Cabot Explorer Issue: June 20, 2024

Portfolio Changes: Franco-Nevada (FNV) – Move from Buy a Full Position to Watch List

Energy Rules the World

Explorer stocks had a good week led by Super Micro (SMCI) up 20% and Cloudflare (NET), up 9%, as PayPal (PYPL) has struggled a bit as it launches a new, higher-margin digital ad business. The S&P 500 is up 14% so far this year but the 10 biggest stocks recently represented almost 37% of the index’s total value, the highest since September 2000, according to FactSet. Use caution and take partial profits if you have some of these in your portfolio.

We have been discussing some great companies and breakthrough technologies, but it is easy to overlook that energy is the foundation of economic and technological development. It is also at the core of how countries secure and project national power. China and the U.S., in that order, are the world’s two largest producers and consumers of energy.

Energy demand is set to jump as Goldman Sachs estimates that data processing and storage power demand will grow 160% by 2030. Why? Because AI chips use so much electricity for even basic searches. This means that companies looking to make AI chips faster are going to need a larger share of world electricity output. That additional power will have to be sourced from coal, natural gas, renewables, and nuclear power.

Before outlining today’s new Explorer recommendation, let’s step back for some perspective.

About 60% of the reduction in CO2 emissions during the past 15 years has come from switching from coal to natural gas. Renewables have expanded but have only made a small dent in the world’s dependence on fossil fuels. This leaves the growth of nuclear energy as the only other cleaner solution to generating the world’s energy needs. Nuclear energy is virtually emissions-free energy, takes up very little land, consumes very little fuel, contributes to fuel diversification and the stability of the grid, creates skilled, well-paid jobs, and produces very little waste.

Then there is the important issue of reliability. Nuclear power plants on average operate at full power 336 out of 365 days per year. Hydroelectric systems deliver power on average 138 days per year, wind turbines 127 days per year and solar electricity only 92 days per year. Even plants powered with coal or natural gas only generate electricity about half the time for various reasons. Nuclear power is a clear leader on reliability.

In addition, nuclear plants can run for 100 years while solar panels and wind turbines last only about 20 years. No wonder nuclear power accounts for 70% of France’s electricity mix and 30% for Switzerland, South Korea, and Sweden.

In the public’s perception, there are two issues with nuclear power: the risk of accidents, and the question of disposal of nuclear waste.

There have been three large-scale accidents involving nuclear power reactors since the onset of commercial nuclear power in the 1950s, but these incidents all represent old technology and that is one reason Japan recently announced it is expanding nuclear energy.

Nuclear waste disposal, although a continuing political problem in the U.S., is no longer a technological problem. More than 90% of spent fuel could be recycled to extend nuclear power production by hundreds of years and can be stored safely in impenetrable concrete-and-steel dry casks on the grounds of operating reactors, its radiation slowly declining.

Advanced nuclear energy can be cheaper than natural gas, more dependable than solar or wind, and as it scales up it could be even cheaper than coal when you take into consideration costs of emissions.

The United States has long led the world in developing nuclear energy technologies, providing about 30% of global nuclear energy production and 52% of America’s own carbon-free electricity in 2020, according to the Department of Energy, even though American commercial nuclear development has markedly slowed.

China is now the leader with plans for at least 150 new reactors over the next 15 years. In comparison, the nuclear fleet in Western economies is 35 years old on average and many plants are nearing the end of their designed lifetimes. With advancing age, plants are beginning to close, with 25% of existing nuclear capacity in advanced economies likely shutting down by 2025.

In addition, the U.S. Navy has a long and impressive history with nuclear technology and the future of the nuclear Navy is secure. It has its own design and research laboratories, supports its own extensive computing capabilities, and trains its own operators. While any expansion of nuclear technology in America should be commercially led, the Navy could support the development of human capital in the nuclear field by expanding cooperation with universities and industry.

There are significant American beachheads to support and validate the expansion of nuclear energy in America. For example, for Duke Energy (DUK), 40% of the electricity the company produces comes from nuclear power. America has 94 reactors that generate about 20% of our electricity but we have not built one new plant in the last 25 years.

Bill Gates has explored the development, through his startup TerraPower, of simpler, cheaper reactors since 2008 and expects to complete a new reactor in 2030, stating just last week that, “I put in over a billion, and I’ll put in billions more.”

Gates is banking on costs coming down with scale so that nuclear can even compete with coal.

But achieving scale will require fuel, and this brings me to our new recommendation.

New Explorer Recommendation

Centrus Energy (LEU)

Centrus Energy, based in Bethesda, Maryland, supplies nuclear fuel and services for the nuclear power industry in the United States, Japan, and Europe.

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. Drawing on decades of experience, Centrus can help with the design and manufacture of critical components as well as design and licensing of facilities to produce new fuels.

One catalyst for this stock is that Washington is demanding that U.S. companies buy enriched uranium directly from domestic producers to wean the U.S. off Russian imports of the nuclear-reactor fuel. Russia accounts for about 23% of the enriched uranium needed to power U.S. commercial nuclear reactors.

Energy Department officials are making the case that any interruption in the supply of enriched Russian uranium could cause operational disruptions at commercial nuclear reactors.

Their proposal aims to spur development of more domestic enrichment and other steps needed to turn uranium into reactor fuel. This would create a government buyer directly purchasing enriched uranium, including the type used in a new breed of advanced reactors now under development.

Right now, America has only one remaining commercial enrichment facility – a New Mexico plant owned by Urenco Ltd., a British-German-Dutch consortium. Other backers of expanding U.S. enrichment capabilities include Senator John Barrasso, a favorite of mine and a Wyoming Republican who serves as the top GOP member of the Energy and Natural Resources Committee.

Centrus Energy is building an enrichment facility in Ohio and would be very likely to benefit especially if federal funding moves forward to support this and other nuclear projects.

In addition, Centrus stock has pulled back 23% so far this year and is trading at just nine times trailing earnings with a profit margin of 24%.

I believe Centrus stock will benefit from increasing demand for its services, and that downside risk is low while upside potential is significant.

Buy a Half

Explorer Weekly Stock Commentary

ASML Holdings (ASML) shares were steady in their second week as an Explorer recommendation as the U.S. government requested it further restrict selling its more advanced technology products and services to China. ASML makes the lithography equipment that manufacturers use to make advanced chips. By 2026, ASML’s revenue could reach at least $40 billion as the market for AI chips is projected to grow at an annual rate of 36% through 2030. This is an aggressive stock trading at a high multiple to earnings so we can expect some volatility. Buy a Half

Cloudflare (NET) shares were up about 9% this week. This cybersecurity stock has a deep and wide client base coupled with impressive network speed that beats competitors such as Amazon and Google. Buy a Half

Franco-Nevada (FNV) shares are trading within a narrow range in line with gold prices. Given that this is a core gold asset allocation play with little news week to week, I’m moving this stock to our watch list. The company provides funding to hundreds of mining companies to develop new gold, silver, copper, platinum, and other mining projects. Move from Buy a Full Position to Watch List

Neo Performance (NOPMF) shares jumped out of the gate this week to over 6 a share after an upgrade by leading mining and metals broker Stifel, but in the last couple of days pulled back to where it started the week. The company also announced a strategic board review to maximize shareholder value. Neo remains a buy due to its strategic importance, trading at a 50% discount to book value, with a nice dividend, and a strong cash position coupled with low debt. Buy a Half

Novo Nordisk (NVO) shares were largely unchanged as the company faces political pressure on the high pricing of its products in the United States. A Wegovy prescription costs about $1,349 per month in the U.S., while it costs just $140 in Germany and $92 in the U.K. Novo Nordisk’s Ozempic product carries similar markups. Novo’s CEO is expected to testify before a key Congressional committee soon. Novo is in a strong position in this huge and growing market. Hold a Half

PayPal (PYPL) shares were down 8.7% this week. The issue is that while revenue is growing, it is from lower-margin opportunities, so cash flow and profits are weak. The stock does represent good value trading at 16 times earnings and, more importantly, the company just launched a digital advertising business which is a high-margin business. Uber did the same in late 2020 and this venture took off quickly, so we’ll give this stock a bit more time. Hold a Half

Sea Limited (SE) shares again made gains this week and this stock is now up 88% so far this year. The beginning of a turnaround in its crucial Garena gaming group is progressing and its digital entertainment properties, including its leading mobile title, Free Fire, have a massive user base of 595 million people. Its Shopee e-commerce platform is dominant in Southeast Asia. Buy a Half

Super Micro Computer (SMCI) shares were up about 20% this week as the company announced it was adding three new manufacturing facilities to meet increased production demands and support the growth of demand from its clients. Supermicro benefits not only when Nvidia releases new advanced chips but when other leading chipmakers do so as well. This aggressive stock is at the heart of the AI boom. Hold a Half

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

International Business Machines (IBM) shares inched up to 170 despite the company’s AI pilot project with McDonald’s drive throughs did not work out highlighting that AI applications will take time to develop. IBM’s software and cloud consulting sides will deliver steady growth and the stock is a smart, conservative AI play. Buy a Half

Unilever (UL) shares were unchanged this week and are up about 17% so far this year. This is a classic, reliable, long-term play on global consumer spending and particularly international and emerging consumer growth markets. Buy a Half

Visa (V) shares were steady this week as there are over 4.3 billion Visa-branded credit, debit, and pre-paid cards in circulation today and 61% of all credit card transactions in the U.S. were done with Visa cards last year. Some analysts expect the company’s sales to increase 20% this year. Buy a Half

Watch List

• BYD (BYDDY)
• ConocoPhillips (COP)

Explorer ETF/Fund Positions

Aberdeen Asia-Pacific Income Fund (FAX) is a close ended fixed income mutual fund launched and managed by Aberdeen Standard Investments (Asia) Limited in Singapore. Buy a Half

Grayscale Bitcoin Trust (GBTC) offers investors a way to track very closely to the day-to-day or “spot” movement of bitcoin prices. For aggressive investors comfortable with volatility. Buy a Small Allocation

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) offers exposure to a basket of the largest Chinese-listed stocks. 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’s Japan Hedged Equity ETF (DXJ) offers exposure to a broad basket of dividend-rich Japanese stocks hedging for yen currency fluctuations. Buy a Full

Model Portfolio

ETFs

Explorer Stocks Summary

Brief company summaries that will not change week to week.

ASML Holdings (ASML) makes the lithography equipment that use to make advanced chips. It is currently the only company that makes cutting-edge extreme ultraviolet lithography (EUV) machines that are used to make the world’s most advanced and expensive semiconductor chips. That is at the seven nanometer (nm) and below size and standard. I would argue that this company has a stronger competitive position than even Nvidia does given its highly prized specialty. This gives ASML significant pricing power and a wide economic moat, making it highly profitable as it sells some of these machines for close to $400 million apiece.

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.

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

Watch List: 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.

Franco-Nevada (FNV) is a company with more than half of its revenue coming from gold, but it also offers exposure to platinum, silver, and oil and gas. Franco-Nevada’s focus on royalties and streaming reduces risk and enables it to sidestep the huge capital costs that impact traditional miners. It enjoys cash flow and profits as its mining partners finance and complete exploration and expansion projects. That cash flow enables it to invest in new deals, pay a dividend, and operate debt free. Franco-Nevada has increased its dividend each year since its IPO in 2008.

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 permanent magnets and powers many modern 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 permanent magnets. 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 stock is down 4% this year as rare earth stocks have pulled back due to weak prices; the stock trades at just 19 times forward earnings and 54% of book value. Neo also has ample cash and very low debt levels. The stock also offers us an excellent hedge on China/Taiwan risk, a forward 5.3% dividend, and incentives are aligned with about 20% of the outstanding stock held by management.

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 its weight-loss drugs, Ozempic and Wegovy, 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.

Sea Limited (SE) has three core businesses: 1) digital gaming/entertainment, 2) e-commerce, and 3) digital payments and financial services, known as Garena, Shopee, and SeaMoney, respectively. Garena is a leading global online games developer and publisher. Shopee is the largest e-commerce platform in Southeast Asia and Taiwan. SeaMoney is a leading digital payments and financial services provider in Southeast Asia. Some of you may recall this stock was an Explorer recommendation in the fall of 2019 at around $30 and became more than a 10-bagger to its 2021 high.

Super Micro Computer (SMCI), commonly known as Supermicro, 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.

Unilever (UL) is a dominant consumer goods giant with a trove of recognizable 400 brands in its diversified portfolio- from Vaseline to Dove - that it sells in over 190 countries. However, thirty “power brands” account for almost 75% of Unilever’s total sales. It is a steady, stable stock for an uncertain environment and for a change, its stock is selling at a rare discount – down about 12% from all-time highs and at about two times sales. Two other reasons I like Unilever are that 78% of its sales are outside North America and almost 60% are from emerging markets that offer higher consumer sales potential due to better demographics.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. 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 July 18, 2024.

Copyright © 2024. All rights reserved. Copying or electronic transmission of this information without permission is a violation of copyright law. For the protection of our subscribers, copyright violations will result in immediate termination of all subscriptions without refund. Disclosures: Cabot Wealth Network exists to serve you, our readers. We derive 100% of our revenue, or close to it, from selling subscriptions to our publications. Neither Cabot Wealth Network nor our employees are compensated in any way by the companies whose stocks we recommend or providers of associated financial services. Employees of Cabot Wealth Network may own some of the stocks recommended by our advisory services. Disclaimer: Sources of information are believed to be reliable but they are not guaranteed to be complete or error-free. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. Buy/Sell Recommendations: are made in regular issues, updates, or alerts by email and on the private subscriber website. Subscribers agree to adhere to all terms and conditions which can be found on CabotWealth.com and are subject to change. Violations will result in termination of all subscriptions without refund in addition to any civil and criminal penalties available under the law.