Cabot Explorer Issue: February 1, 2024

Portfolio Changes: Sociedad Química y Minera de Chile S.A. (SQM) – HOLD to SELL

Super Micro Computer Up 86% in 2024; Novo Nordisk Resumes March

Chinese Auto Industry Booms but Debt Weighs on Growth and Stock Market

The Federal Reserve held interest rates steady and signaled it is open to cutting later this year, especially if economic growth and employment slow in an election year. Big tech earnings so far are a mixed bag and below elevated expectations.

While I realize you are primarily looking for stock ideas that outperform the market, avoiding stocks and markets that decline sharply is just as important. We recently sold our Tesla (TSLA) position just prior to its sharp pullback and when I took over this investment letter about six years ago, all of its recommendations were Chinese stocks.

China followed up on its recent scheme to support weak stock markets with deposits of state-owned companies by ramping up a crackdown on short sellers. This is against the backdrop of a sharp loss of faith in investing in Chinese property markets, where Chinese park most of their wealth.

In December 2023, housing sales were down 17% from a year earlier and Nomura Securities estimates that there are still 20 million homes already sold but still waiting to be finished due to lack of funds. Chinese property developer Evergrande has roughly $300 billion in liabilities and has been ordered to liquidate.

Chinese companies are moving quickly to take sodium-ion batteries from lab to commercialization, again demonstrating why the Chinese battery industry is so far ahead of America’s, Europe’s, and Japan’s. This is something to watch.

Chinese autos are pretty much locked out of U.S. markets, but Hyundai and Kia sell a broader lineup of EVs than many rivals, including Tesla, with battery technology that allows for fast charging speeds. They take advantage of changes to the EV tax credit rules to offer attractive lease deals that made these cars more affordable than U.S. rivals. While Tesla still dominates the EV market in the U.S., accounting for about 55% of all battery-powered vehicles sold, its share is falling even as it cuts prices, and this is part of its problem with its stock.

New Recommendation

Cloudflare (NET)

Cybersecurity is one of the fastest-growing segments of IT spending and chief information officers consistently rank cybersecurity as their top spending priority.

Damages from cybercrime cost the world more than $6 trillion annually, prompting individuals, companies, and governments to retain cybersecurity firms to provide sophisticated software and services to protect proprietary data.

Cybersecurity is a powerful enduring theme that will be further fueled by the growth of new technologies including AI, cloud computing, and the internet of things.

As the world becomes digitized, protecting valuable and sensitive data is not a maybe but rather essential. As more valuable data is created, cybercriminals become increasingly motivated to steal the data and sell the data.

Cloudflare (NET) can block over 100 million threats per day. That’s equivalent to more than one thousand threats blocked every second. But all it takes is one breach to cause severe damage for companies and users. Hackers sponsored by foreign governments such as China or Russia account for about 23% of global breaches while organized crime accounts for another 39% of data thefts.

Cloudflare is both an aggressive and dominator recommendation, offering products and services in four cutting-edge fields: cloud computing, AI, cybersecurity, and edge computing.

If you are looking for a good primer on how prevalent cyber-attacks and espionage are across the world, pick up Nicole Perlroth’s book about the cyber-weapons arms race with the provocative title, “This is How They Tell Me the World Ends”. This is not just a geopolitical issue; every time an internet user visits a website, their computer or smartphone pulls it from a server in a data center. Cloudflare ensures a quick upload due to its network of data centers in more than 300 cities around the world.

Safety is just as important as efficiency, so Cloudflare integrates cybersecurity into its services, blocking approximately 170 billion cyberthreats per day.

Its global reach is breathtaking as 20% of all web traffic runs through Cloudflare’s network and over 95% of internet users from 180 countries worldwide access the company’s services each day. And it reaches these users within 50 milliseconds.

The firm’s client list includes more than 30% of Fortune 1000 companies and the ability to efficiently move and connect data – from where it is located to where it is needed (edge computing) – is a massive business opportunity in which Cloudflare already excels.

Cloudflare is a Buy because the company has exceeded the Wall Street earnings consensus by 79% on average over the last four quarters. In the most recent quarter, net income improved 167% on a 32% increase in sales. The number of paying customers rose 17% while those paying over $100,000 a year jumped 34% to more than 2,500.

BUY A HALF

Explorer Weekly Stock Commentary

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.

Explorer Disrupter Recommendations – need to watch more closely and have 20% trailing stop-loss in place

10x Genomics (TXG) shares rose to 45 before pulling back to 42 as we wait for its next earnings report of February 15. Buy a Half.

Exscientia (EXAI) shares were steady this week as this AI-driven biotechnology company continues to partner with mega-drug companies to launch new products. Buy a Half.

Novo Nordisk (NVO) shares zoomed from 105 to 115 after the company reported that sales jumped 36% year-over-year, largely due to the success of Novo’s weight-loss drugs Wegovy and Ozempic. Novo Nordisk’s market value moved beyond $500 billion, becoming only the second European company to achieve this milestone. Hold a Half.

PayPal (PYPL) shares are up a bit since being recommended two weeks ago but this week’s announcement that it plans to cut 9% of its workforce, or 2,500 employees, in 2024 seemingly went unnoticed. The fourth-quarter earnings report for PayPal is due on February 7. PayPal is a digital payments company with 430 million active accounts. If you have not done so already, consider buying this blend of value and innovation. Buy a Half.

SK Telecom (SKM) shares were up slightly on no news as the company accelerates spending on innovation centered on AI Infrastructure, AI Transformation and AI Services. The stock is trading below book value with a solid dividend yield. Buy a Half.

Sociedad Química y Minera de Chile S.A. (SQM) shares tumbled from 48 to 42 this week so we need to limit our downside by moving this lithium stock to a Sell. This is difficult since the stock is incredibly cheap with a dividend yield of nearly 12%. Only very aggressive investors should consider bucking this downtrend. Move from Hold to Sell.

Super Micro Computer (SMCI) shares jumped again this week and are up 86% so far this year. This AI play recently reported a surge in demand for its Nvidia, AMD, and Intel AI platforms. Super Micro is in some ways a leveraged play on Nvidia and other advanced chips for AI since it sells to the servers and systems that incorporate and support those premium chips in data centers. Buy a Half.

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

ConocoPhillips (COP) shares were up a couple of points to 111 as Gulf tensions battle with China’s slowdown leading to oil prices trading within a narrow band. The company will report its next earnings on February 8. Hold a Half.

International Business Machines (IBM) shares gave back a bit this week but over the last month have shot up from 161 to 183. After strong quarterly earnings and cash flow, the stock is benefiting from a sharp uptick in demand for its hybrid AI and cloud computing services. Buy a Half.

Visa (V) shares were up a couple of points this week as consumer spending remained resilient, with last week’s quarterly report showing year-over-year payments volume growth at 8%. U.S. payments volume grew 5% and international payments volume grew 11%. This stock remains a strong, dominating core holding. Buy a Half.

Watch List - BYD (BYDDY): The story remains the same with China’s emerging EV powerhouse: The company’s fundamentals look great, and the growth is impressive. But the stock is stuck in the mud thanks to the aforementioned weakness among Chinese stocks at the moment. We will continue to keep an eye on it.

Explorer ETF/Fund Positions

Global X Lithium & Battery Tech ETF (LIT) offers solid exposure to other beaten-down lithium names at a low cost. With an expense ratio of 0.75%. Buy a Half.

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

Morgan Stanley China A Share Fund (CAF) is a contrarian value play on China’s beaten-down market. Buy a Half

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 summaries that will not change week to week.

Watch List: BYD (BYDDY) 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.

Exscientia (EXAI) was founded in 2012 and based in Oxford, England, Exscientia is using AI to develop new medicines and is attracting high quality partners. Exscientia (EXAI) stock is trading way off its high in an uptrend at 5.83. It went public at 22 a share so the company has about $500 million in cash on the books – a big number for a company with a market capitalization of just $728 million. Finally, keep in mind that this is an attractive speculative stock which may have a bumpy ride. It is a young company that is not and will not be profitable next year.

10x Genomics (TXG) is a leader in the emerging field of “spatial biology,” a cutting-edge life science for making new discoveries about human health and disease. Founded in 2012 and based in Pleasanton, California, 10x builds tools for scientific research to advance human health. Its instruments, reagents and software allow researchers to examine cells and molecules at a resolution and scale never imagined or experienced before. 10x helps researchers look at the roots of biology.

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.

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.

PayPal (PYPL) is a digital payment giant. With 430 million active accounts generating over $1.5 trillion in payment volume annually, PayPal retains a strong leadership position in the e-commerce payment ecosystem. PayPal has been cutting costs and expanding margins and earnings growth. In addition, PayPal’s new CEO is spearheading an innovation drive doubling down on growth efforts and boosting crypto capabilities.

SK Telecom (SKM) is one of the largest telecommunications companies in South Korea and is placing AI at the core of its business. SK Telecom is rapidly transforming into an artificial intelligence (AI) company.

Its affiliate, SK Hynix, is already the world’s second largest memory chipmaker. SK Telecom’s stock was flat in 2023 but importantly, it is the parent of Sapeon, an artificial intelligence (AI) chip startup. Backed by South Korea’s telecom-to-chip conglomerate SK Group, it has launched its latest chip for data centers, joining the global race to develop AI chips with bigger rivals like Nvidia (NVDA).

Super Micro Computer (SMCI), commonly known as Super Micro, manufactures enterprise computer server hardware for cloud computing, artificial intelligence, data storage and telecommunications. Super Micro stock looks relatively inexpensive right now for the growth that it has been delivering. The company trades at just two times sales. Super Micro has two larger rivals, Dell (DELL) and Hewlett Packard (HPE), but it is forecast to grow five to 10 times faster. Furthermore, both Dell and HPE have relatively high debt whereas Super Micro has a net positive cash position. This is an aggressive pick in a sector experiencing extraordinary growth.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. Visa has the largest card network in the U.S., processing $14.8 trillion of payment volume in the last 12 months. Visa’s financial infrastructure also underpins much of the world’s commerce. 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 discount to its archrival MasterCard. This leaves it much better poised to outperform the latter going forward.

The next Cabot Explorer issue will be published on February 15, 2024.

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