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Well, here we go again:

source: finviz.com

The bounce from June lows increasingly looks like a bear market rally. The Fed is not messing around, inflation remains persistent, and the news from overseas remains as negative as it was when we wrote about that issue in July.

Where the broad market goes from here is up for debate. We’ve been correct in being generally bearish since our first post in late March, though we haven’t nailed the timing of all our picks.

There’s still a fundamental case for considerable downside ahead. A higher risk-free rate, elevated profit margins in 2020-2021, and earnings multiples that don’t exactly scream “bottom”. Conversely, the U.S. equity market might well be seen as a safe haven internationally, and the bear case does seem a little too simple (though that was true this spring as well).

At the least, there’s reason for caution and a focus on quality. That latter point might seem self-evident, but as we wrote in late July a bottom is the time to buy risk, not quality.

And so it’s worth looking at some of the stocks that have actually outperformed during this five-week leg down. Here’s a look at five of the more interesting stories in the group, all of which have some concern.

Eve Holding

Eve Holding (EVEX) is one of the six (!) eVTOL (electric vertical take-off and landing) stocks on the market; all went public as part of the SPAC boom. Eve does have a better pedigree than most of its peers: the company was founded as part of Brazilian aerospace company Embraer (ERJ) before being carved out.

Unlike Joby Aviation (JOBY), which will itself operate an “air taxi” service, Eve doesn’t plan to own its aircraft. Instead, the company will manufacture the aircraft and then set up joint operations with partners. For example, regional jet operators Republic Airways and SkyWest (SKYW) both have non-binding purchase agreements for Eve eVTOLs, which presumably can be used to then transport airplane passengers to or at least near their final destination.

Unsurprisingly, investors are somewhat skeptical toward the space. The other five eVTOL stocks on average closed Wednesday at $4.08. (All had merger prices of $10, so an equal weight basket is down almost 60%.) The futuristic nature of the industry seemed perfect for the roaring market of late 2020 and early 2021, but not so much for the more cautious (to put it mildly) sentiment that has dominated trading this year.

And yet:

source: finviz.com

Among stocks with a market cap over $300 million, EVEX is the eighth-best stock (out of 3,700-plus) over the past month. Exclude event-driven names (biotechs and buyouts) and EVEX is number three.1

There is an apparent catalyst here. On Sept. 8, United Airlines (UAL) announced a $15 million investment in Eve, as well as a conditional purchase agreement for 200 aircraft plus an option for another 200. EVEX soared on the news and has kept gaining; shares have now doubled from the Sept. 7 close.

But looking closer, the rally here looks rather strange. First, this isn’t United’s first entrance into the space. In January 2021, United placed a $1 billion order with Archer Aviation (ACHR), and also agreed to participate in that company’s PIPE. ACHR closed Wednesday at $2.99; its market cap of $720 million is less than one-quarter that of Eve.

Second, the terms of the deal are immensely favorable to United. United is acquiring 2.04 million shares at $7.355 per share. But it’s also getting 2.722 million warrants (now worth $30 million) with an exercise price of $0.01 simply for coming to a “concept of operations” at any United hub, and the same for a binding agreement for “up to” 200 eVTOLs.

Third, this is basically the same deal Eve has done elsewhere, in terms of booking a purchase agreement and selling equity. Both Republic and SkyWest were investors in the PIPE (private investment in public equity) transaction executed alongside the SPAC.

On the whole, then, the United deal is not exactly a huge vote of confidence in Eve. Rather, United simply seems to be hedging its bet on Archer with a second deal with terms skewed heavily in its favor. Nor is it clear why ACHR hasn’t benefited from its existing United deal, or why suddenly EVEX is attractive when its agreements with Republic and SkyWest were better (both companies invested at $10).

Obviously, the market right now is interpreting the agreement differently. Indeed, while the eVTOL sector seems like a perfect 2020/early 2021 play, the reaction seems like a 2020/early 2021 reaction. Investors are buying a bullish headline in a “futuristic” industry, and ignoring the details — and valuation. Incredibly, Eve has added more than $1.5 billion in market capitalization in two weeks.

But volume figures don’t suggest some massive euphoria. If money was really moving into the stock in the wake of a deal that is more consequential than the 8-K shows, we’d expect to see more volume:

source: YCharts

In context, this is one of the stranger rallies in recent memory. We talked last month about an insane Friday and the post-IPO rallies in AMTD Digital (HKD) and Magic Empire Global (MEGL), but those moves felt like remnants of 2021’s “meme stock” trading.

To be honest, it’s difficult to tell exactly what this is. Pricing in the options market (puts are way more expensive than calls) suggests it’s a move to fade, and that would be our tentative take as well, but volume on the bearish side remains light. We’re skeptical, but we’d be loath to bet against EVEX too aggressively without a clearer picture of precisely why the stock has moved higher.

Destination XL

We’re as surprised as anyone that a retailer made this list. But even a cursory look at Q2 earnings from Destination XL (DXLG) shows why. As with EVEX, this seems like a 2021 story happening in 2022.

At a time when the industry is reeling, same-store sales rose 6.1% against a 21.6% comparison. Adjusted EBITDA margins did compress 360 basis points, but at 17.9% were still triple the Q2 FY19 level. While even Walmart (WMT) and Target (TGT) are dealing with too much product, DXL’s clearance inventories are “the lowest they’ve been in years”, and overall inventories are down from the same point in FY18 and FY19.

For the full year, Destination XL is guiding for EBITDA margins of better than 10%, against ~5% pre-2020. It’s not just the pandemic, either: the company has made significant strategic changes, including a shift away from discounting. Gross margins of nearly 50% show the success of those changes, at least so far. DXLG has even repurchased shares successfully this year, buying back more than 4% of shares outstanding at a 23% discount to the current price.

Despite those positives, and even following a 36% rally since earnings, DXLG looks cheap. Based on guidance, the stock is under 6x EV/EBITDA at the absolute highest (assuming a low 10% EBITDA margin); a two-analyst Street consensus suggests the multiple might well be under 4x.

Really, the question here seems to be: can an investor own any retailer in this environment? If so, DXLG has to be at the top of the list.

Poshmark

Secondhand fashion platform Poshmark (POSH) is another surprising name on this list. To be fair, its performance hasn’t been that impressive: though shares have gained 24% over the past month, they’re only about level with August highs, and down 19% so far in 2022.

Still, in context, POSH has held up. In recent weeks, both The RealReal (REAL) and Rent the Runway (RENT) have plunged to all-time lows after weak earnings.

A big part of the reason why, admittedly, is that Poshmark has over half of its market cap in cash on the balance sheet. EBITDA is negative but modestly so. Unlike many growth companies at the moment, that cash isn’t going to head out the door over the next few years.

That cash does create an intriguing opportunity — at the right price. Notably, when POSH hit its own all-time low under $9 in May, the company had an enterprise value of about $125 million. Given that revenue still is growing, and that the company has said it can be profitable at any point it chooses to be, that figure does seem low.

Of course, EV now is at ~$500 million or so, which seems far more reasonable. It’s a roughly 1.5x multiple to trailing twelve-month sales. Operating margins including stock-based comp (11% of revenue in the first half of this year, 15% for full-year 2021) are still sharply negative. Revenue growth of ~10% this year is fine in the context of a difficult external environment (at least in terms of demand; 2021 spending sprees probably help 2022 supply), but hardly spectacular.

In a market that continues to sell off, it wouldn’t be surprising to see POSH head at least toward those May lows. That might create an opportunity, either to own the stock outright or to sell puts at the 7.50 strike. That latter trade should provide either reasonable returns via option premium or ownership of POSH at an enterprise value of ~zero.

Snowflake

Once again, we come to a 2021 story here in 2022 — or, perhaps more accurately, a 2021 debate here in 2022.

As a business, Snowflake (SNOW) no doubt is attractive. Investors can argue over specific long-term growth rates or the ability to outcompete Databricks (increasingly its rival). But there’s a reason Snowflake was a hot IPO two years ago and why, even in a tough software market, it’s up ~50% from its IPO price (albeit down almost one-third from its first-day close).

But the valuation is tough. Snowflake still trades at about 27x this year’s revenue, backing out net cash. The stock had a nice rally from June lows, and a big pop after fiscal Q2 earnings (gaining 23%), but it looks like a “fill the gap” move is in progress:

source: finviz.com

In a way, it’s a test of sentiment. Even in 2019, let alone in last year’s more bubbly market, it was easy to see a name like this and still have a bullish posture. Yes, the multiple looked high — but high multiples had been no impediment to strong returns. Growing software stocks for years had looked “expensive” and then stayed that way, with strong revenue growth and stable EV/sales multiples driving impressive multi-year performance.

The gut reaction now is completely opposite: it feels like there’s no way that a 25x-plus EV/revenue multiple is going to hold up, even after 80%-plus growth in Q2.

Indeed, SNOW has short interest of about 4.5% of the float and 4%-plus of shares outstanding. That’s not huge relative to the stock but it represents ~$2.5 billion worth of short interest in precisely the type of name that shorts feared for the most of the past decade.

For years, shorting a good business solely on high valuation was a widowmaker trade. In 2022, it’s been a profitable trade, and it’s not hard to get the sense that’s likely to continue.

Royal Caribbean

Until the past couple of sessions, Royal Caribbean (RCL) had posted the kind of rally that suggested real underlying strength. In a market selling off consumer names, shares of the cruise operator powered higher for most of the month:

source: YCharts

There was little apparent news driving the rally. Q2 earnings back in late July were mixed, with a solid quarter but a disappointing outlook. The shares then dumped after a refinancing of convertible notes early last month.

The trading since seems like a “somebody knows something” kind of move, at least in terms of the operating business2. (One alternative explanation would be that hedge funds struggling with underperforming long positions are also covering shorts like RCL, but the data here doesn't suggest a huge amount of short covering of late.) And indeed Royal Caribbean did disclose on Thursday morning that bookings during this quarter were above pre-pandemic levels.

RCL stock is quite definitely not above pre-pandemic levels: shares are down 64% since the start of 2020. But a big part of that fact is the massive losses incurred during 2020, which required the issuance of both equity and debt. The business’s enterprise value actually hasn’t fallen that far at all3:

source: YCharts

Betting against the strength shown over the past month seems dicey, and there’s some anchoring bias at play in assuming that the January 2020 price was the “correct” one.

That said, Royal Caribbean is dealing with macro concerns, a strong dollar, and higher fuel prices in a way that it wasn’t three years ago. The impact of the pandemic, and the horror stories of early 2020 cruises, likely lingers in customer perception of the industry. Higher interest rates will also impact debt refinancings going forward.

There is a lot of bad news here, and in that context it does seem surprising that the enterprise value has declined just ~15% from pre-pandemic levels, even with bookings holding up — for now.

As of this writing, Vince Martin has no positions in any securities mentioned.

Tickers mentioned: EVEX DXLG POSH SNOW RCL

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