Cabot Top Ten Trader Issue: September 23, 2024

Certainly Improving, but More Work to Do

Between the late-July/early-August market plunge and the relatively sharp post-Labor Day selloff, more than a few weak hands were likely kicked out of their positions—though, even as that happened, many leaders (or potential leaders) began to flex their muscles after earnings in August and took the selling earlier this month in stride. That paved the way for the past two weeks, which have been very encouraging, with the major indexes certainly improving and with many of those same leaders acting well, including a bunch that moved to new high ground. It’s all to the good, though a lot of the same flies in the ointment that we’ve written about are still out there, including solid action among defensive sectors and indexes, lagging action from growth measures (like the Nasdaq) and, while we’re not huge seasonality investors, it’s hard to ignore the fact that the next couple of weeks (especially this one) tend to be bad for stocks. There’s definitely more good than bad out there, but we continue to pick our spots, aiming to add strong names at decent entry points that can really move once the buyers take full control of the market. We’ll leave our Market Monitor at a level 7 today.

This week’s list has something for everyone, from high-tech to infrastructure to stocks leveraged to asset prices. Our Top Pick is GE Aerospace (GE), which isn’t going to be the fastest mover but looks to have finally broken out on the upside.

Stock 1

Arista Networks (ANET)

Why the Strength
Data centers have gotten a lot sexier to investors since AI stormed onto the scene. They’re where the massive computing happens for AI, and it occurs at such a scale that companies need hardware that can manage much larger data flows than had been seen in the past. That’s set to be gold for Arista Networks, which is something of the Cisco of our time, producing highly sophisticated networking equipment like switches, routers and relays. Many of the biggest names in tech are customers—Microsoft and Meta have long been users and in 2023 they contributed a combined 39% of Arista’s revenue as they upgraded to the next wave of faster hardware. Moreover, the company recently added two more brand names to its customers list, Oracle and Apple: Oracle joins Microsoft and Meta as “cloud titans,” meaning they operate more than 100,000 servers (Apple is a bit less than that), and while the two new additions aren’t expected to contribute 10% or more of Arista sales yet, the fact they’re on board is a big positive for the long term. That not only reflects the market position Arista is likely to have in AI but also continuing strength in its traditional markets of cloud and corporate campus networking. The belief is there is still a huge runway for AI, so Arista is heavily investing in developing routing architectures that optimize how to utilize computing power and transmit information for AI. Its “AI Spine” will run on Ethernet, which Arista sees as retaking market share from a different architecture called InfiniBand. For the here and now, business is good—management raised revenue guidance for 2024, saying last earnings call it would be at least 14% greater than 2023’s $5.86 billion—and big investors are starting to discount an AI-related demand surge in 2025 and beyond.

Technical Analysis
AI stocks have become a mixed bag—many chip stocks have softened, but more than a few networking names are still resilient, and ANET is one of the best out there. The uptrend in recent months has been choppy, with higher highs and higher lows but also with big swings up and down. The latest rest fit that pattern, with ANET gyrating wildly but failing to crack in August or after Labor Day—and since that final shakeout, the stock has moved out to new price and relative performance highs. If you want in, aim for minor weakness.

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Stock 2

Carrier Global (CARR)

Why the Strength
Long known for its residential heating and cooling products, indoor climate control and refrigeration solutions specialist Carrier is focused on transforming itself into a leader in the enterprise market for energy-efficient buildings. While the company still maintains a top position in heating, ventilating and air conditioning (HVAC) for homes, its new priority is to lead the global market for “sustainable” climate and energy solutions for larger commercial and industrial structures. The firm’s recently completed deal for Viessmann Climate Solutions was part of that strategy, which it expects will improve its position in the renewable and energy-efficient climate solutions space, particularly in Europe. To further sharpen its focus on large-scale indoor climate solutions, Carrier agreed to sell its Industrial Fire business for $1.4 billion in March and its Commercial and Residential Fire business in August for $3 billion—and then in June, it closed a $5 billion sale of its Global Access Solutions home security business. These moves were also aimed at paying down debt to a point where Carrier can resume share repurchases by the end of this year (which is a reason for the stock’s strength; management has guided to $1 billion or so of repurchases in the second half and more in 2025). Another part of Carrier’s expansion blueprint includes a commitment to increasing its global heat pump business—the firm plans to invest $2 billion by 2030 to create sustainable solutions in the electric heat pump market (which have a lower carbon footprint than other indoor heating systems), and it recently partnered with the U.S. Energy Department to develop next-generation heat pump technologies for commercial buildings. Finally, the company wants to strengthen its electric transport refrigeration capabilities and has formed a strategic alliance with commercial vehicle leader ConMet to deliver a zero-emissions transport refrigeration solution. Of course, Carrier isn’t suddenly going to grow like an AI stock, but growth has picked up of late and earnings estimates have climbed—and the Fed’s move to aggressively ease should help things heading into 2025.

Technical Analysis
CARR’s pattern is to etch a series of tight, multi-month bases followed by brief-but-strong rallies to new highs. That tendency continued into this year, when the stock spent the first four months of 2024 in a six-point range before breaking out in late April. Another three-month consolidation followed, with the latest run-up showing a nice big-volume buying cluster thanks to the Fed. A dip of a couple of points should set up a solid entry.

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Stock 3

Emcor (EME)

Why the Strength
Emcor is a global engineering and specialty contractor focused on electrical and mechanical construction along with building, industrial and facilities services. While there are multiple growth catalysts at play here, the main story right now are the booms in hyperscale data center and domestic semiconductor plant construction, with additional strength provided by the infrastructure buildout in support of artificial intelligence and cryptocurrency mining. Among Emcor’s major reporting segments, Mechanical (HVAC systems, plumbing, central plants) and Electrical Construction (electrical distribution, alternative power and solar installations) were the key drivers for the firm’s record performance in Q2, while the Industrial Services segment reported its second-best quarter since the pandemic as demand improved for both shop and field services. U.S. Electrical Construction revenue increased 18% from a year ago, driven predominantly by data center projects, with Mechanical Construction sales booming 39% thanks to strength in the high-tech manufacturing market (mainly from customers engaged in the manufacture of semiconductors, electric vehicles and lithium batteries). Elsewhere, the Transportation business grew about 39% as a result of heavy infrastructure awards largely focused around airports. Total revenue increased 20% to $3.7 billion, while EPS of $5.25 exceeded estimates by a ridiculous 40%. Meanwhile, remaining performance obligations (all the money due under contract but yet to be earned and paid) of $9 billion increased 9% and remained at record levels, with management calling the project pipeline “robust” and supporting a positive outlook for the rest of the year. Also during the quarter, Emcor closed four acquisitions which are expected to bolster a few of its segments, with other small M&A likely in the quarters to come. Growth is expected to slow some, but bottom-line estimates are almost surely conservative; indeed, 2025 estimates moved up nearly $3.50 per share (!) following the Q2 report, so there’s clearly a lot of earnings power here.

Technical Analysis
EME spent the last half of 2023 tightening up around 215, with the start of this year ushering in a huge wave of strength; the stock soared to the 400 mark in the first five months, where it met strong resistance at the end of May. Fifteen weeks of consolidation followed, which featured a big August shakeout (nearly to the 40-week line) and another sharp dip after Labor Day, but EME has taken off since then on good (not amazing) volume, hitting new price and relative performance peaks. Minor weakness would be tempting.

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Stock 4

GE Aerospace (GE) ★ Top Pick ★

Why the Strength
About the only press you see in the aerospace field these days is negative or uncertain, with Boeing’s continued problems grabbing the headlines—but, in the market, many individual names remain in favor as the major trend of increased orders, deliveries and travel worldwide are firmly in place, which is leading to the kind of quick, steady, predictable growth that is like catnip for institutional investors. We’ve written about GE Aerospace a couple of times before in Top Ten, and it looks like it’s finally getting going after a couple of false starts: The firm is the industry leader in engines/propulsions (for both commercial, which is where most of the growth is, but also defense), an area that’s obviously a very good bet to grow as airlines look to expand and update (more fuel efficient, etc.) their fleets. Like many in the industry, there’s a huge recurring revenue component to the engine business; GE says that each engine sale leads to at least a couple of decades of service-related upkeep, with revenue from that follow-on business eventually totaling three times the initial sale. Right now, business is good and getting better, but the best is yet to come—in April, the firm saw earnings of around $3.92 per share and free cash flow of “more than $5 billion” for the full-year 2024, but after a very solid Q2 report (including orders for commercial engines/services: up a huge 38%), their outlook was bumped to $4.08 per share and $5.45 billion. And that should be just the tip of the iceberg, At the post-split Investor Day earlier this year, the top brass released an outlook that showed annual free cash flow growth in the mid-teens through 2028, and these things usually prove conservative as they hope to topple expectations. Of course, this firm or other aerospace plays aren’t going to suddenly grow at triple digit rates, but GE Aerospace quacks like a liquid leader that institutions can steadily accumulate as business and shareholder returns ($2.3 billion of buybacks in Q2; $15 billion total buyback authorization from Q2 2024 through 2026) pick up. We like it.

Technical Analysis
GE had a beautiful run in anticipation of the firm’s split, with sellers finally putting up a fight near the 170 level in early May and leading to a very quiet, sideways phase into July. After that the stock did begin to gyrate—the earnings-induced breakout attempt in July failed; the shakeout in August with the market was scary but quickly found support; but then the modest late-August test of resistance was quickly repelled. But now it looks like the buyers have finally taken control, with GE moving to new highs two weeks ago on good volume and following through last week. We’re OK entering here or (preferably) on dips with a stop near the 50-day line.

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Stock 5

Hamilton Lane (HLNE)

Why the Strength
While public markets are still larger in size than their private counterparts, the global private equity market has experienced stellar growth in recent years—in part due to its historical outperformance in returns over public markets—with assets under management expected to continue to surge in the years to come. A leader in this field is Pennsylvania-based asset manager Hamilton Lane, which offers everything from early venture and emerging growth investments to private equity and alternative asset funds. Primarily, the company’s venture and growth equity strategy is focused on concentrating capital into what it sees as “best-in-class,” high-growth companies through fund investments with venture and growth managers, direct investments and secondaries (where investors buy an existing interest in a private equity fund from another investor). The trend of falling interest rates and easier money is expected to benefit Hamilton Lane and should translate into lower capital costs and higher asset values, in turn boosting revenue growth while making deals more profitable and reducing leverage. In fiscal Q1 (ended June), the company reported an eye-opening 57% year-on-year revenue increase, to $197 million, with earnings of $1.51 beating estimates by 41 cents. Total assets under management (AUM) of $130 billion grew 11%, while fee-earning AUM grew 13%. Other key metrics were equally impressive, including management and advisory fees of $140 million which increased 33% and carried interest of approximately $1.2 billion which rose 12%. The sanguine results were the main reason for the stock’s latest show of strength, with this month’s announcement that Hamilton Lane will become a component stock of the S&P MidCap 400 Index another reason (that addition was effective as of today). Wall Street sees a big finish to calendar 2024, and if the markets remain in good shape and the Fed continues to ease, it’s a good bet this Bull Market stock will see good results for a while to come.

Technical Analysis
HLNE shot up 40 points in the three months following last October’s market bottom, meeting with resistance at 120 soon after the calendar flipped. A multi-month consolidation followed, with a false start in May and, after the stock got moving, a big shakeout with the market in August. But since that final low, though, HLNE has been a great performer, hitting new highs in late August and again last week. We’ll set our buy range down a bit, expecting a post-index-addition exhale.

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Stock 6

KKR (KKR)

Why the Strength
Right now, the long-term trend of stocks (and even bonds) is up, the Fed (and other central banks) have started an easing program and big-picture sentiment is mixed at best (meaning there’s still plenty of buying power on the sideline). Put it together and the backdrop for Bull Market stocks is about as good as you could hope, especially if the new easing regime bolsters the struggling real estate sector (commercial and residential). KKR is one of the lead dogs in the group, with $601 billion of assets at the end of June that are spread around private equity, real assets and credit (which is the largest slice of the pie); the total figures is up a healthy 16% from a year ago despite the so-so environment (including $32 billion organically raised), with 81% of the assets fee-generating and more than 40% being perpetual! A big factor here was last year’s decision to buy out the portion of Global Atlantic (a good-sized insurer) it didn’t already own, and that business now has $183 billion of assets (three-quarters or so is credit), providing plenty of net investment income. Business is very strong now and this should be the tip of the iceberg—in Q2, KKR had fee-related earnings of 84 cents per share, up 25% from a year ago, and operating earnings of $1.17 per share, up 36%, but that pales in comparison with the long-term outlook, with the top brass having 2026 goals of $4.50 per share of fee-related assets and total earnings of $7.50 per share by then as total assets get to $1 trillion or more. (They’re also aiming to reach $15 in total earnings per share within a decade.) Now, to be fair, long-term forecasts in the markets can be taken with a grain of salt, with any financial crunch putting a dent in things, but there’s no question that KKR is on a path to get much bigger thanks to its own moves, and the bullish backdrop tells us that results are more likley to surprise on the upside in the quarters ahead.

Technical Analysis
KKR was shot out of a cannon last November, quickly hitting multi-year highs and really not meeting with any selling until March. After that, things got very choppy, with no net progress into July, and while shares tried to get going after that, the market’s August dip caused a wild shakeout. Still, since then, KKR has acted well, quickly pushing back to new closing highs three weeks later, and after a modest dip to the 50-day line, shares have moved out to new highs in recent days. We’re OK taking a swing at it here on a small retrenchment.

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Stock 7

Maplebear (CART)

Why the Strength
Online grocery shopping is a convenience-driven business, something that Instacart, Maplebear’s sole business, caters to extremely well. More than 70% of groceries ordered online are through Instacart—Amazon and Wal-Mart are two of the larger competitors in that 30% slice—and the online grocery sector as a whole is growing. The percentage of grocery stores in North America with some sort of available online ordering component is now 87%, up from 85% to start the year, though online ordering by customers makes up something like 4% of the $1.5 trillion Americans spend on groceries annually, suggesting there is plenty of room for growth. Importantly, it’s not as simple as setting up website: A single grocery stores has thousands of items, making finding and buying in-stock items online a big fulfillment challenge, but one Instacart does well. It integrates with grocery systems to not only reliably tell a shopper what is available but to also allow them to build a single order from multiple stores. In many cases the app can tell them where a product is physically located in a store, too, in a nod to those who want to put it in their physical shopping cart. Online grocery sales overall are seen growing 13% annually, slowly gaining share and reaching about $77 billion by decade’s end. Instacart makes money by taking a 5% to 6% cut of total sales, plus fees for speedy deliveries, as well as selling advertising on its app and using big data capabilities to help marketers track and reach customers on other platforms, like streaming TV. Maplebear senses opportunities to expand the Instacart business beyond groceries, recently adding Uber Eats into its ecosystem in response to its customers wanting ways to get prepared dinner on the table, too. Though there were fears business would slow as the pandemic further recedes into memory, Instacart growth has been accelerating: Maplebear has reported two straight quarters of double-digit merchandise volume growth and is projecting a third for the current Q3. While earnings are erratic, EBITDA is the better profit metric here, and it (up 89% in Q2, estimated up 29% in Q3) and cash flow are solidly positive and growing nicely. It’s a good story.

Technical Analysis
CART was wild after its IPO a year ago, with a huge initial spike, followed by a dip and months of bottom-building before a rally back to its post-IPO highs in March. After that, the stock constructed a reasonable launching pad, with a 25% maximum correction and five months of back-and-forth action. But shares found support during the market’s August dip near its 40-week line, and after one more (relatively modest) dip after Labor Day, has now come alive, with CART mushrooming to new highs in increasing volume. We’re OK starting a position here or (preferably) on dips of a point or two.

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Stock 8

RH Inc (RH)

Why the Strength
Home furnishing sales have struggled in recent quarters as high mortgage rates and declining home sales have impacted the demand for décor. However, the high end of this market has been more immune to the downturn, and with mortgage rates expected to decline going forward, the overall market should see some improvement. RH (formerly known as Restoration Hardware) is an upscale home furnishings provider specializing in traditional furniture, lighting, textiles, rugs and bathware, as well as baby, child and teen products. The company’s marketing strategy is unique among its rivals in the luxury furniture space, as RH displays its high-end furnishings in expansive design galleries located in prime markets aimed at wealthy customers and vacationers (with some of these galleries including fancy restaurants as an added attraction). The resilience and potential rebound of the high-end furnishings market was highlighted in the company’s just-released Q2 results (quarter ending in July), which featured better-than-expected same-store sales (up 7% from a year ago), with August sales up 12% “despite operating in the most challenging housing market in three decades.” RH also pointed to its investments in the “most prolific product transformation” and platform expansion in its history as contributing to the quarter’s 4% revenue increase, to $830 million, and per-share earnings of $1.69 that, while down huge from a year ago, beat estimates by 13 cents (a reason for the share price strength). Still, this is all about what’s to come—overall housing conditions have been challenging, but management believes easing interest rates will improve the market outlook, with demand trends to accelerate heading into 2025. Going forward, the company is expanding its platform globally, including the opening of a 90,000-square-foot store in Newport Beach and a 50,000-square-foot RH in Raleigh, plus the opening of RH Montecito (in California) in December. Wall Street sees sales growth picking up from here, with earnings rebounding in a big way starting this quarter. It’s a high-end, housing-related turnaround play.

Technical Analysis
The end of the pandemic-era home improvement trend brought the bull market for RH to an abrupt halt. Shares ultimately collapsed 70% from the late-2021 high to the bear market low in mid-2022, and over the next couple of years, the 200 to 230 area was tested (and held) repeatedly. It’s early, but the latest earnings (and group) action looks intriguing, with two big-volume buying weeks in a row, and with the relative performance line (not shown here) up for 13 weeks for just the second time since the top. No, it’s not a true uptrend, but we like the setup; if you want in, enter on dips.

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Stock 9

Sterling Infrastructure (STRL)

Why the Strength
States across the U.S. are spending a sizable chunk of their most flexible federal infrastructure dollars on what has been described as a “highway widening binge.” Indeed, work on highways, bridges and other transportation assets is proceeding at a torrid pace, which is a big part of the growth behind Sterling. The Texas-based company provides building and transportation solutions through its subsidiaries, and it does a good business with high-growth infrastructure projects such as AI data centers and e-commerce warehouses. Its solutions also include residential and commercial concrete foundations for single-family and multi-family homes, parking structures, as well as infrastructure and rehabilitation projects for roads, bridges, airports, ports and light rail systems. Although Sterling’s E-Infrastructure segment is the biggest by revenue (48% of annual sales, and also a top priority for M&A), the firm’s Transportation Solutions business, its second largest, has lately seen the most growth. In Q2, Transportation delivered 54% revenue growth and 57% operating profit growth, with Sterling commenting that transportation markets are “the strongest they have been” in company history, driving expectations for “very strong” sales and profitability growth in 2024. Awards in Q2 for Transportation were $88 million, with unsigned awards totaling $309 million and a combined backlog of $1.5 billion (up 5% from a year ago)—and even with that, management said the “picture is stronger than the backlog and unsigned awards reflect.” As for E-Infrastructure, revenue was down 7%, but the segment’s operating income grew 20%, with Sterling achieving 100% growth in the higher-margin data center segment. All in all, Q2 revenue increased 12%, to $583 million, while earnings of $1.67 a share beat estimates by 24 cents and EBITDA rose 18%. Q3 should be another great one for the bottom line, and while Wall Street expects a slowdown in 2025, those estimates are almost surely too low.

Technical Analysis
After a big run, STRL built a seven-month launching pad into February of this year when it staged a fresh breakout that, after a dip with the market into April, led to a run to 137 in May. Then came another base-building effort, with a drop to 110 or so in June and July, and then a plunge to 94 during the market’s August shakeout. Like so many stocks, STRL had one more wobble after Labor day, but shares have gone vertical since then, clearing new highs last week on accelerating volume. Dips of two or three points would be tempting.

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Stock 10

Uber (UBER)

Why the Strength
When Uber came public in 2019, it was generally an overhyped, bloated, money-losing operation. But these days it’s much leaner and meaner, yet it remains the hands-down leader in its Rides segment, as well as a major player via its Delivery operations—and, importantly for big investors, is now cranking out huge earnings and even larger free cash flow with a lot more of that to come. Now, there have been a few uncertainties that have affected investor perception of late, the first being the overall economy (affecting the outlook for Rides in particular), and more specifically, the impact of autonomous vehicle (AV) taxi and rideshare fleets, led by fears that Tesla’s Robotaxi (supposedly to be revealed next month, though it’s been delayed since August) could take a lot of share in the industry. Still, the economy looks OK here (with Fed rate cuts likely to help), and Uber has its own autonomous plans, thinking its top-notch back-end technology will make it the go-to partner for firms putting together AV-related mobility offerings. News will surely impact the stock, but after a tough correction and base-building effort, we see a good setup as business here remains pristine: In Q2, not only did sales and earnings look great, but all the sub-metrics did as well, with Rides and Delivery bookings up 27% and 17%, respectively, while total users lifted 14%, EBITDA boomed 71% while free cash flow came in at $1.7 billion (about 80 cents per share), while free cash flow for the past 12 months was $4.8 billion (something like $2.25 per share, well ahead of earnings). Moreover, earlier this year, Uber’s top brass said it thinks EBITDA can lift at mid-30% rates annually for the next three years while free cash does the same or even better, helped along by the core businesses and newer offerings (its ad business is growing fast and should bring in well over $1 billion in sales this year). All in all, we think this remains a great growth story.

Technical Analysis
UBER was one of the liquid leaders of the market’s big November-March rally, with shares breaking out near 50 and running to north of 80 before stalling out. The retreat from there started normally but got uglier in April and May, and after a modest bounce, really looked bad into the August selling storm. But UBER immediately bounced back with the help of Q2 earnings, and after a low-volume dip earlier this month, has pushed right back to key resistance near 75. We’ll set our buy range up from here, looking to enter on a clear show of strength.

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Previously Recommended Stocks

The next Cabot Top Ten Trader issue will be published on September 30, 2024.

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