This week’s recommendation is a special situation—a transport stock that, thanks mostly to a game changing acquisition, is poised for major earnings growth. And the stock is holding up well after a recent earnings pop.
Cabot Stock of the Week 183
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The market has obviously taken a beating during the past seven trading days, and after a moonshot advance in January, a longer correction and consolidation could easily occur, one that pulls investor sentiment lower and allows the market to digest its big gains. That said, the longer-term bull market is intact, many stocks are acting fine and the selloff has given us a chance to see which stocks are holding up best. For this week’s pick, I’m going with a special situation—a transport stock that, because of a recent merger (and a strong economy) should see earnings boom. And the stock just recently got going, too. It was strongly recommended by Crista Huff of Cabot Undervalued Stocks Advisor, and her reasoning why is below.
Knight Swift Transportation (KNX)
Think about what typically happens when big companies decide to merge. The targeted company’s stock jumps anywhere from 10% to 30% during those first trading days after the big announcement. News media tout the proposed merger for a handful of days, fueling investor excitement. But six to 18 months later the merger is finalized, and you hear nary a word about it from Wall Street.
I have a theory about the silence within the investment community about these post-merger companies. There are lots of analysts assigned to take up research coverage on these companies, but the future is cloudy. They can make educated guesses on how well the merger might work, but there’s no track record to use in forecasting the future. None of them wants to stick their necks out as they might with more established companies like Apple (AAPL) or Biogen (BIIB). So the analysts make conservative forecasts…every single one of them.
How do I know this? After 30 years of investing, you notice all kinds of nuances about stocks and markets and economics and Wall Street. And what I’ve noticed is that time and again, analysts are unusually cautious when estimating future earnings growth at new companies.
Of course, not all mergers are successful. So what I watch for are post-merger situations where analysts are projecting attractive earnings growth, perhaps 15% per year or higher. Because it’s very likely that analysts are lowballing those numbers; if they’re going out on a limb and predicting solid growth, then I’m going to assume that the real numbers will be even better. And the market is going to be thrilled when the new, combined company finally starts reporting strong quarterly results.
This strategy has worked well in the recent past for all of these post-merger companies: Andeavor (formerly Tesoro), Dollar Tree, FedEx and Kraft Heinz. I buy the companies after the merger, but before combined company results burst onto the scene. It’s proven to be a solid investment approach, and it’s the big reason I’m very bullish today on Knight-Swift Transportation (KNX).
Knight Transportation and Swift Transportation Company merged in September 2017 to form the largest U.S. truckload carrier. The new company’s management team is widely respected. Post-merger cost synergies and efficiencies (especially in the Swift business), and increases in fuel surcharges, trucking rates and volumes are all contributing to a multi-year surge in profits. Plus, December 31 marked the first major deadline for a new requirement that companies and drivers use electronic logging devices (ELDs) to log hours of service (HOS).
The company reported a strong fourth quarter 2017 earnings beat last week. Adjusted earnings per share (EPS) were $0.52 when analysts were expecting $0.41. Quarterly revenue came in on target, expenses came in below estimates and operating income came in much higher than expected. Just as important, management made some bullish statements on contract rates (it expects prices to rise high single-digit/low double-digits this year) and synergies—it’s already achieved $10 million worth, and the top brass expects that number to rise to $100 million this year and $150 million by 2019 (around 80 cents per share!).
Wall Street is expecting EPS growth rates of 52% and 21% in 2018 and 2019. Those estimates have risen every week this year. The 2018 P/E is 21.9. Meanwhile, the tiny dividend (0.5% annual yield) has remained unchanged for many years and, encouragingly, the long-term debt-to-capitalization ratio is quite low at 10.4%.
Bottom line, KNX is an undervalued growth stock with some positive upcoming catalysts in the transportation sector. The stock will likely react well to the growing U.S. economy (despite the recent stock market plunge, leading economic indicators are strongly positive), aggressive EPS growth and quarterly financial results that build investors’ confidence in Knight-Swift management’s ability to achieve merger-related goals.
KNX surged 13% upon its earnings release, but has given back most of those gains during the market volatility of recent days. Still, the price chart appears far more bullish than those of most stocks (growth or otherwise). That resilience is encouraging, and while the stock could get yanked lower if the market remains weak, we’re adding shares here, thinking this dip presents a solid entry point for this special situation. BUY.
Knight Swift Transportation (KNX 48)
20002 North 19th Avenue
Phoenix, AZ 85027
602-269-2000
www.knight-swiftinc.com
CURRENT RECOMMENDATIONS
After a huge run last month (which comes on top of 14 months of rallying following the U.S. Presidential election in November 2016), the sellers have finally flexed their muscles, which (along with some shenanigans in volatility-related funds) has caused a very sharp drop in the indexes and most stocks.
When I take a step back and look at the evidence, I see that the intermediate-term trend has turned down by our measures; that doesn’t preclude a bounce, but it does imply the environment has changed and the next bounce or two will probably be sellable.
Second, though, the longer-term trend is up and the market didn’t show any of the typical warning signs (deteriorating breadth, etc.) that preclude a major top. Altogether, it’s fair to expect further ups and downs in the intermediate-term, but remember that the odds still favor higher prices when looking months down the road.
What does that mean for us? I’ll be working to hold our resilient performers, cut losses and be very selective on the buy side (and possibly keeping any new buys smaller than normal). Tonight, we’re selling three stocks (LCII, PBA and PWR) and switching five others to Hold. All in all, we now have 16 recommendations, including Knight-Swift (KNX), seven of which are rated Buy.
Alphabet (GOOGL), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor, is being moved to Hold tonight after a so-so earnings report last week kicked off its recent decline. Sales (up 24%) and earnings (up 28%) weren’t bad, but came in a bit shy of estimates, and analysts are now looking for the bottom line to rise just 15% this year. Of course, the action isn’t horrid—shares are just 11% off all-time highs—but it’s prudent to move to Hold and see if (and how well) shares can bounce going forward. HOLD.
BB&T Corp. (BBT), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, got hit with everything yesterday but found solid support at its 50-day line today. All told, the action is encouraging given the wild action among financial stocks. Partially thanks to the tax bill, earnings are expected to rise 25% this year, and the 2.5% dividend yield is solid. (The next ex-dividend date is Thursday, February 8.) With solid price support in the 50 area, I’ll stay on Buy. BUY.
BioTelemetry (BEAT), originally recommended by Tyler Laundon of Cabot Small-Cap Confidential, has been yanked lower by a few points, but the action isn’t unusual given what’s going on in the market, with BEAT continuing its base-building effort. I’m betting the good story and buoyant expected earnings (up 42% this year) will keep investors interested. BUY.
Broadridge Financial Solutions (BR), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her Dividend Growth Tier, is being switched to Hold tonight for a couple of reasons. First, it’s had a good run, with its last meaningful dip back in August. Second, the stock has broken its 50-day line this week on good volume. And third, earnings are due out on Thursday (February 8). A quick rebound on earnings could actually provide a good entry point, but right here, we think it’s prudent to go to Hold and see what earnings brings. HOLD.
China Lodging Group (HTHT), originally recommended by Paul Goodwin of Cabot Emerging Markets Investor, is down to its 50-day line and close to the top of its prior base, which isn’t too bad all things considered. Still, Paul is keeping his eyes open, writing “there’s no doubt that the stock’s action since it hit a new high at 166 on January 22 has been problematic. HTHT has had a very long run, but its November correction likely shook out many weak hands. Management has said it wants to build the company’s string of properties from its present 3,656 to 10,000, with accommodations for every price point. HTHT needs to find support here, but I’m not too worried, yet.” I’m a bit more worried than Paul, but am fine holding our position given the evidence. HOLD.
Discovery Communications (DISCA), originally recommended by Azmath Rahiman of Cabot Benjamin Graham Value Investor, bounced off its 50-day line today, and thus remains within its new uptrend that started in mid-November. That said, Azmath has rated the stock a Hold, and I’ll follow his lead. (Remember that for all Cabot analysts, hold actually means hold, unlike Wall Street, where hold usually means sell.) Earnings are due out February 27. HOLD.
Facebook (FB), originally recommended by Mike Cintolo in Cabot Growth Investor, reported a solid quarter last week, with sales (up 47%) and earnings (up 83%) topping expectations, and importantly, the market was pleased that management sounded bullish on the changes its implementing to its News Feed. The stock has been all over the map, first moving to new highs before being yanked down by the market (though it’s actually improving a bit relative to the performance of the indexes). Mike is keeping FB rated Hold, and I’m doing the same. HOLD.
Insulet (PODD), originally recommended by Mike Cintolo in Cabot Growth Investor, is just 5% off its high and looks fine on the chart. Earnings (due out February 21) will be vital, but I’m confortable staying on Buy, but it’s probably best to keep positions small given the market and the upcoming quarterly report. BUY.
LCI Industries (LCII), originally recommended by Azmath Rahiman of Cabot Benjamin Graham Value Investor, is now a Sell, with the stock having plunged due to sector weakness. In Azmath’s words, “A recent report by Northcoast Research indicating that the RV inventory is reaching an unsustainable level, caused downward movement in the stocks of both Thor Industries (THO) and its leading supplier, LCI Industries (LCII). We will not have conclusive proof on the inventory level until Thor releases its quarterly earnings in March, but if the research findings are right, it would be risky to have significant exposure to either of the stocks.” It’s never fun to sell so quick after buying, but the huge-volume selling in the group (which has been exacerbated by the market) and our loss tells us it’s best to cut the loss and look for greener pastures. SELL.
Melco Resorts (MLCO), originally recommended by Paul Goodwin of Cabot Emerging Markets Report, found support at its 50-day line today, an encouraging sign. Also encouraging was the very bullish monthly report for Macau—January saw gaming revenues surge 36% from a year ago, well above expectations, with a 50% jump in VIP revenue and a 23% hike in the mass market segment. The big event will be earnings, which are due out Thursday (February 8); analysts expect $1.37 billion in revenue and 24 cents per share of earnings, but just as important will be any color on the firm’s expansion projects and updates on the first quarter. Keep any new positions small this close to the report. BUY.
PayPal (PYPL), originally recommended by Mike Cintolo of Cabot Growth Investor, took a hit after its quarterly report last week, though the selling wasn’t based on the firm’s results (sales up 26%, earnings up 31%). Instead, the bears appeared after eBay, PayPal’s former parent, said it would be phasing out PayPal as its exclusive payment option by mid-2020, though PayPal would be still offered on eBay for another couple of years after that. Combined with the market slide, that news has chopped about 10% off the stock. Mike did respond to the move by selling one-third of his remaining holdings, and I’m fine with that logic—taking some chips off the table makes sense. But officially I’m staying on Hold here, as the stock’s overall uptrend is still intact, earnings estimates have actually been hiked (analysts see the bottom line rising 20% this year and 21% next) and the stock is back into an area of support. HOLD.
Pembina Pipeline (PBA), originally recommended by Chloe Lutts Jensen of Cabot Dividend Investor for her High Yield Tier, looks like it’s changing character for the worse. PBA has found support around its 200-day line a handful of times, but on this pullback (which started in early January), it’s cut through the line like a hot knife through butter. I’m not expecting a collapse, but we’ve now owned PBA since last July and are up just a few percent (though, to be fair, we’ve collected a handful of monthly dividends during that time). A bounce is certainly possible, and if you want to hang on for one, go for it. But given the market environment, we don’t want to hang around with stocks acting abnormally. I’ll sell tonight and take the modest profit. SELL.
Planet Fitness (PLNT), originally recommended by Mike Cintolo in Cabot Top Ten Trader, has broken below the 50-day line, which is enough for me to move to Hold. But, frankly, I think the chart looks OK (it’s basically been going sideways since early December), and the cookie-cutter story remains powerful. (Many retail stocks have shown resilience in recent days, which is a plus.) Earnings are likely out at the end of February. HOLD.
Quanta Services (PWR), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor for her Growth Portfolio, is our third sale in tonight’s issue, and the reason is simple: the stock has come completely unglued, diving on big volume below its 200-day line and nearly back to our buy price from July. Earnings, which are likely out in a couple of weeks, could pull the stock out of its tailspin, but the action looks abnormal to me. I’ll take our modest profit and look elsewhere. SELL.
Teladoc (TDOC), originally recommended by Mike Cintolo in Cabot Growth Investor, has, as expected, run into resistance in the 38 area and pullback toward its 200-day line. A major break down from here could have us cutting the loss, but right here, I see TDOC sitting in a solid seven-month consolidation, which is a nice foundation for future advances. Earnings are likely out around March 1. HOLD.
Tesla (TSLA), a recommendation of Cabot Top Ten Trader, is bringing its solar products (including Powerwall batteries) to about 800 Home Depot locations; Tesla is in talks with Lowe’s for a similar program. Solar doesn’t get a lot of attention for the company, but over time I think it can be very big. That said, near-term, Model 3 sales are what investors are most focused on, and tomorrow’s quarterly report and conference call will be key to unveiling production and cost trends. The stock has moved lower in recent days, but remains within the confines of its big trading range. HOLD.
WestRock (WRK), originally recommended by Crista Huff of Cabot Undervalued Stocks Advisor for her Growth & Income Portfolio, is another stock that recently reported a terrific quarter (sales up 13%, earnings up 85%, with estimates being raised in the wake of the report) but has slipped since, sinking about 11% from high to low. With such huge growth expected this year (more than 50% on the bottom line!) and a solid dividend (2.7% annual yield), I think there’s a good chance this dip will prove to be a big shakeout, but I can’t ignore the price action and the giant volume (last week’s volume was the largest in two years!). I’ll go to Hold and use a tight mental stop in the low 60s. HOLD.
Wingstop (WING), originally recommended by Mike Cintolo in Cabot Top Ten Trader, looks totally fine—you’d never know the market had suffered a mini-meltdown in recent days looking at this chart! Of course, in a tough market, good stocks can often go bad in a hurry, but so far, so good for WING. Earnings are due out February 22. You can pick up some shares, preferably on dips of a point or two. BUY.
THE NEXT CABOT STOCK OF THE WEEK WILL BE PUBLISHED FEBRUARY 13, 2018
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