Cabot Top Ten Trader Issue: November 4, 2024

Some Earnings Wobbles Appear

It’s fair to say the evidence has taken a small step back in recent days for three reasons—first, because the intermediate-term trend of the major indexes is essentially on the fence for the moment after the selling seen last week; second, because the broad market has also faded somewhat, with more stocks hitting new lows; and third, because we’re finally seeing some earnings-induced dents in strong stocks, with a few breakdowns (nothing major, and there have been some good reactions too) and some generally sloppy near-term action. Of course, the election has finally (almost) arrived, which could easily cause some hecticness in the days ahead—but also remove some uncertainty (assuming we know most of the results by Wednesday). Put it all together and we’re still bullish and advise holding most of your strong stocks (albeit with some partial profits here and there), but we did pull in our Market Monitor to a level 7 and will take it as it comes in the days ahead, both with the election and as more earnings are released.

This week’s list has a pretty solid growth component to it, which we do find encouraging. There are many good-looking names, but for our Top Pick, we’ll go with a zinger: Procept Biorobotics (PRCT) has a great story and a powerful chart that we think can go far, though we favor keeping it small and aiming to enter on weakness.

Stock 1

Alcoa (AA)

Why the Strength
Aluminum demand is on the rise thanks to an ongoing recovery in packaging, electrical and automotive-related demand. According to a major industry group, global demand for the metal will increase by almost 40% by 2030, which means the sector will need to produce an additional 33 metric tons to meet demand growth in multiple spaces, but particularly for transportation and electronics. Meanwhile, the latest round of fiscal stimulus in China is expected to boost base metals demand next year, which is a big reason for the strength behind Pittsburgh-based Alcoa, America’s top aluminum producer. At a recent industry conference, management said the firm seeing considerable growth in India and emerging Asian countries, which amounts to around 10% year-over-year growth overall. The company emphasized that while the growth is across all the industries it serves, including building and construction, packaging-related demand for the North American and European markets is especially strong. Additionally, Alcoa recently increased its exposure to the lucrative market for alumina and bauxite (key inputs for aluminum production) by acquiring Australia-based Alumina Ltd., which strengthens the firm’s global leadership as a pure-play, upstream aluminum company and increases its economic exposure to alumina through third-party sales from two million to six million metric tons of production. In Q3, aluminum production increased for the eighth straight quarter for Alcoa, resulting in revenue of $2.9 billion that was up 12% from a year ago. Even better was that earnings of 57 cents more than doubled estimates while adjusted EBITDA of $455 million soared 550% from last year’s Q3 and boomed 40% sequentially. Also helping the cause is that a major Wall Street bank just increased its rating on Alcoa and raised its target price, citing a bullish aluminum price outlook for the next couple of years due to strong global demand and supply constraints. Analysts see earnings ripping higher in 2025, coming in north of $3 per share, and given the way trends go in the commodity world, even that could prove too low.

Technical Analysis
After a dull start to the year, AA sprang to life in early March and rallied 20 points before hitting a peak at 45 at the end of May. Sellers took control from there, pushing the stock under the 40-week line by August (down 40% from its peak), but with the decline coming to an abrupt halt shortly afterward. Shares then etched out a double bottom over the next five weeks, with China’s stimulus announcement causing a turnaround from there. After getting near its old highs, AA has eased back on light trade, making for a good risk/reward situation—you could nibble here with a tight stop and consider averaging up on a move above 45.

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Stock 2

Argenx (ARGX)

Why the Strength
Argenx is a Dutch autoimmune-focused biotech firm that has emerging blue chip written all over it thanks mainly to its blockbuster treatment known as Vyvgart, a drug that the firm has long believed is a “pipeline in a product,” with a unique action mechanism (attaches and blocks a protein that regulates antibody levels) that should lend itself to many different autoimmune indications. The first approval came a couple of years ago for generalized myasthenia gravis (gMG; causes weakening muscles including in the throat), and sales from that have boomed for many quarters. However, some iffy trials last year had Wall Street starting to doubt the pipeline-in-a-product idea, but that’s changed in a big way in recent months: Vyvgart was approved for a different indication in the spring in Japan (ITP, which can cause reduced platelet production) and, importantly, got the thumbs up for a new indication in the U.S. in June (CIDP, which can cause reduced sensation in arms and legs); the firm got 300 CIDP patients on the rolls in Q3 alone, which the top brass said was about on par with the gMG launch. All of this should be the tip of the iceberg, with Argenx aiming to have 10 total indications approved by 2030 (mostly from Vyvgart, though two or three from a pipeline drug that has great potential), with some analysts believing Vyvgart itself can eventually see peak sales well above $10 billion a year down the road. That’s obviously a speculation, but right now all the tidings are good: Q3 revenues were up 73% and came in well ahead of expectations, and the bottom line has exploded into the black the past two quarters, both of which have caused analysts to again ratchet up their outlooks for 2025 (now approaching $9 per share) and much more beyond that. As a biotech, there will be event risk (clinical trials in new indications), but there’s no question the company is set to get much bigger over time.

Technical Analysis
ARGX staged a powerful turnaround starting in May, with shares racing higher 12 weeks in a row (a sign of persistent accumulation), with most on above-average weekly volume, too. However, starting in August, shares began to rest … and kept resting for the next two and a half months, though they never did anything abnormal, mostly hovering between 510 and 550. Now ARGX has moved to new highs on solid volume after earnings—we’re OK taking a stab at it around here with a stop under the 50-day line.

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Stock 3

Exelixis Inc. (EXEL)

Why the Strength
Exelixis stock is riding its best four-week stretch since early 2020 thanks to a ton of positive momentum behind the biotech’s cancer treatments. Its franchise right now is cabozantinib, marketed under the name Cabometyx, which is a tablet that is used to counter renal cell (kidney), hepatocellular (liver) and thyroid cancers. It sold $478 million in the U.S. alone last quarter and $653 million globally (international partners Takeda and Ipsen take a percentage of those non-U.S. sales). That put Exelixis’ Q3 net sales at $540 million, a whopping $40 million better than Wall Street expectations. All of that is to the good, but equally encouraging is that the company has a another very promising treatment called zanzalintinib (zanza for short), a treatment for solid kidney tumors—zanza builds on the approach of Cabo, directed for patients with head and neck cancers as well as colon, kidney and neuroendocrine tumors, a group of some 100,000 U.S. patients annually with a critical unmet need. Management said in a call with analysts last week they believe Wall Street has been overlooking the potential of zanza and the success it’s been having in late-stage trials. They anticipate approval in 2026 for that treatment with an (admittedly very early) projection of $5 billion in sales through 2033 from the treatment. The company has another nine treatments in its pipeline it feels are promising, with an approach that doesn’t rely on one style of drug development or a particular molecule, something Exelixis feels lessens the R&D risk. Full-year guidance – all net Cabometyx revenue – was just hiked to $1.8 billion on about $2.2 billion gross global sales. Analysts expect that to produce $1.67 in earnings per share for 2024. A nice tailwind: An October court judgment in favor of Exelixis means a competitor can’t sell a Cabometyx generic until 2030, when zanza should be doing well.

Technical Analysis
EXEL basically hit a peak near 25 at the end of last year and embarked on a long, grinding base before breaking out in August—however, instead of running, the stock meandered for another couple of months after that. But now EXEL has changed character, bolting higher first on the court verdict and then after earnings, with the stock exploding to new highs on big volume. We’ll aim to enter on dips, though given the power, we’re not expecting a huge retreat.

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Stock 4

Procept Biorobotics (PRCT) ★ Top Pick ★

Why the Strength
Hydros, Procept’s AI-assisted robotic system for urology surgeries, had an excellent launch in the third quarter. Analysts projected that training Procept’s sales teams on Hydros, which was approved by the FDA in August, would make the third quarter a bit slow and something of a transition, but in its results announced a week ago, the company beat expectations handily. Procept posted revenue of $58.4 million, about 10% better than expected, with a net loss per share of 40 cents, well ahead of consensus. Hydros contributed its part, with 45 pricey systems being sold in the period, most to new customers. That increased Procept’s installed base to 445, up about 63% from last year. Procept’s business has focused on robotic surgical systems for benign prostatic hyperplasia (BPH), commonly called enlarged prostate, for which eight million men in the U.S. are undergoing treatment, often with drugs or surgery, both of which have side effects. Procept’s treatment for BPH is usually through aquablation, a surgical procedure in which a jet of water is used to destroy excess prostate tissue that cause BPH. Aquablation is preferred over other options because it’s minimally invasive and tends not to affect sexual function or cause incontinence. Procept’s base system, which Hydros replaces, is called AquaBeam and sells for $380,000 to medical facilities. Recurring revenue from additional consumables is the real prize, though, and that figure grew faster than total sales in Q3 and makes up about half of the total now. AquaBeam isn’t being made obsolete for existing clients and Procept saw some facilities opting to carry both last quarter. Hydros’s AI system has been trained on thousands of real-life ultrasounds from prior BPH patients, and multiple studies have shown that doctors using AI assistants are more effective. The bottom line is in the red, but it’s a big story, gross margins are improving and sales growth is rapid: Management expects full-year sales to come in close to $223 million, up 64% from 2023, with Wall Street seeing another 40% top-line gain in 2025, which will likely prove conservative.

Technical Analysis
PRCT staged a longer-term breakout (from a big IPO structure) in May of this year, leading to some big, quick gains, but then it got choppy—shares retreated 30% into the August low, zoomed to marginal new peaks in September, but then pulled back again last month, making for five months of no net progress. But the Q3 report brought another round of buying on record weekly volume, so it looks like the real deal. Expect volatility, but we’re OK with a small buy here or (preferably) on dips, albeit with a loose stop.

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Stock 5

Roblox (RBLX)

Why the Strength
Roblox (covered in the September 9 issue) is an online game platform and game creation system that hosts millions of user-generated video games and other content, including 3D experiences across various devices. A big focus for Roblox in recent quarters has been the expansion of its user base, along with increasing monetization for its highest-demand games (most of the video games offered on Roblox are free to play), and last week’s Q3 report underlined the company’s progress on these fronts. Revenue of $919 million increased by a strong 29% from the year-ago quarter, while bookings were up nearly 35%, to $1.1 billion and significantly above expectations. And while earnings per share remained in the red, free cash flow improved substantially (up 66% to around 34 cents per share). Other metrics were equally impressive, including daily active users (DAUs) that rose 27% to 89 million, led by DAU growth in Japan (up 59%) and India (up 55%), with North America increasing 28%. Meanwhile, total hours engaged rose 29% to 21 billion, backed by a 6% increase in average bookings per DAU, to $12.70. Average monthly unique payers of 19 million rose 30%, and average bookings per monthly unique payer was $19.70. The top brass recently announced a goal of having 10% of the world’s gaming software market running on Roblox, and after the stellar quarter, it now believes this is achievable (it’s currently mapping out how to support the content that will drive this goal). Right now, Roblox thinks it has just 3% of its potential market, with big opportunities in genres like simulation and role play as well as sports and racing games (it plans to double market share in the latter two categories). In the wake of earnings, a major institution put Roblox on its Best Ideas List while reaffirming a bullish rating for the stock (another reason for the strength). Wall Street sees the top-line growing 24% this year and 18% next with free cash flow likely picking up steam.

Technical Analysis
RBLX has been stuck for what seems like an eternity inside a lateral trading range between the upper 20s and upper 40s, gyrating between those levels in the past couple of years. The test of the top of that zone in September failed, but shares etched a higher low (its second since May), and now the bullish Q3 earnings have changed the stock’s character, with RBLX breaking out on strong volume to its highest levels since 2022, though it did have a wobble today on big volume. We’re going to set our buy range up from here, looking to enter on follow-through from the earnings move.

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Stock 6

Shake Shack (SHAK)

Why the Strength
Shake Shack has always had a good underlying cookie-cutter growth story, but what held it back from becoming a big winner was execution—specifically costs, which seemed to increase as much or more than revenues, keeping the bottom line capped even as the firm’s footprint grew larger. However, the firm has been tightening its belt for many quarters now, and the hiring of Papa John’s CEO in May lays the groundwork for a long runway of profitable growth. Indeed, the numbers have been improving for a while and the stock just popped to new highs after the Q3 results last week—in the quarter, sales lifted a solid 15%, bolstered by a solid 4.4% gain in same-store revenue (to be fair, most of that was from pricing, but traffic trends have also improved) and an 11.5% lift in the total number of stores (which includes both company-operated locations in the U.S. and licensed restaurants, usually overseas). There’s plenty of top-line expansion potential left (“only” 552 locations around the globe; aiming to open 27 new locations in Q4 and 80-plus in 2025), but as mentioned above, the upside surprises have come on the cost side: New build costs are down about 10% from a year ago, while cost of goods sold and labor costs as a percent of revenue both fell by nearly a full percentage point in Q3 from last year, allowing restaurant-level profit margins to move up (should be up 1.1 percentage points this year) while EBITDA lifted 28%. (Earnings of 25 cents per share were up 47% and easily topped estimates by six cents per share.) Of course, another wave of food inflation could have an impact, but at this point, it’s really just keeping the momentum in place—Shake Shack is a proven brand, so if the top brass can pull the right levers, there’s no reason the bottom line can’t grow significantly from here.

Technical Analysis
SHAK has made good progress during the past couple of years but timing has been vital, with some wild swings up and down: There was a 34% deep base from the summer of 2023 into February of this year, and the breakout from there seemed solid … but shares ran into resistance soon after and slipped into another good-sized (30% deep) correction and launching pad. SHAK began to change character after earnings in August and spent the past couple of months tightening up—before last week’s report brought the breakout. Given the fact that many earnings winners have pulled in of late, we’ll aim to enter on a little weakness.

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Stock 7

Trip.com (TCOM)

Why the Strength
After years of stagnation, the Chinese inbound and outbound travel industry has made significant strides toward recovery this year, punctuated by last month’s Golden Week (when a large number of Chinese people travel around the country). The country’s tourism industry—both inbound and outbound—is one of the world’s largest, and it has just set a milestone as domestic hotel bookings have exceeded pre-pandemic levels by a significant margin, signaling a robust recovery in the hospitality and tourism sectors ... with hopes there will be more of that to come given the humongous economy-wide fiscal and monetary support measures now in place. Trip.com is a leading one-stop travel service provider of accommodation reservations, transportation ticketing, packaged tours and corporate travel management. The online booking website offers customers deals in over 1.2 million hotels across more than 200 countries, with China its most important market. Accommodation bookings on the company’s Chinese sites grew by approximately 20% year over year in Q2, driven by superb growth across all segments of the business. The strength in outbound hotel and air reservations internationally was especially pronounced and recovered to 100% of pre-Covid levels for the same period in 2019—far surpassing the industry-wide recovery rate of 70%-ish. Revenue of $1.8 billion increased 13% year-on-year in Q2, with earnings of $1 per share beating estimates by 25% while adjusted EBITDA increased 9%. Trip.com said inbound travel to China has seen “remarkable growth” in the first half of 2024 (up 150%), with visitors from visa-free countries surging 190%. Management noted that its introduction of new flight routes has significantly increased travelers’ interest in those specific destinations, with the move more than doubling search volumes for the corresponding destinations. The firm is also leveraging AI to channel customers’ discretionary income towards “enriching” travel experiences and premium services (a key part of its growth strategy going forward). Wall Street sees steady mid-teens sales growth going for many quarters to come, with potential upside if the stimulus measures work.

Technical Analysis
TCOM was stronger than the average Chinese name for much of the year, but the character of the stock completely changed along with the entire peer group in September, when China’s central bank and government announced their intentions to flood the system with money. We wrote about the stock on September 30 but never got our buy price over the next couple of weeks, but after a quick dip, TCOM has been riding its 25-day line up and acting much more “under control.” Indeed, shares popped today, and while we don’t advise chasing them higher, a small retrenchment would be tempting with a stop under the October low.

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Stock 8

Twilio (TWLO)

Why the Strength
Twilio is known for its cloud-based platform that allows developers to add communications between customers and end users to their applications, including messaging, voice, email, marketing campaigns, as well as user identity and authentication. Of significance, its Twilio Flex and Twilio Conversations API software allow enterprises to integrate ChatGPT-like capabilities into their tech offerings, from web chat to short message service (SMS). The huge top-line growth from the pandemic days is in the past, but the company’s longer-term turnaround plan is starting to pay off as metrics like free cash flow, margins and net retention rate are all showing notable improvement, and it’s rapidly becoming a beneficiary of the artificial intelligence wave. On that note, its customer data platform, Twilio Segment, helps businesses collect, analyze and use customer data to create personalized marketing strategies. While Segment currently accounts for a small part of the firm’s revenue (less than 7%), Twilio sees it as a long-term “activation engine” to monetize its AI strategy and accelerate the turnaround. Additionally, the company has recently collaborated with OpenAI to bring its new Realtime API to the Twilio platform. The integration of Realtime API’s streaming speech-to-speech capabilities will enable over 300,000 Twilio clients and more than 10 million developers to build conversational AI virtual agents. On the financial front, Twilio’s Q3 numbers show that revenue is accelerating, prompting a number of Wall Street institutions to raise their price targets for the stock (a reason for the latest show of strength). Revenue of $1.1 billion increased 10% from a year ago, while earnings of $1.02 a share boomed 76% and topped estimates by 16 cents, while free cash flow came in at $1.18 per share (nicely ahead of earnings). Meanwhile, Twilio’s customers spent 5% more in Q3 than they did a year ago, representing the firm’s best performance for this metric since Q1 2023 and reflecting the “improved growth trends” in its communications business over the last several quarters. The company is also executing on its $3 billion buyback authorization (total shares outstanding down 12.5% in Q3 from a year ago). Earnings should advance at mid-teens rate from here (probably conservative), while the valuation (24x trailing earnings) is supportive.

Technical Analysis
Like many of its peers, TWLO was a pandemic-era darling but fell out of favor in 2022, with shares dropping 400 points before hitting rock bottom at 50 later that year and spending the last couple of years etching out a bottom above that level. The stock has shown a few bullish clues since its latest bottom in June, with weekly winning streaks of seven and six weeks, and after some very tight trading of late, TWLO has gone vertical following last week’s report, hitting two-year highs. We advise looking for pullbacks, but we’re not thinking a major retreat is likely.

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Stock 9

Vertiv Holdings (VRT)

Why the Strength
Vertiv specializes in cooling devices for computing systems. Historically that’s been a nice business for Vertiv (it got its start during World War II), but now it’s being supercharged by AI. Energy-hungry AI chips run hotter than standard chips, and that makes cooling servers (especially arrays of them in data centers) more critical than ever, providing a big growth lane for Vertiv. (The company’s complementary businesses producing uninterruptable power supplies and server enclosures benefit too.) The company’s third-quarter earnings, reported last week, reflect the continued strength and demand seen in this area. Sales were up 19% year over year to $2.07 billion (accelerating growth over the past couple of quarters), with earnings per share of 76 cents up 46%, beating expectations. Vertiv saw double-digit growth around the globe, as the rest of the world looks to catch up to American leadership in AI. Most encouraging was China, and though management thinks there could be a slowdown of sorts there in Q4, it’s a big opportunity, and either way, the Americas and Europe should remain robust. Management bumped up full-year revenue guidance by $140 million to about $7.7 billion – that’ll put 2024 sales up about 14% – with full-year diluted EPS right around $2.68. Next year is looking even better, as Vertiv says its order backlog of $7.4 billion should mean the 2025 growth rate bests this year’s; Wall Street sees the top line up 16% or so while margins continue to expand, driving earnings up 31%. Possibly more important was management’s commentary on the Q3 call, where they expressed confidence they were winning the global market for AI-driven cooling, in large part thanks to liquid cooling solutions and partnerships with NVIDIA and Intel to closely develop cooling designs for next-generation chips. All in all, it’s a good AI growth story.

Technical Analysis
VRT has had a huge run since the AI boom began over a year ago, so it’s possible the stock needs time to re-set itself—but it’s certainly not acting like it, with the stock hanging near its highs and actually a bit stronger than the Nasdaq overall. The recent correction was the first severe one for the stock (43% deep) since it got moving, but the straight-up six-week run to marginal new highs was a good sign. The post-earnings action has been choppy, but normal, and we see a decent risk-reward situation setting up—we’re OK with a small buy here and a stop under the 50-day line.

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Stock 10

XPO (XPO)

Why the Strength
Connecticut-based XPO is one of North America’s largest less-than-truckload (LTL) transportation providers, with coverage spanning the U.S., Canada, Mexico and the Caribbean, and with a fleet of more than 38,000 semi-trailer trucks across 562 locations. It also has a European trucking division (primarily France and the U.K.), comprising 40% of sales. LTL is a category of the broader logistics business that tends to be less cyclical and higher margin than other parts, and this is why XPO has focused heavily on this segment in recent years—and that focus has paid off for many years, including in the latest quarter, which produced better-than-expected results: The firm’s North American LTL segment saw business inch ahead by 2%, while sales (up 7%) and volume growth in the European Transportation segment was even better. Both businesses helped push company-wide revenue to just over $2 billion, a 4% increase from the year-ago Q3, while per-share earnings of $1.02 beat estimates by 12 cents (the reason for the stock’s strength). The standout result of the quarter was the firm’s “strong” margin expansion, with a two-percentage-point improvement in LTL operating margins. XPO also highlighted its continued improvement in its damage claims ratio of 0.2%, as well as an improvement in on-time performance for the 10th consecutive quarter. In addition, the company has opened up 21 of the 28 service centers it acquired from last year’s Yellow bankruptcy, and it expects to open the last seven sites by early next year, which should lock in higher market share. Going forward, XPO is focused on increasing cost efficiency, partly though reduced outsourcing thanks to it delploying more driver teams in sleeper cab trucks. All together, you have what’s likely to be slow, steady sales growth and expanding margins that will lead to solid, 20%-plus bottom-line growth in 2025 and beyond.

Technical Analysis
XPO had a big run from the spring of 2023 through earlier 2024 as Yellow’s bankruptcy goosed the entire sector (much less competition for the remaining big players). The past eight months, though, were essentially a rest period, with shares trading in a 26% band, which was reasonable given the huge upmove that came before. But after consistent support near the century mark, XPO seems to be changing character, with two good-volume weeks and last week’s earning report pushing the stock back near its old highs. We’re OK starting small here or on dips with a stop in the upper 110s.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on November 11, 2024.

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