Explorer stocks had a great week as Centrus (LEU) is up another 10%, Cloudflare (NET) adds 20%, Infineon (IFNNY) reports revenue jumping 33% and Ford (F) reports eye-popping sales results for July. Data and analysts are divided so stay cautiously optimistic and consider today’s new recommendation at the heart of U.S.-China rivalry.

Cabot Explorer Issue: August 4, 2022

Speaker Pelosi Taiwan Trip Highlights U.S. Critical Materials Vulnerability
What recession? Explorer stocks had a great week as Centrus (LEU) is up another 10%, Cloudflare (NET) adds 20%, Infineon (IFNNY) reports revenue jumping 33% and Ford (F) reports eye-popping results for July.

All this despite the Speaker Pelosi-led trip to Taiwan – which seemed to me to be all risk and little if no reward. It did not further the goals of Taiwan or America and its allies. We all seek a realistic status quo – Taiwan not as an independent country (that horse left the barn many years ago) but rather as a free, self-governing, secure island with a vibrant economy and democracy for its 24 million people.

America and its allies remain committed to helping Taiwan by selling it the armaments it needs to deter China from even thinking of taking Taiwan by force. This is a challenge we should be dedicated to achieving as quickly and quietly as possible and this urgency needs to be even higher within Taiwan.

In addition to Taiwan’s defenses, China will also need to take into consideration the likelihood that America and its allies will intervene to support Taiwan in the event that China uses force to coerce or invade Taiwan. Taiwan does not need symbolic gestures that merely provoke China. The time for diplomatic gestures is also long gone. What Taiwan, America, and their allies need now is “armed diplomacy” executed with consummate diplomatic skill and married to overwhelming military deterrence.

The map below highlights just how differently China and Asia view the Taiwan issue.

As the U.S. delegation left Taiwan, China conducted a live fire naval drill surrounding the island of Taiwan as depicted below.

These risks need to be hedged in some way – which brings me to today’s new recommendation.

New Explorer Recommendation

MP Materials (MP)
Imagine an America that produces no oil and a China that produces 80%-85% of the world’s oil.

That’s America’s situation when it comes to rare earths and many rare strategic metals. It is a much bigger risk to an America-tech-led economy than OPEC ever was.

These strategic rare metals are not only critical to American technology – they are essential to our modern economy from smartphones to our most advanced weapons systems.

• An F-35 fighter requires 920 pounds of rare earths.
• An Arleigh Burke destroyer requires 5,200 pounds of rare earths.
• A Virginia-class submarine requires 9,200 pounds of rare earths.

Yet America does not now produce any rare earth oxides and China produces 85% of world supply.

Semiconductors, the brains of modern technology, are full of these critical materials and Asia now produces about 75% of global semiconductor chips.

And these chips all require not only rare earths but a dozen or more critical materials that China dominates as well.

MP Materials (named after its mining and processing center in Mountain Pass, CA) emerged from the Chapter 11 of Molycorp and is the only producing rare earths mine in the United States. At one time in the 1990s it was producing upwards of 40% of the world’s rare earths.

MP has made some interesting news this year. Its first-quarter revenues of $166.3 million represented 50% of their revenues from all of 2021. This is due to the high prices of Neodymium (Nd) and Praseodymium (Pr) this year.

Gross margins in Q1 2022 were 88%, up from 81% in 2021, but I expect this will fall for the balance of the year. Either way, MP is poised to improve its Net Income to $168.4 million.

MP has done a good job in their sales price to China for their rare earth concentrate. They are getting somewhere in the range of 40-50% of market value, which is high versus traditional pricing for concentrate.

In April a definitive supply agreement was announced between MP Materials and GM to supply rare earth alloy and magnets for GM’s electric vehicle (EV) program.

I would expect that MP, with the input from Shenghe Resources (a related 9% investor in MP whose ultimate parent is Shenghe Resources, a rare earth company listed on the Shanghai Stock Exchange), is a buyer of MP’s rare earth concentrate that accounts for more than 90% of MP’s product sales.

Other recent news was that the U.S. Department of Defense (DOD) granted MP Materials $35 million to build a heavy rare earths refinery at Mountain Pass.

Given the strategic importance of MP Materials, it should continue to have strong government support and an allocation to this stock offers you the following:

• MP is a fundamental way to play clean tech, defense, semiconductors and other advanced and emerging technologies through some of their basic inputs – rare earths
• As a real asset commodity, MP is a hedge on inflation, and,
• MP can be seen as a strategic hedge on rising tensions in Asia and between the U.S. and China with flashpoints in Asia, including Taiwan, since China could disrupt rare earth supplies sending prices sharply higher.

BUY A HALF POSITION

Model Portfolio

Portfolio Changes
Portfolio Changes: NIO (NIO) From Hold to Sell

Updates
Centrus Energy (LEU) was up another 10% this week after adding more than 20% last week to reach 35 in its third week as an Explorer recommendation. Based in Bethesda, Maryland, Centrus supplies nuclear fuel and services for the global nuclear power industry.

The nuclear power industry is rapidly changing, with a new generation of advanced reactors under development. Centrus provides an integrated solution for meeting the industry’s engineering, manufacturing and fuel needs. The United States has 94 reactors that generate about 20% of our electricity but we have not built one new plant in the last 25 years.

Centrus stock is still trading way off its 52-week high and at just over three times earnings. My six-month target remains at 50 for now. BUY A HALF POSITION

Cloudflare (NET) shares were up 20% this week as Wall Street returned to the cyber security story and the company expects second-quarter earning out today. While Cloudflare is not yet profitable, it consistently delivers impressive revenue results and the correction in this stock in 2022 seems way overdone relative to the company’s track record, market, and potential for growth.

Revenue soared 53% to $731 million in the past year. I still believe this is a buy given that the stock is trading at its lowest valuation of the past two years. The company will report its next financial results on August 4, 2022. BUY A HALF POSITION

CVS Health Corporation (CVS) shares surged past 100 and were up 6% yesterday alone as the company raised its outlook for the year after reporting an 11% increase in second-quarter sales. Retail sales were driven by higher prices and increased prescription sales. Overall revenue came in at $80.6 billion, ahead of average analyst expectations for $76.4 billion, according to FactSet. CVS Health’s is not only, by revenue, the tenth largest company in the world, its earnings per share has grown 26% each year, compounded, over the past three years. CVS Health is one of the nation’s leading healthcare companies with almost 10,000 stores and its core markets grow each year even in a weak economy. BUY A HALF POSITION

Fanuc (FANUY) shares were up slightly this week at 16 as we wait for the sharp drop in the value of the Japanese yen to boost sales and exports.

Fanuc is the world’s leading manufacturer of computerized numerical control (CNC) devices that are used in machine tools and also serve as the “brains” of industrial robots Fanuc’s stock offers us a high quality stock that should be firm with its strong balance sheet with plenty of cash. Fanuc is a play on a clear industrial robotics growth trend and my six-month price target for this low-risk stock remains 25. BUY A HALF POSITION

Ford (F) shares rose about 15% this week as July sales in the U.S. climbed 37%, rebounding sharply from year-ago production shortages and supercharged by growing electric-vehicle sales that jumped 169%.

Ford had a 70% bounce in SUV sales while U.S. sales of trucks, which made up just over half of Ford’s U.S. monthly sales, climbed about 20%.

Ford said its electric-car business grew more than three times the rate of the overall EV segment in July – powered by Mustang Mach-E and F-150 Lightning sales. The company said its market share of the electric-vehicle segment increased to 10.9% in July, its highest level on record. Ford is planning to add electric vehicles to its lineup as it seeks output of 2 million electric vehicles globally by 2026,

Ford stock still stands out in value as it trades at just under five times trailing earnings. I encourage you to buy if you have not already done so. BUY A HALF POSITION

Infineon Technologies (IFNNY) shares jumped yesterday after the company reported its latest quarter with 33% revenue growth and increased its revenue forecast thanks to auto-industry demand, while AMD and other semiconductor companies focused on markets such as the personal-computer business struggle. The company’s automotive revenue rose 41% while its industrial power control revenue grew by 6% year over year. Power & sensor systems revenue rose 35%.

Infineon is a leading broad-based European chipmaker with exposure to secular growth drivers in the industrial and automotive chip sectors. Infineon was founded when the company was divided from its Siemens parent in 1999. The stock is still trading at a discount to its intrinsic value and offering investors a margin of safety. BUY A HALF POSITION

Nio (NIO) shares gained a point this week to finish at 20 and, given its lack of momentum in a growth market, I’m moving this stock to a sell.

Nio is still worth watching as it is down about 70% from its all-time high and China accounted for almost 60% of global exports of electric vehicles in 2021.In addition, Nio drivers can quickly swap their batteries up to six times per month without leaving their cars. It’s faster than EV charging – taking only three minutes per swap. MOVE FROM HOLD A HALF POSITION TO SELL

Oracle Corporation (ORCL) shares added a few points this week after it slimmed its workforce while moving to expand its efforts in cloud computing. Oracle and Microsoft (MSFT) recently announced a deeper interoperability of their clouds, allowing customers to more easily run projects across both platforms. My expectations for Oracle are somewhat muted since it is a conservative company with a decent dividend and has historically been one of the safest stocks in software. HOLD A HALF POSITION

Sociedad Química y Minera de Chile S.A. (SQM) shares cooled off 3% this past week but are clearly demonstrating relative strength amidst the commodity stock pullback by surging in the last two weeks. The challenge will be for the next quarter to keep pace with the company’s last quarter, which posted revenues more than four times the year-ago quarter. Revenue from the lithium segment surged more than tenfold. I suggest you take some profits off the table now.

The company is also the largest producer of potassium nitrate, used for fertilizer, and a leading producer of iodine, so SQM is viewed as a fertilizer and lithium play. HOLD A HALF POSITION

The next Cabot Explorer issue will be published on August 18, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld

Analyst Bio

Carl Delfeld

Carl Delfeld is a member of the Cabot investment team, and chief analyst of Cabot Explorer.

He received his Masters 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 and wrote a book, titled, Red, White & Bold; the New American Century.