The Uptrend Continues; Earnings Season Looms
Current Market Outlook
The strength that began around July 4 continued last week as big investors returned to their desks, pushing most major indexes to marginal new recovery highs. There’s still plenty of news-driven action (volume was light even through last week), and earnings season, which is beginning to get underway in earnest, is sure to have an impact. But the intermediate-term trend (which was iffy in late June) has rejoined the longer-term trend on the upside, and many leading stocks have either snapped back to new highs or are building sound launching pads. We’re always on the lookout for renewed selling pressure, but the evidence has improved, so we’re moving our Market Monitor back to a level 8.
This week’s list is again heavy on growth stocks, though there are a couple of special situations presented as well. Our Top Pick is ZTO Express (ZTO), a young, volatile Chinese stocks with huge growth and a very strong chart. Start small, ideally on dips.
| Stock Name | Price | ||
|---|---|---|---|
| Energen (EGN) | 77.04 | ||
| Etsy (ETSY) | 112.97 | ||
| GDS Holdings Limited (GDS) | 80.15 | ||
| Grand Canyon Education (LOPE) | 121.03 | ||
| Madrigal Pharmaceuticals (MDGL) | 234.07 | ||
| Palo Alto Networks (PANW) | 236.92 | ||
| Roku, Inc. (ROKU) | 150.46 | ||
| Sonic Corp. (SONC) | 35.22 | ||
| Workday (WDAY) | 194.88 | ||
| ZTO Express (ZTO) | 28.84 |
Energen (EGN)
Why the Strength
Oil explorer Energen has had a couple of false starts this year, but the stock is strong today for a couple of key reasons. The company is a Permian Basin pure play, with most of its production in the Delaware and Midland areas; the firm estimates that it has more than 4,000 drilling locations on its 149,000 acres (compared to plans to drill 130 this year)! After spending a year or two divesting non-core assets and bolstering its position in the Permian, Energen is now in a big growth phase—production surged 39% in 2017, partially due to its Generation 3 drilling techniques that have meaningfully boosted new well results and returns, which generally range from 40% to 80% at $60 oil. And last year’s growth looks likely to continue for many years—management sees output rising 25% this year, and growth should accelerate a bit from there, advancing 28% from 2018-2020, and there’s possible upside given the firm’s very solid balance sheet (no debt maturities until 2021). Cash flow excluding exploration costs is expected to grow at 35% annual rates during that same time. Not surprisingly, sales and earnings are booming, and at least one smart investor has noticed—Carl Icahn has been buying shares and now holds a 7.5% stake in the company (and rumors are he’s thinking about buying it all). All told, Energen is a good story with some strong backers. Earnings are due out August 7.
Technical Analysis
EGN was bottled up by the 60 level from the start of 2017 through March of this year. But the stock has acted better since then, albeit with some hair-raising volatility—shares broke out in late March, but after rallying to 70 were twice yanked back down to 60. Support held, though, and EGN has gone on to easily hit new recovery highs during the past couple of weeks. We’re OK buying some here or on further dips, with a stop near 66.
EGN Weekly Chart
EGN Daily Chart
Etsy (ETSY)
Why the Strength
Etsy remains a mid-cap leader in the market due to its excellent and improving fundamental trends, as well as its big potential as the Amazon for homemade goods. At the end of March, the company had two million active sellers (up 9.4% from a year ago) and 34.7 million active buyers (up 17% from a year ago), and the first quarter saw gross merchandise volume rise 20% to $861 million. Management thinks the firm has just a 2% share in the types of goods being sold on its platform, and that potential has big investors signing up—407 funds owned shares at the end of June, compared to 311 at the start of the year and 224 a year ago! That said, the biggest recent reason for the stock’s strength was the top brass’ decision to hike its transaction fee (from 3.5% to 5%) and expanding its line of premium subscription plans for sellers to help with layouts, restock notifications, custom web addresses, and additional features to manage your Etsy shop at scale. Some of the added revenue will go toward investments (higher marketing spending, for instance), but it’s going to help the bottom line in a big way—the company significantly hiked its revenue (now looking for 33% growth vs. last year) and EBITDA (up 60% from a year ago) guidance on the news. Analysts see earnings up 81% this year and 43% next. This remains a big story. Earnings are likely out in early August.
Technical Analysis
ETSY has admittedly had a big run from its market-induced shakeout in February—it’s more than doubled since! But it’s certainly not showing any weakness despite that move. The biggest clue on the chart came after its transaction fee hike, which boosted the stock 36% on 10 times average volume. And, just as important, the stock has moved straight sideways since, a sign big investors aren’t letting go of any shares. You can buy a little here and see what earnings brings.
ETSY Weekly Chart
ETSY Daily Chart
GDS Holdings Limited (GDS)
Why the Strength
GDS Holdings is a fast-growing carrier-neutral data center provider in China, offering collocation and managed services to all major Chinese telecommunications carriers and many of the largest Chinese cloud service providers that are hosted in its facilities. The company has a 17-year record of successfully serving the needs of cloud service providers, internet companies, financial institutions, telecom and IT service providers and private sector companies, with most of the big internet players in China signed up as customers. Data center capacity is measured in square meters (sqm), and GDS Holdings had 103,475 sqm in service in its Q1 report, up from 68,000 sqm a year earlier. Of that area, 93.8% was committed, compared to 90% a year ago. The company began construction of three new data centers during the first quarter and upsized another expansion project from 5,000 sqm to 7,858 sqm. There has also been growth via takeovers. GDS Holdings has been increasing revenue rapidly—54% in 2017 and 76% in Q1 2018, but is plowing cash flow back into expansion rather than realizing profits. EPS isn’t expected to hit profitability until 2019, but cash flow growth has been strong, with Q1 EBITDA rising 127% from a year ago. The purity of GDS Holdings’ offering, combined with the size of the Chinese opportunity, has made this a popular choice of institutional investors, over 100 of whom now own positions even though the stock came public just in late 2016. This is a big story.
Technical Analysis
GDS came public at around 10 in November 2016 and slumped to 7 in June 2017. But since the rebound began about a year ago, GDS has been in a powerful uptrend, with just one flat patch in February and March. GDS corrected to its 50-day moving average in late June, but gained a new all-time high last week. There may be some volatility in GDS as investors sweat through all the trade war talk, but the bottom line is that this is almost exclusively a domestic Chinese story. You can buy on this pullback with a loose stop around 38.
GDS Weekly Chart
GDS Daily Chart
Grand Canyon Education (LOPE)
Why the Strength
The last time Grand Canyon Education was featured in Top Ten Trader, it was a large for-profit university with a Phoenix, Arizona physical campus (Grand Canyon University) and massive online enrollment. Grand Canyon Education purchased Grand Canyon University when the University ran into financial difficulties in 2004, and the company took a lot of flak during the Obama administration for its practice of signing up veterans, taking their GI Bill money, but delivering relatively few successful degrees. Now, the University is going back to its non-profit status and Grand Canyon Education has bought out the physical assets of the University and will run the academic, student housing and athletic buildings, employ all non-academic staff and provide tech support, marketing, promotion and financial aid functions. Grand Canyon Education is now the for-profit, service side of GCU, essentially a dedicated service operation whose client is a successful university with 90,000 students. There may be opportunities for the company to leverage its expertise to provide similar services to other educational institutions, but expansion will likely have to wait while investors assess the success of this new arrangement. In the meantime, sales and earnings are showing steady improvement and analysts see more of that coming.
Technical Analysis
LOPE went through a three-year dead zone from trading at 50 in October 2013 to 40 in October 2016, but since it broke out in November 2016, it has been a strong performer. The stock went through multi-month consolidations in mid 2017 and from September 2017 through January 2018. But the stock hit a series on new highs last week, and is trading just under 120. With earnings likely coming out in early August, you can take a small position in LOPE on any normal weakness, then watch the chart after Q2 numbers are released.
LOPE Weekly Chart
LOPE Daily Chart
Madrigal Pharmaceuticals (MDGL)
Why the Strength
Madrigal Pharmaceuticals is a clinical-stage company working on novel therapeutics targeting a very specific thyroid hormone receptor pathway in the liver. This receptor is a key regulatory mechanism common to a variety of cardio-metabolic and fatty liver diseases. And the company’s first drug candidate, dubbed MGL-3196, is believed to improve components of both metabolic syndrome and fatty liver disease. Based on positive Phase 1 data, Madrigal initiated Phase 2 trials for treatment of both non-alcoholic steatohepatitis (NASH), a common liver disease affecting 3% to 5% of the U.S. population with no approved therapies, and familial hypercholesterolemia (FH). The stock just went vertical in late May when interim data showed that the drug achieved its liver biopsy endpoint (a reduction in liver fat) in patients with NASH after 36 weeks of treatment. Management believes the drug could resolve NASH in roughly nine months in 30% to 40% of patients and is working on a Phase 3 trial design with the FDA that could begin later this year. Investors should also be on the lookout for topline data from the Phase 2 trial for FH, and if that’s good a second Phase 3 trial could begin later this year. With two major programs advancing, a secondary offering out of the way, and takeover chatter for NASH players, MDGL is an interesting speculation.
Technical Analysis
MDGL has been around for a number of years but only came to life late in 2017, leading to a monstrous run through January of this year; shares traded up to 155 before profit takers arrived, resulting in a normal-looking base-building effort that saw the stock trade in the 100 to 120 area for a few months. Then the positive NASH data ignited another blastoff rally that took MDGL above 275. For the past six weeks shares have been consolidating relatively tightly in the 270 to 320 range. This is early-state biotech so don’t invest the rent money. But the fundamental potential and tight chart make for a good setup.
MDGL Weekly Chart
MDGL Daily Chart
Palo Alto Networks (PANW)
Why the Strength
After two years in the doghouse, the cybersecurity sector began to come to life in February, and for good reason—with commerce and identity going online, mobile and to the cloud, the opportunity for nefarious deeds from cybercriminals continues to increase. Palo Alto Networks looks like the emerging blue chip in the group, with its security operating platform using all of the latest technology (including AI and automation) to help companies with network, web and endpoint security. Palo Alto has been rapidly gaining share (especially from legacy players) in recent years, and there should be more of that coming—at the end of April, the company had a whopping 51,000 customers (up 29% from a year ago), and most of these clients greatly increase their spending in the quarters after their initial purchase. The most recent quarter continued the fantastic growth in all key metrics: Revenues rose 31% (with strength seen in both product sales and subscription and support revenues), billings were up 33%, deferred revenue was up 34% and free cash flow rose 30%. (Incredibly, free cash flow was equal to 37.5% of revenue!) Analysts see solid growth and expanding margins for at least the next couple of years, and we think Palo Alto’s growth could surprise to the upside as demand for next-generation solutions picks up and technology spending as a whole remains strong. We like it.
Technical Analysis
The big clue on the chart with PANW came in February and March, when the stock bounced off its 50-day line and proceeded to rally 20 of 21 days on huge volume, a clear sign big investors were piling in. The advance has continued since then, albeit with plenty of choppy action along the way. Most recently, PANW found support twice at its 50-day line before rallying to new highs last Thursday. You can buy some here with a stop near 200.
PANW Weekly Chart
PANW Daily Chart
Roku, Inc. (ROKU)
Why the Strength
Roku is essentially a way to play the internet TV (i.e. cord-cutting) movement. The company plays in a two main sandboxes. Roku’s Platform segment (55% of revenue in the last quarter) generates revenue from advertising, subscription and transaction fees, sales of branded channel buttons on remote controls, and licenses from operating systems installed on TVs. Its Player segment (45% of revenue in the last quarter) includes sales of over-the-top (OTT) streaming players. The business model works by Roku making a small profit margin on Player sales (16% gross margin) then making a much higher profit on Platform revenue (71% gross margin). For the model to work, Roku needs to keep pulling in users, then selling high-margin advertising. That trend is moving in the right direction, with active accounts up 47% in Q1 to nearly 21 million; roughly 50% of these new accounts come from licensing partners, which include Hitachi, Insignia, TCL, Sharp, RCA, Hisense and Philips, so these partners are an important part of the story. One of the arguments against Roku has been competition from other operating system providers. But the TV streaming market appears big enough for multiple players (Samsung, Google, Amazon, etc.). And analysts and big investors have been encouraged by Roku’s execution. Consensus estimates call for 33% to 36% annual growth over the next two years, and the firm’s bottom line to leap into the black next year. It’s a big idea.
Technical Analysis
ROKU went public at 14 last September and the stock went ballistic, eventually topping out at 59 in December, before the post-IPO droop eventually saw the stock find support at 29 in early April. A month consolidating in the 30 to 35 range preceded the Q1 earnings report on May 9, after which investors began to pile back in. ROKU rallied to 48 in June, handled the growth stock dip nicely, and has since hit higher highs. There’s still overhead, of course, but buying on dips toward the 25-day line makes sense.
ROKU Weekly Chart
ROKU Daily Chart
Sonic Corp. (SONC)
Why the Strength
Sonic operates the largest chain of drive-in restaurants in the U.S., with around 3,600 locations that serve three million people every day. It’s certainly a decent, profitable business, but growth has been mundane at best, which has left the stock stuck in the mud during the past three years. So what’s causing the strength today? A few things. First, business is improving—whereas same-store sales did fall 0.2% in the quarter ending in May, demand has been improving month-by-month, with May seeing a 2.5% hike and management guiding to 0% to 2% same-store growth for the rest of the year. Second, and more important, management is going with an “asset light” business model—lower levels of marketing and CapEx spending, more franchisees (95% of stores are now franchised), etc.—to boost cash flow and return a ton of that to shareholders. Indeed, even with modest expected growth during the next few years (4% to 7% EBITDA annual growth), the top brass is looking to return around $550 million of cash to shareholders by 2021, which is about 43% of the stock’s current market cap! Some of that will come from the dividend (current annual yield 1.8%, with some hikes likely in the years ahead), but the bulk will be share buybacks; indeed, Sonic’s share count is down 13% during the past year, and another $390 million of shares will likely be bought back during the next three years. It’s not a great growth story, but with stabilizing fundamentals and a shareholder-friendly management, there’s a good chance shares have upside ahead.
Technical Analysis
SONC traded between 23 and 30 for the most part from the summer of 2016 through May of this year. But then came the blastoff when earnings were preannounced and the buyback authorization was boosted in June—shares soared from 25 to 36 within a couple of weeks, and despite some wobbles, has held up well. There is still some old resistance in the 36 area, but the odds favor that being taken out in short order.
SONC Weekly Chart
SONC Daily Chart
Workday (WDAY)
Why the Strength
Workday is one of the bigger cloud application stocks out there, with over $2 billion in annual revenue, roughly half of which is recurring. Along with Salesforce.com (CRM), the only other pure-play SaaS stock that’s bigger, Workday has been garnering attention from analysts because of several positive long-term growth drivers. First, Workday has a nearly $70 billion addressable market selling enterprise solutions for finance, human capital management (HCM), payroll, and business analytics. Second, analysts believe Workday can keep growing at a relatively good clip given its broadening portfolio and success grabbing customers from legacy vendors, including SAP and Oracle. Revenue was up 36% in fiscal 2018 (ended in January) and is seen rising 26% in fiscal 2019. Finally, Workday is seen as a relatively defensive stock given that it has a large existing customer base contributing to a roughly 30% operating margin, well above the average of 15% across a large peer group. This all boils down to a stock that has upside potential from future growth, as well as reduced downside given its strong recurring revenue base should technology spending subside or slow down. With only 20% market share in the cloud ERP market and a growing customer list of big clients, Workday is a force to be reckoned with.
Technical Analysis
WDAY had a nice run in 2017 and raced to a new all-time high of 140 early in 2018. The stock hasn’t done a heck of a lot since, but it’s holding up just fine and shares routinely found support around the 122 level (with one dip below 120 and its 200-day line two weeks ago). And now, after the recent shakeout, WDAY is showing signs that the weak hands may have left the building. Of course, there’s still overhead to chew through, but we’re OK starting a position around here and looking to add on a move to new highs (above 140) sometime in the weeks ahead.
WDAY Weekly Chart
WDAY Daily Chart
ZTO Express (ZTO)
Why the Strength
ZTO Express, making its third appearance in today’s Cabot Top Ten Trader, is the FedEx of China. The explosive growth of ecommerce in China has created a huge need for delivery services, and ZTO Express serves the needs of Alibaba and JD.com, the two largest ecommerce operations in China. The company has an extensive network of sorting hubs, warehouses and trucks, plus partnerships with other delivery services, making it a logistics giant with international connections via collaboration agreements. There is also a software system that tracks parcels, optimizes routes and manages the fleet. The company has been consistently profitable, with earnings expected to grow by 25% this year and 24% next year. But the real excitement about ZTO Express comes from the company’s $1.38 billion investment from Alibaba and its logistics arm, Cainiao Network. Alibaba is looking to improve the speed and efficiency of its first- and last-mile pickup and delivery capabilities, and this investment will make ZTO Express a de facto part of Alibaba’s delivery system. Investors see no downside to the arrangement and analysts are forecasting revenue of $653 million in Q2 (up from $379 million in Q2 2017), with earnings of 22 cents per share (topping last year’s 17 cents per share). China’s GDP growth has slowed to 6.7%, but that’s still a powerful motor for a continuation of ecommerce growth, which is great news for ZTO Express.
Technical Analysis
ZTO came public in October 2016 at 18, and took a year and a half to get back to that price. The stock rallied through April and May, then changed character in late May, gapping up from 19 to 22 on huge volume on May 29 after the Alibaba sponsorship news hit. The stock got caught in the trade-war turmoil in June, but has rallied back to hit a new high in today’s trading. We think ZTO is buyable on any normal weakness.
ZTO Weekly Chart
ZTO Daily Chart
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 green.
