September 27, 2021

Rotation Remains Fierce

Current Market Outlook

After last Monday’s plunge, the initial rebound was very encouraging, and the fact that the major indexes are still doing their best to hang in there is a plus. But, while many individual stocks are in decent shape, the wild rotation that has been a hallmark of 2021 has returned, with money racing into cyclical areas and out of growth stocks the past couple of days. We’re still sticking with a stock-by-stock approach, and most names, despite their wobbles, remain in fine shape, simply pulling in after big runs; others, however, look worse and should be pared back or sold. To be fair, such action isn’t totally surprising—big breaks like last Monday’s usually have some reverberations, so we wouldn’t say the action is negative as much as it’s a sign we’re still in the tricky, choppy environment that has existed for some time. We’re going to leave the Market Monitor at a level 5 and see how things play out in the days ahead.

The good news is that this week’s list is full of names that have enjoyed outsized accumulation of late. Our Top Pick is Devon Energy (DVN), which looks like a leader of a fresh breakout in energy stocks (and cyclical stocks more broadly). We suggest aiming for dips as these names usually pull in after powerful rallies.

Apache (APA)

www.apachecorp.com

Why the Strength

APA Corp. (formerly known as Apache) is the first of three energy stocks in this week’s issue, as that group appears to be re-emerging after months of rest. The company has operations both in the U.S. (about 60% of ouput this year, split nearly evenly between oil, gas and gas liquids) and overseas (40%-ish of output, two-thirds of which is oil), and the company does have a potentially lucrative offshore find in South America off the coast of Suriname. But like its peers, the stock is strong today because energy prices remain elevated, production and costs have leveled off and the firm has vision into years worth of huge cash flow—APA has cranked out well north of $2 per share of free cash flow in the first half of 2021, and most of that has gone to debt reduction (long-term debt is down a whopping 21% in the first eight months of the year). But there’s much more cash to come: Recently, management said that excluding any extra investment into the offshore Suriname area, it believes it can crank out $1.6 billion-plus of free cash flow annually for many years (“well beyond five years”) starting in 2022 (assuming current energy prices), which comes out to around 20% of the current market cap each year. There will be further debt reduction for sure, and there will obviously be ups and downs in prices, but it likely won’t be long until big dividends and share buybacks are implemented. All in all, APA does have more moving parts than the best energy plays—investments in Suriname plus some negotiating going on with Egypt’s government about its operations there—but there’s no doubt that the free cash flow story is very strong.

Technical Analysis

APA had a big bounce off the March 2020 lows and another post-November 2020 rally to 24 in March of this year, but that’s been the peak for a while, albeit with a lot of movement—shares fell to 16 in April, ran back to 24 in June and then slipped to 15.5 last month (below the 40-week line). But after a brief rally and some tests of that long-term trend line, last week was very encouraging, with a huge-volume rally starting on Wednesday. APA still has some old overhead to chew through, but we think it’s likely the correction is over—if you want in, you can start a position here or on dips.

APA Weekly Chart

APA Daily Chart

Biohaven Pharmaceutical Holding (BHVN)

biohavenpharma.com

Why the Strength

Over 40 million Americans suffer from migraines that often result in disabling symptoms and lost productivity, but a recent milestone drug approval could change that. Biohaven is a biopharmaceutical company with several commercial therapies and late-stage candidates targeting neurological and neuropsychiatric diseases. Biohaven’s latest run was kickstarted in May when its Nurtec ODT became the first and only FDA-approved drug for preventative treatment of episodic migraine in adults. (The drug was approved for acute treatment in all eligible adult patients with migraine, regardless of the number of monthly migraine days, significantly expanding the drug’s potential market.) The company plans to keep the growth train going with an extensive pipeline of candidates in various phases for other neuroscience disorders, including Troriluzole for treating Alzheimer’s (in Phase II trials) and Obsessive-Compulsive Disorder (Phase III), Verdiperstat for Multiple System Atrophy and Amyotrophic Lateral Sclerosis (both in Phase III) and Zavegepant for acute treatment of lung inflammation due to Covid-19 (Phase 2) and migraine prevention (Phase 3). Back to the stock, further strength was seen in July when Biohaven reported preliminary Q2 revenue for Nurtec of $93 million, which beat consensus expectations by 72% and was up 112% from the prior quarter, figures that held up when full results were reported a few weeks later. From a small base, analysts see revenues up six-fold this year and improving another 88% next year as Nurtec penetrates the market.

Technical Analysis

BHVN’s upmove has occurred in three stages; the first began in May following the Nurtec approval and saw the stock catapult from 65 to 105 within a month, followed by a pullback to 90. The second stage saw shares rise to 130 by July before dropping to the 50-day line at 108 in August. And the third phase saw BHVN hit new highs around 140 before its latest rest. We think it’s set up as a good risk-reward around here.

BHVN Weekly Chart

BHVN Daily Chart

Brooks Automation, Inc. (BRKS)

brooks.com

Why the Strength

For much of its 43-year history, Brooks was a dual semiconductor/medical play, providing contamination control equipment and robotic vacuum and handling systems for chipmakers, along with genomic services and tissue sample management to pharmaceutical and research customers. But Brooks has decided to focus mainly on its life sciences segment after selling its legacy semiconductor solutions business to a private equity firm for $3 billion in cash (a deal expected to close in the first half of 2022). Brooks further plans to put the cash to work by making acquisitions that will expand its life sciences footprint, a move that convinced a big Wall Street firm to raise its price target for Brooks (contributing to the stock’s recent strength). On the financial front, Brooks reported a top line of $315 million in fiscal Q3, up 10% sequentially and 43% from a year ago. Both segments showed nearly identical growth rates, with overall life sciences revenue up 42% and semiconductor sales 43% higher. Life sciences services revenue was up 28%, including record revenue in the three sub-segments of genomics services, synthesis and next-generation sequencing. It also saw “robust” product sales (up 60%), albeit down modestly from Q2 due to lower Covid testing. In its storage segment, Brooks reported encouraging momentum across large automated stores, cryogenic and clinical stores, plus strong demand for its BioStore Cryo systems. Management sees the acceleration of lab workflows, as well as a worldwide shortage of life science consumables and instruments, as tailwinds going forward. Wall Street sees earnings doubling this fiscal year (ending this month) and rising another 20% next year.

Technical Analysis

BRKS did very well through March of this year as the prospects for both major segments brightened. After that March peak, shares dipped as low as 76 last month, falling decisively below its 40-week line. But that turned out to be a shakeout—since that time, BRKS has not only rallied four weeks in a row but staged a nice-looking volume cluster and is testing its old highs. Given the resistance up here, we’ll set our buy range a bit lower, thinking a modest dip will offer a nice entry point.

BRKS Weekly Chart

BRKS Daily Chart

Cimarex Energy (XEC)

cimarex.com

Why the Strength

Cimarex Energy was a leader of the energy group earlier this year, but it fell back when it muddied up its straightforward story—around Memorial Day, the company announced a merger of equals with Cabot Oil & Gas (no relation to us), which obviously introduced some uncertainty into the equation. Today, though, that move looks great, as Cabot’s leverage to natural gas is a boon today as that commodity has soared 60% or so since June. Moreover, as management teams have communicated more with investors, it looks like the combined outfit is going to be in great shape: Even at lower energy prices, the combined outfit sees a cumulative $4.7 billion of free cash flow from 2022 to 2024; expects to pay a special $2 per share dividend when the deal closes in the months ahead; sees a base dividend of around $2 per share (a ~2.5% annual yield); and, like others, will pay 50% of remaining free cash flow out in dividends going forward. Plus, even those estimates could prove super conservative—at $70 oil and $3.50 natural gas (still way below current gas prices), the company sees a whopping $7.5 billion of free cash flow from 2022-2024, just to give you an idea of what’s possible. Throw in the fact that the top brass is expecting decent synergies from the merger and debt to be next to nothing and there are many reasons for the strength here. The biggest downfall, as mentioned above, are the moving parts and uncertainty about the merger and timing, but it seems that in all but the worst-case scenarios, the Cimarex/Cabot combination is going to prove very attractive.

Technical Analysis

XEC soared after the November 2020 kickoff, rising as high as 69 in March thanks to its clean cash flow story. Shares made it up to 75 two months later but the merger agreement brought in the sellers, with XEC eventually giving up the ghost, sinking 25% in short order to its 40-week line in August. But we’re impressed by the big-volume move since then, with five weeks up in a row bringing the stock to new price and relative performance highs. The next modest dip should be buyable.

XEC Weekly Chart

XEC Daily Chart

Devon Energy (DVN)

devonenergy.com

Why the Strength

Devon Energy is the third energy play in this week’s issue, and in our view, it has the best story, not just among them, but in the entire sector. The company operates solely in the U.S. in a few of the most lucrative basins including the Williston, Powder River, Anadarko, Eagle Ford and Delaware, the latter of which is the big draw—in Q2, 63% of total output (and a bit more of higher-margin oil output) came from the Delaware, where it has four years of “permit inventory,” meaning lots of runway to keep drilling to keep production level (if not rising slightly). But the real attraction here is the out-of-this-world cash flow story—with CapEx remaining relatively flat, drilling costs coming down and hedges (most at lower prices) falling off, Devon thinks free cash flow will come in around $1.30 per share, per quarter at $70 oil and $3.50 natural gas (actually well below current levels). Of course, not all of that will be paid out, but a lot will—Devon was one of the first to have a solid base dividend (1.3% annual yield) and add in a 50%-ish payout of excess cash flow, which resulted in a total payout of 34 cents per share in Q1, 49 cents per share in Q2, and likely meaningfully more in Q3 given energy prices since June. Moreover, this is all happening while debt is paid off rapidly to the tune of $1.2 billion so far this year (debt should total less than annual cash flow by year end). And, believe it or not, 2022 could prove even more lucrative due to cost reductions and hedge book improvements, and even if energy prices slip 10% or 20%, dividends should remain buoyant. There’s a lot to like here.

Technical Analysis

DVN had a huge post-November advance to 32 in June, but shares needed a rest at that point and that’s what came—the correction totaled 25% from high to low, and for six months (March through early last week), shares effectively made no net progress. But the stock began to shape up a month ago, and after a couple of down weeks has found big-volume buying, including a solid breakout late last week. We’re not huge fans of chasing oil stocks higher, but we’re OK starting small on minor weakness.

DVN Weekly Chart

DVN Daily Chart

DoorDash (DASH)

Why the Strength

The pandemic made lots of people more open to delivery services, from high-end restaurant owners who had scoffed at take-out, to consumers getting drug store essentials brought to their door. DoorDash is a pure play on the people’s sudden openness to getting seemingly everything delivered same-day, a segment that long belonged to pizza places and local one-offs. There are other national players–Uber Eats is in second place–but DoorDash has the majority of the market, grabbing a remarkable 40 points of market share since the start of 2020 through aggressive sign-ups of food establishments and consumer promotions, which helped the firm triple its sales last year. Those types of gains may not be seen again as sellers push back–chains like Chipotle now set higher menu prices for DoorDash to offset fees–but sales are seen growing a still-robust 60% this year. If you believe people will gravitate to same-day delivery similar to how Amazon used same-week delivery to get people out of stores, DoorDash should be able to capitalize on keeping habits changed as the world returns to normal. To that end, management has signed up more than 5,000 convenience stores to its marketplace last quarter, as well as Albertson’s groceries and PetSmart pet supplies. Now it’s adding alcohol delivery too, all of which should help customer order frequency in a model that benefits from volume increasing in every contractor’s car trip. Management thinks it can expand similarly in Canada, Australia and Japan as well. It’s a good story.

Technical Analysis

DASH rallied as high as 250 after its IPO, plunged as low as 110 in May and has worked its way back toward its highs in the months since—net-net, the stock has etched a (very deep) eight-month launching pad. Usually, when the bases are this deep, the final rest takes a while, so DASH’s latest pullback is likely to go on for a bit—combined with the market and we think it’s best to enter on dips.

DASH Weekly Chart

DASH Daily Chart

SeaWorld Entertainment Inc. (SEAS)

seaworldentertainment.com

Why the Strength

SeaWorld is a reopening play, a 12-theme-park company that saw most of its revenue evaporate last year with widespread closure of its parks. Only by the middle of this summer did the business get all its park brands–SeaWorld, Busch Gardens, Sesame Place and Aquatica–fully open. There was still consumer hesitation to gathering in large groups, of course, but Q2 attendance was 90% of the same quarter in 2019, and there were signs that individual ticket sales in July actually were stronger than they were pre-pandemic. With attendance returning, expectations are that sales will return to 2019 levels next year, at about $1.4 billion. But there are actions that could meaningfully boost revenue longer term too, such as adding operating days past Labor Day in colder climates, with Halloween and winter-themed specials, and the opening of a new Sesame Place in San Diego next year. Management is also rolling out a new in-park app that allows for dynamic pricing for theme park perks like skipping the line for rides–something Disney and Universal parks already sell. SeaWorld does have more than $2 billion in long-term debt, and its emphasis on live animals throughout its parks brings higher operating costs than other theme parks operators. Still, the company believes it unearthed operating savings during the pandemic that it can sustain, allowing cash flow and margins to expand. Analysts see earnings coming in around $3 per share this year, the highest figure in years.

Technical Analysis

SEAS stormed back to the 50 level by February of this year, but that was effectively it for a while—there were some minor new highs over the next couple of months, as well as some weakness into July, but net-net, shares went nowhere for nearly seven months. But now, as cyclicals gain steam, SEAS is moving, lifting to new price highs in recent days. We advise entering on modest weakness.

SEAS Weekly Chart

SEAS Daily Chart

Signet Jewelers (SIG)

signetjewelers.com

Why the Strength

After several rollercoaster years, Signet managed to turn its jewelry business around in 2020 with a focus on digital sales, becoming one of this year’s best-performing retail companies in the process. The world’s largest diamond jewelry retailer operates several iconic brands, including Kay Jewelers, Zales and Jared. Signet’s fiscal Q2 earnings exceeded expectations, with sales of $1.79 billion more than doubling from a year ago, while per-share earnings of $3.57 trounced the year-ago deficit of $1.13 and doubled consensus estimates. Same store sales rose 97%, with brick-and-mortar same store sales increasing 131%. Showing the power of its newer digital model, total revenue was nearly $425 million higher than two years ago despite having roughly 450 fewer stores. Relating to that and in a testament to the success of Signet’s Inspiring Brilliance strategic growth strategy (which involves leveraging data to target new and existing customers), e-commerce sales rose 25%. Management noted four trends which it believes will propel growth going forward, including strong consumer confidence among millennials and higher-income customers (which is leading to gifting at higher price points), higher self-purchasing among both men and women and a “rising tide” of engagements (up in the high single digits compared to a typical pre-pandemic year). On the strength of these trends, Signet raised its guidance for fiscal year 2022 (ending next January) and now expects sales of around $6.87 billion at the midpoint, a bit above consensus. The company also authorized a $225 million share buyback plan based on longer-term growth opportunities and balance sheet strength. Analysts see earnings falling back a bit after exploding this year, but those are likely conservative.

Technical Analysis

SIG’s advance from last year hit resistance in March near 66, which led to a two-month rest before another buying surge took the stock up to 80. But that wasn’t sustained, either, with a pullback back to 60 or so—net-net, shares didn’t make any progress for about five months. But things have improved since late August, with a big-volume pop to minor new highs and now a three-week rest around the 80 area. We think SIG is a decent risk-reward around here.

SIG Weekly Chart

SIG Daily Chart

Snap Inc. (SNAP)

snap.com

Why the Strength

Social media platforms flourished during the pandemic, but not all of them kept audiences engaged during this year’s reopening. Snap is a high-profile exception, as its younger user base still uses Snap to watch videos, play games and communicate with friends via its camera platform to create “snaps.” Snap’s user engagement is shown by its daily active user growth, which increased 22% last year to 265 million and rose 23% in Q2 from a year ago, to 293 million, its fastest user (and revenue) growth in four years despite the world turning right side up. But this isn’t just an eyeballs-type story—sales more than doubled in the second quarter and were 28% higher than the previous quarter as Snap continues to boost its revenue-per-user figure, which has lots of upside compared to other big social media peers. Analysts expect the firm’s top line to rise a mouth-watering 68% for the full year, while management forecasts sales to increase at 50%-plus rates in the next few years, led by Snap’s growing engagement across all its segments, including games. (Snap has reached over 200 million players for its games and mini-apps alone and has a multi-year, exclusive partnership with social game developer Zynga.) Snap also recently rolled out the next generation of its popular Scan to Snap camera tool, which allow users to turn the camera into a search engine by pointing it at an object they want to know more about (while making it easier for businesses and developers to find the right lens). Snap also continues to expand its partnerships with major companies like Disney and Google, with its Camera Kit allowing users to access exclusive augmented reality lenses with Disney characters, while working with the latter to expand its lens offerings to users in India. All in all, the firm seems poised for years of rapid and reliable growth.

Technical Analysis

After SNAP’s huge-volume breakout last October (up 28% on 13 times average volume!), shares ran up an additional 75% before hitting resistance around 70 in February. That began what basically morphed into a seven-month rest—shares fell below 50 in the spring and gapped to new highs near 80 in July, but as of early last week, the stock was back to 70. However, it looks ready to get moving: The past few weeks have shown relatively tight trading, and SNAP did move to new highs on Friday before pulling in with growth stocks today. We’re fine entering around here with a stop near the recent lows.

SNAP Weekly Chart

SNAP Daily Chart

SVB Financial Group (SIVB)

www.svb.com

Why the Strength

SVB Financial isn’t your typical stodgy financial outfit; it’s a high-tech lender that has assisted more than 30,000 start-ups and is one of the largest banks in the U.S. Thanks to its Silicon Valley exposure, SVB’s growth has been fueled by rapid expansion in the digital economy and massive healthcare and life science sector growth. While many banks struggle to grow loan portfolios, SVB is benefiting from frenetic activity in the private equity (PE) and venture capital (VC) space and forecasts full-year average deposit growth of around 90% compared to last year. The bank specializes in capital call lines of credit, or short-term loans with above-average interest rates (around 3%), to PE and VC firms that then use them for investments in start-ups or other ventures. (This lending product comprises more than half SVB’s loan book, and the bank has had nearly zero loan losses since it started this segment over 20 years ago.) Because its balance sheet is asset sensitive, the bank will realize an extra $300 million in interest and fee income for every 0.25% increase in the Fed funds rate, something that could help results next year. As for the here and now, SVB’s Q2 revenue of $1.5 billion soared 69% from a year ago, while per-share earnings of $9.09 that beat the consensus by 40%, thanks to “thriving markets” and an improving economy. Despite a low rate environment, the company saw excellent loan growth (up 38%) that led to a similar surge in interest income (up 42%). Management sees strong tailwinds supporting the “innovation economy” and sees net interest income rising 45%-ish for all of this year, with core fee income increasing in the high teens. Analysts see earnings sliding back some next year, but even those estimates have been racing higher as the company crushes expectations.

Technical Analysis

SIVB had a great advance for much of last year and early 2021, finally meeting some resistance near 575 in March. The stock went on to nose to new highs in June, but really, shares had entered a quiet sideways phase that persisted through August. But this month has been better, with SIVB briefly poking above 600, shaking out early last week with the market, and then surging to new highs in recent days. Another wobble or two isn’t out of the question, but if you want in, we’re fine entering here or (preferably) on dips.

SIVB Weekly Chart

SIVB 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.

The next Cabot Top Ten Trader issue will be published on October 4, 2021.