Cabot Explorer Issue: November 2, 2023

Portfolio Changes: Sociedad Química y Minera (SQM) – Move From Buy to Hold

Fed Keeps Rates Steady, IBM Beats Expectations

The Federal Reserve yesterday maintained its benchmark interest rate while leaving the door open for further action as officials work to bring inflation back to the central bank’s 2% target. This makes sense, though markets are still a bit on edge as further increases are a possibility.

Technology stocks – which led the market higher this year – slumped into correction territory last week, due primarily to a wave of poorly received earnings reports. The tech-heavy Nasdaq Composite is now down about 10% from its July high.

Solid demand helped Explorer recommendation IBM (IBM) deliver third-quarter results that were above analysts’ expectations. IBM reported revenue of $14.8 billion, up 4.6%, and adjusted earnings per share came in at $2.20, up 22% year over year and $0.07 ahead of analysts’ average expectations.

Three quarters of IBM’s revenue comes from software and consulting, and both of those segments produced robust growth during the third quarter.

Software revenue was up 6% year over year while transaction processing revenue grew by 5%, and revenue from its hybrid platform and solutions segment rose by 7%. Annual recurring revenue for the software business jumped by 7% to $14 billion. Strategic partnerships drove a big part of this growth, generating 40% of consulting revenue. This portion of consulting revenue is expanding by a double-digit percentage.

IBM stock trades for roughly 12 times free cash flow guidance, a valuation that doesn’t give the company much credit for its software- and consulting-led turnaround. IBM is capable of consistently pushing revenue and earnings higher thanks to strong demand for hybrid cloud solutions and AI.

Now to a new recommendation combining biotech with artificial intelligence.

New Recommendation

Artificial Intelligence Meets Biotech

Exscientia (EXAI)

Founded in 2012 and based in Oxford, England, Exscientia is using AI to develop new medicines and is attracting high quality partners.

You have probably heard more than you want about the incredible potential of artificial intelligence (AI). AI enables computers, robots, and other devices to think like humans but far faster and more powerfully. Some refer to AI as “inhuman intelligence,” or machine learning.

The potential of AI can be applied to many industries but perhaps the most exciting is the field of medicine. Exscientia has the first AI platform clinically validated to improve treatment outcomes for cancer patients and the world’s first AI-designed drugs to enter clinical trials.

Exscientia has a rapidly growing pipeline of more than 25 projects in motion with the goal of drug discovery in areas such as ovarian and hematological (blood) cancer.

In total, the company has stated it has eight drugs that are either in trials or likely to be in clinical trials soon. It also has expanding facilities at Oxford Science Park, a new laboratory in Oxfordshire, and a medical center in Vienna, Austria.

And they have received grants from the Gates Foundation, as well as equity ownership by that foundation (about 1.3%). Many of Exscientia’s shareholders, in fact, are still the early venture investors from before they went public a little over two years ago (including Softbank, which owns about 5%).

Exscientia (EXAI) stock is trading way off its high but is in an uptrend at 5.30. It went public at 22 a share so the company has about $500 million in cash on the books – a big number for a company with a market capitalization of just $658 million.

Finally, keep in mind that this is an attractive speculative stock which may have a bumpy ride. It is a young company that is not and will not be profitable next year.

BUY A HALF POSITION

Explorer Stock Update

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 – need to watch more closely

Alibaba (BABA) shares were again unchanged at 82 this week. This stock went public at 68 in September 2014 and reached an all-time high of 317 in October 2020. Alibaba is still the largest e-commerce and cloud company in China by big margin. Its Taobao and Tmall marketplaces still account for over half of China’s entire e-commerce market, according to the International Trade Commission. The shares trade at a cheap valuation of less than 9 times this year’s consensus earnings estimate. Buy a Half.

BYD (BYDDY) shares were largely unchanged in the wake of BYD announcing strong third-quarter earnings and sales growth. Gross margins surged and are now far above Tesla’s. Buy a Half.

Novo Nordisk (NVO) shares were up a point this past week. We await third-quarter earnings that are expected sometime this morning. Hold a Half.

Sociedad Química y Minera de Chile S.A. (SQM) shares gave back another five points this week even as the Australian lithium miner Azure Minerals announced that it had entered a binding agreement to be bought out by SQM – the world’s largest lithium producer. Although SQM has a 15.8% forward dividend yield and a solid balance sheet, I’m moving the stock to a hold based on recent weakness. Move from Buy a Half to Hold.

Explorer Multinational Blue-Chip Recommendations – More Buy and Hold

ConocoPhillips (COP) shares treaded water this week as the company reported today that earnings and adjusted earnings decreased from the third quarter of 2022 primarily due to lower prices. Cash provided by operating activities was $5.4 billion. I’m keeping a buy rating on this stock which is among the lowest-cost oil producers and delivers a relatively strong cash flow. Buy a Half.

International Business Machines (IBM) shares were up three points to 145 this week after recently reporting solid earnings. Three quarters of IBM’s revenue comes from software and consulting, and both of those segments produced robust growth during the third quarter. The stock is not particularly expensive, trading at just 12 times free-cash-flow guidance. Buy a Half.

Visa (V) shares were up this week in the face of regulatory efforts to limit swipe fees. This is a great story as in the quarter ending in September, Visa facilitated 68.4 billion transactions worth a total of $3.2 trillion, providing net revenue of $8.6 billion. More than half of that revenue was turned into net income so you can see this is high-margin business. 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 10%. 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 summaries that will not change week to week.

Alibaba (BABA) is one of China’s most well-known brands and the country’s largest e-commerce company. The stock got knocked down over the last few years thanks to a heavy political hand by the Chinese government and a sluggish consumer economy. The shares are now selling at a cheap valuation that barely prices in any future growth, which seems to me unrealistic given all the opportunities for this tech giant to grow beyond its massive consumer platform. Cloud computing and artificial intelligence (AI) are just two examples. This is a contrarian recommendation in a high-quality company.

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.

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.

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.

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.

Sociedad Química y Minera de Chile S.A. (SQM) produces specialty plant nutrients, iodine, lithium, potassium chloride and potassium sulfate, industrial chemicals, and other commodity fertilizers which together account for about 30% of SQM’s annual revenue. SQM is generally considered the world’s second-largest lithium producer, behind U.S.-based Albemarle (ALB) and in recent years, demand for the “white gold” has been strong. Demand for lithium is strong due to electric vehicle growth and lithium contributes about 40% of the company’s gross profits. Fertilizer ingredients supply another 40%, and iodine contributes the rest.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. Visa has the largest card network in the U.S., processing $14.5 trillion of payment volume in the last 12 months. 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 November 16, 2023.

PUBLISHED — New book from Chief Analyst Carl Delfeld