Cabot Explorer Issue: June 29, 2023

U.S.-China Rivals Make News in EVs and Semiconductor Investments

Fed Chairman Jerome Powell’s continued warnings of future rate hikes weighed on markets as did the Biden Administration’s suggestion that there should be new restrictions on selling advanced chips to China. Despite this, chip stocks such as Nvidia (NDVA) and the PHLX Semiconductor index were down by less than 1%.

Artificial intelligence (AI) calculations largely take place in data centers full of servers with graphics processing units (GPU)s from Nvidia and its competitors. It is estimated that 20% to 25% of the company’s revenue from Nvidia’s AI chips have been coming from China. To avoid further upsetting Beijing, no action is expected until after Treasury Secretary Janet Yellen’s visit to China in July. Washington is also preparing legislation to screen China-bound investments by U.S. companies. AI, quantum computing, biotechnology and large-capacity batteries are at the top of the list.

To try to close the gap with China, the Biden Administration is issuing a conditional $9.2 billion loan to Ford for the construction of three battery factories.

The new factories that will eventually supply Ford’s expansion into electric vehicles are already under construction in Kentucky and Tennessee through a joint venture called BlueOval SK, owned by Ford and a South Korean battery company.

Ford hopes to make as many as 2 million EVs by 2026, a massive increase from the roughly 132,000 it produced last year.

More than 100 battery and electric-vehicle production projects have been announced or are already under construction in the U.S., representing about $200 billion in total investments.

Meanwhile, electric vehicles’ slice of the light-duty vehicle market inched to a new high last quarter according to Alliance for Automotive Innovation. Models with a plug (fully battery-powered or plug-in hybrids) were 8.6% of the U.S. light-duty market in Q1 – up from 8.5% in Q4 of 2022, and well above the 5.9% share a year before.

Consumer choice in America is growing with 97 EV models available in the first quarter. The top five markets for EV sales in Q1:

1. California (24%)

2. Washington, D.C. (20%)

3. Washington State (17%)

4. Oregon (16%)

In other news, Tesla captured the top four spots on Cars.com’s 2023 list of the top 10 most American-made vehicles. Automotive production is a big source of American jobs – and the origin of vehicles and their parts is important politically. Note that beyond Tesla, Japanese and German automakers have more U.S. content than GM, Ford, and other U.S. automakers.

The rankings:

1. Tesla Model Y

2. Tesla Model 3

3. Tesla Model X

4. Tesla Model S

5. Honda Passport

6. Volkswagen ID.4

7. Honda Odyssey

8. Acura MDX

9. Honda Ridgeline

10. Acura RDX

Finally, the Beyond Zero is Toyota’s new brand and vision with five options, including:

• Hybrid
• Plug-in hybrid
• Fuel cell electric
• Battery-electric

New Recommendation: International Business Machines (IBM)

A Blue-Chip Artificial Intelligence (AI) and India Play with a 5% Dividend Yield

Within the growth technology sector, the sector that has taken off most this year has been artificial intelligence (AI).

You may be wondering whether this is another investment stock mania or a long-term opportunity.

I think it’s both.

The internet, for example, has certainly transformed the world but a lot of investors got burned in the dot.com boom. On the other hand, investors who stayed with established technology companies – like Microsoft (MSFT), Amazon (AMZN), and Apple (AAPL) have done remarkably well.

Artificial intelligence – a field of computer science that focuses on building software for machines to perform intelligent tasks like and even better than humans – or what I call inhuman intelligence – is a disruptive development that’s potentially more powerful than the internet or electricity.

BCA Research believes that AI could boost economic growth by 30X to 100X, roughly comparable to the impact of the agricultural or industrial revolutions.

There is opportunity here and one way to invest is to try to find the new companies in the AI space that will emerge as winners in this competitive space.

Lots of risk and lots of chances for big gains.

A more conservative strategy is to invest in a blue-chip tech stock that support AI, especially if this move is not yet recognized by the market.

Known as “Big Blue,” IBM now primarily helps businesses and governments manage their information technology in the cloud era.

For IBM, the only constant is change. IBM began by making clocks and cheese slicers, and then the punched-card tabulator. After that came one innovation after another: typewriters, vacuum tube calculators, magnetic tape, the first disk drive, the memory chip, FORTRAN, fractals, ATMs, mainframes, mini-computers, personal computers, and supercomputers.

In 2005, IBM’s personal computer business was sold to China’s Lenovo since it was evolving into a low-margin commodity business. Most recently, the company has moved from hardware into a higher margin consulting and services business and is focused on helping clients migrate to the cloud.

IBM does not sit on its reputation. About 6% of its revenue is poured into intensive research and development. This firepower yields thousands of patents each year as the company masterfully leverages its global network of staff and nine research labs. IBM is now an active player in 170 countries and sales to emerging markets have boomed and it might surprise you to learn that about 30% of its workforce is based in India.

IBM has also been blessed with outstanding leadership at the top. Tom Watson is of course famous as the gruff but driven founder, readily handing out cash on the spot for ideas he liked.

Getting back to artificial intelligence (AI), consider that the world now creates astronomical amounts of data each day. AI is the only way to effectively process and use all this information.

It enables computers, robots, and other connected devices to instantly share information and copy human perception, learning, and problem-solving. This allows machines to independently perform specific tasks with increasing accuracy.

It can be argued that IBM is already the world leader in AI.

It has been working on applications in this field for more than four decades and has deeper AI knowledge than virtually any company. Its supercomputer Deep Blue beat world chess champion Gary Kasparov in a six-game match in 1997.

Recently, IBM launched an all-new version of Watson – called watsonx – to help customers create AI applications of their own, to squeeze more value out of their data.

The complicating factor for us is that IBM won’t say how much of its revenue is tied to AI because it is so difficult to break out of each of its market segments.

As IBM CEO Arvind Krishna put it recently...

“Our mainframes have AI circuits – so is the mainframe business AI? I am going to do storage backup in the future with AI – is storage backup AI? Maintenance applications use AI. All of cybersecurity is going to use AI. Before the next five years are done, everything is going to have AI fused inside it.”

IBM is also constantly on the lookout for acquisitions. Just this week it announced it bought software company Apptio for $4.6 billion, marking the seventh acquisition this year as CEO Krishna pushes the company’s transformation into a hybrid-cloud and artificial intelligence business.

Finally, compared many other AI-related stocks that have made major moves already this year, IBM is a bargain.

The stock sells for about 14 times projected earnings for the next 12 months while the S&P 500 multiple is 19 and the information technology sector’s forward earnings multiple is 27.

IBM also has a dividend yield just over 5% and the company has paid a dividend every quarter since 1916 and has had 28 consecutive years of dividend increases. BUY A HALF POSITION

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: None

Butterfly Network (BFLY) shares went from 2.1 to 2.3 this week and this stock has been flat for the last month and YTD. Still, I find the story compelling and keep waiting for a breakthrough as Butterfly recently received FDA clearance for a groundbreaking, AI-enabled product that can empower providers to assess abnormal lung conditions easier, faster, and with more confidence. Hold a Half.

BYD (BYDDY) shares were unchanged this week as the company recently announced the launch of a new “leopard” EV brand featuring a range of vehicles from sports cars to off-road models. BYD has already sold almost a million cars in the first five months of this year, double the previous year’s figure – with hopes for 3.6 million for the year. BYD is the world’s largest producer of electric vehicles including hybrids and the second largest producer of EV batteries. Buy a Half.

ChargePoint (CHPT) shares went to 8.4 this week after announcing on Tuesday that it would start supporting NACS, the standard designed by Tesla, by adding a NACS connector option. This will allow its chargers to be used by almost all EVs. Buy a Half.

ConocoPhillips (COP) shares were up a point this week and have been treading water due to lower oil and energy prices. ConocoPhillips is among the lowest-cost producers, so it can generate a tremendous amount of cash even under the current market situation. Conoco has been delivering 20% net profit margins, a return on assets of almost 17%, and a return on equity of 32%, so it is a great core energy holding. Buy a Half.

Geely Automobile Holdings Limited (GELYF) was steady this week. Hong Kong-based Geely is profitable with last quarter’s sales up 59% and net profit up 50%. Plus, its stock is trading at only about 60% of sales. Buy a Half if you have not already done so.

Novo Nordisk (NVO) is the leader in weight-loss treatment as the company currently has two drugs on the market approved for Type 2 diabetes (Ozempic) and obesity (Wegovy) – both of which are injectables. It also has Rybelsus, its pill for Type 2 diabetes.

In addition, it has an initiative to begin researching new weight-loss drugs that prevent type-2 diabetes and obesity. But there are more competitors coming into the market, so I encourage you to take some partial profits. Hold a Half.

Pfizer (PFE) announced that its submission in the U.S. and EU seeking approval for hemophilia B gene therapy treatment has been accepted for review. A final decision of the FDA and EU is expected in second-half 2024. The stock pulled back a couple of points this week and is trading at a discount to the market at just 11 times forward earnings with a dividend yield of 4.5%. In addition, it delivers an 11.6% return on assets and a 31% return on equity. Buy a Full.

Polestar (PSNY) shares rose from 3.5 to 3.8 this week as the Swedish/China electric vehicle (EV) maker offers the Polestar 4 SUV coupe which goes from 0-100 km/hr. in just 3.8 seconds. Meanwhile, the 2024 Polestar 2 Long Range Single Motor reportedly starts at a reasonable price of $51,300. Polestar still projects 2023 global volumes of 60,000 – 70,000 vehicles sold. Hold a Half.

Solid Power (SLDP) shares were up 13% this week. The advantages of its solid-state battery technology will include higher energy density, longer battery life spans, greater safety, and cost savings over lithium-ion batteries. This is an aggressive Explorer recommendation that comes with both risk and high upside potential. 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.

Butterfly Network (BFLY): Butterfly’s breakthrough software can be tied into a medical network to provide instantaneous images and improve both the speed and quality of healthcare. This is so much better than scheduling a test in a week and then having the patient come back and must pay for another appointment.

While an MRI machine can cost more than a million bucks, the Butterfly iQ+ costs a little over $2,000. The top 100 hospitals in the country already use Butterfly iQ devices.

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.

ChargePoint (CHPT) is an industry leader in electric vehicle EV charging. ChargePoint operates in both North America and Europe, with more than 225,000 charging points on its networks. ChargePoint has more than 5,000 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 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.

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%. Volvo sales of fully electric cars nearly doubled to account for 17% of total sales.

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 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 annual revenue of $100 billion. Over the next 18 months it expects to launch at least 19 new products.

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 for two reasons. 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 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 partnerships 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 13, 2023.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld