Cabot Top Ten Trader Issue: September 16, 2024

Bullish Whiplash

The post-Labor Day selling was worrisome, bringing many indexes down to key levels and putting a dent in strong stocks while money continued to flow into defensive areas, all of which suggested the correction that began in mid-July (for the big-cap indexes) or March (for the broad market) was still ongoing. And, frankly, we continue to think that—from a top-down perspective, the market is still mostly working through a consolidation, and safer measures are outperforming (a sign big investors are hesitant). That said, there’s no doubt the action among individual stocks remains mostly encouraging: Yes, some faltered two weeks ago, but most held firm, and last week saw tons of beefy action, with many roaring right back to (or out to) new high ground as soon as the pressure came off the indexes. As we often write, good stocks can go bad in a hurry in a tricky or tough environment, so that’s not something to forget—but we’re not going to ignore the action among stocks, with many looking like they want to run if/when the market allows it. We’re going to nudge our Market Monitor up a level 7, though our general advice (small new positions, hold some cash) still holds.

This week’s list again has many familiar names from a range of sectors, a sign that the underlying resilience is persisting and broadening a bit. Our Top Pick is Flutter Entertainment (FLUT), which has a great-looking launching pad—as with many names, it hasn’t broken out yet, so either start small here and use a loose leash and/or aim to buy on a decisive breakout.

Stock 1

Blackstone (BX)

Why the Strength
There are many stories out there (especially with the dawn of the AI realm) that can give you the proverbial ice cream headache, but Blackstone offers a reprieve from that, with a straightforward, bull market business that has been fairing OK during the challenging past two years and could thrive as the Fed turns easier. The firm, of course, is one of the biggest players in the alternative asset management field, with just over $1 trillion in assets spread across real estate, private equity and credit that produce a steady stream of fee-related earnings (91 cents per share in Q2) on top of realization-related earings (five cents per share, way down from prior peaks as asset values have obviously come in), which in turn produce some solid payouts (the dividend is variable but came in at 82 cents per share in Q2). The problem in recent years, of course, was the environment, with the bear market and tighter money slowing growth; total assets were up “only” 8% in Q2 from a year ago, for instance, with real estate actually down a smidge given the issues in the commercial sector. Even so, we always found it encouraging that Blackstone was able to grow somewhat during the rough times (especially its fee-related assets—up nearly 11% in Q2, which hints that fee-related earnings, up 4% in the first half, could accelerate), and if it can do well when the Fed is draining liquidity, the upside for fees, distributable earnings and dividends should be big if the spigots open again—especially if real estate kicks into gear, which has the potential to be big. Like we wrote above, it’s a solid, simple story that institutions could continue running to as rates are lowered.

Technical Analysis
BX had a nice run late last year, but the scaling back of rate cut expectations caused the stock to top near year-end in the mid-130s. This year hasn’t been awful, but instead tedious, with shares retreating a maximum of 15% or so and repeatedly testing and finding support near the 40-week line. BX appeared to be getting going in July, but one more quick shakeout with the market in August (again, with support provided by the 40-week line) followed, and now the stock is starting to stretch its legs. If you want in, we’re OK starting a position here or dips of a few points.

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Stock 2

Carpenter Tech (CRS)

Why the Strength
Aerospace industry demand has been remarkably robust this year as measured by passenger traffic, airline miles and the demand for new planes among the major airliners. (The backlog for commercial airplane orders reported by Boeing and Airbus is now over 15,000 planes, which equates to about nine years of demand.) This is welcome news for Carpenter, which is a major player in the aerospace market and other fields—including defense, medical and electronics—by way of its provision of specialty metals like titanium, stainless steels and powder metals, as well as other items. According to a recent industry survey, more people than ever want to travel via airplanes, while airline operators want the newest generation of airplanes to replace aging fleets, improve fuel efficiency and meet the additional needed capacity for more airline miles, which is a key growth driver for Carpenter. On that score, sales to Carpenter’s largest end-use market, aerospace and defense, were up 19% sequentially and up 28% year over year in fiscal Q4 (ended June). The company posted a record fiscal Q4, completing the most profitable year in its history and achieving nearly $800 million in Q4 revenue and $2.8 billion in sales for fiscal 2024. The sanguine results were led by strength in the Specialty Alloys Operations segment, which saw a sequential shipment increase of 13% in the quarter. Notably, adjusted free cash flow (FCF) was $179 million for the full year—miles above last year’s FCF outflow—and there should be more of that ahead. On the defense industry front, Carpenter said customers “continue to request emergency orders to support elevated military activity levels due to ongoing world events,” while in the medical market, the firm saw a record quarter with sales up 9% sequentially and 38% year over year, led by robust procedure backlogs. Elsewhere, the energy segment is also seeing strong demand for power generation, which drove a 31% sequential sales increase in Q4. Looking ahead, management said backlog across all its end markets remains “significantly elevated,” which should ensure decent revenue (10%-ish) and much faster earnings growth for each of the next couple of years.

Technical Analysis
CRS carved out a multi-month launching pad between September and March, with shares blasting off to new highs beginning in April. The first pullback in June found support at the rising 50-day line, which in turn pushed the stock higher, and the latest wave of volatility also stopped short of breaking the trend line, with CRS now bouncing back. We’ll set our buy range up from here, aiming to enter on a bit more strength and with a stop near the recent lows.

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Stock 3

Coherent (COHR)

Why the Strength
Coherent makes sophisticated products in networking, materials, industrial products and instruments. Each arm is growing, but it’s the networking area that’s seeing particular strength thanks to artificial intelligence-related demand. AI data centers are hungry for Coherent’s optical transceivers which allow the high-speed connectivity AI requires. In its fourth quarter, reported last month, total company revenue rose 9% to $1.3 billion, reversing a shrinking trend and powered almost totally by AI-targeted products. Starting in calendar 2025, Coherent will be rolling out even more powerful transceivers—1.6 terabyte, more than double the throughput of its current top-line model. Those will be in field tests with some customers first, but the product should feed sales for the next few years. With a new CEO who vows to double down on growth areas while cutting underperforming ones, it’s a good bet Coherent will be focusing on AI more, which offers the types of margins that can improve profitability. Right now networking is about half of Coherent sales—the company’s other business lines aren’t millstones but it wouldn’t be a surprise to see one or two sold off. Coherent is known for precision fabrication of rare materials used in aerospace applications, such as making specialized windows for sensors on military aircraft; the materials segment performed better than expected as production hiccups in one raw material, silicon carbide, were fixed. Its Industrial materials arm, like OLEDs for smartphone, also was up single digits as was instrumentation, largely laser technology. But it’s the AI networking angle that is driving the stock and should be the engine behind a big upturn in sales and earnings for many quarters to come.

Technical Analysis
COHR has been choppy but strong for many months, with investors looking ahead to better times. The big early-June breakout and associated follow-through looked like the start of something, though that move was completely erased during the market’s August swoon—but the snapback from there was extremely impressive, and after the post-Labor Day dip, COHR is set up nicely to attack new highs. We’ll set our buy range up from here, entering if we see decisive strength.

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Stock 4

Doximity (DOCS)

Why the Strength
The percentage of physicians using telemedicine—which involves making video calls to patients—has grown from 15% in 2019 to a staggering 80% today. Doximity (covered in the August 19 issue) is the leading digital network for healthcare professionals in the country, with a substantial percentage of U.S. doctors (over 80%), medical school graduates, nurse practitioners and pharmacists included among its verified members. But the company’s Doximity Dialer feature, which enables telemedicine calls, is an integral part of its offerings and a reason why investors are enthusiastic about its future growth prospects. Some 47% of all billing physicians with Medicare telemedicine claims were Doximity Dialer users last year, according to Doximity’s annual State of Telemedicine report, making it one of the top telemedicine platforms behind Zoom. And with a total addressable market of nearly $19 billion, the company believes it has plenty of upside. While the growth potential for telemedicine is huge, the lion’s share of Doximity’s revenue is currently from subscriptions among biopharma companies and healthcare providers that use the platform for employment recruiting, as well as to market new therapies and update disease management protocols. In fiscal Q1 (ended June), Doximity’s top 20 customers (mainly pharmaceutical manufacturers) outpaced other segments of its clientele, with the firm not just retaining all of those clients but also seeing same-customer revenue growth of 21%. Meanwhile, the company’s 102 customers with more than $500,000 in annual spending grew by 16% (and accounted for 82% of total revenue), prompting a major Wall Street institution to raise its price target for Doximity shares (a reason for the strength). Growth isn’t projected to be rapid, but the stock is likely looking ahead to estimate-beating results.

Technical Analysis
Following a steep post-pandemic drop from its 2021 peak near 100, DOCS clawed its way from 20 to 32 between last November and January, then spent the next six and a half months building a launching pad for the next phase of its turnaround. Earnings gapped the stock to multi-month highs in August, with DOCS tightening up beautifully during the next month before following through to new highs last week. There is leftover resistance in this area, so we’ll set our buy range down a couple of points.

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Stock 5

Eagle Materials (EXP)

Why the Strength
Lofty housing prices and mortgage rates kept many prospective homebuyers on the sidelines in the last couple of years, but the recent decline in rates has many thinking that will change, with existing U.S. home sales recently breaking a multi-month downward trend (albeit still at low levels). Aside from the rising prospects for a housing market rebound, continued infrastructure spending growth is another reason for the recent strength behind Eagle Materials. The Dallas-based company produces both heavy and light construction materials, including concrete, construction aggregates, gypsum and wallboard, as well as sand for hydraulic fracturing. But cement is its core market, with construction spending on infrastructure and heavy industrial projects continuing to drive cement demand. On the residential building front, the firm observed that “activity remains resilient” in the face of chronic housing-supply shortages and continued underlying demand strength. In fiscal Q1 (ended June), revenue of $609 million increased 1% from a year ago, with earnings of $3.94 beating estimates by 10% (a reason for the recent share price strength) and lifting 16% from a year ago. Adverse weather conditions across many of Eagle’s core markets affected sales volumes for the cement, concrete and aggregates segment, but the overall business performed well, with paperboard sales (used for making concrete forms) increasing 10% to a record 91,000 tons. Elsewhere, operating earnings in Eagle’s light materials segment rose 5% thanks to higher gypsum wallboard prices and lower operating costs. Looking ahead, the top brass sees years of strong public infrastructure spending ahead to support cement demand, with the residential housing market creating an “appealing performance backdrop” for the firm’s wallboard business going forward. Wall Street sees 12% to 15% earnings growth ahead, with share buybacks (share count down 4.3% from a year ago) helping the cause—and with lots of upside if the housing market truly kicks into gear.

Technical Analysis
After a solid flight higher beginning last November and extending into May, EXP ran into a wall of resistance around 270 and fell as much as 24% into its July low. Shares found a strong bottom at that point, ripping right back to its highs, though the market’s August shenanigans caused EXP to gyrate further. Now the stock is attacking its highs again, with lots of good-volume buying this month. We’re OK starting small here or a bit of weakness and potentially buying more on a breakout into the mid-280s.

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Stock 6

Flutter Entertainment (FLUT) ★ Top Pick ★

Why the Strength
Flutter Entertainment is the owner and operator of FanDuel, the leading online sports betting platform in the U.S. (just above DraftKings) as well as having a big presence overseas (often through its BetFair brand), and it also has a good-sized iGaming (online casino) angle, too. There’s no question that the online sports betting sector is in a long-term growth phase, though there have been some tough periods for the stocks, first due to the industry shakeout (2022-2023) as money became tighter and ridiculous sign-up bonuses came down to Earth; and, more recently, uncertainty surrounding state tax policy (a few have hiked taxes on winnings), which has caused some reactions (surcharges on winnings from DraftKings) that has resulted in some backlash. Still, as we said, the long-term growth trend is definitively up, and the best example of that is how quickly business is growing even in “mature” locations: For FanDuel, U.S. states that it’s been up and running in since before 2020 still grew 27% in Q2 (compared to 45% for those in 2022/2023), a sign there’s plenty of untapped potential out there, both in terms of new sign-ups and higher gambling per client. To be fair, the firm’s international operations are a big part of the story, producing nearly two-thirds of the total EBITDA for Flutter and growing decently (up 15% in Q2); a recent acquisition in Brazil will push it further into that market in the quarters ahead. But the U.S. segment is clearly the growth driver and where most of the investment is being seen, with a 39% revenue gain, a 27% gain in monthly bettors and a 51% surge in EBITDA in the latest quarter, and with basically all other key metrics pointed in the right direction. We like the accelerating revenue growth, and Wall Street sees earnings and free cash lifting beautifully from here.

Technical Analysis
FLUT is essentially near the top of a year-and-a-half-long consolidation, with the 210 to 220 area providing resistance in the early/middle period of 2023 and again in early 2024. That second peak led to a multi-month correction, with shares finding support three times in the 175 to 180 zone before the Q2 report in August brought a nice gap up. FLUT has since traded very tightly and is now beginning to attack its old highs. We’re fine starting small here and buying more on a decisive breakout.

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Stock 7

Impinj (PI)

Why the Strength
Impinj manufactures tiny RFID integrated circuits it calls RAIN that cost a few pennies to make and can be attached to just about any item to allow them to be tracked automatically. RAIN is at the center of what people mean when they say Internet of Things: they are battery-free, don’t need line-of-sight to work, get read at rapid speed and can be built into everyday products like shirts and shoes; Nike uses RAIN in every sneaker they make while Macy’s puts them on every product they sell. RAIN chips are well-suited to combating theft in retail, enabling more efficient self-checkout and creating excellent supply chain visibility across industries. Impinj says the potential market is literally trillions of items, which suggests a big upside given it just shipped its 100 billionth chip this year. Shares are strengthening in part because Wall Street sees big opportunity from a new European Union initiative called digital product passports (DPPs). DPPs are like digital twins for everything sold in the E.U., allowing the tracking of every item from cradle to grave, including information such as place of origin, carbon intensity and recycling information. Batteries, not really an Impinj market, are the first products to be tagged, to be followed by textiles in 2027, which is right in the firm’s wheelhouse. Mobile phones are expected to have RFID readers for consumers to read product info, which management believes will make RAIN chips a standard for certain products like clothes. To date, Impinj business tends to move largely by the ups and downs of the retail market. That meant 2023 presented a lot of headwinds, but those have been abating this year as management believes retailers, its main customer, are poised to boost their orders based on inventory and import trends this year. The brighter market shone through in Q2, reported in July, with revenue topping $100 million for the first time. This quarter, Impinj expects sales to be about 40% greater than a year-ago, $93 million at the guidance midpoint, with earnings expected to ratchet higher from here.

Technical Analysis
PI had a huge decline for much of 2023 as business slowed, then saw an equally huge rebound that took the stock to new highs in May of this year. The selloff in August looked like an ugly double top, but PI rebounded nicely, tightened up for a bit, and has now nosed to new price highs. It’s definitely a down-the-food-chain stock that can move quickly, so if you want in, start small and aim for dips.

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Stock 8

Pulte Group (PHM)

Why the Strength
It’s been a long trip from record-setting quantitative easing and 0% interest rates in 2021/2022 to two-decade highs in rates and record quantitative tightening in 2023/2024 ($600 billion has run off the Fed’s balance sheet this year alone); investors have repeatedly gotten optimistic that the Fed would finally turn from foe to friend only to have their hopes dashed—but this week, it’s basically a sure bet that it’s going to happen. That has investors thinking that major national homebuilders like Pulte, which have actually seen results increase some despite the tightening phase, could see surprising upside if home demand picks up with lower rates. Pulte itself should see a lot of leverage to any potential industry pickup, as three-quarters of business is first-time or move-up sales, both of which (especially the former) have likely been stunted a bit in recent years. (It also sells houses all across the price spectrum, too, making it more likely to participate in any group boom.) As with many of its most successful peers, Pulte’s growth has obviously slowed and should continue to do so for another quarter or two (new orders in Q2 were down 4% while the backlog was off 1%), but business is very resilient, and the firm is cranking out huge cash flows that it’s using to pay down debt (assets are now more than 3x liabilities), pay a token dividend (0.6%) and buy back a ton of relatively cheap stock (share count was down 5.5% in Q2 from a year before), all while continuing to expand its footprint as it moves into a variety of new (and higher-growth) geographies. It’s not changing the world, but Pulte is well-positioned to thrive if the housing market accelerates.

Technical Analysis
Like most homebuilders, PHM has been trending up since late 2022, so it’s not in the early innings of its overall advance—but it’s certainly acting as if the buyers remain in control. Shares topped out in March after a great run, eventually falling 16% to its 40-week line (the second test of that long-term trend line since the run began in 2022) in July. PHM then spiked with the broad market in July and mostly futzed around for a while before scoring new price and relative performance peaks last week. We’ll set our buy range down a bit, with some pre- and post-Fed volatility possible.

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Stock 9

ServiceNow (NOW)

Why the Strength
The hot topic for much of this year has obviously centered around the artificial intelligence revolution and the need for tech-focused firms to fully embrace it. But the million-dollar question has been how companies (outside of big players like Google and Amazon) can quickly and efficiently monetize AI. Solving this conundrum has been the major focus for enterprise software leader ServiceNow (covered in the July 29 issue) and is a big reason for the stock’s strength. The company is known for its end-to-end workflow automation software for companies, and lately it’s been infusing generative artificial intelligence (GenAI) capabilities across its platform for IT applications. Indeed, the company is turning its attention to what it sees as the next phase of AI deployments for enterprises, with management recently pointing out that several technology leaders among its customer base “have moved beyond experimentation with GenAI and are focused on implementation.” Underscoring this trend, net-new annual contract value (ACV, a key metric) for its Pro Plus offering, which incorporates GenAI capabilities, doubled on a sequential basis in Q2 and delivered 11 deals over $1 million and two deals over $5 million in value. What’s more, Pro Plus saw a 30% price increase in Q2, with average deal size tripling compared to deals made prior to the latest Pro adoption cycle. ServiceNow is also heavily investing in another big GenAI offering—dubbed Now Assist, in collaboration with Microsoft and NVIDIA, the product incorporates a virtual agent to answer queries in real-time along with field service management and workflow automation capabilities, and it has become the company’s fastest-growing new product in history (new ACV for this product doubled in Q2 from the prior quarter). Analysts see 20%-ish top-line growth for 2024 and each of the next two years, which should prove too low.

Technical Analysis
NOW spent several months churning sideways and making no progress through the first five months of this year, with a big shakeout after earnings in late May. However, shares came all the way back to hit new highs after earnings in July before being yanked back by the market in August. Since then, NOW has shown great relative strength, repeatedly pushing to new highs every time the pressure comes off the market. We’re OK buying some here or (preferably) on dips, with a stop near 800.

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Stock 10

Wheaton Precious Metals (WPM)

Why the Strength
Fed watchers expect the central bank will cut interest rates at this week’s FOMC policy meeting for the first time since the pandemic crash in 2020. Falling rate expectations are one reason for the latest strength in gold and silver, but there are other variables at play, including geopolitical tensions and fears that the global economy is weakening (both of which tend to increase gold’s allure as a safe haven). Altogether, these factors are boosting the outlook for Vancouver-based Wheaton, which is one of the world’s largest precious metals streamers; as a streaming company, Wheaton is able to avoid the operational risks of traditional mining companies by financing projects in exchange for a percentage of a mine’s future production, giving it a lot of leverage to rising metal prices. Wheaton currently has agreements for 18 operating mines and 27 development-stage projects to purchase all or a portion of their gold, silver or cobalt output at set prices, in exchange for an upfront payment. This model paid off handsomely for Wheaton in Q2, which saw total revenue of nearly $300 million increase 13% year-on-year, thanks to a “solid” production base and an 18% jump in average realized gold equivalent prices. By metal, 61% of the revenue was gold, 37% was silver, with cobalt and palladium accounting for the rest. Meanwhile, earnings of 33 cents beat estimates by three cents, while pre-tax margins (nearly 58%!) were enormous. Attributable gold equivalent production (GEOs) of just over 147,000 ounces (in line from a year ago) in Q2 and 306,000 in the first six months of 2024 (up 5%) wasn’t overly impressive; indeed, the full-year tally should be down a smidge from last year. But the big attraction here besides pricing is that Wheaton projects industry-leading growth of 40% to over 800,000 GEOs by 2028, with upside to 850,000 between 2029 and 2033. Wall Street sees the bottom line growing 20% this year and next, likely conservative if gold and silver prices continue strengthening.

Technical Analysis
After starting off on a weak note in the first two months of this year, WPM came to life in early March, pivoting off major support around 40 and breaking above resistance at 50 by April. It’s been choppy since then, with three tough dips to or below the 50-day line, but the buyers have stepped up each time, with WPM notching new closing highs on good volume on Friday. We’re OK starting a position here, albeit with a tight stop.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on September 23, 2024.

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