Cabot Explorer Issue: October 5, 2023

Portfolio Changes:
Neo Performance (NOPMF) – Move from Buy a Half to Sell

Latin America EV Play With 14.6% Dividend Yield

Explorer stocks, with the exception of Neo Performance (NOPMF), held their own in a difficult week. The market concerns center on the impact of high interest rates and mortgage rates on consumer spending, investment, and economic growth.

I will host a webinar on October 12 to cover these issues and why a portfolio strategy can be as important as stock ideas. We’ll cover how to better organize a portfolio to protect and grow wealth with and include specific stocks and ETFs to capture opportunities in sectors such as artificial intelligence (AI) and electric vehicles (EVs).

EV markets are going through a consolidation but there are many different investment angles to this story, such as today’s lithium recommendation. A key issue is the relationship between cost, price, and scale. For example, Rivian vehicles sell for over $80,000 on average. Yet they’re so expensive to build that in the second quarter the company lost $33,000 on every EV it sold. That’s roughly the starting price of a base-model Ford F-150! Therefore, Rivian has burned through half of its $18 billion cash stockpile. As of the end of June, Rivian had only built a total of around 50,000 vehicles and is operating at less than one-third of its capacity while China’s BYD has already sold 2 million vehicles this year.

New Recommendation

A Latin American Double Play With 14.6% Dividend Yield

Sociedad Química y Minera de Chile S.A. (SQM)

This week we head back to SQM, which we sold at a share price of about 100 a year or so ago for a nice gain.

To begin, let me highlight that farmers all over the world have a daunting task ahead of them. Over the next 50 years, they must produce more food than they have in the past 10,000 years. The combination of a growing global population, a rising middle class hungry for more protein, fruit and vegetables, and less productive land has many asking how on Earth (literally) are we going to feed everyone. For example, 1 pound of chicken requires 3 pounds of corn, 1 pound of pork requires 4 pounds of corn, and 1 pound of beef requires 7 pounds of corn.

In short, a growing global population equals higher demand for fertilizer products to boost yields. In addition to lithium, 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.

The iodine business was the only SQM segment that grew revenue in the latest quarter year over year. Its entire 27% revenue increase was due to higher average realized sales prices. This business has been benefiting from a combination of robust demand for iodine and SQM being the only company that has added production capacity in recent years.

SQM has long been a darling of global investors looking at Chile though the country has unfortunately taken a sharp left political turn. Chile’s President Gabriel Boric was elected in a landslide after a campaign promising revolutionary change so we need to keep an eye on political risk.

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.

SQM has lithium plants in Chile plus a joint venture in Australia and its combined output is almost 20% of global lithium production. SQM is also the world leader with a 46% market share of potassium nitrate, which is a chlorine-free premium product for plant nutrition. The company is also the world’s #1 producer of specialty chemicals.

The lithium segment’s revenue accounts for about 70% of total revenue, so it was the main driver of the company’s overall results and in the latest quarter, its lithium segment’s sales volume increased 26% from the year-ago period though lower lithium prices led to a pullback in overall revenue.

Global lithium demand should stay firm primarily due to it being a key ingredient for lithium-ion batteries for electric vehicles. Even with the accelerating use of lithium iron phosphate batteries (LFP) which do not need nickel or cobalt, lithium is necessary. SQM has signed a long-term lithium supply agreement with Ford (F) and inked a new long-term lithium supply deal with South Korea’s LG Energy Solutions, one of the world’s largest makers of lithium-ion batteries.

In addition, the expected development of solid-state batteries will require multiples of lithium though this is probably a couple of years out. It could come sooner as Toyota and others are making great progress.

SQM stock is compelling as it was trading at about 111 in November 2022 as lithium prices boomed but is now at 55, providing a reasonable entry point for aggressive investors. Revenue and profits are down with lower lithium prices (down 37% in second quarter of 2023) but return on assets and equity continue to be very strong.

A 14.6% forward dividend yield is a big bonus, and the stock is also trading about four times forward earnings estimates. SQM’s balance sheet is also in solid shape. The company ended the quarter with $2.0 billion in cash and cash equivalents and $2.5 billion in long-term debt.

This is an aggressive idea, but at the current prices of its stock as well as lithium, which has probably overshot on the downside, it seems to me to have significant upside.

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.

Explorer Trading Recommendations - Need to Watch More Closely

Alibaba (BABA) shares were steady at 84 this week as the stock presents good value, expecting $9 in earnings this fiscal year. While Chinese consumers save more than 30% of their earnings, it is international markets where Alibaba is growing the fastest. This is a contrarian recommendation in a high-quality company selling way off its high. Buy a Half.

BYD (BYDDY) shares were unchanged this week though the company sold 431,603 fully electric vehicles in the three months ended Sept. 30, up 23% from the second quarter. Tesla shipped 435,059 cars globally in the quarter; the 3,456-car gap between the two EV makers is the narrowest yet. BYD has sold 2 million EVs so far this year and remains confident of selling 3 million EVs in 2023, which is about the total number of EVs sold in America over the last decade. Buy a Half.

Neo Performance (NOPMF) shares fell from 6 to 5.4 this week and, given the market, I think it’s best that we sell this stock. I will monitor and perhaps later we will look at it again. Move from Buy a Half to Sell.

Novo Nordisk (NVO) shares gave back a couple of points as the market for Novo’s twin drugs used to aid weight loss is predicted to skyrocket to $100 billion by 2035, according to BMO Capital Markets. Medical research cited by the Centers for Disease Control and Prevention said obesity-related healthcare accounts for more than $170 billion in excess medical costs on an annual basis. Hold a Half.

Tesla (TSLA) shares rebounded 20 points to go from 241 to 261 this week as the company launched a Model Y RWD with a base price of $43,990, and buyers would be eligible for the $7,500 U.S. tax credit for EV purchases. Tesla bulls are betting on a fourth-quarter rebound in deliveries with the revamped Model 3 in China and the expected Cybertruck delivery launch, plus plans to build a new EV factory in India that would produce a car priced around $24,000. Buy a Half.

Explorer Multinational Blue-Chip Recommendations – More Buy and Hold

ConocoPhillips (COP) shares reversed this week with oil prices. The stock is still in the black, but this may be the best proxy among the lowest-cost producers and delivers a relatively strong cash flow. Buy a Half.

International Business Machines (IBM) shares held steady as IBM CEO Arvind Krishna said it was a misconception that increases in productivity from artificial intelligence must lead to job losses. Big Blue is making a transition from IT infrastructure to cloud computing, AI, and quantum computing. Buy a Half.

Pfizer (PFE) shares gained a point to 33 this week. Pfizer recently bought Biohaven Pharmaceuticals for its migraine assets and Global Blood Therapeutics for its sickle cell disease treatment. Hold a Half.

Visa (V) shares were up slightly this week after it reported net revenue of $8.1 billion with 62% operating margins in the third quarter of 2023. Visa plans to acquire cloud-based issuer processor and core banking Brazilian software provider Pismo for $1 billion. The Boston Consulting Group predicts the industry will reach $3.3 trillion in annual revenue by 2031. 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 overviews 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.

Pfizer (PFE) served more than a quarter of a billion patients that 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.

Tesla (TSLA) has always confused investors and Wall Street analysts alike. One reason is that it often has valuations that are, many times higher than its auto industry peers. What many miss is that it is not an auto stock but rather a tech stock and platform stock. Tesla’s value is really in its ever-expanding platform, AI capabilities, charging infrastructure, battery manufacturing, autonomous driving capability, and other areas ripe for disruption that nobody even knows Tesla is working on. Revenues have scaled from $32 billion in 2020 to $54 billion in 2021, to $81 billion in 2022, and are set to move past $100 billion in 2023.

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 October 19, 2023.

PUBLISHED — New book from Chief Analyst Carl Delfeld