Cabot Explorer Issue: August 24, 2023

Portfolio Changes:
Geely Automobile Holdings (GELYF) – Move to Sell
Solid Power (SLDP) – Move to Sell

Look for Moats and Monopolies

“In business, I look for economic castles protected by unbreachable moats.”

-Warren Buffett

Nvidia (NDVA) stock busted through the 500-dollar mark in after-market trading Wednesday as the company reported long-awaited quarterly revenue of $13.51 billion, a 101% jump from last year, while adjusted earnings came in at $2.70 per share, up 429% from last year.

This remarkable company that designs premium graphics semiconductor chips critical to key markets is seen as the top play for artificial intelligence.

“A new computing era has begun,” said Nvidia CEO Jensen Huang. “Companies worldwide are transitioning from general-purpose to accelerated computing and generative AI.”

Nvidia’s lead in this sweet spot of technology is an example of a valuable moat.

The concept of economic moats is the primary theme of a great book by Pat Dorsey called, The Little Book that Builds Wealth. Dorsey defines an economic moat as a durable competitive advantage that allows a firm to earn above-average returns on capital over a long period of time.

Since investing in a share of a stock is buying a small piece of a business, successful investing involves picking companies with a built-in advantage giving it above average profits for as long as possible.

This is important because in a free-market economy, like a hungry tiger, capital hunts for the areas of highest return. Whenever a company develops a profitable product or service, it doesn’t take long before competitive forces drive down its economic profits. Only companies with an economic moat can hold competitors at bay and generate economic profits over an extended period.

In his book, Dorsey explains that Deere & Company’s (DE) moat is its dominant dealer network. The liquidity and the closed network of future exchanges like the Chicago Mercantile Exchange leads to high levels of consistent profitability.

The world’s largest producer of paper pulp is based in Brazil because seedlings mature in the temperate climate of Brazil more than twice as fast as in North America.

Absolute size and scale are important and the key reason for Exxon Mobil (XOM) stock’s stellar performance with margins in refining and chemicals dwarfing the competition. Ditto for China’s dominance in processing commodities from copper to rare earths.

Invesco’s QQQ Trust (QQQ) is synonymous with tech investing and jumped with Nvidia today. QQQ has nearly doubled S&P 500 returns over the last decade. This $200 billion exchange-traded fund was created in 1999 by Nasdaq and is now the fifth largest ETF by assets.

An easy way to get some moat stocks into your portfolio is with the VanEck Morningstar Wide Moat ETF (MOAT), introduced early last year. MOAT is a basket of 20 moat stocks trading at relatively low valuations according to a Morningstar model. It is up 19.4% so far this year.

Today’s new recommendation also has a moat and even better, a quasi-monopoly on payment communications and credit card transactions.

New Recommendation: Visa (V) – A Powerful and Wide Moat

Visa doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world.

It has the largest card network in the U.S., processing $14.5 trillion of payment volume in the last 12 months. Visa’s financial infrastructure also underpins much of the world’s commerce.

Payments processing giant Visa had another stellar showing during its recent quarter, reporting $8.1 billion in revenues, up 12% ear-over-year, compared to $7.3 billion a year ago. The company posted a profit of $4.5 billion, or $2.16 per share, against $4.2 billion, or $1.98, the year before. Resilient and resurgent global travel and trade, coupled with healthy consumer spending, helped the company beat expectations at the top and bottom lines.

During the quarter, Visa processed a total of 54 billion transactions across the world, up 10% and worth over $3.2 trillion, an increase of 8%. The total cards issued now stand at 4.2 billion, up 7%, compared to 3.9 billion, divided between credit and debit cards. The recovery in global travel resulted in an impressive 17% growth in cross-border payments.

The duopoly between Visa and Mastercard is often referred to as one of the best businesses in the world, with insurmountable moats, low operating costs, and plenty of opportunities for unlocking additional value. Visa currently trades at a 21% discount to its arch rival Mastercard. This leaves it much better poised to outperform the latter going forward.

Visa continues to reward shareholders generously, with $3.9 billion returned during the quarter in the form of dividends and stock repurchases. Visa’s steady revenue stream, strong profit margins, and sturdy balance sheet confirm to me that it can continue delivering exceptional value to investors for years to come. It ended the quarter with $15.6 billion in cash, $21 billion in debt, and $14 billion in cash flow. Its market value now exceeds $500 billion, putting it at or near the top 10 largest market caps in the country. BUY A HALF

Weekly Explorer Stock Updates

Below is a brief update on each Explorer stock. Any changes in ratings will be highlighted. This section is all you need to read each week and will be followed by a new recommendation every other week.

Explorer Trading Recommendations - need to watch more closely

BYD (BYDDY) shares pulled back 3 points this week but as the the world’s leader in terms of Chinese and global EV sales, its stock is relatively cheap compared to rival Tesla. Buy a Half.

Geely Automobile Holdings Limited (GELYF) shares were steady this week. However, some question whether China’s EV sales will catch up to EV production leading to rumors of sizable inventories, so I’m moving this to a sell. Move from Buy a Half to Sell.

Neo Performance (NOPMF) shares were up this week following the recent release of second-quarter financials. Revenue was slightly higher and adjusted net income was $2.5 million, while the cash position is up to $126 million. Neo manufactures advanced tech and industrial metals and materials such as magnetic powders and magnets, specialty chemicals, metals, and alloys. Buy a Half.

Novo Nordisk (NVO) shares broke above 190 yesterday on the heels of a Reuters published an article stating that Novo Nordisk has secured Thermo Fisher Scientific (TMO) as its second contract manufacturer for its highly popular Wegovy, a weight-loss drug that remains very much in demand. Novo Nordisk recently raised its full-year 2023 outlook to call for sales growth of 27% to 33%. Hold a Half.

Solid Power (SLDP) shares have not performed well so far this quarter despite a strong second quarter reported last week. This relative recent weakness prompts me to move Solid Power to a sell even though it has progressed technologically to develop breakthrough high density solid-state battery technology. Move from Buy a Half to Sell.

Tesla (TSLA) shares, in their second week as an Explorer recommendation, jumped from 222 to 237. In Q2, Tesla achieved record EV sales on the back of price cuts. The global EV leader makes four models, and its long-awaited Cybertruck is due later this year. It also plans the Semi and Roadster, for which launch dates have been pushed back. Tesla expects to grow deliveries 50% annually. In 2022, its vehicle sales jumped 40% year over year and production increased 47% to 1.37 million vehicles. Buy a Half.

Umicore SA (UMICY) shares had another subpar week due to softer commodity pricing. Umicore is one of the world’s largest producers of battery materials including cathodes, the most expensive part of the battery, and is an important supplier and partner for European carmakers such as Volkswagen, Peugeot-owner Stellantis and Mercedes-Benz. It has also been working with Japan’s Idemitsu Kosan to develop materials for solid-state batteries. Buy a Half.

Explorer Multinational Blue-Chip Recommendations - More Buy and Hold

ConocoPhillips (COP) shares were largely unchanged this week on little news. The company is among the lowest-cost producers and delivers relatively strong cash flow. Buy a Half.

International Business Machines (IBM) shares moved up a bit this week as the company continues to streamline its operations with the sale this week of its Weather company assets to focus more on its core hybrid cloud and artificial intelligence businesses. Buy a Half.

Pfizer (PFE) shares added a point over the last week. Although Pfizer’s revenue and stock price is down from the pandemic high, the company projects that its adjusted earnings per share for the year will be between $3.25 and $3.45. The stock delivers a 4.5% dividend yield. Buy a Full.

Explorer ETF/Fund Positions

JPMorgan Equity Premium Income ETF (JEPI) offers double-digit yield coming from both option premiums and dividends using a value-focused strategy. Current yield is about 10.4%. Buy a Full.

WisdomTree Emerging Markets High Dividend Fund (DEM) offers a high dividend yield and some of the highest quality emerging market stocks. Buy a Half.

WisdomTree China ex-State-Owned Enterprises Fund (CXSE) is a way to gain China exposure without any state-owned enterprises (SOEs). Buy a Half.

Model Portfolio

Explorer Stocks Summary

Brief company overviews that will not change week to week.

BYD (BYDDY): In 2022, China auto giant BYD (for Build Your Dreams) switched to producing only all-electric battery vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs). The company also manufactures and supplies EV batteries, including to Tesla, and makes its own chips. This is vertical integration that would make Henry Ford proud. BYD is in a strong position to be one of, if not the leader of the EV revolution in terms of size, scale, and growth.

ConocoPhillips (COP) is a global energy industry giant and one of the largest independent exploration and production (E&P) companies in the world, as measured by production levels and proved reserves. The company, founded in 1917 and based in Houston, has operations in 13 countries, although almost half the company’s production is derived from U.S. sources.

International Business Machines (IBM) is a blue-chip artificial intelligence (AI) and India play with a nice dividend yield. Known as “Big Blue,” IBM now primarily helps businesses and governments manage their information technology in the cloud era. The stock sells at a discount to the S&P 500 multiple and the information technology sector’s forward earnings multiple. IBM has paid a dividend every quarter since 1916 and has had 28 consecutive years of dividend increases.

Neo Performance (NOPMF) manufactures the building blocks of many modern technologies and advanced industrial materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys – all using rare earths and minerals critical to the performance of many important products and emerging technologies. Based in Toronto with offices in Denver, Singapore, and Beijing, the company is organized along three segments: Magnequench, Chemicals & Oxides, and Rare Metals.

Neo has a global platform that includes nine manufacturing facilities located in China, the United States, Germany, Canada, Estonia, and Thailand, as well as one dedicated research and development center in Singapore.

Novo Nordisk (NVO) specializes in treatments for diabetes, hemophilia, and obesity. The company supplies half of the world’s insulin, and its diabetes care products are used by over 34 million people today. Novo highlights that more than 750 million people are currently living with obesity and that this is up a multiple of 3X since 1975. In summary, based on sizable and growing demand for this weight-loss drug, this well managed, highly profitable company with an excellent growth profile and potential to develop new products has limited risk.

Pfizer (PFE) served more than a quarter of a billion patients that were treated with its medicines and vaccines in the first quarter of this year. Pfizer has 10 products with sales greater than $1 billion a year.

Tesla (TSLA) has always confused investors and Wall Street analysts alike. One reason is that it often has valuations that are many times higher than its auto industry peers. What many miss is that it is not an auto stock but rather a tech stock and platform stock. Tesla’s value is really in its ever-expanding platform, AI capabilities, charging infrastructure, battery manufacturing, autonomous driving capability, and other areas ripe for disruption that nobody even knows Tesla is working on. Revenues have scaled from $32 billion in 2020 to $54 billion in 2021, to $81 billion in 2022, and are set to move past $100 billion in 2023.

Umicore SA (UMICY) is a materials technology company based in Brussels. The venture is set to begin production in 2025 and is slated to process materials for enough batteries to power 2.2 million fully electric cars a year. The company has a long history in mining and has evolved into more of a processing and recycling company.

Umicore’s leading battery materials technology portfolio consists of nickel, manganese, cobalt technologies, manganese rich lithium and solid-state battery technologies. The company delivers a 17% return on equity and is a rather conservative way to play critical metals on the refining rather than mining side.

The next Cabot Explorer issue will be published on September 7, 2023.

PUBLISHED — New book from Chief Analyst Carl Delfeld