January 31, 2022

As we wrote in last week’s issue, we started to see some extremes out there when it comes to selling pressure, with a few different breadth-related measures nearly reaching levels seen at prior major lows of the past decade. And the major indexes did mostly hold their Monday lows for the rest of the week, even flashing an encouraging turnaround on Friday with a couple of minor positive divergences, before today’s pop higher. The question is how far this nascent bounce can go--so far the Nasdaq has bounced about 1,000 points after declining 3,100, and up action has been limited to just a day or so before the sellers are back at it. That can always change, of course—in fact, we think the odds are decent that it will—but our point is that the onus remains on the buyers to continue to step up to form a workable low the market can build from. In the meantime, we’re sticking with the same cautious stance, holding plenty of cash and keeping new positions small.

This week’s list is actually fairly mixed between sectors, with some commodities, some biotechs and some earnings winners. Given the environment, our Top Pick is Corning (GLW), which isn’t their fastest horse, but it has a solid business and a very good chart, having just enjoyed a nice buying cluster after earnings.

Market Overview

Waiting for a Bounce
As we wrote in last week’s issue, we started to see some extremes out there when it comes to selling pressure, with a few different breadth-related measures nearly reaching levels seen at prior major lows of the past decade. And the major indexes did mostly hold their Monday lows for the rest of the week, even flashing an encouraging turnaround on Friday with a couple of minor positive divergences, before today’s pop higher. The question is how far this nascent bounce can go--so far the Nasdaq has bounced about 1,000 points after declining 3,100, and up action has been limited to just a day or so before the sellers are back at it. That can always change, of course—in fact, we think the odds are decent that it will—but our point is that the onus remains on the buyers to continue to step up to form a workable low the market can build from. In the meantime, we’re sticking with the same cautious stance, holding plenty of cash and keeping new positions small.

This week’s list is actually fairly mixed between sectors, with some commodities, some biotechs and some earnings winners. Given the environment, our Top Pick is Corning (GLW), which isn’t their fastest horse, but it has a solid business and a very good chart, having just enjoyed a nice buying cluster after earnings.

Stock Picks & Previously Recommended Stocks

Stock 1

Alcoa (AA)

Why the Strength

Aluminum prices remain near record levels (up 50% in the past year!) thanks to strong industrial demand, but also because of supply-squeezing plant closures in China and Europe due to soaring energy costs. Adding to these pressures, recent tensions between Russia (a top producer) and Ukraine have caused worries that aluminum could see additional supply shortages in the coming months. While these are unwelcome developments for end users, producers are benefiting in a big way, and more and more of Wall Street is thinking these higher prices are going be around for a long time; some outlooks see aluminum posting a 2.2 million ton deficit this year (demand greater than supply). All of this is great for Alcoa, one of the world’s largest aluminum companies. In Q4, the company easily beat expectations by reporting a mouth-watering 40% increase in sales and earnings-per-share of $2.50 (a 57-cent beat). The company generated revenue of $12.2 billion for the full year, up 31% from a year ago and the highest since 2018, while recording its highest ever annual net income and per-share earnings of $6.63. Although total third-party aluminum shipments fell 5% from the previous quarter (mainly due to the impacts of a strike at one of its smelters in Spain), Q4 aluminum production increased 2% sequentially following up strong output in Q3. Going forward, the company sees higher aluminum prices as a major tailwind and plans to continue its strategy of reducing debt and pension obligations while increasing shareholder returns, recently initiating a new $500 million share repurchase program. While growth won’t be big from here, the bigger point is that earnings are expected to remain elevated, north of $7 per share both this year and next—if true, Alcoa’s likely to seriously beef up shareholder returns.

Technical Analysis

AA has been stair-stepping higher in recent months, with a pullback from May through July, a rally into October (highlighted by a huge pop on earnings), another dip into December with the market, and then a push into the mid 60s earlier this month. The action of late has been sloppy, but of course it’s all relative—given what’s going on with the market, AA is holding up well, and it did find some good-volume support near its 50-day line two weeks ago. If you’re game, it’s not a bad risk-reward situation here, though we suggest a stop just under 50.

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Stock 2

Charles Schwab (SCHW)

Why the Strength

Charles Schwab (covered in the January 13 report) is a name that needs no introduction; its recent acquisition of TD Ameritrade has made it the nation’s largest brokerage firm as measured by total client assets. Schwab’s financial performance is the reason for its recent strength, and the likelihood of higher interest rates is expected to give the bottom line a boost going forward, too. In Q4, revenue leapt 13% from a year ago to $4.8 billion, while per-share earnings of 86 cents rose 16%, though both figures actually fell short of Wall Street’s estimates. The earnings and revenue misses were partly due to disappointing trading fees, although asset management and administration fees were up 12%. Additionally, the company’s trading revenues of just over $1 billion were 19% higher (and up 6% from the prior quarter). It’s not unusual for a brokerage firm to miss their number, and forward-looking measures are more encouraging: Assets under management increased a solid 22% from a year ago (and 7% from Q3) to a record of just over $8 trillion across 33 million brokerage accounts as the firm continues to attract new clients, helped in part by the Ameritrade acquisition. On that front, Schwab cited “unprecedented” activity in the past year and said clients remained “actively engaged” with the financial markets through 2021, with customers depositing north of $80 billion in December alone—28% above the firm’s prior single-month record! Looking ahead, management said rising interest rates would help the firm navigate volatile market conditions and generate meaningful revenues in 2022. Wall Street sees top- and bottom-line growth in the low single digits for Q1 but rising 11% and 35%, respectively, in Q2, with earnings expected to grow north of 20% both this year and next. The company’s latest 11% dividend increase (0.9% yield) is an added bonus.

Technical Analysis

Following a four-month period of basing and a near-test of the 40-week line, the latest uptrend in SCHW began in September when shares rallied from 67 and peaked at just under 85 in late October. Ten more weeks of consolidation followed, with the stock levitating to 95 early in the New Year. The latest pullback has been tedious, but SCHW remains north of its 50-day line and found good-volume support on three days last week. The market will obviously be key, but buying a small amount here with a stop centered around 80 makes sense.

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Stock 3

Cheniere Energy (LNG)

Why the Strength

Cheniere Energy is a unique story, and, as its symbol suggests, it’s all about liquified natural gas (LNG) exports, which are seeing big demand for economic and environmental reasons: The company is the largest LNG producer in the U.S. and second largest in the world, operating the Sabine Pass and Corpus Christi liquefication facilities that have a combined 45 million tons of annual LNG capacity. And there’s plenty of growth potential, too, both from greater efficiencies (per-line production has been rising more than 3% annually) and added production lines (including a 10 million ton expansion at Corpus Christi and another line of production that’s just coming online at Sabine). The attraction here, though, has usually been less about growth and more on dependability—Cheniere signs very long-term (usually 20 years; average remaining contract is 17 years), take-or-pay type deals for well-situated energy customers all over the world that cover the vast majority of its business, leading to dependable and huge cash flow. (In November it inked two 20-year deals with major players in China.) And, right now, one of the drivers is a desire to get gas to Europe, where prices are something like five or more times as much than here in the U.S. (!) and is one reason why gas flows into Sabine Pass are hitting new records. All of this adds up to good things for Cheniere in 2022 and beyond—the firm has started a regular dividend payment (yield 1.2%), will be paying off $1 billion of debt per year through 2024 and re-upped a $1 billion share buyback plan through 2023. There’s probably not the upside here given the set-in-stone contracts, but the bigger the natural gas story gets around the world, the more demand there will be for Cheniere’s offerings.

Technical Analysis

LNG kicked off in late 2020 with most energy stocks, and while the advance hasn’t been as dramatic, it’s been very steady, with a persistent push into June and two base-building efforts since, the latest of which began in late October. Shares tried to break out right after the turn of the year, but got yanked back by the market—but then, last week, the stock snapped right back on great volume. Further volatility is possible, but if the market stabilizes, it looks like LNG wants to head up. Minor weakness should be buyable.

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Stock 4

Chesapeake Energy (CHK)

Why the Strength

A year ago at this time, Chesapeake Energy was in Chapter 11; despite terrific acreage mostly in the Marcellus, Eagle Ford and elsewhere, years of low natural gas prices and a huge debt load sent the company into a tailspin. Today, though, the firm has done a 180: Chesapeake cleaned up its balance sheet (debt is 0.8 times annual cash flow) and slashed costs (it has hundreds of Marcellus locations that will return 50% at just $2.50 gas!), and with gas prices well above $4, the firm is printing money; in Q3 alone, Chesapeake cranked out $2.26 per share in free cash flow. Things are going so well, in fact, that the company is now on the offensive—it’s agreed to buy out privately held Chief Holdings and sell its Powder River basin assets for a net of $1.55 billion in cash and nine million shares, giving it an extra 113,000 acres in the Marcellus. Better yet, the purchase should be accretive to free cash flow, with the top brass saying that, given early-January strip prices for natural gas, the firm should be on pace to crank out nearly $11 in free cash flow in 2022! In response, Chesapeake hiked its base dividend (now a 2.6% annual yield), and will pay out 50% of its free cash flow on top of that each quarter, which could push the total yield into the double digits. There’s a $1 billion share buyback plan, too! To be fair, natural gas prices are a huge variable here, and they’re extremely volatile; just in the past few months, they’ve gone from $3.50 to $6 to $3.50 and back to $4.80 or so today. Moreover, part of the recent rise has to do with weather (in the U.S.) and demand from Europe (even before the recent tensions), so big swings are likely going forward, too. But there’s no question that Chesapeake is going to throw off a ton of cash barring all but the worst-case scenarios.

Technical Analysis

CHK came out of Chapter 11 last February and stair-stepped higher during the next few months, rallying to 57 before resting, and then rallying again to nearly 70 before catching its breath. Recently, it tried to emerge from its base before the market pulled it down two weeks go, but last week’s big-volume snapback is encouraging. We’re OK starting small here, with a loose stop under last week’s lows.

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Stock 5

Corning (GLW) ★ Top Pick

Why the Strength

Corning’s name is well known in the consumer market for its eponymous glass-ceramic cookware. But these days the company’s glass and ceramics are mainly used in industrial and scientific applications, including TV panels and mobile phone displays, as well as for telecom and automotive components. After spending much of last year under the radar, Corning captured Wall Street’s attention last week with a stellar fourth-quarter earnings report and upbeat guidance, prompting upgrades by a couple of big firms. Revenue of $3.7 billion was 10% higher from a year ago and beat estimates by 3%, while full-year sales rose by a head-turning 23%. What’s more, per-share earnings of 54 cents beat the consensus by 4% and the company guided for a 6% sales increase (to $15 billion) in 2022, expecting profits to grow more than sales. And while margins were lower in Q4 (a concern among analysts in 2021), management reassured investors that improving the gross margin will be given “top priority” going forward. The company further allayed worries about the inflationary environment by stating it has already negotiated to increase prices in its customer contracts (which should obviously help margins). The company believes it’s at the beginning of a “multi-year wave of growth” for optical networks and sees “significant” potential in its optical communications business for 2022 and beyond, including as much as $1 billion a year from U.S. infrastructure spending plans starting in 2023. Corning also sees an opportunity in life sciences (sales up 21% in 2021) due to ongoing pandemic demand. For Q1, the firm guided for top- and bottom-line increases of 9% and 13%, respectively (in line with estimates). A reasonable valuation (20 times trailing earnings) and solid dividend (2.3%) help the cause, especially given the market environment.

Technical Analysis

After posting a solid post-crash performance, GLW peaked last April around 46 and spent the rest of the year in a steady decline, falling 28% from high to low by the middle of last week. But that’s looking like the final low—shares exploded higher by 20% on the week, including three excellent gains after earnings on big volume. Yes, there’s still resistance to chew through, but we’re not expecting a big pullback given the prolonged decline and sharp turnaround on earnings.

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Stock 6

Deere (DE)

Why the Strength

We’ve written about Deere before, and the world’s largest tractor maker is clearly benefiting from strong crop prices and rising farm equipment demand. But what you may not know is that Deere has become something of an artificial intelligence (AI) play, with plans to introduce an autonomous tractor later this year. The recently revealed 8R tractor (designed for large-scale farmers) combines a chisel plow and a GPS guidance system, and can be controlled by a smartphone app. The announcement is a reason for the latest strength, but Deere’s fiscal Q4 report (released in November) provided another reason for optimism, featuring sales of $11.3 billion that rose 16% from a year ago and full-year sales that rose 24%. Per-share earnings of $4.12, meanwhile, beat estimates by 23 cents in Q4 while net income nearly doubled for 2021 and sailed past the firm’s prior earnings record from 2013. By segment, production and precision ag sales soared 23%, small ag and turf rose 17% and forestry and construction increased 14%, with all three segments reporting higher shipment volumes. Looking ahead, management sees another year of “robust” sales in 2022 based on the current order book, with farm and construction equipment expected to benefit from higher crop prices, economic growth and increased infrastructure investment, which has prompted some high-profile analyst upgrades (another reason for the strength). Deere also anticipates growth in its tech-enabled precision fertilizer application systems, as well as in its digital tools (where customer engagement now stands at over 315 million acres). Deere forecasts net income for 2022 of around $6.8 billion, while analysts see mid- to upper-teens earnings growth this year and next. Earnings are due out February 18.

Technical Analysis

DE broke out around 180 in 2020 and enjoyed a beautiful, persistent rally right through mid-March, when the stock finally hit resistance just shy of 400. And since then it’s … done a whole lot of nothing, with a straight-sideways trading range for the past nine months. Still, the chart is giving off some positive vibes, with two big-volume buying weeks in the past four as DE sits just 7% off its highs. You could nibble here, or just wait for a decisive breakout going forward.

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Stock 7

Intra-Cellular Therapies (ITCI)

Why the Strength

More than 11 million Americans suffer Bipolar illness, and that’s a huge market for Intra-Cellular Therapies. The company makes the only FDA-approved treatment of Bipolar I and II episodes; Bipolar I is when manic episodes last a week or are so intense they require immediate hospitalization, while Bipolar II is similar, but has longer cycles and less intense episodes than the mania of Bipolar I. Both are underserved by medicine, considering more than 4% of Americans have one of the conditions and, when left untreated, increases the likelihood of suicide. The drug, lumateperone, is sold under the brand name Caplyta. It’s a once-a-day pill that is also approved for use in treating schizophrenia, expanding the market by another 24 million potential U.S. patients. The drug was first launched commercially in 2020 and has been shown to perform consistently with clinical trials, indicating a low prevalence of serious side effects—and the late-December approval for Bipolar indications should goose business going ahead. The early success—and easing of Covid restrictions on hospitals—sent sales up nearly four-fold last year to more than $80 million (Q4 results will likely be announced in late February). Caplyta has the potential to expand into treatment for major depressive disorder (MDD), a Bipolar II-like condition that affects 19 million people in the U.S.; trials for that are in Stage III right now. A related study, for treatment of people with mixed indications of MDD and Bipolar II, is also entering Stage III trials. Back to the numbers, this year sales should push to $218 million or so, and while the bottom line is still in the red, Intra-Cellular is debt-free and has around $850 million cash, making it well-positioned to execute on its growth plan.

Technical Analysis

ITCI has been extremely choppy, which isn’t surprising given its transition from development-stage to commercialization in recent months. Shares popped in a big way after getting the Bipolar approval late last month, but then gave most of that up after a good-sized share offering. But ITCI held the 200-day line and has actually snapped back despite the horrid market, including a four-day buying cluster starting two weeks ago. If you want to roll the dice, you can nibble here with a loose stop.

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Stock 8

Regeneron Pharm (REGN)

Why the Strength

Regeneron is a diversified pharma company that has added a new offering to its core portfolio: A Covid-19 treatment, REGEN-COV. It’s an antibody cocktail approved by the E.U. for both Covid prevention and treatment of Covid patients. In the U.S., the treatment is allowed under an emergency use authorization for high-risk patients. The drug has generated about $5.8 billion in net sales in 2021 from 2.8 million doses. That likely puts total 2021 sales—to be announced Friday, February 4—close to $16 billion. Odds are Regeneron won’t be pulling in as many billions of dollars in the future as more people get vaccinated and as distribution partner Roche takes its fee for handling distribution to much of the developing world. That has Wall Street predicting a dip in sales this year, though projections on the decline vary widely, with estimates on 2022 revenue ranging from $9.9 billion to $15.4 billion. Even so, there’s a lot to like here. By April 12, the FDA promises to rule on Regeneron’s Biologics License Application (BLA) to use the cocktail as a preventative treatment for high-risk patients. Beside REGEN-COV, the company boasts an already strong business: Eylea, a 10-year-old treatment related to retinal disease, grew 17% in 2021 to produce $5.8 billion sales, while Dupixent, a COPD treatment debuting in mid-2020, is selling at a $6.6 billion annualized rate, and a third drug is Libtayo, originally launched for a type of skin cancer and approved a year ago for advanced basal cell carcinoma and non-small-cell lung cancer. While profits will dip as Covid (hopefully) eases, 2022 earnings are still thought to come in 53% above 2020’s level, so the underlying business is strong. In the meantime, the firm approved a $3 billion share buyback program approved in November that helps the cause.

Technical Analysis

REGN rallied back to its 2020 highs by Labor Day last year and was looking primed for higher prices, but a sharp pullback a couple of weeks later shattered that idea. Even so, the stock did hold the 200-day line and bounced back above 650 before settling down in recent weeks—despite the weak market, REGN has been finding support in the 600 area (give or take) as the 200-day line catches up. We’ll put our buy range above the stock, thinking a strong-volume rally could kick off a solid move.

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Stock 9

Royalty Pharma (RPRX)

Why the Strength

As its name suggests, Royalty Pharmaceuticals (located in Britain) is a royalty play on biotech and drug development—it calls itself the largest buyer of biopharmaceutical royalties, offering good-sized chunks of money (often a few hundred million at a clip) for clients that use it to push forward their development efforts (though occasionally the company will acquire royalties on an already-approved product); all told Royalty has stakes in around 50 approved and development-stage products, including 16 therapies under contract that currently have more than $1 billion of annual revenue! The big producers for Royalty are a who’s-who list of major players, including Vertex, Biogen, AbbVie, Novartis, Johnson & Johnson, Gilead, Pfizer and Merck, and its average contract length at this point is around 15 years (about six-plus years on some of the big producing contracts), so there’s a good amount of dependability here. But this is also a growth story, with Royalty inking $5.5 billion of transactions during the past two years for 20 different therapies that, based on sales projections, should bring in an addition $750 million annually by 2025 (and those projections have generally increased in recent months). Of course, funding plays like this can be affected by the market environment, but right now Royalty makes up very little of biotech’s overall funding and the demand from biotech players should be monstrous in the years ahead. Last year, the firm’s cash receipts likely grew 17% to 18%, and 2022 should be fruitful as well; the dividend (1.9% yield) is a nice cherry on top. Earnings are due February 15.

Technical Analysis

As we’ve broadened our screens (so few stocks are looking good), we’re picking up on some big bottoming bases of sort, and that’s exactly what RPRX has—it came public in mid-2020 but hasn’t done much since then, mostly sagging into the latter part of last year. But shares are showing more hopeful signs, with the low in early October holding and with the stock etching higher lows since then. We’re going to put the buy range above the current price, aiming to enter on signs the buyers are showing up.

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Stock 10

Seagate Technology (STX)

Why the Strength

Seagate (covered in the December 20 report) is a top producer of hard-disk drives (HDDs), which still play an important role in the bulk storage memory market compared with newer (but more expensive) NAND flash technology. Seagate served notice last week that its HDD offerings are still in high demand with a solid earnings report for its fiscal second quarter ending December 31. Revenue increased 19% in Q2, reaching its highest level in over six years, led by cloud data center demand for its 18-terabyte near-line products. Per-share earnings of $2.41 topped estimates by 5 cents, while calendar-year free cash flow rose to $6.27 per share. Other highlights include a fifth consecutive quarter of record capacity shipments in Seagate’s HDD drive segment, which rose 26% (and up 3% from the prior quarter), while mass capacity market shipments increased 41% (up 4% sequentially). Shareholder returns remain a priority with the company, which repurchased over five million shares worth $471 million in the quarter (compared to a year ago, the share count is down nearly 11%) and paying its solid dividend (2.6% yield); with around $3.3 billion remaining in its buyback authorization, there should be more returns coming, too. Moving forward, management expects fiscal Q3 revenue to come in at around $2.9 billion, up 7% and in line with estimates, while earnings are expected to be around $2.00, up 35%. Seagate also expects a “very steep” production ramp for its 20-terabyte products this year, with the potential of surpassing its previous record-setting ramp for its 16-terabyte drives. Further out, Seagate sees hard-disk drives remaining a “critical enabling technology” over the coming decade while the data management trend continues growing. It’s not changing the world, but Seagate’s doing good business and is a cash flow machine.

Technical Analysis

STX’s post-vaccine rally topped out around 107 last May and led to a tedious five-month correction and consolidation. But after tagging the 40-week line, shares briefly popped to new highs in November, but the market has been a headwind since then—STX held up well until the calendar flipped, then quickly dove back to its 40-week line. But the quarterly report may have marked the low, with shares reacting well to end last week. It’s very volatile, but you could take a swing at it here with a stop in the mid-90s.

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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 February 7, 2022.