February 28, 2022

Overall, nothing has changed yet with the major evidence out there, but we continue to think a bottom-building process is playing out in decent fashion so far: Last week, the major indexes sank below their January lows on news of the Russian invasion, but then rallied hugely to close the week all while showing small positive divergences in the broad market (fewer stocks hitting new lows on the Nasdaq, fewer below their 200-day lines, etc.). Moreover, there’s little doubt that sentiment is getting pretty bearish, and believe it or not the intermediate-term trend of growth funds actually isn’t far from a green light. Thus, there are some positives as it attempts to etch a low area to this three-plus-month downturn, so we’re nudging up our Market Monitor, but we need to see the market build on these baby steps before thinking the downtrend may be over.

This week’s list is very heavy on the commodity complex, as that’s clearly where the big money has been flowing. Our Top Pick is a natural gas-heavy play with as good a cash flow story as there is.

Market Overview

Another Couple of Baby Steps

Overall, nothing has changed yet with the major evidence out there—the major indexes and the vast majority of individual stocks are still in downtrends, so we think holding plenty of cash and mostly letting everyone else try to play the wild day-to-day, news-based swings is generally your best court of action. That said, we continue to think a bottom-building process is playing out in decent fashion so far: Last week, the major indexes sank below their January lows on news of the Russian invasion, but then rallied hugely to close the week all while showing small positive divergences in the broad market (fewer stocks hitting new lows on the Nasdaq, fewer below their 200-day lines, etc.). Moreover, there’s little doubt that sentiment is getting pretty bearish, and believe it or not the intermediate-term trend of growth funds actually isn’t far from a green light. Thus, there are some positives as it attempts to etch a low area to this three-plus-month downturn, so we are bumping up our Market Monitor to a level 5, but we need to see the market build on these baby steps before thinking the downtrend may be over.

This week’s list is very heavy on the commodity complex, as that’s clearly where the big money has been flowing—we’ve even seen some solid breakouts on volume of late. Our Top Pick is Chesapeake Energy (CHK), which just left behind a multi-month range after releasing superb cash flow forecasts.

Stock Picks & Previously Recommended Stocks

Stock 1

Arch Resources (ARCH)

Why the Strength

Arch Resources provides thermal coal that powers electric utilities and other industries as well as metallurgical coal (“met” coal) used for steel production; all in all, it’s the second-biggest coal supplier in the U.S, producing over 13% of the coal used domestically. Along with 32 active mines and 5.5 billion tons of coal reserves, Arch’s flagship Leer mine ranks among the lowest-cost, highest-quality U.S. metallurgical mines, and that’s the biggest part of this story—the company’s thermal mining operations are being phased out, which means steelmaking coal will be Arch’s focus going forward. The demand for met coal relies on steel production, and with steel use on the rise worldwide as economies reopen, Arch’s met coal is in high demand, the extent of which was seen in Arch’s Q4 cash flows (the highest in three years) being used to pay off nearly all its remaining term loan balance and returning to a near net-debt-free (net debt = current cash less debt outstanding) status while building liquidity. Sales of $806 million were 123% higher than the year-ago quarter and 13% above the consensus, while per-share earnings of $11.92 were up from a loss a year ago. And the huge numbers should have legs: Arch contracted 85% of its 2022 sales in Q4, prompting the company to enhance its shareholder return program—it will begin paying out 50% of the prior quarter’s discretionary cash flow through its existing fixed dividend, along with a new variable quarterly cash dividend. The end result is that some analysts estimate Arch could pay out as much as $20 per share in dividends in 2022!. Going forward, Arch is developing what it calls a “world-class” coal portfolio that’s nearing completion as it transitions to becoming a pure-play met coal producer. Wall Street sees ridiculously huge earnings this year, with the bottom line staying up around $20 per share in 2023.

Technical Analysis

ARCH established a pattern of higher peaks starting last March, rising from 40 before finally hitting the wall at 105 in October. Then came what turned out to be a great-looking consolidation (a cup-with-handle if you’re into that sort of thing)—the dip to 75 was sharp, but ARCH then rallied eight weeks in a row, and after a one-week shakeout, bolted to new highs. We like the recent calm pullback in recent days, though we’ll set our buy range a touch lower.

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Stock 2

Allegheny Tech (ATI)

Why the Strength

Aerospace and defense companies were never in danger of going away, but the war in Europe surely will refocus the Defense Department’s desire for airpower. That means Allegheny Technologies’ announcement earlier this month it intends to expand its business further into defense – especially high-performance metals for fighter jets, submarines and tanks – is probably good timing. Allegheny is a metals company that produces titanium- and nickel-based alloys, stainless steel and specialty components for several industries, including oil and gas and chemicals, but aerospace is the focus. The business already had good tailwinds, with an eye-opening Q4 report detailing that demand for jet engine materials snapped back to the highest level in over two years. Sales, earnings and operating income all blew past expectations and grew nicely from a year ago and, in a further sign of building momentum, Allegheny eclipsed 2019’s full-year adjusted EBITDA margins for a second straight quarter due to cost controls and improved product mix and pricing. In the current quarter, management guided for per share earnings between 18 and 26 cents which far surpassed consensus estimates. Analysts now see sales up 10% and earnings surging this year, with both likely conservative. Allegheny expects continued forgings and materials demand growth, driven mainly by the ongoing commercial aerospace recovery—indeed, this industry usually has long cycles, and it appears a new upleg is just beginning here. Along with the fresh emphasis on defense, management also said it sees sales growth of about 10% a year through 2025, expanding EBITDA margins over that time and a rapid improvement of return on invested capital.

Technical Analysis

We featured ATI in our February 7 issue, aiming to get in on a dip below 22.5. That never happened, as shares showed excellent strength following its earnings gap. With the Ukraine invasion, shares have seen buying along with other defense-related stocks, hitting new highs today. We’ll again put our buy range down a bit, thinking a pullback of a point or two will present a good opportunity.

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Stock 3

CarGurus Inc (CARG)

Why the Strength

So here’s an interesting story. CarGurus got its start nearly two decades ago as an auto listings-type site, signing up thousands of U.S. and international dealers to more effectively reach and market to potential car buyers. It’s been a solid, profitable and steadily growing business (thanks in part to the fact that cars listed on the firm’s site sell 16% to 22% faster than its competitors), though recently, the car shortage (generally due to chip factors) has seen the number of dealer members level out; it’s been near 24,000 in the U.S. since late 2020, and that’s down a few thousand from the pre-pandemic peak, though revenue per dealer is still rising. That’s still a solid business, but the real attraction here is CarOffer, which CarGurus bought back in early 2021: CarOffer is essentially a dealer-to-dealer network that is rapidly replacing vehicle auctions, allowing dealers to buy and sell inventory and pay flat fees (no subscription, etc.), which is always valuable but especially so these days as many dealerships struggle to keep inventory on the lot. The number of locations and value of cars sold using CarOffer doubled just in the past nine months, and the business is already profitable! Moreover, CarGurus has used CarOffer’s platform to launch its own “Instant Max Cash Offer,” allowing 70% of U.S. consumers to get an instant quote on a car they’d like to sell, which is another way dealerships (and big outfits like Carvana and Karmax) are building inventories. All told, the two CarOffer products now make up more than half of CarGurus total revenue, leading to blowout Q4 results (sales up 124%, earnings of 43 cents beat by 13 cents) and a huge Q1 forecast (sales of $400 million, up 134% and miles ahead of estimates). It’s a good, fresh growth story.

Technical Analysis

There’s really not much to the chart of CARG—it’s basically been dead as a doornail for a long time, with a peak way back in 2018 and, in recent months, a lot of ups and downs as the legacy business was hampered by the pandemic. But last week certainly could be a game changer, with the stock going from nothing burger to multi-year highs in just one day following earnings, which pushed the stock up north of 40% on volume that was eight times average. In this environment, it’s hard to chase things, but dips of a couple of points would be tempting.

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Stock 4

Chesapeake Energy (CHK) ★ Top Pick

Why the Strength

Chesapeake Energy has a checkered past, as it was one of the highest-profile energy firms to essentially go belly-up during the last down cycle, suffering from years of low natural gas prices and, of course, too much debt. Ironically, though, it was that process that’s created what could be the sector’s greatest cash flow story today. Through a few moves back then and in recent months, Chesapeake now operates in three basins: The Marcellus is super low cost (wells return 150% at $3 natural gas!) and makes up 45% of output; Haynesville is also a cash cow (105% returns at $3 gas) and makes up 33% of output; while the Eagle Ford (110% well returns at $3 gas and $62 oil) cranks out the rest. Despite a now-healthy balance sheet (0.7x debt to cash flow; no debt maturities until 2024), the firm does hedge quite a bit (north of 60% of output hedged for 2022), but that only gives more certainly to the spigot of cash that’s coming—in Q4, Chesapeake cranked out $372 million in free cash flow (north of $3 per share), leading to a variable-plus-base dividend of $1.77 for the quarter. But 2022 should be even larger: At current strip prices, the firm sees a jaw-dropping $2 billion of free cash flow (pro forma for a good-sized acquisition that’s underway, that cash flow should total about 20% of the market cap), which will lead to $1 billion of dividends (10%-yield-ish) as well as $500 million of share buybacks. And like most of the best energy plays, this isn’t a one-year phenomenon, with the company saying 2022-2026 could bring $9 billion of free cash flow and $5 billion of dividends (north of $30 per share) at current prices. As always, you should take these long-term forecasts with a grain of salt in this sector; things can change in a hurry. But there’s no question that, even if natural gas prices fade 25% to 30%, you’re still looking at healthy cash flow and payouts going forward.

Technical Analysis

Chart-wise, CHK is just about as good as the story. Shares haven’t been on a tear, but have made steady (albeit choppy) progress for many months, with a few corrections clearing the decks for the next advance. The latest rest period started in early November, which led to four months of up-and-down action, but our guess is the next upmove has begun—CHK surged last week on four straight days of great volume before and after earnings. We’re OK taking a swing at it here with a loose stop.

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Stock 5

Freeport McMoRan (FCX)

Why the Strength

Political unrest in top copper producing countries Chile and Peru, coupled with surging demand for the metal in alternative energy and electric vehicle applications, have pushed copper prices to the highest level in over a decade. Add to that some of the tightest global inventories ever and the outlook for companies that mine the metal has never looked better. Freeport, the world’s third-largest copper producer, shined in the fourth quarter, reporting revenue of $6.2 billion that was 37% higher than a year ago while unveiling a plan to more than double its capital spending in 2022; per-share earnings of 96 cents were basically even with estimates. As copper prices rallied last year, Freeport’s operating cash flows increased by a jaw-dropping 146%. For Q4, copper production was 19% higher, at just over one billion pounds (in-line with expectations) on average realized prices that were 30% higher from a year ago at $4.42 per pound. As a result, the company’s net cash costs rose less than 1% to $1.29. Freeport is also benefiting from higher gold prices, and its production of the yellow metal in Q4 surged 48% to 405,000 ounces at an average realized price of $1,808 per ounce. As a result of the improved performance on both fronts, the company unveiled a performance-based shareholder return plan for 2022 that provides for up to 50% of Freeport’s free cash flow to be used for buybacks and variable dividends, with the balance used for growth and further balance sheet improvements. Looking ahead, management guided for consolidated copper sales of 4.3 billion pounds in 2022, along with 1.6 million ounces of gold. Even after last year’s huge earnings leap, analysts see another 22% gain in 2022.

Technical Analysis

After a strong start to 2021 (up 67% from its January level before peaking around 46 in May), FCX spent the next four months correcting. The stock bottomed out at 30 in September and began forming the right-hand side of a bowl-shaped pattern. It looked like the bowl was completed in January after shares leapt briefly above 46, but sellers stepped in and pushed the stock down to 35 in just two weeks when the market was plunging. But the buyers re-emerged in early February, and the stock finally made it above the old high last week. We’re fine nibbling here or (preferably) on dips.

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Stock 6

Barrick Gold (GOLD)

Why the Strength

Safe-haven demand for gold has dramatically increased as geopolitical tensions rise along with inflation, giving a major boost to low-cost producers like Barrick. With an all-in sustaining cost of $1,026 an ounce ($864 below current prices), Barrick is one of the world’s lowest-cost gold miners and the second-largest by production. In its just-released Q4 report, total revenue of $3.3 billion in Q4 was 1% higher from a year ago while per-share earnings of 35 cents beat the consensus by 6%. But it was the company’s free cash flow from operations that wowed Wall Street, along with a new $1 billion share repurchase plan and dividend strategy. Barrick’s cash strength also allowed it to increase the dividend by 11% (now a 1.8% annual yield) and announced a performance dividend policy that will enhance shareholder returns (extra five to 15 cents per share, per quarter) when its net debt is less than zero. Barrick set a couple of notable records, including overall gold production of around 1.2 million ounces in Q4 (led by record production at its 62% owned Nevada Gold Mines), and a record return of $1.4 billion in cash to shareholders for the year. Barrick’s copper business also had a great year, with average realized prices for the metal up 48% from a year ago while the firm’s costs were just 17% higher. (The improved margins have prompted analysts to forecast a 6% increase in Barrick’s copper revenue for 2022.) Looking ahead, the company plans to advance its pipeline of large copper, silver and gold growth projects, in Alaska and Chile, while at the same time working on the resumption of operations at its major gold mine in Papua New Guinea later this year. And if bullion prices keep rising, Barrick’s gold margins should notably improve this year. It’s an interesting commodity, turnaround and cash flow story.

Technical Analysis

GOLD’s post-crash rally petered out in August 2020, with the stock then starting a slide that didn’t end until last September at around 18. It took shares 11 more weeks of backing and filling to establish a double-bottom at this level, but the bottoming process wasn’t fully complete until shares blasted out of the base two weeks ago. There’s still overhead supply to chew through, but our bet is the long decline and bottoming process wore out the weak hands. Expect volatility, but we’re OK taking a small position here.

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Stock 7

Halliburton (HAL)

Why the Strength

Booming oil prices mean that drilling activity is on the rise globally as energy firms continue to add new oil and natural gas rigs (which have risen for a record 17 months in a row as of January!). Halliburton is a near-sure thing to benefit from this trend (one which management believes can last years given the prior dead period), as it’s one of the largest and broadest oil service outfits out there, with various products and technologies that help clients with reservoir evaluation, well construction and completions, production and more. Halliburton saw earrings double in Q4—its third consecutive quarter of earnings growth after remaining positive even through the pandemic—as higher oil prices and drilling activity boosted demand for the firm’s offerings. Fourth-quarter revenue of $4.3 billion expanded 32% from a year ago, while full-year sales were up 6%. By segment, the firm’s completion and production division delivered solid mid-teens margins along with a 10% sales bump, driven by higher tool sales globally and increased pressure pumping services in North America and the Middle East. Drilling and evaluation revenue rose 11%, due to increased drilling-related services globally and higher wireline sales in Latin America and the Mid-East region. The improved performance led Halliburton to push its then-tiny dividend up quite a bit (now a 1.5% yield) with plans to reinstitute share buybacks. Management further guided for continued growth in North America and overseas and expects industry fundamental to stay supportive in the face of what it sees as a multi-year energy upcycle. Wall Street, meanwhile, sees the bottom-line growing 62% this year and another 32% in 2023, and given how these cycles go, those figures should prove too conservative.

Technical Analysis

After its post-pandemic rally stalled out in March of last year, HAL spent the next nine months making no net progress, with three 20%-plus corrections during that time. But we think that’s one reason shares have such great potential—HAL experienced a major change of character at the start of this year, rising in a straight line (helped by a bullish Q4 earnings reaction) to 34, with the dip to the 25-day line finding support. We’re OK with a small buy here, but we’d prefer to get in on dips of another point or two.

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Stock 8

Matson (MATX)

Why the Strength

Matson is a newer name to us, but it’s been around forever: Founded in 1882, the firm is a niche ocean transport player, shipping goods in the Pacific, including between China and the west coat, though Hawaii is a big market and it does business to Alaska, Guam and some other smaller countries, too. Matson is a nice, well-run operation, with profits in the black for years even during some dry times, but the big story today is much more about macro factors—first, e-commerce demand is booming and that means a bunch of stuff is coming over from China (containers shipped from China in Q4 lifted 33% from a year ago), while consumer demand in general is up post-pandemic (containers shipped to other locations were up double-digits as inventories are busy being restocked). Throw in the well-known port congestion and supply chain issues, which have hiked rates, and a decent logistics operation, and Matson’s numbers are going through the roof. In Q4, sales boomed more than 80% with earnings reaching nearly $10 per share (!), and best of all, management believes that (especially in its China business) the underlying bullish industry factors should remain in place for much of this year. Management is getting busy returning some of that cash to shareholders—it pays a modest dividend (1.1% annual yield) but is starting to buy back shares at a good clip; the share count is down 4% from a year ago, but it approved another three million share repurchase program (7% of the share count) that could be completed this year. Of course, when the industry’s conditions change, Matson’s earnings will pull in, but investors are starting to think the bottom line will stay higher for longer than most expect—even in 2023, analysts still see north of $10 of earnings for the company.

Technical Analysis

MATX has generally been uptrending since the depths of the 2020 crash, but if you look closely, you’re see the stock spent most of last year effectively chopping around—after shares rallied to around 80 in February, they pulled back 25% and then got going again to some extent. But the breakout attempt in September didn’t really work; MTAX spent the next few months bobbing up and down. The end result is that from that February peak to two weeks ago, the stock rose a total of four points. But now the buyers are back, with two straight big-volume accumulation weeks even as the market has been hectic. It’s a bit thinly traded, so we advise aiming for dips if you want in.

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Stock 9

Nexstar Media (NXST)

Why the Strength

Nexstar is the largest independent television broadcaster in the U.S., setting it up as one of the major beneficiaries of wall-to-wall political pitches that come with competitive federal and state races. It owns 200 stations in 118 markets, typically taking 12% to 15% of all the broadcast spending in each election –in Q4 2020, it soaked up nearly $300 million in political spending. This year, about $3.8 billion of money is projected to be spent on the midterms, larger than any other year but the last presidential election. More than 80% of the races predicted to be competitive occur in one of its markets. And that’s not the only tailwind. As the second-largest NBC affiliate, its local stations benefitted from huge Super Bowl viewership and the as-expected ratings of the Olympics this quarter. Management says automaker ad spending is rebounding and they foresee sports bookmakers gearing up to spend heavily on Nexstar’s local sports reports and affiliated broadcasts of pro games. While cord-cutting and streaming clearly affect broadcaster futures, Nexstar presents a calm front, saying that as one of the country’s largest owners of spectrum, it believes there will be demand for its use in some form for the foreseeable future. For cord-cutters, it’s pushing over-the-air networks, Antenna TV and Rewind, gaining exposure to half the U.S., population by year’s end. For 2022, management said free cash flow will hit $1.3 billion (nearly 18% of the market cap) , a record, allowing it to continue to grow the dividend (now a 2.0% annual yield). Longer term: Nexstar renegotiates the majority of retransmission fees it collects from networks in coming months. Right now, it gets paid well less in fees than it should given its ratings, so a bump is all but guaranteed.

Technical Analysis

NXST started the year breaking out of a tight, nine-month range between 140 and 155. Shares have gotten livelier while holding over the 50-day moving average, suggesting good institutional buying support despite the wild market. The latest snapback is another sign that buyers are adding on dips, with NXST already close to new high ground. We’ll set our buy range down a smidge, thinking a pothole is possible after the recent rebound.

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Stock 10

Reliance Steel (RS)

Why the Strength

Reliance is the largest metals service center operator in North America, providing metals processing, inventory management and delivery services for several industries, including construction, energy, electronics, automotive and aerospace. With metals demand and pricing buoyant in each of these key industries, Reliance finished 2021 on a high note, setting records in a number of key metrics despite supply-chain disruptions and labor market tightness. Revenue of nearly $4 billion was up a whopping 87% from last year’s Q4, with record per-share earnings of $6.83 beating the consensus by 31%. Cash flow in Q4 was $394 million, up 177% from the prior quarter. By segment, agriculture and construction equipment demand was steady from the previous quarter despite seasonal headwinds and supply bottlenecks. Demand from the semiconductor industry (one of the firm’s strongest end markets) remained firm in Q4, while aerospace demand improved on the back of higher military and defense spending from its customers. Energy sector (oil and gas) sales rose, with Q4 tons surpassing the prior quarter. Reliance continued its focus on accretive growth in Q4, completing four acquisitions with combined annualized sales of $1 billion. The company also returned over $500 million to shareholders through dividend (1.9% annual yield) and buybacks, with $713 million remaining on a $1 billion share repurchase authorization. Further out, management said it was optimistic about business conditions across its end markets and estimates a 6% increase in tons sold for Q1 compared to the year ago. All in all, after earnings went vertical last year ($22 per share!), analysts see $20-plus this year and north of $15 in 2023. It’s a solid story.

Technical Analysis

RS zoomed up 50% in the first 19 weeks of last year, peaking at 180 in May. From there, shares entered a long, grueling period of up-and-down consolidation that continued until just a couple of weeks ago—the net effect of the last nine months was a bowl-shaped pattern, which typically carries a bullish connotation. And that’s what’s taken place since, with RS exploding to the old high following earnings and, despite crazy market-related volatility last week, hit a record level by week’s end. If you’re game, aim for dips of a few points.

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Previously Recommended Stocks

Below you’ll find Cabot Top Ten Trader recommended stocks. Those rated HOLD are stocks that traded within our suggested buy range within two weeks of appearing in the Top Ten and still look good; hold if you own them. Stocks rated WAIT have yet to dip into our suggested buy range … but can be bought if they do so within the next week.

Those stocks rated SELL should be sold if you own them; they will no longer be listed here. Finally, Stocks in the DROPPED category are those that failed to trade within our buy range within two weeks of our recommendation; that’s not a bad thing, we just never got the price we wanted. Please use this list to keep up with our latest thinking, and don’t hesitate to call or email us with any questions you may have. New recommendations each week are in bold.

The next Cabot Top Ten Trader issue will be published on March 7, 2022.