Cabot Top Ten Trader Issue: October 7, 2024

Resilient Action as Defensive Stocks Sag

In the market, it’s not the news that counts, but the market’s reaction to the news—and that makes last week’s trading noteworthy: Middle East attacks, tensions and uncertainties along with a dockworkers strike (that was quickly put off for a few months) could have easily caused risk-on assets to pull in, but instead, most indexes took the news in stride and, somewhat surprisingly, we’ve seen defensive stocks hit the skids, too. Now, to be clear, there are still flies in the ointment out there, including rising Treasury rates (the 10-year note yield is up more than 0.4% in two and a half weeks and hit a two-month high today) and a lot of indexes, sectors and stocks that are still relatively range bound. There’s no question the resilient action is an overall positive and there remain many stocks that act well (including tons of Top Ten names), but we’re staying in the same stance as we wait for upside confirmation from more of the market—we’re encouraged, but we’re leaving our Market Monitor at a level 7 as we wait for the buyers to truly flex their muscles

This week’s list is another one with something for everyone in terms of stories and setups. Our Top Pick is BWX Technologies (BWXT), a firm that has its hands in many nuclear power cookie jars; the stock just emerged from a multi-month rest on big volume.

Stock 1

Apollo Global (APO)

Why the Strength
Apollo is one of the world’s largest alternative asset managers, with investments including private equity and real estate, but its credit unit is its largest business, encompassing the public and private corporate credit and asset-backed finance markets. A series of deals on the credit market is one reason behind the stock’s latest strength, including a just-announced $25 billion private credit, direct lending program led by Apollo’s subsidiary, Athene, in conjunction with Citigroup. Meanwhile, Apollo announced last week that it was in talks to acquire the aerospace component maker Barnes Group in a deal valued at $2 billion. But the biggest news of late came from the firm’s Investor Day on October 1, where the firm sees a booming next five years: Apollo thinks it can grow fee-related earnings 20% annually during that time, while spread-related earnings (from its insurance and annuity operations) should grow 10% annually despite expectations of falling rates. All told, the firm is aiming for assets under management to reach a whopping $1.5 trillion (up from $696 billion at the end of June) while adjusted net income per share roars ahead from $7 during the past 12 months to at least $9 per share in 2026 and $15 per share in 2029! Of course, forecasts are one thing, but this Bull Market company has been showing signs of acceleration of late anyway—the underlying earnings here are picking up steam (driven by fee-related income rising 17% from a year ago in the first half of the year; three-quarters of assets under management are now fee-generating), and importantly, it’s gotten easier to raise money (mostly from credit) in the past year, with originations rising from $33 billion to $43 billion to $56 billion in the past three quarters. And with the Fed turning easy, that pickup should be sustainable. All told, Apollo is a well-managed outfit, and with the monetary environment shifting in its favor, results will likely surprise on the upside going forward.

Technical Analysis
After a solid run late last year and into early 2024, APO began to lag its Bull Market stock peers starting in February, with the declining Fed rate cut expectations back then likely impacting perception given the firm’s big credit focus—indeed, the stock eventually took a hit with the market in August that nearly took away all of its year-to-date gains. However, APO did recover quickly after that, with shares turning very strong after a post-Labor Day shakeout, and the early-October move to new highs came on big volume. We’ll aim to enter on weakness.

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Stock 2

BWX Technologies (BWXT) ★ Top Pick ★

Why the Strength
A growing demand for cleaner sources of energy, driven in part by federal and state legislation in support of small modular nuclear reactors, is just one of the catalysts behind the latest strength in the nuclear service space. BWX is a leading public and private sector supplier of nuclear components and fuel, as well as technical and site services, to assist in the operation of nuclear facilities and environmental restoration. The company also supplies precision manufactured components, services and so-called heavy water (CANDU) fuel for the commercial nuclear energy industry, which is a major growth driver for the company thanks to the ongoing alternative energy movement. Lately, the company has collected a string of high-value contracts for the construction and support of small-scale nuclear reactors: In April, it was selected as the first qualified supply chain company to team up with the nuclear business of GE Vernova to advance the global deployment of the BWRX-300 small modular reactor. (BWX will be responsible for the design, manufacturing and procurement of the reactor pressure vessel for BWRX-300 to be built at Ontario Power Generation’s Darlington New Nuclear Project site, with project completion expected by 2029.) In June, the firm was awarded the second phase of a contract with the Wyoming Energy Authority to assess the viability of deploying small-scale nuclear reactors in the state. And more recently, BWX was named a partner with the Pentagon to assist with the construction of a site in Idaho where the Project Pele mobile nuclear reactor will be tested. (The portable reactor is designed to be transported to remote military bases that need power, with BWX to begin assembly next February.) For the here and now, Q2 saw BWX book total sales of $682 million, up 11% from a year ago, with the firm’s commercial operations segment leading the way (up 17%). Per-share earnings of 82 cents beat estimates by eight cents, supported by microreactor demand across several verticals, including global security, clean energy and medical markets. Going forward, the top brass expects commercial operations revenue growth in the 10%-ish range for the next few years, though nuclear deal flow will probably be what affects perception in the weeks to come.

Technical Analysis
After experiencing a relatively smooth, steady upside run for most of 2023, the calendar flip earlier this year saw BWXT go vertical heading into March. But the blow-off ran out of energy in April, with shares backtracking 19% and finding support around 90 the following month. Shares spent the next three months chopping around in a 15-point trading range with sharp dips in August and September, but now the buyers are unloading, as BWXT has roared ahead to new highs on many days of big volume. We’ll set our buy range lower, though we’re not expecting a big retreat.

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Stock 3

Fortinet (FTNT)

Why the Strength
Networking and security technologies are rapidly converging in the wake of the hybrid work trend, with growing cyber threats driving demand for even more adaptable and secure network solutions. This is where Fortinet enters the picture: The California-based company is one of the world’s top cybersecurity software providers, originating as a traditional firewall provider, but in the last few years augmenting its product offerings to combine artificial intelligence (AI) and machine learning (ML) to stay ahead of evolving network threats. (The company’s FortiNDR, for instance, detects threats that may slip past traditional security solutions by using both ML and AI.) More recently, the company expanded its reach in the enterprise-level data loss prevention (DLP) category by acquiring Next DLP, which is expected to strengthen Fortinet’s position in that area as well as within its own unified Secure Access Service Edge (SASE) solution. Meanwhile on the cloud front, as more than 50% of all enterprises are expected use cloud platforms to accelerate their business initiatives by 2027, Fortinet has introduced FortiCNP, an all-in-one, integrated security and compliance solution for cloud-native application protection platforms (CNAPP) and related environments. (The platform is also regularly updated with enhancements, including AI-driven features like zero-permission malware detection.) To strengthen its CNAPP space leadership, Fortinet also just acquired CNAPP trailblazer Lacework—the firm said it expands its total addressable market by $10 billion and plans to combine the strengths of both companies to create “the most comprehensive, full-stack AI-driven cloud security platform available from a single vendor.” On the earnings front, Fortinet reported revenue of $1.4 billion in Q2, up 11% from a year ago, with earnings of 57 cents beating estimates by 40% (!) and operating margins hitting a company record of 35%. Meanwhile, deferred revenue of almost $6 billion increased 15%, which points to good things ahead.

Technical Analysis
FTNT was crushed in mid-2023 and rallied more than half way back by March of this year before suffering another downmove into August—all in all, it was more than a year of generally poor action. But the quarterly report reaction on August 7 changed the stock’s character, with a big gap up, a rally to the upper 70s after and, now, tight trading in recent weeks just shy of its 2023 highs. We took a quick-ish profit in FTNT a couple of months ago but like the current setup—we’ll set our buy range up from here, aiming to enter on a resumption of the post-earnings rally.

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Stock 4

Glaukos (GKOS)

Why the Strength
Glaukos is a pioneer in treatment for glaucoma and other eye disorders. The company pioneered micro-invasive glaucoma surgery (MIGS) early last decade, which is emerging as a standard worldwide—the surgery is used to implant Glaukos’ first product, iStent, to lower intra-ocular pressure (IOP), one of the primary ways of treating glaucoma. (iStent, by the way, is the smallest approved device that gets implanted in the human body.) That’s still a growth sector, but the new part of the story came last year when regulators approved another glaucoma treatment that has investors particularly enthused. Called iDose, it’s an intracameral treatment that can deliver drugs to a glaucoma patient’s eyes for up to three years. It’s likely an important step in the treatment of the disease, since the current course of regular eye drops is shown by studies to be largely ignored or done incorrectly by patients – more than half of prescriptions never get refilled after six months – and since glaucoma is a low-progressing disease, the problem of not continuing treatment isn’t easily recognized by patients. Glaukos is just getting started commercially with iDose – insurance reimbursement fees were just set in July – and management reports a lot of enthusiasm from laser eye surgeons who see the product as a way to continue to service existing patients. Sales of iStent already have been providing good growth for Glaukos – revenue was up 19% in Q2 to $95.7 million and the company inched up full-year guidance to around $373 million as a result. iDose will be just about 2% of that this year, with 2025 the time when sales of the treatment will be ramped up. Glaukos isn’t offering any sales estimates for iDose, but the market opportunity is large, given estimates are more than 20 million eyes in the U.S. with high pressure or glaucoma, about 13 million of which have been diagnosed at any one time. As it stands now, analysts see sales growth accelerating to 24% next year, which will likely prove too low.

Technical Analysis
GKOS changed character late last year and has been in an uptrend since, though it’s had lots of multi-week rests and dips to or below the 50-day line on the way up. Since the big-cap indexes topped in mid-July, the stock has had two pullbacks (16% during the market’s August plunge, and then 12% starting in late August); in total, shares made no net progress for about three months. But now GKOS is showing some bullish signs, holding the 50-day line and beginning to perk up. We’ll set our buy range up from here, looking to buy on strength and use a tight loss limit.

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Stock 5

Jacobs Solutions (J)

Why the Strength
The $1 trillion infrastructure spending bill passed by the federal government is providing a huge lift for the infrastructure services unit for Jacobs Solutions. The Dallas-based technical services firm provides engineering, design, construction and maintenance services, along with cyber engineering and security solutions, for public and enterprise customers. It also provides support for life sciences, aerospace and data center facilities. This summer, Jacobs announced it was spinning off its Critical Mission Solutions segment (which supports national security, space, nuclear remediation and 5G technologies), along with the cyber and intelligence business of its Divergent Solutions segment, in order to streamline the company while improving margins and concentrating more attention on critical infrastructure projects, including advanced manufacturing, energy, life sciences, transportation and environmental sustainability, as well as a continued focus on data center infrastructure. Although revenue and earnings were up just a smidge from a year ago in fiscal Q3 (ended June), Jacobs reported a more than 50% increase in free cash flow, which allowed it to reinvest in the business while returning capital to shareholders. Importantly, the backlog grew 6% year-on-year, to a record $31 billion, led by the People & Places Solutions segment (architecture, energy transition and water services), with the backlog heavily weighted toward water and advanced life science facilities. On that score, Jacobs has exposure to the booming weight-loss drug market through longstanding partnerships with pharma giants Eli Lilly and Novo Nordisk. (Jacobs recently noted that its work for the two firms involves “nearly over 50% of the capital” that Eli and Novo are allocating to meet “intensifying demand” for obesity drugs.) Elsewhere in the sustainability space, Jacobs won several key awards, including emissions management contracts with major oil and gas producers. Analysts expect earnings to expand nicely this year and tick up in 2025, though the firm usually tops estimates. Big picture, it’s likely Jacobs sees new orders and backlog accelerate going forward.

Technical Analysis
J isn’t the most dynamic stock out there, but the latest breakout looks like it can produce a solid run. The stock rallied nicely into its March top before pulling back 14% and consolidating for nearly six months with multiple tests of the 40-week line. But now we see a change in character, with J up eight of the past nine weeks, with some big-volume buying coming on last week’s breakout. We’re OK buying some around here with a stop under the breakout level of 127.

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Stock 6

Modine Manufacturing (MOD)

Why the Strength
A typical data center can generate up to 50 megawatts (MW) of heat, while a data center campus can generate up to 300 MW. Needless to say, the demand for cooling technology in the ongoing data center buildout trend (bolstered by AI) is massive and continues to grow, particularly with hyperscale data center projects that typically cover millions of square feet. The data center boom is a key reason behind the strength of Modine, a global leader in the field of thermal management. The Wisconsin-based company provides heating and cooling solutions for commercial, industrial and vehicular customers, and its markets also include mining, agriculture, utilities, home and industrial refrigeration and electric vehicles (EVs). Data centers were the focal point of Modine’s Q1 fiscal report (ended July), which saw a 6% year-on-year revenue increase to $662 million, along with earnings of $1.04 a share that beat estimates by 18 cents. The firm’s Climate Solutions segment led the way with a 25% sales increase, driven by higher sales of data center cooling products (partially offset by lower sales of heat transfer products), resulting in a 31% adjusted EBITDA jump for the segment. The Performance Technologies segment, meanwhile, reported a 10% sales decrease, mainly due to lower sales to off-highway and automotive customers as well as divestitures. However, segment margins increased due to higher average selling prices and lower material costs, while adjusted EBITDA rose 25%. Still, the story here is mostly about data centers: The top brass guided for a “continued acceleration” in data center cooling sales and sees a big few years ahead, believing there’s an opportunity to triple data center cooling revenue over the next three years to just over $1 billion, which in and of itself would nearly double current Climate Solutions segment revenue. There’s also good potential in the high-growth, high-margin stationary power generation business, which Modine said “remains strong” and should help offset weakness in the automotive and agriculture equipment markets. Wall Street sees earnings growing 20% or so both this year and next, which will likely prove conservative.

Technical Analysis
MOD had smooth sailing for a few months after last October’s market correction, running up over 60 points before encountering strong resistance near 105 in March. Trading became a lot choppier from there, as shares had trouble making new highs and saw tons of volatility, including a violent post-earnings drop to the 40-week line in August and another wild dip in September. At that point, MOD had gone nowhere for six months—but now the stock has resumed the uptrend, moving to new price and relative performance peaks on solid volume. If you want in, aim for a pullback under 130.

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Stock 7

On Holding (ONON)

Why the Strength
When hunting for potential big winners, we like to look at the three Rs—firms with long runways of rapid and reliable growth, the combination of which entices big growth managers to accumulate positions (and add to them) over time. Retail is a good place to find this combination, because, while preferences do change over many years (most of the popular retail brands a decade ago are lagging today), the fact is when you find a solid brand, it usually remains in favor for many years. That’s the 10,000-foot investment attraction of On Holdings, a Swiss-based firm that is taking big share in the athletic footwear sector as some other peers (Nike released another dud of a quarterly report last week) struggle. Importantly, the growth here isn’t just brand building or advertising; the firm’s footwear was actually designed to be better for runners (more cushion-y impact, spring-ier push off), and indeed, the winner of the last two women’s Boston Marathons is a client. And the firm has since moved into other areas, incuding tennis shoes (designed and endorsed by Rodger Federer), hiking and even “lifestyle” (wearing around town) footwear. Moreover, On is following in the footsteps of others by moving into apparel and accessories, and while they’re surely a small piece of the pie at this point, uptake looks good, with apparel sales up 66% and accessories up 26% in Q2 (compared to footwear up 28%, all on a currency-neutral basis). From here, it’s a matter of the top brass pulling the right levers and doing so in a prudent way—Q2 results, for instance, were solid but hurt a bit by capacity issues as it transitions to an automated production facility in Atlanta. Even so, the top line here should grow 30% in 2024 (excluding currency movements), those hiccups seem behind it and there’s no reason On can’t get much, much bigger in the years ahead.

Technical Analysis
ONON essentially consolidated for a year into May of this year, when the Q1 report brought a breakout—but it wasn’t up and away from there, as the market’s narrow rally and summer correction saw this stock dip into a shallower 10-week launching pad. Big buying volume appeared near the August market low, and follow-on buying was seen after the August quarterly report soon after, and shares have continued to act well since, riding the 25-day line higher. If you want in, we’re OK starting a position here or on dips of a point or two.

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Stock 8

Reddit (RDDT)

Why the Strength
Reddit is the world’s largest collection of message boards where you can literally find likeminded people discussing any specific topic, location, show, event, or category, allowing millions of people to chat and get answers to nearly everything imaginable. The scale is what makes Reddit unique, with something like 130,000 active “sub-reddits” (community boards) that are often managed by moderators and bots to keep boards and posts appropriate and the conversations moving forward. AI is sure to help automate and improve these functions, as well as make Reddit as a whole easier to use; there are even machine translations that allow posts from different lauguages to be read (the firm had 45 million daily active international users at the end of June). Indeed, in Q2, the firm attracted 91.2 million active daily users (up 51% from a year ago) and an unbelievable 342 million weekly unique users (up 57%), which of course has advertisers eager to get their messages and wares in front of them, especially given the targeted nature of the sub-reddits (a specific crockpot, for instance, in the r/slowcooking thread). Not surprisingly, most of Reddit’s focus now is on improving ad capabilities and placement for its ad clients, with dynamic product ads and generative AI campaigns help taking hold—in Q2, ad revenue lifted 41% and made up about 90% of the total, with strong growth both in and outside the U.S. Interestingly, there’s also a data licensing angle, which could be big given that Reddit’s collection of real human interactions is by far the largest out there. The bottom line is still a bit in the red, but EBITDA is picking up steam ($40 million in Q2, up from a $35 million loss a year ago; $50 million expected in Q3), and more important to us is the runway here, with Reddit still getting “just” $3.08 of revenue per user—by comparison, Meta gets $40 or so, and while nobody is predicting that sort of growth, there’s no reason Reddit’s figure can’t double or triple going forward. Earnings are due October 29.

Technical Analysis
Recent IPOs are usually more volatile, and RDDT certainly fits that bill, with a wild post-IPO drop in April, an even sharper rally into July and then another 37% decline over 18 trading sessions when the market was weak this summer. But shares started to pick up from there and have continued to round into form—RDDT is now up seven of the past eight weeks, most on above-average weekly volume. There is resistance up above here, so we’ll set our buy range down a bit.

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Stock 9

Tradeweb (TW)

Why the Strength
Tradeweb is a growing electronic platform for trading fixed-income products, including municipal bonds, Treasuries, derivatives, money markets, mortgages – really anything fixed income, as well as some equity products, like ETFs. The business was founded in 1996 and continues to have a big upside: A lot of debt instruments are still traded verbally between institutional trading desks, though automation continues to make headway; in particular, Tradeweb’s low cost continues to grab market share from much pricier competitors like Bloomberg. For September, the company reported a huge jump in average daily volume traded on the platform, up 69% from the year before to $2.21 trillion. While much of that volume was driven around one-time activity related to the Fed’s rate cut, the increase is a sign Tradeweb continues to gain market share in debt markets that are only getting bigger over time. And in institutional trading, market share means a lot because it usually begets more share—larger volumes make it easier for traders to execute large dollar trades quickly without moving the market much and generally improves pricing of trades for customers by drawing more bids and offers, a virtuous cycle. Tradeweb makes money from a small commission it takes on each transaction or from subscription fees to trade, as well as business lines in consulting and providing market data. For the quarter ending September, consensus had been for revenue of $420 million with net income of $0.69 a share, though expectations are probably higher now after the blowout report of monthly volume. For the year, Wall Street expects a 25% jump in revenue to $1.67 billion and $2.81 per share earnings, along with continued out-of-this-world margins. It’s a solid long-term growth story, with the Fed’s new easing path providing a near-term catalyst for volumes.

Technical Analysis
TW has been in a long-term uptrend since last summer, with a three-steps-forward, two-steps-back advance over time. That latest steps back came after a peak in May, with shares consolidating for three months and, after a breakout attempt in August, a shakeout in September to the 50-day line; at that point there had been no net progress for four month). But TW has taken off since then, capped by a huge rally on its September volume metrics. We’ll set our buy range down a couple of points.

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Stock 10

Viking Holdings (VIK)

Why the Strength
Viking Holdings looks like a follow-on leader in the still-booming cruise ship sector, which was easily one of the hardest hit areas during the pandemic and for years after—but now, capacity is tight, prices are rising and demand (thanks to the seemingly never-ending travel boom) remains strong, driving earnings higher. Viking has something like 90 ships on the water today, but it offers a different angle than big boys like Carnival and Royal Caribbean, as it’s best known for (and the vast majority of its business comes from) its river cruises that have a cultural component (often dock at historic cities across Europe, include educational lectures, have local artisans teaching onboard, etc.) and usually don’t have any gambling or kids. 90% of its clientele is North American and they’re often more affluent and can book ahead of time (at the end of June, 95% of 2024 capacity was booked and 55% of 2025 was booked; total deferred revenue was $3.8 billion, equal to about three-quarters of the past 12 months of revenue), which adds resilience and reliability to the business. The firm is making a bit of a push into ocean voyages in the years ahead, though river cruises will remain the core, and overall Viking is still expanding, with one ship delivered in August (will operate in Egypt) and two more likely to be delivered by year-end—all in all, there should be 5% capacity increase for 2024 with a bigger 12% coming in 2025. As for the here and now, things are good and getting better, with Q2 sales up 9% and EBITDA up 12%, with growth likely to accelerate starting in the current (Q4) quarter as the new ships hit the water. It’s not changing the world, but Viking should crank out solid numbers for a long time to come.

Technical Analysis
VIK came public in early May and immediately headed higher, rallying from a first day close near 26 to a high around 37 in July. Then came the stock’s first correction, egged on by the market in July/August, and after a quick snapback, shares saw a retest of the lows near 30 after Labor Day. VIK rebounded decently from there, before a rush of buying late last week took the stock back to its prior highs. There could be some wobbles near prior resistance, but we’re OK starting small here or on modest dips.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on October 14, 2024.

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