Cabot Early Opportunities 115

In November’s Issue of Cabot Early Opportunities we discuss the supposed rotation from growth stocks into value stocks and the underlying reasons, which we think could drive erratic market action in the coming weeks. Despite the somewhat conflicting trends out there, we serve up a menu of compelling opportunities spanning Medtech, manufacturing, software and even health and beauty products, which we can all use a little of these days!

Cabot Early Opportunities 115

Stock Name	Market Cap	Price	Investment Type
Avantor (AVTR)	$15.8 billion	27.46	Growth – MedTech
Berkeley Lights (BLI)	$5.5 billion	86.15	Rapid Growth - MedTech
e.l.f. Beauty (ELF)	$1.1 billion	21.67	Growth – Personal Care
Farfetch Limited (FTCH)	$15.2 billion	44.56	Rapid Growth - Ecommerce
Kornit Digital (KRNT)	$3.2 billion	79.06	Rapid Growth – Textile Printing

Preparing for the Next Phase of the Pandemic
The current investing climate is one of the most fascinating in history.

We are in an economic recovery, which suggests investors should stay long stocks.

We also have an incoming president intent on reducing the sense of chaotic leadership that accompanied the Trump White House and bringing back a sense of relative calm to U.S. leadership. That, combined with what is likely to be a republican controlled senate, is also bullish for stocks.

Then we have the pandemic.

On the one hand, huge wins on the vaccine front hold the promise of an eventual return to normal life by the end of 2021. That is incredibly bullish for many stocks, including economically sensitive companies and those most impacted by the pandemic (travel, restaurants, areas of retail, banks, etc.).

But on the other hand, we have the pandemic currently raging out of control. That points investors toward the growth stocks that have helped their portfolios thrive during the pandemic, including many of the technology stocks we’ve held in this advisory service.

This contrast between raging pandemic now and potential vaccine distribution starting near year’s end cuts to the heart of the growth versus value debate that has driven so many headlines since Pfizer and BioNTech released news of their vaccine’s early success.

Stepping back, it seems likely that vaccines will start to get distributed toward the end of 2020 and ramp up through 2021. At some point we’ll get to a phase where enough people are vaccinated that restrictions will lift, masks will drop, and people will congregate again.

That should mark the time when investors start thinking in terms of normal economic recovery factors, like rising interest rates. But we’re not there yet and a lot can change between now and then.

In the meantime, I think it’s wise for growth investors to be prepared for a bumpy road, as this timing disconnect – ongoing pandemic versus vaccination rollout – creates persistent uncertainty heading into early-2021.

Ultimately, while there’s certainly room for the biggest pandemic plays to give some back and for valuations to come down, many of the trends that were going strong when the pandemic struck, like digital, ecommerce, and cloud software, will likely be stronger in a post-pandemic world than they otherwise would have been.

Plus, the rising generations of young workers and entrepreneurs, many of whom grew up with a smartphone in hand, will be driving a larger share of economic activity and innovation in the decades to come.

In short, while there will still be painful corrections in the types of companies we’re investing in (there always are) the next phase of the pandemic should prove to be a net-positive for growth stocks, as well as value stocks.

A broader economic recovery is better for everyone. And while we’ll have to mind our steps as we move forward, I still see a lot of innovative and exciting companies that can help us generate outsized returns, regardless of what the headlines say.

What to Do Now
Be prepared for conflicting headlines driving erratic trading action as we deal with an intensifying pandemic and a path toward vaccine distribution.
Same as last month, now is a good time to keep new positions somewhat smaller than normal and average up to a full position with more purchases (three to five purchases to get to a full position seems about right).

As the stronger stocks emerge, investors will want to allocate more capital to them while reducing exposure to weakening positions.

While we prefer to stay invested in most positions for several years to maximize our upside potential, in an uncertain environment we may start to take some shorter-term profits, especially with those stocks that aren’t showing a willingness toward a sustained uptrend.

STOCKS

Avantor (AVTR)

Avantor (AVTR) is a diversified global supplier of mission-critical products and services to customers in the life sciences, advanced technologies, applied materials, and education and government markets. It has a market cap of $15.8 billion.

Its products, which include chemicals, reagents, lab products, and equipment, are used across all stages of research, development, and production activities. Additionally, Avantor’s specialty procurement and other value-added lab services help customers advance their R&D and manufacturing operations.

The company is characterized by its extensive product offerings, diversified operating platform (no customer accounts for more than 3% of revenue) and significant recurring revenue mix (over 85% of revenue) aided by consumables, which helps drive high customer loyalty and free cash flow.

This isn’t the highest growth company out there. But Avantor’s diversified revenue mix and role in bringing Covid-19 treatments and vaccines to market make it an attractive stock during this murky time.

The company reported Q3 2020 results on October 27. Revenue was up 6.7% to $1.06 billion, beating by $38.4 million, while adjusted EPS of $0.24 rose by 60% and beat expectations by $0.03.

Cyclical parts of the business, such as advanced technologies and applied materials (25% of revenue), which trend with broader industrial markets, are being adversely affected by the pandemic. Others, such as education and government (15% of revenue), have regained some ground lost in Q2 as schools and labs reopen, but are exposed to potential weakness in the coming months should closures go back into effect.

The main attractions right now are Avantor’s healthcare business (10% of revenue), biopharma R&D (35% of revenue), and biopharma production (15% of revenue) businesses.

Healthcare is growing by double digits as demand ramps for diagnostics (think Covid-19 testing) and recovers for surgical procedures. Biopharma is leading the charge now, growing by double digits in the U.S. and 40% in Europe and is poised to accelerate much faster in the coming months. The bioproduction order book doubled in Q3.

Bioproduction will benefit from Covid-19 vaccine production. However, management isn’t able to quantify the potential impact yet since much depends on which vaccines gain approval.

Stepping back, investors get the diversification benefit of a company that could see some areas of the business accelerate when the pandemic abates while others are accelerating right now as the world moves to the next phase of massive testing and vaccination efforts.

Look for revenue to be up at least 3.3% in 2020 then accelerate to 7% in 2021. EPS should jump roughly 40% to $0.84 this year then another 30%, to $1.08 in 2021. That said, there’s significant potential for these numbers to come in better than consensus expectations.

The Stock
AVTR came public at 14 in May 2019 and immediately advanced to 19.6 before a quick trip back to the IPO price. Another rally to 19.4 preceded the market’s crash in March, which pulled AVTR to a closing low of 8.3. The recovery was swift. AVTR was back to its previous high by June, then broke out above resistance and closed at 22, a new all-time high, after Q2 earnings were released on July 29. Since then the stock has made a series of higher highs and higher lows.

Berkeley Lights (BLI)
There are a lot of companies active in areas of the cell-based market, which reached $148 billion in 2019 and is growing by around 11% annually.

The market includes activities such as harvesting, culturing, imaging, sequencing, and characterizing cells. Major players include Thermo Fischer (TMO), Danaher (DHR), and our very own 10X Genomics (TXG).

However, Berkeley Lights (BLI) is arguably the most attractive pure-play company for access to the cell-based product market. Its solutions do everything biopharma companies need done on one single platform. And, arguably, Berkeley does it all better. The company’s technology can measure tens of thousands of single cells in parallel. That means it can find the best cell out of millions and do so quickly.

Moreover, Berkeley’s platform enables functional characterization quickly without killing cells. That means it helps users save the best cells for downstream development.

In contract, competing solutions often work slower and with high cell death rates. That crushes the ROI of the biopharma company using those solutions.

This is why biopharma companies, CROs, and CDMOs are increasingly turning to Berkeley Lights. Its platform helps them do everything they need to find therapeutic candidates faster and cheaper, often shaving three to five months off the process, boosting yields and reducing manufacturing costs. It’s a win-win-win.

The company has three automation systems. Beacon launched in 2016 and sells for almost $2 million, Lightning launched in 2019 and sells for around $450K and Culture Station just launched in January. Berkeley also sells workflow and automation software, and offers a portfolio of consumables (chips, reagents, etc.).

Berkeley has also adapted its antibody discovery workflow to allow the recovery of neutralizing antibodies from Covid-19 patients, which helps researchers discover therapies.

In Q3 2020, which was reported last Thursday, management said it sold eight systems for $12.4 million, twice what it sold in Q2. CROs and CDMOs bought half of them. The addition of new workflows and assays in the quarter aided in sales of at least six of those systems. Two more workflows are being added in 2021, which should keep system sales flowing.

Adding in recurring revenue ($3.7 million) from consumables and partnership revenue ($2.1 million) Berkeley delivered quarterly revenue of $18.2 million, up 16%. While not a huge revenue base today – estimated 2020 revenue is just $60 million, up 6% over 2019 – Berkeley’s growth should take off as it places more systems in the market and starts to generate more significant recurring revenue from subscriptions and consumables.

Looking into 2021 revenue could jump by 50% to $90 million and adjusted EPS loss could be cut by 25% to -$0.61.

With a market cap of $5.5 billion, a high valuation and a relatively recent IPO (July 17) Berkeley lights isn’t without risk. But the many merits make a stake in this company attractive for risk-tolerant investors. Adjust your position size based on your own risk profile.

The Stock
BLI came public at 22 on July 17, 2020 and soared 198% its first day. Since then the stock has traded in a wide range – moves of 15% to 20% within a week or two are not uncommon. But the trend is up and BLI has recently made a series of higher highs and higher lows. The most recent low of 69 (November 2) represented a 23% pullback from the previous high of 89.7 (October 7). BLI then rallied to a new intraday all-time high of 90.2 on November 16 (just a couple days ago). With this trading pattern we want to buy on the dips. At roughly 12% off the recent high, we’re at a decent entry point for a half-position, and we will look to buy more on a deeper pullback to just below 80 (if the stock gets that low). BUY A HALF

e.l.f. Beauty (ELF)
Despite fewer social interactions and overall lower usage of beauty products during the pandemic, one company stands out from the pack. That’s e.l.f. Beauty (ELF), which makes and sells cosmetics and skin care products under the e.l.f. brand name.

The company sells both direct-to-consumer (DTC) as well as through major retailers, including Target (TGT), Walmart (WMT), Ulta Beauty (ULTA) and Shoppers Drug Mart (in Canada). Its products are priced at the value end of the spectrum, which means e.l.f. is going after a huge market, including Gen Z (born roughly 1995 to early 2012) and young millennials (born roughly 1980 to 1994).

This also means e.l.f.’s customer base likely benefited from stimulus checks in May and June, which, along with price hikes, has contributed to the company’s durability during the pandemic.

Those factors aside, the compelling thing about e.l.f. right now is its digital expertise. The company has invested heavily in digital marketing and ecommerce, which has helped drive new customer acquisitions and repeat customers during the pandemic. Some of this success has come at the expense of other manufacturers that are less savvy in the digital realm.

While there’s potential for e.l.f.’s market share gains to slow when the pandemic abates, it appears more likely that the company’s digital acumen and increasing relevance to the more affluent cosmetics buyer will keep sales and market share gains trending higher years.

Growth isn’t off the charts, but it’s steady. In fiscal 2020, which ended in March, revenue rose by 6% to $283 million. Adjusted EPS was $0.63.

Over the first two quarters of fiscal 2021 (ending June and September) revenue was up 8% and 7%, respectively. This puts the company on target to grow by at least 6% this fiscal year, and 7% in fiscal 2022, while delivering adjusted EPS of $0.62 and $0.68, respectively. That’s in-line with management’s three-year growth model, which calls for mid to high single digits growth and expanding profit margins.

I like e.l.f.’s steady growth profile and potential to move up-market even while gaining more shelf space at large retailers, including Walmart and Ulta Beauty. That the company has a market cap of just $1.1 billion and is on the verge of breaking out to multi-year highs is the icing on the cake.

The Stock
ELF came public in September 2016 at 17. The IPO was a big success and ELF hit an all-time high of 32.5 that December. Things then went steadily downhill until March 2019 when ELF bottomed out near 6.7. Shares then raced higher and were trading near 20 before the pandemic-induced market crash, which sent ELF back to 7.6. Shares recovered nicely and ELF was back to 20 in early-July. Since then the stock has been rangebound between 17.3 and 22. Following the Q3 earnings report on November 4 ELF has looked like it wants to break higher.

Farfetch Limited (FTCH)
Farfetch (FTCH) is the undisputed global leader in online luxury fashion sales. The UK-based company, which was founded in 2008 and went public in 2018, operates an end-to-end technology platform purpose-built to connect the worldwide luxury fashion ecosystem.

It is the only digital platform for luxury fashion that operates at scale, aggregating over 1,200 luxury sellers – from the best-known to newly emerging brands and retailers – and connecting them with over 2.5 million active customers.

Just a few of the brands selling on the platform include Gucci, Fendi, Saint Laurent, Prada, Burberry, and Jimmy Choo. In Q3, the company also added Moncler, Dolce & Gabbana, and Ralph Lauren.

As of August 8, 2019, Farfetch also owns New Guards Group (NGG), a portfolio of rising brands that includes Palm Angles, County of Milan, Off-White (streetwear) and Heron Preston. Gross merchandise value (GMV) from NGG brands topped the growth chart for six consecutive quarters.

Online access to these brands is just part of the special sauce. Farfetch is also winning because of its unique e-concession business model. This means Farfetch lists products for which it doesn’t hold any inventory. The company simply takes a commission on sales, equal to around 30%.

This business model allows Farfetch to list as many products as it wants. For example, it lists ten-times more products than competitors like Net-A-Porter. That’s critical because online shoppers want choice.

Also, this model is good for luxury brands selling on Farfetch because they retain control of inventory, data and pricing. In short, they maintain control over their brand.

Farfetch is a global player. Last year China was its fastest growing and second largest market. The U.S. was the biggest. A partnership with Alibaba (BABA) could increase sales into China tenfold over the next five years.

That partnership, announced earlier this month, included a $300 million investment from Alibaba. Concurrently, Richemont, which owns luxury brands including Cartier, Montblanc, and Piaget, also invested $300 million in Farfetch. Also, Alibaba and Richemont contributed a combined $500 million into a new joint venture, Farfetch China, for a 25% ownership stake.

In short, the online luxury sector is growing like wildfire and Farfetch is the dominant player, aided by a global reach and a unique business model that works for everyone.

Revenue, which grew 69% to $1.02 billion in 2019, could triple and surpass $3 billion by 2023. With sales up 71% in the just reported Q3 Farfetch is on pace to grow by at least 60% (to $1.64 billion) in 2020. The company won’t be profitable on the bottom line for a while but could be profitable on an EBITDA basis in 2021. Wall Street will like that.

The company has a market cap of $15.2 billion and is for aggressive growth investors.

The Stock
FTCH came public at 20 in September 2018 and had a rough start. After bouncing around for a few months in the 16 to 32 range FTCH fell below 10 in August 2019. A modest recovery was intact until the pandemic struck and FTCH fell to 6 in March 2020. The stock came roaring back and was above its pre-pandemic high of 13.5 in early-May. It’s been racing higher since, despite two normal-looking pullbacks in the 22% to 30% range (lows hit in May and September). The last big jump was on November 2 when FTCH started a rally that took shares from 28 to 45.7. That high was hit just a couple days ago. To balance out the risk of buying a hot stock near a short-term top, we’ll start with half a position. BUY A HALF

Kornit Digital (KRNT)
We took a swing at Kornit Digital (KRNT) last September but stepped aside when the pandemic hit. For the last several months the stock has been acting well so we’re stepping back up to the plate today.

The story is that Kornit is a way to play mass-market adoption of digitally printed textiles in the garment, apparel, and home goods markets. Think of things like clothes, sheets, furniture coverings, and rugs.

Digital printing on textiles was a growth market before Covid-19 but has since gathered steam because of online shopping and social media, both of which have helped countless companies survive the pandemic.

The pitch for digitally printed textiles is straightforward. The technology allows for short runs and just-in-time manufacturing. That means shorter time to market and less inventory. Supply chains can be streamlined and shifting market dynamics can be quickly addressed. Finally, printing textiles is also more environmentally friendly than dyeing.

Kornit has been developing complete digital printing solutions since it was founded in 2002. It now offers direct-to-fabric (DTF) and direct-to-garment (DTG) printers, software, inks and consumables, and value-added services.

Historically, both DTF and DTG printing required five steps. Kornit’s equipment can do DTG in two, and DTF in just one. That’s a huge time saver.

As brands try to put products closer to their customers, meet rising demand for online sales, get products shipped out quickly, and even allow consumers to play a role in designing their own items, digital printing has taken off. But it still represents a small slice of all decorated textiles. That means a lot more room for Kornit to grow.

Kornit’s customer base is expanding. Spreadshirt is a customer. Adidas is another. Printful, Spoonflower, Fanatics, and Next are customers as well. Kornit also sells to digital fulfillment companies, including Creazioni Digitali, which serves fashion brands including Versace. Altogether, Kornit has over 1,300 customers.

Of note, Kornit’s equipment is being used in the Merch by Amazon program, a self-service platform that lets creators design tee-shirts that consumers can order. Kornit also has a strategic relationship with Amazon, which purchased warrants in the company in 2017 and in September 2020. This relationship means Amazon is incentivized to see Kornit succeed.

In 2019 revenue rose by 26% to $180 million. The first half of 2020 was dramatically impacted by Covid-19 related shutdowns and revenue fell 32% in Q1 and 17% in Q2.

However, Kornit’s revenue has rebounded sharply. Sales in Q3, which were just reported on November 10, rose by 21% to $57.4 million. With roughly 28% growth expected in Q4, Kornit should have roughly flat growth in 2020. Analysts foresee nearly 40% revenue growth in 2021. Kornit should deliver adjusted EPS of $0.20 in 2020, then grow that by 345% to $0.89 in 2021.

The Stock
KRNT went public at 10 in early 2015 and bounced around for a few years before gathering momentum in 2019. Shares hit an all-time high of 45 just before the pandemic, then the stock was cut in half during the market crash. But KRNT roared back and made a new all-time high in late-May after Q1 earnings were released. Since then the stock has been walking steadily higher, mostly making a series of higher highs and higher lows. One week after the Q3 report (on November 10), KRNT is yet again trading at an all-time high.

Previously Recommended Stocks
Clarivate (CCC) moves to SELL. The stock has been with us for just one month but the company reported an uninspiring quarter in late-October with results missing slightly on both the top and bottom lines. Since then shares have failed to progress in any meaningful way. Relative to other opportunities the stock isn’t as attractive as it was a month ago, so we’ll cut it loose now for a small loss and possibly come back when the chart looks more compelling. SELL

Azek Companies (AZEK) moves to SELL. With a few exceptions most of the construction materials manufacturers and construction/home improvement retailers have seen their stocks level off lately, and some have even pulled back significantly since vaccine news has broken. I’m not sure I buy the argument that construction and home renovation activity will abate when the pandemic is gone, but regardless we’ve seen shares of Azek stall out with the group. Let’s step aside and reassess as we work through the next phase of this pandemic. SELL

Vital Farms (VITL) moves to HOLD. Vital Farms delivered Q3 results above expectations as the growth story continued to unfold (revenue up 57% to $53.4 million and adjusted EPS of $0.04 up 100%). In the wake of the report analysts increased estimates for both 2020 and 2021, but the stock has been a disaster due to a stock offering from institutional investors. The offering was priced at 30.25, which initially seemed like strong enough pricing to drive a rebound in shares. However, the opposite occurred and VITL is now trading well below 30 just days after the offering closed. It’s possible the combination of Vital Farms’ small market cap, the offering and an iffy market could be driving a short-term wave of weakness, so we won’t cut the cord just yet. But we will move to hold now and monitor closely. HOLD

Sprout Social (SPT) moves to BUY. reported last Monday and the quarter was solid. The market for growth stocks was a little iffy at the time so I moved to hold after the report. However, I have been impressed with the resilience in the stock and even in the face of a few growth stock beatdowns lately shares of Sprout have held firm above 42, which was the low from a couple weeks ago. With the recent relative strength I’m more comfortable adding shares here. Moving Sprout Social back to buy. BUY

In addition to the three rating changes just discussed, we’ve made several changes since the October Issue of Cabot Early Opportunities, all communicated via Special Bulletins

An updated table of all stocks rated BUY and HOLD, as well as recent stocks SOLD, is included below.

Please note that stocks rated BUY are suitable for purchasing now. In all cases, and especially recent IPOs, I suggest averaging into every stock to spread out your cost basis.

For stocks rated BUY A HALF, you should average into a position size that’s roughly half the dollar value of your typical position. We may do this when stocks have little trading history (for instance IPOs), when there is more uncertainty in the market or with a stock than normal, or if a stock has recently jumped higher.

Those rated HOLD are stocks that still look good and are recommended to be kept in a long-term oriented portfolio. Or they’ve pulled back a little and are under consideration for being dropped.

Stocks rated SOLD didn’t pan out, or the uptrend has run its course for the time being. They should be sold if you own them. SOLD stocks are listed in one monthly Issue, then they fall off the SOLD list.

Please use this list to keep up with my latest thinking, and don’t hesitate to call or email with any questions.

^Average of high and low price if published intraday, or closing price if published after 4 PM ET

The next issue of Cabot Early Opportunities will be published on December 16, 2020

Cabot Wealth Network
Publishing independent investment advice since 1970.

CEO & Chief Investment Strategist: Timothy Lutts
President & Publisher: Ed Coburn
176 North Street, PO Box 2049, Salem, MA 01970 USA
800-326-8826 | support@cabotwealth.com | CabotWealth.com

Copyright © 2020. All rights reserved. Copying or electronic transmission of this information is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. No Conflicts: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to its publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: All recommendations are made in regular issues or email alerts or updates and posted on the private subscriber web page.