Cabot Explorer Issue: October 13, 2022

New Explorer Recommendation: Toyota Motors (TM)

American car buyers on average have been buying up hybrids within just 12 days from their arrival on dealership lots this year – faster than electric-only vehicles and almost twice as fast as the 23 days for internal-combustion vehicles, according to data from consumer research site Edmunds.com.

Hybrid sales jumped 73% last year according to research firm Motor Intelligence.

This all makes sense to me and to Toyota – the global leader in hybrid vehicles. Consumers may want to transition to electric vehicles (EVs) through hybrids, especially people that live in urban settings and can make the round trip to work done within the 50-60 miles or so that a hybrid can go before being recharged or switching to the gas-powered engine.

This may also be a crucial part of the EV puzzle for America given its dearth of charging stations and widespread gas stations that want to stay in business.

While most auto executives increasingly believe the market is headed toward all-electric vehicles, their strategies sometimes include hybrids, which combine an internal combustion engine with a small battery and electric motor to save fuel.

The leaders in hybrids such as Toyota, Sweden’s Volvo, and South Korea’s Hyundai are betting that some customers aren’t ready to rely merely on electric power. Each of those three companies has a more balanced approach with hybrid models and full EV models.

“There are a lot of people who will leap into an EV, and there are others who will prefer a hybrid, especially depending on what part of the country you live in,” said Randy Parker, chief executive of Hyundai Motor America.

Wall Street seems to favor pure-play EV companies such as Tesla and startups such as Rivian, whose market valuation rivals some traditional auto makers. GM and Volkswagen are among those that have downplayed hybrids or stopped offering them while centering their efforts on introducing fully electric models in coming years.

“Our strategy is focused on battery electric vehicles as they represent the best solution,” said GM CEO Mary Barra during the company’s annual shareholder meeting in June.

We will see who wins but Toyota has an edge in this global market where one size does not fit all consumers. For example, Toyota sells millions of vehicles in developing countries, where the electricity supply is unreliable or in rural areas in developed countries that lack access to widely available charging infrastructure or have longer commutes.

Toyota pioneered hybrid cars in the late 1990s with the Prius, which quickly became a strong seller allowing auto makers to meet tightening regulations on emissions in the U.S. and abroad.

Toyota remains the No. 1 hybrid seller in America, led by a gas-electric version of the RAV4 sport-utility vehicle, the nation’s top-selling hybrid. Toyota leader Akio Toyoda recently told reporters the company could make eight plug-in hybrids with the same number of batteries in a single 320-mile-range EV.

Hybrids, including plug-in cars, accounted for around 20% of Toyota’s U.S. sales in September, but the company said that rate could have been double if not for supply chain issues. For example, Longo Toyota in El Monte, California, has around 1,500 orders for the hybrid RAV4, a backlog of more than a year.

Besides the hybrid edge, the second reason to look at Toyota right now is that the yen’s sharp fall is boosting sales and profits at top Japanese companies.

The world’s biggest car maker by sales volume, Toyota’s forecast is for an operating profit of 2.4 trillion yen, equivalent to about $18 billion, for the fiscal year through March, despite its supply-chain challenges and higher raw material prices. The strengthening of the dollar against the yen will likely offset some of these rising costs for the remainder of the current year.

A cheaper yen has typically been a positive for big businesses in Japan since the dollars that companies such as Toyota earn overseas are worth more in yen when brought back home, and cars made in Japan by workers paid in yen are cheaper than those made in the U.S. by workers who earn dollars.

A weak yen used to be a bone of contention as it boosted Japan’s economy by increasing inflation and exports. However, many Japanese manufacturers have moved production overseas, diluting some of the impact of currency fluctuations. Toyota Chief Financial Officer Kenta Kon said that the positive impact of a cheap yen was being somewhat offset by higher imported material costs. But Japan still exported nearly $700 billion in goods in the year that ended in June so overall it is a plus for its economy and consumer spending.

In this sort of volatile market, putting some cash in high quality Toyota seems right as it trades at just 10 times earnings at about 135 – down from a 52-week high of 213. I have a price target in the next six months of about 175 which is doable if the market stabilizes. BUY A HALF POSITION

Model Portfolio

Portfolio Changes

Fanuc (FANUY) - MOVE FROM BUY A HALF TO SELL
Taiwan Semiconductor (TSM) - MOVE FROM BUY A HALF TO SELL

Updates

Centrus Energy (LEU) shares followed last week’s gain giving this and more back, finishing yesterday at 37. There was no negative news for this nuclear fuel supplier’s deployment-ready centrifuge that enriches uranium for utilities in the U.S. and abroad. No other commodity matches the incredible energy density of nuclear fuel. Just one uranium fuel pellet has the energy potential equivalent of 149 gallons of crude oil.

Centrus’ net income margins are above 50% so far this year, and the company recently announced that it has secured new nuclear fuel sales contracts and commitments worth an estimated value of $270 million this far this year.

Nuclear power provides 20% of the power for our electricity grid and more than 50% of U.S. emission-free energy, according to the Department of Energy. Centrus stock is still trading way off its 52-week high and at less than four times earnings so this stock remain an excellent value and a buy. BUY A HALF

Fanuc (FANUY) shares lost a point this week and although it has been a solid stock and has held its value rather well, it is not doing much despite very strong fundamentals so I’m removing this as an Explorer recommendation. Fanuc’s robot orders in the latest quarter rose 23% from the previous quarter, driven by strong demand everywhere and especially in the U.S. Jefferies estimates that Fanuc is the world’s leading manufacturer of industrial robots. MOVE FROM BUY A HALF TO SELL

Ford (F) shares slid this week to 11.5 and a forward price-to-earnings valuation of right around four which is why this remains a favorite of mine despite a challenging market and economy. Morgan Stanley upgraded the stock to overweight last week. One indication of value is that its dividend yield at 4.9% is higher than its forward price-to-earnings ratio of just about 4X. Ford stock will benefit from big $7,500 EV subsidies and is still a buy. BUY A HALF

Infineon Technologies (IFNNY) shares were up almost 20% last week but gave a couple of points back this week to settle at 23. Infineon has an advantage on many other semiconductor stocks in that it is focused on auto and industrial markets where shortages and high demand persists. Management predicts its markets will heat up into 2023 allowing it to raise prices. This stock seems undervalued to me with a price-to-earnings ratio of 11, compared with 16 for the semiconductor industry. The company’s earnings per share is expected to grow 38% this year and cash flow growth is strong. Infineon is a leading broad-based European chipmaker founded when the company was divided from its Siemens parent in 1999. This is still a buy given its markets and sales and earnings momentum. BUY A HALF

Kraken Robotics (KRKNF) shares, probably the most speculative of Explorer stocks, ironically was firm this week at 0.30. The company recently signed a follow-on contract to supply additional KATFISH™ and landed a major contract to provide new sonar systems for the Royal Danish Navy.

Based in Newfoundland, Kraken Robotics is a marine technology company providing ultra-high resolution, software-centric sensors and underwater robotic systems. Though a micro-cap stock, Kraken is a well-run company and a prime takeover candidate in a growth defense sector. It is, however, an aggressive play somewhat offset by a strong management team. BUY A HALF

MP Materials (MP) shares dipped from 31 to 28. The stock is trading at just 22 times earnings, which is about half of where this metric sat a year ago, and the issue may be that its key products have come back in price over the last six months making forward comparisons difficult. This stock is an effective way to play clean tech, defense, semiconductors, and other advanced and emerging technologies. Based on its valuation, MP is moving close to being rated a buy again but if pulls back much more, it may have to be sold to limit losses. MP is a far cry from the 56 it traded for in early April of this year. HOLD A HALF

Oracle (ORCL) shares dipped from 66 to 63 this past week, following a move up from 61 the previous week. The company’s recent relative outperformance is based on the growth in cloud computing and its reported results in its first fiscal quarter, as its cloud infrastructure revenue increased 58% year over year.

Oracle’s founder and chairman, Larry Ellison, noted that Oracle can save cloud users money and offer a better product than Amazon’s cloud products. One advantage for Oracle is that its cost structure is fairly fixed, so each additional dollar of revenue earns more profit than the last. Despite all these strengths, Oracle’s shares are still a hold until market sentiment improves. HOLD A HALF

Sociedad Química y Minera de Chile S.A. (SQM) shares were down 8% yesterday and over the past month are down about 18% so they are on the edge of being out as an Explorer stock. Lithium prices are quite high, up about 500% over the past year – unlike many other commodities. SQM offers us an intriguing package with a dividend yielding 12.3% and an impressive 12% five-year annualized dividend growth rate, plus a price-to-earnings ratio of 12. Prices will eventually cool off so we need to err on the side of caution.

SQM is also the largest producer of potassium nitrate used for fertilizer so the stock offers two drivers of revenue and profits. We need to watch this stock closely and make sure you have a trailing stop-loss in place. HOLD A HALF

Taiwan Semiconductor (TSM) shares had a terrible week, falling from 79 to 64, and the company expects to announce earnings sometime today. All this is against the backdrop of the Biden Administration imposing more chips and chip equipment restrictions regarding selling to China. China accounts for about 12% of TSMC’s revenue.

Given all the drama surrounding the stock, I think it’s best to sell, though the stock may recover a bit depending on today’s earnings report. MOVE FROM BUY A HALF TO SELL

Explorer ETF/Fund Update

WisdomTree Emerging Markets High Dividend Fund (DEM) went from 34 to 33 in its second week as an Explorer recommendation.

The WisdomTree Emerging Markets High Dividend ETF covers 17 different emerging markets and gives broad exposure to large caps, mid-caps and small caps in these countries. This ETF has a clear income and value strategy. The stocks in its basket tend to be conservative, defensive companies with low valuations and high dividends. In addition, it holds some of the cheapest quality stocks in the world with an average price-to-earnings ratio of just 5. BUY A HALF

The next Cabot Explorer issue will be published on October 27, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld