Cabot Explorer Issue: July 27, 2023

Federal Reserve Raises Interest Rates – Market Gains Broaden

The Federal Reserve resumed lifting interest rates Wednesday with a quarter-percentage-point increase that brings interest rates to a 22-year high. The decision was unanimous.

The benchmark federal funds rate will go to a range between 5.25% and 5.5% as the Fed continues its fight against inflation. This is the 11th increase since March 2022, when rates were near zero.

Inflation has already retreated from a four-decade high last summer and the consumer-price index was up 3% in June year over year which is much lower than the June 2022 peak of 9.1%.

Stock gains, which this year have been concentrated in the “magnificent seven” leading stocks, seem to be broadening with the equal weight S&P 500 index recently outperforming the market value-weighted S&P 500 index. This is a good sign.

GDP numbers for the second quarter are out this morning with expectations of around a 1.7% growth rate. Growth comes from only three places: more people, more capital or better use of workers and capital, in other words, higher productivity.

Volkswagen announced plans yesterday to invest $700 million into Chinese EV maker Xpeng, taking a 4.99% stake, and jointly develop EVs for China.

Also yesterday, General Motors, Stellantis, Hyundai, Kia, Honda, BMW and Mercedes-Benz formed a joint venture aiming to become “the leading network of reliable high-powered charging stations in North America.” The group will compete not only with Tesla, but also with other charging networks like Electrify America, EVgo and ChargePoint.

Our new Explorer recommendation this week goes to the heart of the electric vehicle and tech supply chain to a little-known European company with roots going back to 1805.

New Recommendation: Umicore SA (UMICY)

Starting next week, China will impose stricter controls on the export of two critical tech metals, gallium and germanium.

This new regulation is a reaction to the U.S.’ efforts to cut China off from the supply of modern semiconductor chips. The Middle Kingdom occupies a dominant position in semiconductor material inputs but has not yet been able to catch up technically with the chip industry of South Korea or Taiwan, and America and others want the status quo to continue.

Just one day after China’s above announcement on gallium and germanium, plans leaked out from the U.S. government to prohibit Chinese companies from accessing some cloud computing services, from companies like Amazon and Microsoft.

China no doubt will use its significant leverage in the technology supply chain to continue to push back. This extends from the mine through refining/processing to the manufacture of tech hardware. China now accounts for as much manufacturing output as America, Japan and Germany put together.

What is sometimes misunderstood is that most of what China refines and processes is not mined in China but around the world in mines that China owns, or controls through long-term supply contracts.

Take cobalt, a critical mineral which is a byproduct of copper and nickel mining and vital to America’s economy and military. This element is necessary for lithium-ion batteries in electric vehicles, superalloys in jet engines, and permanent magnets in advanced electronics. Without cobalt, neither America’s clean energy revolution nor its high-tech military modernization is possible.

The cobalt market today depends significantly on a single country: the Democratic Republic of the Congo (DRC). The country possesses 46% of global cobalt reserves with only 0.9% in the United States.

Chinese-backed companies own or have financial interests in fifteen of nineteen cobalt mines in the DRC, granting China control over about 50% of the DRC’s cobalt mining capacity. Consequently, China wields significant influence over the world’s cobalt ore supply.

China’s real leverage is on the refining/processing side of the commodity equation. China refines 72% of the world’s cobalt, while the United States refines zero percent.

While getting cobalt ore is one thing, coming up with ways to refine it more cleanly and recycle is another more pressing concern.

This why companies such as Volkswagen are searching the world, from Canada to Indonesia, for battery supplies for electric vehicles it sells in the U.S. and Europe that are now 100% reliant on China with the goal to reduce that number to below 50% as soon as possible.

To build up its ex-China processing/refining capabilities, VW is teaming up with this week’s recommendation, Umicore SA (UMICY), a materials technology company based in Brussels, Belgium. 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 going back to 1805 and has evolved into more of a processing and recycling technology company, changing its name to Umicore SA in 2001.

Umicore’s leading battery materials technology portfolio consists of nickel, manganese, cobalt technologies, manganese-rich lithium and solid-state battery technologies. Just last month Umicore inaugurated one of the world‘s largest and most advanced solid-state battery material prototyping facilities in Olen, Belgium, which will expand and accelerate its innovation and technology development.

Perhaps the best way to understand Umicore is through the below slide from its investor presentation which highlights its circular approach to critical metals, which of course includes recycling.

The company, which spends 6.7% of revenue on research & development and delivers a 17% return on equity, is a rather conservative way to play critical metals on the refining rather than mining side.

UMICY is also a stock in an uptrend (+8.8% in July), though its share price is down about 17.5% in 2023, giving us an attractive entry point. 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 – positions we need to watch more closely

Portfolio Changes: None

BYD (BYDDY) shares have risen from 64 to 69 in the last month as we await earnings, expected tomorrow. The company, which went all-EV last year, is targeting 3 million vehicle sales this year, with hopes for 3.6 million, nearly doubling vs. 2022. June sales surged 88% vs. a year earlier. BYD also announced big plans to invest in India and Brazil. Buy a Half.

Geely Automobile Holdings Limited (GELYF) shares were up 7% this week and the company is in a strong position to gain market share. Last quarter’s sales were up 59% and net profit was up 50%. Buy a Half.

Neo Performance (NOPMF) shares dipped from 6.8 to 6.5 this week. Neo manufactures advanced tech and industrial metals and materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys – all using rare earths and critical metals. Neo stock is also an excellent hedge on rising U.S.-China tensions. Buy a Half.

Novo Nordisk (NVO) shares retraced to 158 this week as we await earnings on August 2. I expect sales to remain strong for this Danish drugmaker but have been advising over the past several weeks to take some profits. There are more competitors coming into the market so I will leave this a hold for now. Hold a Half.

Polestar (PSNY) shares are up 23% in July and were little changed with no news this past week. Polestar will soon have access to Tesla’s expansive Supercharger network for all Polestar drivers in the United States and Canada. Hold a Half.

Solid Power (SLDP) shares are up 18% in the last month, but this week went from 2.8 to 2.6 with no news. Solid Power seeks to develop breakthrough high-density, solid-state battery technology. This is an aggressive Explorer recommendation. Buy a Half.

Explorer Multinational Blue-Chip Recommendations - More Buy and Hold

ConocoPhillips (COP) shares added another five points this week as energy prices rebound. This is among the lowest-cost producers which delivers a relatively strong cash flow. Conoco is a quality core energy holding. Buy a Half.

International Business Machines’ (IBM) latest earnings were solid but underwhelming with revenue slightly under expectations and net profit slightly better. Bright spots were software sales up 7% and Red Hat cloud sales up 11% year over year. IBM is a play on data, software, cloud computing, and artificial intelligence (AI). IBM shares trade at just 14 times forward earnings and 12 times the expected free cash flows of 2023. Buy a Half.

Pfizer (PFE) shares are only up marginally in the last month but deliver a 4.5% dividend yield and trade roughly 11.1 times projected earnings. The leading drugmaker also plans to launch 19 new drugs within the next 18 months. Earnings are due out next Tuesday, August 1. Buy a Full Position.

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, 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.

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. It also owns the London Electric Vehicle Company, which produces electric black cabs. Volvo is majority-owned by Geely.

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.

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 out 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.

The next Cabot Explorer issue will be published on August 10, 2023.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld