Cabot Explorer Issue: July 13, 2023

Supply Chain Superpower China Pushes Back

Inflation cooled last month to its slowest pace in more than two years, buoying markets even though the Fed may raise interest rates later this month.

While the Nasdaq composite is a basket of more than 3,000 stocks listed on the Nasdaq exchange, the Nasdaq 100 is the basis for the QQQ – the second-most heavily traded ETF in America, after the SPY ETF which tracks the S&P 500.

You should be aware that Nasdaq announced late last week that it plans to carry out a “special rebalance” on July 24 to redistribute weights after the sharp run-up in the QQQs led by seven mega-cap stocks.

In other news, Mexico is replacing China this year as the United States’ top trading partner. This highlights the “reshoring” trend that I have mentioned a few times. Even some Taiwanese companies are shifting some manufacturing to Mexico.

While Japan and some other Asian markets are having a good year, many overseas markets are struggling. Hong Kong’s Hang Seng index is negative for the year, while the Shanghai Composite has gained just 3.5%. The Xtrackers Harvest CSI 300 China A-Shares ETF (ASHR), representing 300 domestic Chinese companies, is down 4% in 2023. It ranks 41st among the 49 country ETFs that I track.

On the positive side, Europe’s Stoxx Europe 600 index is up 5.4% for the year

Turning to U.S. electric vehicle (EV) sales, they account for about 6.5% of the U.S. auto sales so far this year and are expected to exceed 1 million units for the first time in 2023. More than 30 new models are arriving this year, according to Cox Automotive.

A key question is whether sales will keep up with production. The supply of EVs in inventory is now more than 92,000 units. That’s more than three months’ worth of EVs, and nearly twice the industry average.

Japan has been seen as a bit of a laggard in the EV race but a new prototype car from Sony and Honda under the brand name “Afeela” is getting a lot of attention. It features Sony’s tech and entertainment products, including AI, augmented reality and virtual reality and is powered by a partnership with Qualcomm, whose semiconductors and chipsets power the car’s software experience. The Sony-Honda joint venture plans to start taking orders in 2025, with U.S. deliveries set to begin in 2026.

Then there is the development by Toyota which I mentioned a few weeks ago. The company says it can manufacture solid-state batteries giving EVs a range of 745 miles and a 10-minute charge time by 2027. Smaller, faster, and cheaper is the holy grail of EVs.

The production of all these products begins with a limited number of elements in the ground, better known as critical minerals. This week we recommend a smaller but key player in the complex but vital technology supply chain.

My goal is to complement some of the blue-chip Explorer recommendations with some more aggressive ideas to help you with your goal of buying securities that maximize returns for a given level of risk, consistent with your personal financial goals and time horizon.

New Recommendation: Neo Performance Materials Inc. (NOPMF)

As I have been predicting, the big news last week was China announcing plans to restrict exports of gallium and germanium, two critical metals used in semiconductors, defense technologies, and the renewable energy sector.

Beginning in August, Chinese sellers of these materials will have to apply for a dual-use export license from China’s Ministry of Commerce. That gives the Chinese government greater power on which foreign buyers can obtain the metals, and in what quantities.

China controls 98% of the world’s supply of gallium and 68% of the world’s germanium. Strict controls could hamper production of an array of items such as automobiles, fiber-optic cables, and many advanced defense systems.

This demonstrates China’s growing leverage as a supply chain and critical metals superpower, and the willingness to use this power to push back America and its other rivals.

The supply chain for commodities both rare and common goes from ore from the mine to the refinery, to metal making, and finally into the manufacturing of end products such as laptops and smartphones. China has a clear lead right down the line in almost all these areas.

Neo Performance Materials Inc. (NOPMF) manufactures the building blocks of many modern uses of these 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.

Neo Performance Materials announced last week that it has started construction of a manufacturing facility in Europe to produce rare earth permanent magnets, which are key for electric vehicles, wind turbines, and other products. Neo’s manufacturing facility in Narva, Estonia will be near its existing rare earth separation plant in Sillamäe, Estonia.

The development comes at a time when dependence on China for key materials and technologies has become a major issue for Western countries, with some countries ramping up support to boost domestic production of critical minerals including rare earths.

Rare earth permanent magnets are used in a wide variety of technologies that increase energy efficiency and reduce carbon dioxide emissions. These magnets are especially integral to the drivetrains of many electric vehicles manufactured, where they increase the power and efficiency of the motors.

Neo offers us an excellent hedge on China/Taiwan risk, a forward 4.5% dividend, and I like that insiders control about 20% of the outstanding stock. 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.

Portfolio Changes: ChargePoint (CHPT) – Move from Buy a Half to Hold a Half

BYD (BYDDY) shares gained another point this week as June sales surged 88% vs. a year earlier and were up from 240,220 in May and 210,295 in April. In the first half of 2023, BYD, China’s EV leader, sold 1,255,637 EVs with a 2023 goal of selling at least three million vehicles. Buy a Half.

ChargePoint (CHPT) shares were up 6% this week to close at 9. In the wake of a recent announcement that it would start supporting the North American Charging Standard (NACS), the standard technology designed by Tesla, I have reassessed the stock and do not find this step to be favorable for ChargePoint since it commoditizes the market. This conclusion plus stock dilution and negative cash flow prompts me to move the stock to a hold. Move from Buy a Half to Hold a Half.

ConocoPhillips (COP) shares had another good week moving from 103 to 109, fueled by a recovery in oil and gas prices. ConocoPhillips is among the lowest-cost producers, so it can generate a tremendous amount of cash even under the current market situation. Conoco is a quality core energy holding. Buy a Half.

Geely Automobile Holdings Limited (GELYF) was steady this week as China stocks in general underperform. Geely is in a strong position to gain market share in China and overseas markets. Last quarter sales were up 59% and its net profit surged 50%. Buy a Half.

International Business Machines (IBM) was unchanged this week as the company weighs the use of AI chips designed in-house to lower the costs of operating a cloud computing service it made available this week. IBM is a blue-chip play on data, cloud computing, and artificial intelligence (AI). The stock sells at a discount to both the S&P 500 and the information technology sector. IBM has paid a dividend every quarter since 1916. Buy a Half.

Novo Nordisk (NVO) pulled back a bit to 155. Sales remain strong but there are more competitors coming into the market, so I again encourage you to take some partial profits. Hold a Half.

Pfizer (PFE) shares reflect the relative weakness of the healthcare sector this year. But the fact that its dividend yield is over 4%, the stock trades at only about 10 times forward earning projections, and this pharma giant plans to launch 19 new drugs within 18 months are some of the reasons to buy the stock. Buy a Full.

Polestar (PSNY) shares were up 12% this week following last week’s 11% gain as strong deliveries in the month of June, up 73% year-on-year, led to Polestar achieving its best second quarter. Last week, Polestar signed an agreement with Tesla to adopt the new North American Charging Standard (NACS) which will enable access to Tesla’s expansive Supercharger network for all Polestar drivers in the United States and Canada. Hold a Half.

Solid Power (SLDP) shares broke above 3 on Tuesday before finishing the week with a 12% gain. Competing with giants like Toyota, Solid Power’s solid-state battery technology benefits include higher energy density, longer battery life spans, greater safety, and cost savings over lithium-ion batteries. This is an aggressive Explorer recommendation. Buy a Half.

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 11%. 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 the leaders, if not the leader, of the EV revolution in terms of size, scale, and growth.

ChargePoint (CHPT) is an industry leader in electric vehicle charging. ChargePoint operates in both North America and Europe, with more than 225,000 charging points on its networks. ChargePoint has more than 5000 fleet and commercial customers worldwide. The company has a 70% market share in the level 2 charging market in North America, giving it a powerful advantage over even its closest competitor.

ChargePoint has posted seven quarters in a row of increasing revenue with full-year revenue for fiscal ’23 showing a year-over-year gain of 94%. We need to accept the company’s heavy investments in growth; profits will appear as the company monetizes and leverages its charging network.

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 proven 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.

Follow Warren Buffett into big oil and take a stake in the Arctic by purchasing a half position in Conoco, which is trading at just eight times trailing earnings. The company also delivers 20% net profit margins, a return on assets of almost 17%, and a return on equity of 32%.

Geely Automobile Holdings Limited (GELYF), headquartered in Wan Chai, Hong Kong, is a nice complement to Explorer recommendation BYD (BYDDY), China’s electric vehicle (EV) leader. Geely also owns Lotus in the U.K. and half of Mercedes’ Smart brand. It also owns the London Electric Vehicle Company, which produces electric black cabs. Then there is the Volvo car connection. Volvo, which is majority-owned by China’s Geely, has stated that sales in China were up 46% in 2022. Volvo sales of fully electric cars nearly doubled to account for 17% of total sales.

International Business Machines (IBM) is a blue-chip artificial intelligence (AI) 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 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.

Pfizer (PFE) says more than a quarter of a billion patients 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. Annual revenue tops $92 billion as the company closes in on $100 billion. Over the next 18 months it expects to launch at least 19 new products over this period.

Key launches this year include vaccines for respiratory syncytial virus (RSV) and meningitis, as well as drugs to treat atopic dermatitis and multiple myeloma – a blood cancer. Pfizer is also pushing ahead with a diabetes and weight-loss product that will be taken orally that is now in clinical trials and could generate annual sales of $10 billion.

Polestar (PSNY) is a Swedish premium electric vehicle manufacturer. Founded by Volvo and Zhejiang Geely Holding Group in 2017, Polestar enjoys technological and engineering synergies with Volvo. Polestar cars are currently manufactured in China, with 2024 manufacturing planned in America. Polestar has an edge on much of the competition because it has an “asset light” strategy through access to world class owner/partner Volvo’s factories. For 2023, Polestar anticipates global volumes to increase by nearly 60% to approximately 80,000 cars.

Solid Power (SLDP) is a Colorado-based developer of all-solid-state battery and sulfide-based electrolyte technology. Solid Power replaces the flammable liquid electrolyte in a conventional lithium-ion battery with a proprietary sulfide-based solid electrolyte.

Solid Power’s all-solid-state battery cells are expected to be safer and more spread across a broad temperature range, offer an increase in energy density compared to the best available rechargeable battery cells, and enable less expensive, more energy-dense battery pack designs. The company has a partnership with BMW and Ford and received a $5.6 MM U.S. Department of Energy (DOE) award to continue its development of nickel- and cobalt-free solid-state battery cells.

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.

WisdomTree Emerging Markets High Dividend Fund (DEM) offers a high dividend yield and some of the highest quality emerging market stocks. This ETF gives broad exposure with an emphasis on income and value.

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

The next Cabot Explorer issue will be published on July 27, 2023.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld