Cabot Explorer Issue: June 6, 2024

Portfolio Changes: None

From D-Day to the “Chip War”

The S&P 500 closed yesterday at another record, as tech stocks fueled gains and investors increasingly see a rate cut approaching. Nearly $890 million flowed into bitcoin ETFs yesterday.

This morning, from Normandy to Washington, D.C., there will be ceremonies honoring the 80th anniversary of D-Day. I will be there as the number of veterans who participated in that historic event is dwindling as is the number of people that understand how challenging and costly Operation Overlord was to pull off.

Now, we are amidst a different type of struggle, and semiconductor chips are at the heart of it all as brought to life in Chris Miller’s great book, Chip War: The Fight for the World’s Most Critical Technology. This is a must read.

In 1990, the U.S. and Europe accounted for a combined 80% share of chip manufacturing worldwide. Now it’s Asia with the 80% share driven by lower costs, fast construction times, government support, a skilled workforce, and a well-established supply chain. While America may lead in the high-margin area of chip design, the two most important players in producing chips are Taiwan and South Korea, followed by Japan, with China trying to catch up. About 40% of the value of Taiwan’s exports are chips, with South Korea at 20%. South Korean President Yoon Suk Yeol described the competition as “an all-out war between countries.” The country is putting forward $450 billion to develop what it hopes will be the world’s biggest chip-making cluster in South Korea, with 37 factories spread across eight cities.

The U.S. dollar’s strength has eroded U.S. exports and aided Asian chip exports by making them cheaper. It also continues to have an impact on the investment landscape. Against other currencies, the greenback is still below its 2022 peak. Perhaps in anticipation of a weaker dollar, international markets appear to be in “catch-up” mode. This is an opportunity as markets outside of North America have only returned about 200%, compared with roughly 500% for the S&P 500. When will reversion to the mean happen?

Finally, many say that politics don’t affect stock markets, but Mexican markets cooled as investors fear that the incoming president will lead to a less business-friendly environment. India’s hot market pulled back this week as Prime Minister Narendra Modi will now have to share power leading to a weakened mandate for economic reforms. About half the global adult population will go to the polls at some point in 2024.

Britain’s Royal Navy, the most powerful in the world at the outset of World War II, now has just 10 submarines and two dozen major surface warships. It could be argued that one Dutch company, today’s new Explorer recommendation, is more important than all that put together.

New Recommendation

ASML Holdings (ASML)

There are some companies and stocks that you find intriguing but expensive, so you watch and wait for an opening.

This is the case with ASML which makes the lithography equipment that manufacturers such as Taiwan Semiconductor (TSM) 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. This is the price for the most strategically important product in the world, critical to manufacturing AI chips using its EUV lithography technology.

ASML’s business is highly cyclical as it sells only about 100 of its expensive machines each quarter, and while revenue was down in its most recent quarter, it is expected to return to growth in the second half of the year and into 2025.

ASML received net orders worth 3.6 billion euros in the first quarter, down from the 9.2 billion euros worth of bookings it booked in the fourth quarter of 2023. As you would expect, its shares have pulled back a bit from their March 7 high, making now a good time to buy shares of ASML.

Importantly, despite the weak quarter, the company has maintained its full-year revenue guidance and expects its business to pick up sharply in the second half of the year. Supporting this optimism is its backlog of 38 billion euros, which should enable ASML to hit its 2024 revenue target of 27 billion euros as well as a solid follow-on year in 2025.

In 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, providing the company with a nice tailwind.

This is an aggressive stock trading at a high multiple to earnings and sales so you may want to move incrementally in building a position.

Buy a Half

Model Portfolio

ETFs

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.

Cloudflare (NET) shares were off 7% this week, falling from 75 to 70. We need to draw the line here at 70. If it does not move up off this level, I’m going to move this to a sell. This is disappointing since Q1 revenue came in at $379 million (up 30% year over year). This cybersecurity stock has more than 300 data centers and its network speed beats competitors such as Amazon and Google. Buy a Half

Franco-Nevada (FNV) shares finished the week at 120 as the consensus analyst target price for 2024 is at 140. The company provides funding to hundreds of mining companies to develop new gold, silver, copper, platinum, and other mining projects. For the upfront capital, Franco-Nevada receives royalty payments for the life of the mine’s revenue. Buy a Full

Neo Performance (NOPMF) shares are showing good momentum, ending the week at 5. Neo remains a buy due to its strategic importance, trading at a 50% discount to book value, a nice dividend, and a strong cash position coupled with low debt. Buy a Half

Novo Nordisk (NVO) shares have regained some momentum, advancing from 134 to 141. There is increasing competition in this market, but Novo is in a strong position in this huge and growing market. Hold a Half

PayPal (PYPL) shares finished up this week at 64, which is a far cry from its pandemic-fueled high of 308. A good sign is that transaction margins are increasing, and the stock is cheap, trading at 16 times earnings and 2.2 times sales. PayPal processed 6.5 billion payments by about 400 million customers in the first quarter alone. Hold a Half

Sea Limited (SE) shares were up about 5% this week to reach 71. There is evidence from bookings of a turnaround in its important Garena gaming arm. Investing in live streaming about a year ago led Shopee’s e-commerce platform to become the largest live-streaming e-commerce platform in Indonesia, a country of 265 million people. Buy a Half

Super Micro Computer (SMCI) shares were off 4% to 802 this week in sync with the broader semiconductor industry. The company announced it is building with Apple and Japanese partners an AI data center in Japan. The consensus remains that Super Micro’s revenue will rise by 122% in 2024. This is an aggressive stock at the heart of the AI boom. Hold a Half

Explorer Dominator Blue-Chip Recommendations - More Buy and Hold

International Business Machines (IBM) shares were steady at 167 this week. IBM’s book of business is growing nicely on both the software and cloud consulting sides of their business. Buy a Half

Unilever (UL) shares were up two points to 56 after another JPMorgan upgrade to “overweight”. This is a great proxy for international and emerging consumer growth markets as about 3.4 billion people use its products daily and 59% of its sales are from emerging markets. Buy a Half

Visa (V) shares were up 5 points this week to reach 275. In 2023, 61% of all credit cards in the U.S. came from Visa. This was far ahead of Mastercard at 25% and American Express at 11%. There are more than 4 billion Visa cards used at more than 130 million locations worldwide. 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

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.

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 10% this year as rare earth stocks have pulled back due to weak prices, yet it trades at just 18 times forward earnings and 50% of book value. Neo also has ample cash and very low debt levels. The stock offers us an excellent hedge on China/Taiwan risk, a forward 5.7% dividend yield, 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 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.

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 when it 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 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.

Unilever (UL) is a dominant consumer goods giant with a trove of 400 recognizable brands in its diversified portfolio – from Vaseline to Dove – that it sells in over 190 countries. However, 30 “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 just over two times sales. Two other reasons I like Unilever is 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 June 20, 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.