Cabot Stock of the Month Issue: February 9, 2023

Market Review

The markets continued to be choppy over the last month, with a pullback mid-January, but have since recovered some momentum. And recession forecasts seem to be lessening, with just 35% of economists now predicting a 2023 recession, which should be favorable to the markets.

The Federal Reserve raised interest rates again, however, just by 25 basis points this time, which may be another good sign for the market.

Economically speaking, employment remains strong, with continuing jobless claims steady, at around 1.66 million. New claims, at 183,000, came in lower than anticipated. Nonfarm payrolls zoomed to 517,000, more than double the forecast. It’s no surprise that the unemployment rate dropped to 3.4%.

On the home front, home prices nationwide continued to abate, dropping by 3.1% last month. Factory orders improved, and consumer confidence is steady.

Sounds good, huh?

Here at Cabot, the pullback in stocks looks good to us and may indicate that the time to take the “bull by the horns” is getting closer.

We’ll remain vigilant.

Feature Recommendation: Kraken Robotics Inc. (KRKNF): Opening Up the Seas to Extreme Exploration

With technology stocks rising again (thankfully!), up 12.7% since the beginning of 2023, I thought we might take a look at a unique tech company. Now, I must warn you—this is a penny stock, so it’s very speculative. Please don’t load up your portfolio with its shares, but if you have dedicated a portion of your holdings to more speculative names that could turn into what Peter Lynch calls a “ten-bagger,” then help yourself!

The company is Kraken Robotics, a marine technology company that makes advanced sonar and laser systems and subsea power solutions for Unmanned Underwater Vehicles for military and commercial applications. The company says it is a “world-leading innovator of Synthetic Aperture Sonar (SAS) – a revolutionary underwater imaging technology providing ultra-high-resolution imagery at superior coverage rates which dramatically improves seabed surveys.”

This 3D underwater laser scanning technology is primarily used in assisting the offshore energy sector to acquire higher quality subsea asset integrity information, such as providing critical measurements to help clients avoid unscheduled interruption of production and enabling reverse engineering of damaged subsea equipment to enable repairs in place.

The company claims that its series of SAS products, AquaPix®, “offers comparable performance to existing high-end military systems at a fraction of the cost. This allows Kraken to deliver the highest quality at the lowest cost per pixel on the market.”

This recommendation comes to us from Carl Delfeld, Chief Analyst of Cabot Explorer. Here is Carl’s take on Kraken:

“Most of the Explorer recommendations are larger, more established firms, but from time to time I like to put forward smaller, more speculative ideas. Playing on the robotics, maritime, and defense themes, this week we have an idea that is a bookend to Japan’s industrial robotics global leader, Fanuc (FANUY).

“Based in Newfoundland, Kraken Robotics (KRKNF) is a marine technology company providing ultra-high resolution, software-centric sensors, and underwater robotic systems.

“This marine technology company provides advanced sonar and laser systems and subsea power solutions for Unmanned Underwater Vehicles for military and commercial applications. It develops revolutionary underwater imaging technology providing ultra-high-resolution imagery at superior coverage rates which dramatically improves seabed surveys.

“Kraken Robotics Systems is a U.S./NATO-focused company and has landed a major contract to provide new sonar systems for the Royal Danish Navy. The contract, worth $40 million, is the biggest one to date for the company, which has offices in St. John’s and Halifax and operations in Brazil, Boston, Germany, and Denmark.

“Under the program, Kraken will deliver the KATFISH towed synthetic aperture sonar, the Tentacle winch, and Autonomous Launch and Recovery System (ALARS) to the Royal Danish Navy. This builds on the 2021 acquisition of PanGeo Subsea, which enables Kraken to provide subsea capabilities including geophysical surveys, sonar surveys, and 3D laser inspections. Kraken’s highly skilled team manages subsea surveys and delivers a complete data package to the client.

“The firm offers software-centric sensors, batteries, and underwater robotic systems in unmanned underwater vehicles that are used in military and commercial applications. Its products are used by a number of military navies around the world. These include SeaVision, an underwater laser imaging system; Kraken Active Towed Fish (KATFISH), a towed underwater vehicle for high speed and high-resolution seabed mapping; and ThunderFish, an autonomous underwater vehicle.

“Kraken Robotics (KRKNF) is probably the most speculative of Explorer stocks, but it is a well-run company and a prime takeover candidate in the growth defense sector, coupled with a strong management team.

“This is certainly a speculative idea, but I believe Kraken is a well-run company in a strategic area of growth and therefore a prime takeover candidate by a larger maritime contractor. Consider a small position in this small but profitable company.

“Kraken shares slipped a bit this week as analysts see the company bordering on breakeven as the company recently released that non-audited preliminary results show that Kraken has met its $40 million revenue guidance for 2022. Aggressive - Buy a Half.”

Kraken believes that the War in Ukraine and Nordstream pipeline sabotage has increased demand for seabed intelligence, and sees many opportunities for expansion ahead, including:

KATFISH™ High Speed Towed SAS Systems

• NATO countries
• Asia Pacific
• Middle East
  

SAS Sensor and Battery Sales on New Build & Retrofit AUVs & Other Platforms

• U.S. and NATO countries: from man-portable to extra-large AUVs
• Canada mine hunting program upgrade
• Pathway to commercialization

Recurring Services

• Offshore wind & offshore oil and gas in Europe & Americas & Asia Pac
• Defense: Pathway to commercialization programs

As you can see below, the company has a solid list of large customers.

Here’s a picture of some of the products that Kraken provides its customers:

As Carl said, the company recently released its latest quarterly report, saying, “non-audited preliminary results show that we have met the mid-point of our $38 million to $42 million revenue guidance for 2022. This represents more than 50% top line growth year over year. We also expect to be within the range of EBITDA guidance, previously announced at $5 to $7 million.”

According to industry analysts, it looks like Kraken Robotics is approaching breakeven, with forecasts calling for profits of CA$6.3m in its 2023 fiscal year, based on a 191% growth rate.

The company’s latest earnings report has given the stock a nice push, and several analysts have boosted their price target by 9.7% to CA$0.85 per share (currently about $0.63 in U.S. dollars).

About the Analyst

Carl received his Master’s in Law and Diplomacy at the Tufts Fletcher School; worked for the First National Bank of Boston (now Bank of America) in London, serving as director of the Japan and South Korea Group; served as vice president at the investment bank Robert W. Baird & Company, developing new business in Tokyo, Hong Kong and Sydney; was Asia advisor to the U.S. Congressional Joint Economic Committee, the U.S. Finance Committee and the U.S. Department of the Treasury; wrote for Forbes Asia and the Far Eastern Economic Review; served as a member on the U.S. National Committee on Pacific Economic Cooperation and the Japan-U.S. Friendship Commission; was chairman of the Asian Pension Forum. Carl has recently released his latest book:

Power Rivals: America and China’s Superpower Struggle.

Additional books Carl has written include:

Red, White and Bold: The New American Century Paperback,

Think Global, Grow Rich: 7 Principles for Building a Global Portfolio,

The New Global Investor: Using ETFs to Build Smarter, Simpler and Safer Portfolios.

I’ve known Carl for many years and was thrilled when he brought his global investing expertise to Cabot. When I read a recent article he wrote regarding the growing use of robotics, I was intrigued by his insight into the industry, which led me to review his recommendation of Kraken. In the following interview, I delved into this a bit more with Carl:

Nancy: Carl, how would you summarize the global markets in 2023?

Carl: It is only a month into 2023 but the Nasdaq 100 (QQQ) was the best-performing US index ETF with a gain of 10.6%. The small-cap Russell 2,000 (IWM) was next, up 9.8%. The Dow Jones 30 (DIA)—which did the best in 2022—was up only 2.95%.

At the sector level, Consumer Discretionary (XLY) jumped 15.1%, followed closely by Communication Services (XLC) at 14.8%. Three conservative sectors actually fell in January: Consumer Staples (XLP), Health Care (XLV), and Utilities (XLU).

International markets got off the mark fast in January. Up 10% or more were Australia (EWA), China (ASHR), France (EWQ), Germany (EWG), Italy (EWI), Mexico (EWW), and Spain (EWP). India (PIN) was the laggard.

Nancy: So far this year, global markets are looking better. Do you think this trend will continue into the rest of this year?

Carl: It depends on whether the Fed is done or slowing down the interest rate increases. Trying to forecast markets is tough and is a business created to make astrologists look good.

Nancy: Which areas or sectors do you find attractive for investors in 2023?

Carl: I anticipate a rebound in some tech and cyclical ideas. Watching semiconductors, biotech, electric vehicles, fintech, and nuclear energy.

Nancy: In your most recent newsletter, you mentioned that the markets were discounting “China’s leadership in automating production through industrial robots.” Will you please expand on that idea?

Carl: The robot density, defined as the number of robots per 10,000 employees, has now reached 322 in China, overtaking America. The degree of automation in Chinese industry is now in 5th place globally, just behind South Korea, Singapore, Japan, and Germany. Late last year, Swiss ABB opened a new, fully automated $150 million “mega-robot factory” near Shanghai. The most modern generation of industrial robots is produced there, and it’s a research and development center for artificial intelligence (AI) in robots.

More than a million industrial robots are now in use in China—the largest army of robots in manufacturing plants in the world. Chinese robots are particularly strong with industrial robots that do not require the highest degree of precision.

Nancy: Much has been made of China’s “shutting down” due to COVID, but it seems that the market is beginning to reopen. Are there other areas of the China economy that look good for investors this year?

Carl: My primary concern with China is political and specifically, Taiwan.

Nancy: Your portfolio seems nicely diversified, with stocks from the auto, biotech, tech, electrical equipment, materials, rare earth, and medical devices. Do you have any favorite sectors for this year?

Carl: I like both the medical sector and EVs, though Tesla’s recent price cuts have roiled the markets.

Nancy: Tech stocks are making a bit of a recovery. Do you think now may be the time to reenter some of the big names, such as the FANG stocks?

Carl: I think I would avoid Apple because of the China risk, but the others will likely come back somewhat.

Portfolio Updates

Bruce Kaser, Chief Analyst of Cabot Turnaround Letter, recently updated his recommendation on M/I Homes (MHO), saying, “M/I Homes reported a healthy quarter that was well ahead of the consensus estimate, but the boom times of sharply increasing units and pricing have ended. While the shares have surged, they remain about 9% below our price target. The valuation at 0.9x liquidation value per share remains low enough, and the fundamentals remain strong enough, that we will hold out longer in anticipation of the shares reaching our price target.

“In the quarter, revenues rose 14%, comprised of a 3% increase in home deliveries and an 11% increase in average price. Revenues were 18% above estimates. Adjusted earnings of $5.15/share rose 35% from a year ago and were 24% above estimates.

“M/I Homes is well run, is highly profitable, has a solid balance sheet and operates in high-demand local and regional markets.”

Quarterly earnings beat analysts’ estimates, for the fourth consecutive time. The company recently announced that it is commencing operations in the Fort Myers/Naples, Florida market and that Kevin Brown has been named Area President.

We are closing in on our price target. Let’s change the recommendation for MHO to Hold for now.

In his recent update on Qualcomm Inc. (QCOM ), Tom Hutchinson, Chief Analyst of Cabot Dividend Investor reported, “QCOM has been kicking butt. Sure, technology stocks are up. But QCOM is up more. It’s up 20% so far this month, more than twice the YTD return of the sector. It has also cracked the 130 per share level for the first time since September. It got a big upgrade when Barclays came out with a very positive report last week. The analyst said that the worst is over for chip stocks and QCOM should be among the first in the sector to rebound. Before long, the market, which tends to anticipate six to nine months ahead, may start pricing in a real recovery in the sector. HOLD”

There has been a nice rally in the chip sector, which began with memory chip giant Micron heading a list of top investment ideas from research company Rosenblatt, who commented that “The firm expects a particularly strong business performance in the second half of the year but noted that it was time to “start playing offense” while share prices were low.”

Following that nice report, Taiwan Semiconductor beat analysts’ estimates, posting earnings of $1.82 per share on revenues of $19.9 billion.

Qualcomm’s management said they expect “inventory issues will persist into June,” and predicted second-quarter GAAP revenues of $8.7-$9.5 billion and GAAP earnings of $1.53-$1.73 per share. Continue to Hold.

Devon Energy (DVN) is expected to report quarterly earnings on February 15. Analysts are forecasting earnings per share of $1.76 on $4.57B in revenues.

Most of Wall Street is expecting lower production volumes, which may be hampered by the severe winter weather in Devon’s service territories.

Mad Money’s Jim Cramer has a “keep buying” recommendation on Devon’s stock, citing the steady price of crude oil.

Continue to Buy. We may see a bounce after earnings are reported.

The recommendation of Citigroup (C) was recently updated by Bruce Kaser, Chief Analyst of Cabot Undervalued Stocks Advisor. In his report, Bruce commented, “Citigroup reported bland fourth-quarter results. Earnings (excluding the effect of divestitures) were $1.10/share, which fell 45% from a year ago and were about 8% below the $1.19 consensus estimate. Revenues (excluding the effect of divestitures) rose 5% from a year ago and were about 1% above estimates.

“Rising interest rates helped boost net interest income, but this was more than offset by higher credit costs and elevated transformation and other expenses. Citi’s already-healthy capital strength increased further. Overall, nearly two years into CEO Jane Fraser’s term, the bank is making progress with its turnaround. But, given the paltry 5.5% return on tangible equity compared to its medium-term goal of 11-12%, the bank has a long way to go.

“In the quarter, net interest income rose 23% from a year ago, as the net interest margin expanded to 2.39% from 1.98% a year ago. Partly offsetting the higher margin, loans balances fell 2%. However, excluding to-be-divested Legacy businesses, loans grew 2%. Fee income fell 27% (ex-divestitures): better trading profits were more than offset by weaker asset management and investment banking fees.

“Operating expenses rose 5% (ex-divestitures), which we find disappointing as we would like these to remain flat given all of the efficiency improvements underway. However, we recognize that with most turnarounds, expenses increase as the company spends on new staffing, software and other upgrades before it removes older costs, creating an expensive but temporary redundancy. This appears to be where Citi is today.

“Credit costs surged to $1.8 billion compared to a negative ($465 million) a year ago. We view this sharp reversal as a return to more normal credit costs. Loan losses increased 36% but impressively were still below 0.2% of average loans. Non-accruing loans also remain low. The bank increased its reserves by a reasonable $593 million, compared to the unusual post-pandemic $1.2 billion reduction a year ago. Total reserves are now 2.6% of total loans, a size we consider healthy. In the credit card segment, reserves are 7.6% of these loans, also robust even as the economy slows. For perspective, the credit card portfolio is about 23% of total loans—indicating that this bucket is a sizeable driver of Citi’s growth and profits.

“For 2023, the bank expects revenues to increase 5%, coming almost entirely from higher fee income as it anticipates minimal improvement in net interest income. Expenses will increase 7%, with credit costs continuing to normalize (increase). Overall, 2023 will likely be an uninspiring year for profit improvement at Citigroup. We see stronger results in 2024, as the benefits of the turnaround become clearer. Exits of the legacy businesses in Mexico, Asia, Russia and Poland are underway and likely to be mostly done by year’s end or so.

“Citi shares trade at 63% of tangible book value and 8.4x estimated 2023 earnings. The remarkably low valuations assume an unrealistically dim future for Citi.

“When comparing Citi shares with a U.S. 10-year Treasury bond, Citi offers a higher yield (4.00% vs 3.55%) and considerably more upside potential (65% according to our work vs. 0% for the Treasury bond). Clearly, the Citi share price and dividend payout carry considerably more risk than the Treasury bond, but at the current valuation, Citi shares would seem to have a remarkably better risk/return trade-off. BUY.”

I agree. Buy.

In his update of Curaleaf (CURLF), Michael Brush, Chief Analysts of Cabot SX Cannabis Advisor, said, “Curaleaf reported 7% year-over-year sales growth on November 7, and 1% sequential growth to bring in $340 million in the third quarter. Retail sales (76% of revenue) increased by 16% to $260 million, driven in part by store openings.

“The company added six retail dispensaries in Arizona, Nevada and Florida and closed one in Colorado, bringing the store count to 142. It opened two Florida dispensaries in November after the quarter closed, talking to total to 144. The company opened a second dispensary in Tallahassee in December, bringing the Florida store count to 55. Curaleaf posted its 19th consecutive quarter of retail sales growth. Wholesale revenue decreased 14% to $79 million, as the company continued to reduce its wholesale business in lower-margin states.

“Sales growth was hurt by delays in the opening of a Bordentown, New Jersey store, and Hurricane Ian in Florida. Strong NJ sales growth and two new store opening offset these negatives. Curaleaf losses declined to $51 million compared to $55 million in the third quarter of 2021. Note that this company is founder-run, which can be a plus in investing. Board chair Jordan and board vice chair Joseph Lusardi founded Curaleaf. The company has a price/sales ratio of 2.2, among the highest in the group. BUY.”

Curaleaf is a bet on the future, and a long-term play, so I am not worried about near-term fluctuations. Continue to Buy.

Tyler Laundon, Chief Analyst of Cabot Small-Cap Confidential, had this to say about Huron Consulting (HURN), in his latest update: “Huron sold off to about 67 a couple weeks ago and has been bouncing off the 67 to 68 range, and trading as high as 74 since. I’d like to see a little more momentum out of HURN. Maybe the Q4 report will help with that, though it’s not due out until around February 24. The stock reacted well to the last three earnings reports. BUY.

I agree. Continue to Buy.

Portfolio

*Aggressive (A), Moderate (M), Conservative (C)

ETF Strategies

*Aggressive (A), Moderate (M), Conservative (C)

Our ETF portfolio is holding up well. This month, First Trust Water ETF (FIW), iShares U.S. Energy (IYE), ALPS Medical Breakthroughs ETF (SBIO), and Vanguard Dividend Appreciation Index Fund (VIG) remain positive.

I’m feeling a little better about the markets, so am adding two new sector ETFs to our portfolio this month.

Recommendation #1: Financial Select Sector SPDR Fund (XLF)

4 stars
Low-risk
Large value

The fund generally invests substantially all, but at least 95% of its total assets in the following industries: diversified financial services; insurance; banks; capital markets; mortgage real estate investment trusts (“REITs”); consumer finance; and thrifts and mortgage finance. The fund is non-diversified.

Top Holdings

Recommendation #2: Communication Services Select Sector SPDR Fund (XLC)

The fund generally invests substantially all, but at least 95% of its total assets in the securities of companies from the following industries: diversified telecommunication services; wireless telecommunication services; media; entertainment; and interactive media & services. The fund is non-diversified.

3 stars
Average risk
Large value/blend

Top Holdings

Please be sure to add these ETFs to your portfolio only if they agree with your long-term investing strategy and risk profile.

Underwater Robotic Applications are Expanding Globally

Kraken Robotics operates in the $30 billion industry for subsea sensors, robotics, and services. The industry is best characterized as one with significant barriers to entry. And today, industry growth is accelerating, due to geopolitics and energy/renewables policy, as well as the adoption of robotics and upgrade programs by global customers.

Robots can go where humans cannot—into the deep, dark, and very cold oceans—as far down as 6,000 meters (some 19,685 feet).

Just the global underwater robotics part of the market is expected to grow at a compound annual growth rate of 13.5% to reach $6.74 billion by 2025. That’s up from $2.685 Billion in 2020.

Remotely Operated Vehicles (ROVs) are increasingly used for drilling, development, repair, and maintenance operations for offshore oil and gas exploration, without the limitations of human subsea divers. And the industry is also being boosted by demand from defense and security applications.

Source: Grandviewresearch.com

The Autonomous Underwater Vehicle (AUV) market is beginning to encroach on the dominant market share that Remotely Operated Underwater Vehicles (ROV) have held, due to the demand and adoption in defense applications such as surveillance, mine counter measurement, anti-warfare application, and others. Additionally, new uses for the vehicles for ocean floor mapping, testing water samples, polar ice research, and pipeline inspection is accelerating industry growth.

Source: Verifiedmarketresearch.com

This global growth should be a great catalyst for the shares of Kraken.

The next Cabot Money Club Stock of the Month issue will be published on March 9, 2023.