubled and beat estimates by 25 cents (the reason for the stock’s strength). The medical segment was another bright spot for Carpenter, with sales increasing 35% in a record quarter, driven by increasing use of robotics and minimally invasive surgeries. Management said customer engagement remains high across its other end markets, with bookings “strong” and lead times increasing. Indeed, most importantly, the firm’s backlog for the quarter rose 12% and came in at record levels, totaling three times the pre-Covid total! Going forward, Carpenter expects inventory levels to trend down while increasing free cash flow to over $100 million in fiscal Q4 (up 60% from Q3 if realized). Wall Street sees earnings nearly tripling in fiscal 2024 with another solid gain next year, and the top brass sees operating income lifting another 40% over the next two years. It’s a solid story.

Technical Analysis
A sustained 14-month rising trend in CRS finally hit a ceiling last September, with the 70 to 75 area providing resistance. Shares spent the next six months alternating in a lateral range between roughly 60 and 75, testing the 40-week line in February and March. The stock began to get moving in April, and after holding firm during the market’s dip, CRS has exploded higher after earnings. It’s a bit extended, but we like the power—we’re OK buying some here or (preferably) on a little weakness.

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Stock 2

First Solar (FSLR)

Why the Strength
First Solar is shaping up to be an Inflation Reduction Act success story. The firm, of course, is a U.S. solar panel producer that is enjoying large order backlogs for its technically superior products, and that’s despite massive manufacturing overcapacity in China and its market-distorting effects on panel pricing globally. The IRA provides tax incentives for firms to make (and for customers to buy) renewable energy products made in the U.S., with the scale of the incentives making First Solar competitive domestically with products produced more cheaply elsewhere, though China can churn out so many cheap solar panels that the IRA doesn’t make First Solar immune. There is hope its petitions for sterner anti-dumping actions will provide time until the Chinese market shakes out capacity. When on a level playing field, First Solar can sell utility customers looking to build huge solar power plants on its cadmium telluride-based Series 7 photovoltaic panels, which perform better in hot and humid conditions compared to the crystalline silicon panels most of the industry produces. In Q1, First Solar beat consensus estimates for sales by 10%, posting $794 million revenue with a consensus-beating $2.20 earnings per share. For the full year, management expects to post EPS around $13.50 on sales of about $4.5 billion, and that should just be the beginning given the company has an order backlog that takes up its production through 2026, totaling 78.3 gigawatts! Ironically, recent investor pressure on energy developers to opt for more fossil-fuel-based sources over renewable could help near-term results with First Solar able to collect cancellation fees on orders and simply redirect the panels to other open orders. There are plenty of moving parts here that involve governments, trade policy and subsidies (about $1 billion worth for First Solar this year alone!), but the bottom line is that First Solar is raking in a lot of money today and those figures should grow going ahead.

Technical Analysis
Solar stocks have been one of the worst-performing groups in the past year, but FSLR looks like it will resume its liquid leader status in the sector if things turn up. Shares pulled back 44% from their highs in early 2023 to the low last October, but instead of rebounding sharply, they were rejected at the 40-week line and spent a few more months bottoming out. However, the action has improved since mid-March, with a move above that 40-week line, some tightness, and a pop to multi-month highs after earnings late last week. If you want in, aim for a pullback.

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Stock 3

nVent Electric (NVT)

Why the Strength
London-based nVent isn’t an exciting story but it’s an important one: It designs, manufactures installs and services industrial, commercial and residential infrastructure and energy applications worldwide. It operates under three segments, including Thermal Management Solutions that connect and protect critical buildings and infrastructure; Enclosures that manage heat in critical electronics, communication, control and power equipment; and Fastening Solutions that protect electrical and mechanical systems and civil structures. Basically, the firm caters to a broad spectrum of markets used by virtually all companies and in all homes (think cooling systems, connectors, surge protection and cable management). But it’s especially benefiting from growth trends in factory automation, digitization, electrification, and of course, artificial intelligence. Last week, nVent announced estimate-beating sales and earnings number for Q1 that re-ignited interest in the shares—revenue of $875 million increased 18% year over year, earnings of 77 cents beat estimates by three cents and “robust” free cash flow of $74 million increased 41%, reflecting the strong operating performance. The company emphasized that AI was accelerating demand for its data solutions offerings (particularly liquid cooling solutions, similar to Vertiv Holdings), resulting in particularly strong sales for the Enclosures segment (up 15%). And while Fastening Solutions sales were down (due to inventory normalization), Thermal Management (up 22%) continued to improve sequentially and “is positioned for growth the rest of the year,” with the North American and Asia Pacific regions leading the overall growth. For the full year, the top brass guided for sales to increase around 10%, with EPS expected to rise 6%, but those could easily prove low as recent results have shown much stronger growth.

Technical Analysis
NVT has had a big run since the tail end of 2022, though it’s also had three corrections, with the latest kicking off last September—shares retreated 23% and tested their 200-day line before rounding out a launching pad in the weeks that followed. The breakout came in February, and NVT had a nice run afterwards, and the recent dip to the 10-week line found big-volume support after earnings. Grabbing a few shares around here with a stop near the recent low seems like a solid risk/reward trade.

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Stock 4

Pinterest (PINS)

Why the Strength
Social media site Pinterest has long been popular for its recipes, home-and-style inspiration and crafting ideas, as well as for its organizational and planning tools. But a recent shift of focus on increasing advertising revenue, driven by strategic partnerships with giants like Amazon and Salesforce, continues to be a key facilitator for e-commerce on Pinterest, resulting in “significant improvements” in profitability in the company’s first quarter, while seeing the fastest user and revenue growth in three years. Indeed, the company said it’s capturing a growing percentage of advertising budgets among its clients as they realize how effective the platform is for getting the attention of style-conscious consumers: Pinterest easily bested Wall Street’s expectations for sales and earnings in last week’s Q1 report, while growth in global monthly active users (up 12%) accelerated for the seventh straight quarter and surpassed 500 million for the first time. Revenue of $740 million increased 23% (sales growth is also accelerating; see table below), while earnings of 20 cents a share more than doubled and adjusted EBITDA of $113 million soared by an eye-popping 320% (all reasons for the stock’s strength). Management credited the sanguine results on the company’s investments in artificial intelligence and “shoppability,” which it said was “driving even greater returns for advertisers and gaining access to performance budgets.” And with analysts estimating that Pinterest represents only around 5% of the ad budgets for many of its larger customers, the growth runway should be sizable as more of them are expected to scale their ad spend on the platform going forward. Meanwhile, demographic trends remain favorable for Pinterest, which is seeing its largest and fastest-growing user base among Gen Z, and most expect continued benefits from its third-party advertising deal with Amazon. Looking ahead, Wall Street sees high-teens top-line growth and surging earnings over the next few quarters.

Technical Analysis
After a long, choppy sideways pattern that saw the stock capped by resistance in the upper 20s, PINS broke free last November after earnings and had a solid run to 42 in February. A sour earnings reaction hit the stock at that point, kicking off a tedious decline (27% from high to low) to the 40-week line last month. But now the Q1 report has cleared the air, with PINS gapping back to the top of its three-month range and holding firm in recent days. We’re fine entering here or, ideally, on an exhale of a point or so.

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Stock 5

Shake Shack (SHAK)

Why the Strength
Shake Shack is strong today because it’s combining what’s long been a great expansion plan with cost controls and efficiencies, which is resulting in a big pickup in earnings today and what should be a very bright future going forward. The company operates 525 locations that serve great burgers, chicken sandwiches, hot dogs, fries and shakes; it’s like a roadside burger joint and it’s garnered a very loyal following over time, starting in New York City and expanding all over the U.S. (usually company-operated stores) and internationally (via licenses), too. The cookie-cutter aspect of the story has always been a draw and remains so today—Q1 saw the total restaurant count up 17% from a year ago, with another 70 or so openings likely by year-end (about evenly split between company-operated and licenses)—and now both the sales side (performance of existing locations) and cost side are looking great, too. In Q1, same-store sales rose just 1%, but that lapped a 10% gain in the year-ago Q1, and April saw same-store sales lift nearly 5% while total sales were up 18% last month. Just as important has been the cost side, which, frankly, was a big reason the firm could never produce consistent results—but now food, labor and occupancy costs have all come under control, which means restaurant-level margins (19.5% in Q1, up from 18.3% a year ago) and EBITDA margins (12.4% in Q1, up more than a full percentage point) are picking up steam. (Also helping is a drop in start-up costs for new company-operated locations.) To be fair, things like food and even packaging are still showing tedious mid- to upper-single-digit inflation, which is outside Shake Shack’s control, but even with that, it’s looking like mid-teens sales growth and surging EBITDA and earnings are likely in the quarters to come.

Technical Analysis
SHAK built a deep (34%), long (seven months) launching pad from last summer through mid-February, when the Q4 report gapped the stock to new highs and allowed propelled shares to 111 in the weeks that followed. The recent pullback came alongside the market, falling 16% and cracking the 50-day line, but impressively, SHAK turned around quickly and, with the help of earnings, returned to its old highs. Today’s reversal wasn’t pleasant, but it sets up a clear entry—we’ll set our buy range up from here, looking to buy on strength.

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Stock 6

TransMedics (TMDX)

Why the Strength
TransMedics has developed a superior way of storing and transporting donated organs, keeping lungs, hearts and livers alive during transportation through a specialized system that infuses the organs with blood and provides circulation in a way that nearly mimics the body. The company’s organ care system (OCS) is the only FDA-approved alternative to traditional methods where organs are infused with a chemical cocktail and put on ice while transported. The company is entering just its third year of running the OCS commercially, and as the concept gets proven results in real-life conditions, it’s seeing quick uptake among medical professionals; in Q1, sales jumped 133% $96.9 million, a figure that also crushed consensus estimates. Helping adoption is that TransMedics handles all transportation with a network of 14 aircraft, a total it plans to expand to 20 by year-end. By using its own teams and equipment, it lowers the cost/time investment by hospitals, which usually handle transport themselves, and leads to better outcomes and faster uptake of its services. The company says OCS has resulted in better transplant outcomes with donor circulatory death (DCD) organ transplants, seeing a success rate equal to traditional donor brain death (DBD) organs—a plus since DCD causes more problems with organs than DBD. The company also says organs held outside a body for longer time periods and transported farther distances with OCS are also performing on par with traditional methods, which is obviously huge. The main task now is educating the medical community on OCS to expand its network, something it started by having five medical researchers present their findings on the effectiveness of OCS at a recent international transplant conference. TransMedics says all of this should boost full-year 2024 sales to around $395 million, a 63% rise over last year, but most see that as conservative as the top brass here regularly lowballs its outlook.

Technical Analysis
When we last wrote up TMDX, it had pulled back relatively sharply (25%) after a huge comeback from its late-2023 waterfall decline. But the stock found big-volume support coming into April, and while it was pushed and pulled with the market, last week’s earnings reaction stands out, with TMDX not just gapping up but hitting new highs—and following through on the upside on Thursday and Friday. We like the action, but for new buyers, we favor looking to enter on weakness.

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Stock 7

Tri Pointe Homes (TPH)

Why the Strength
Tri Pointe Homes is a mid-sized homebuilder (about $4 billion in annual revenue) focused on the western part of the U.S., especially California, Arizona, Vegas and Seattle, where nearly two-thirds of its revenue comes from, though it also does a growing business in some central states (mostly Texas and a bit in Colorado) and, more recently, has moved into North Carolina and the D.C. metro area. As with the rest of the sector, business surged to higher levels during the pandemic, though it did hit a pothole last year; it’s possible the firm is more sensitive to mortgage rate changes given its focus on first-time and move-up buyers, which combined make up more than 90% of sales, and the average sales price is up there, north of $650,000. Still, that slowdown is in the rearview mirror—in Q1, sales and earnings growth returned to the black and easily topped expectations, and the forward-looking metrics were just as bullish, with new orders up 12% in units (mostly coming from California and Texas), while the backlog was up a whopping 35% in units and 30% in value. Pricing had been a headwind, with the average sales price falling off of late to “only” $659,000 in Q1, but the homes in the backlog are at an average price of $712,000, which is obviously a plus. Other positives here are a big inventory position (owns or controls more than 34,000 lots, which would be a few years’ worth of sales) and a shareholder-friendly management—the top brass has been buying back stock for years, with the share count down 6% from the start of 2023 and nearly 14% from two years ago. Earnings are expected to continue heading higher from here, and current estimates could prove conservative if mortgage rates finally dip.

Technical Analysis
After a big run with the group into last summer, TPH had a tough pullback in the fall and began to emerge with the market later in the year—but it could never quite break out, with a lot of sideways, tight trading in the mid-30s. However, TPH started to get its act together in late March, and after one more quick shakeout with the market (and higher mortgage rates), the stock has quickly returned to its highs. We’re OK with a small buy here or on dips, with a stop near the recent low.

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Stock 8

Vertiv Holdings (VRT)

Why the Strength
Vertiv is a multinational provider of critical infrastructure and services that enables vital applications for data centers, communication networks and commercial and industrial environments, as well as for homes. While it serves several end markets, its products are primarily aimed at data center and commercial use and include critical power (switches, power systems and battery energy storage), thermal management (cooling solutions and monitoring), racks and enclosures, plus software, digital and battery services. Not surprisingly, data center spending related to the early-cycle artificial intelligence boom accounted for a sizable chunk of Vertiv’s profits in Q1, as revenue of $1.6 billion grew 8% from last year’s Q1 on the back of “strong” underlying market demand. But the real excitement surrounded the firm’s bottom line, where per-share earnings of 43 cents beat estimates by 20%, while adjusted free cash flow of just over $100 million improved by a whopping 300% from a year ago. More important is that this appears to be the front edge of a wave of growth: Forward-looking organic orders (excluding foreign exchange) increased 60%, benefiting from ramping AI deployments, including liquid cooling technologies. What’s more, the company had a record $6.3 billion backlog at the end of the quarter, with most of those orders for deliveries beyond 2024 (which should lead to higher profits into next year), and suggesting that AI is starting to scale (mainly in North America) while “becoming a pervasive theme” across the firm’s end markets (indeed, the firm’s pipeline for AI projects more than doubled in just the last two months!). The top brass is also focused on using some of the excess cash to buy back shares, repurchasing $600 million worth in Q1 (2% of shares outstanding). All in all, the favorable trends prompted several Wall Street institutions to upgrade the shares, looking for earnings to grow north of 30% this year and another 28% in 2025, both of which will likely prove too low.

Technical Analysis
VRT has been in an amazing uptrend for more than a year, so it’s not early in its advance—even so, shares have shown no signs of any major distribution, respecting the 50-day line numerous times when it has hit a periodic pothole. The latest dip last month looks iffy, but the Q2 report brought in the buyers, with some wild, but positive, post-earnings action (four straight days of big-volume buying) that’s left VRT standing near new high ground. We’ll set our entry range down a bit, trying to enter on a normal dip.

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Stock 9

Wabtec (WAB)

Why the Strength
After a rough few years, the U.S. manufacturing industry is experiencing a notable pickup in momentum in the wake of three significant pieces of legislation that were passed in 2021 and 2022, which focus on building out the domestic semiconductor and green energy sectors, as well as rebuilding infrastructure. The return to growth across multiple industries means more business for the nation’s rail providers, which carry much of the components and finished goods that are too heavy for other forms of transport. Westinghouse Air Brake Technologies Corporation, better known as Wabtec, bills itself as the world’s foremost rail technology company, manufacturing products for locomotives, freight cars and passenger transit vehicles, while building new locomotives of up to 6,000 horsepower. It operates under two segments: Freight (including equipment, components, services and digital intelligence) and Transit (aftermarket services), and it’s the vendor of choice for railroads that want to grow and modernize their rolling stock, including replacing older equipment with newer, more environmentally friendly options. Wabtec’s recent Q1 earnings featured eye-opening improvements across several key metrics, including revenue of $2.5 billion that rose 14% year-on-year and earnings of $1.89 that beat estimates by 41 cents and surged 48%. Further underscoring the demand for its products, the company’s 12-month backlog was $785 million higher than last year’s Q1 (up 11%), with a total multi-year backlog of $22 billion, prompting management to guide for continued “significant long-term momentum” in growth of new locomotive sales, modernizations, digital solutions and in-transit systems (led by megatrends in urbanization and decarbonization that require cleaner and safer transportation equipment). It’s not changing the world, but growth here should remain solid—analysts expect the company to generate double-digit earnings growth through 2026, with one major bank recently upping its target price based on Wabtec’s “dominant” role in the North American locomotive market.

Technical Analysis
WAB hasn’t garnered many headlines, but the stock has been a fantastic performer since the market’s low last October, not only enjoying a good run but doing so in a very persistent manner with next to no pullbacks. In fact, until the market recently hit a pothole, the stock never even touched its 10-week line! Of course, the reason we’re writing about WAB today is the action since that mini-test, with shares popping to new highs after the Q1 report on their heaviest volume since November 2020, a strong sign. You can enter here or (preferably) on dips.

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Stock 10

Woodward (WWD)

Why the Strength
Woodward isn’t a well-known firm, but it does a good business selling a variety of energy conversion and control solutions—fuel pumps, engine and flight deck controls, air valves, fuel nozzles, injectors, actuators, integrated propulsion systems, etc.—for both aerospace and industrial clients. Aerospace is the largest market, both commercial (about two-thirds of this segment) and defense, and definitely has the biggest runway of growth potential of the two; the global air fleet is expected to double in the next 20 years, which will obviously help both newbuild (where Woodward is seeing much more content on new models than prior versions) and aftermarket services (a steadier, long-lasting business that grew 30% last year and rose 18% in the March quarter). Meanwhile, the industrial segment should be a plus, too, helped along by the energy transition, with power generation and transportation clients producing a 20% revenue gain in Q1, and that was despite a dip in demand from oil/gas clients due to the uncertainty surrounding LNG exports and investment there. As you’d guess, Woodward isn’t suddenly going to grow like an AI stock, but at last December’s Investor Day, the top brass laid out a bullish three-year outlook, with 8% annual sales growth, 16% EBITDA growth and $20 per share of cumulative free cash flow from 2024 through 2026—and it’s already well ahead of those goals. It’s a reliable growth story that could easily top expectations given the strong long-term growth likely in both of its key segments.

Technical Analysis
WWD changed character a year ago in May 2023, when a powerful earnings gap snapped it out of a long funk, and while it hasn’t caught much attention, the stock has made solid progress, with a flat-ish few months late last year giving way to more upside. The shakeout in April with the market was sharp but found support near the 50-day line, and then earnings pushed the stock right back to new highs thanks to a few days of big-volume buying, with another push higher today. If you want in, look to enter on a normal exhale.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on May 13, 2024.

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