Cabot Explorer Issue: September 1, 2022

Nuclear Power Rises while China Struggles

Climate change and an energy crisis are convincing governments around the world to take a fresh look at nuclear power. This means first rethinking already-planned retirements of nuclear reactors.

In California, the legislature is now considering extending the life of its last nuclear plant and Germany is thinking of doing the same as it faces energy shortages due to minimal natural gas imports from Russia while winter approaches. In Japan, the prime minister has called for reopening some facilities for the first time since the 2011 Fukushima nuclear disaster.

American interest in nuclear energy is also reawakening after a long slumber.

In 1974, the U.S. Atomic Energy Commission forecast that nuclear power would produce half the country’s energy by the end the century but it has flat-lined at about 20% since 1990. Congress recently passed a subsidy known as “production tax credits” to existing nuclear plants for the first time as an incentive to keep them in operation. The United States has 94 reactors but we have not built one new plant in the last 25 years.

Elsewhere, China continues to struggle with Covid lockdowns and high youth unemployment while big property developers carry staggering debt. The market borrowing of the largest private property developer, Evergrande, is around $100 billion, and including all liabilities; the company owes an estimated $300 billion. Chinese home prices have gone down for the last 11 months. New construction is down sharply as well.

On the plus side, China’s sovereign debt is quite low and it benefits from a high domestic savings rate, which has averaged about 45% of its GDP over the last 20 years.

New Explorer Recommendation: Kraken Robotics (KRKNF)

Most of the Explorer recommendations are larger, more established firms, but from time to time I like to put forward smaller, more speculative ideas. Playing on the robotics, maritime, and defense themes, this week we have an idea that is a bookend to Japan’s industrial robotics global leader, Fanuc (FANUY).

Based in Newfoundland, Kraken Robotics (KRKNF) is a marine technology company providing ultra-high resolution, software-centric sensors and underwater robotic systems.

This marine technology company provides advanced sonar and laser systems and subsea power solutions for Unmanned Underwater Vehicles for military and commercial applications. They develop revolutionary underwater imaging technology providing ultra-high-resolution imagery at superior coverage rates which dramatically improves seabed surveys.

Kraken Robotics Systems is a U.S./NATO-focused company and has landed a major contract to provide new sonar systems for the Royal Danish Navy. The contract, worth $40 million, is the biggest one to date for the company, which has offices in St. John’s and Halifax and operations in Brazil, Boston, Germany, and Denmark.

Under the program, Kraken will deliver the KATFISH towed synthetic aperture sonar, the Tentacle winch, and Autonomous Launch and Recovery System (ALARS) to the Royal Danish Navy. This builds on the 2021 acquisition of PanGeo Subsea, which enables Kraken to provide subsea capabilities including geophysical surveys, sonar surveys, and 3D laser inspections. Kraken’s highly skilled team manages subsea surveys, and delivers a complete data package to the client.

The firm offers software-centric sensors, batteries, and underwater robotic systems in unmanned underwater vehicles that are used in military and commercial applications. Its products are used by a number of military navies around the world. These include SeaVision, an underwater laser imaging system; Kraken Active Towed Fish (KATFISH), a towed underwater vehicle for high speed and high resolution seabed mapping; and ThunderFish, an autonomous underwater vehicle.

Revenue for the second quarter was $14.3 million compared to $1.9 million in the prior year and driven by the continued delivery to the Royal Danish Navy on multiple mine hunting systems, the addition of PanGeo services, and the delivery of its SeaPower™ battery products to a U.S. defense contractor.

Gross margin in the quarter was 44.8% compared to 39.0% in the prior year. Net profit in the quarter totaled $500,000 compared to a net loss of $900,000 in the comparable quarter a year ago.

In 2022, Kraken expects revenue to be in the $36 - $42 million range, with adjusted EBITDA expected to be in the $5 - $7 million range.

This is certainly a speculative idea but shares trade at just 0.25 per share and I believe Kraken is a well-run company in a strategic area of growth and therefore a prime takeover candidate by a larger maritime contractor. Consider a small position in this small but profitable company. BUY A HALF POSITION

Portfolio ChangesFreeport-McMoRan (FCX) - MOVE FROM BUY TO HOLD A HALF POSITION

Updates

Centrus Energy (LEU) shares had another up week and have surged 56% in the last month. Net income of $37.4 million tripled year over year on revenue of $99.1 million in Q2 2022. In addition, its long-term order book is approximately $1.0 billion and the company has secured more than $135 million in new sales contracts so far in 2022.

Based in Bethesda, Maryland, Centrus supplies nuclear fuel and services for the global nuclear power industry. Nuclear power provides more than 50% of U.S. emission-free energy, and more than all other sources such as wind, solar and hydroelectric combined, according to the Department of Energy. Centrus stock is still trading way off its 52-week high and at just over four times trailing earnings. BUY A HALF

Cloudflare (NET) shares were down five points this week which is disappointed despite its recent 39% surge as the company recently posted strong second-quarter earnings. Its revenue rose 54% year over year to $234.5 million. Cloudflare makes around 60% of its revenue from large customers that spend at least $100,000 annually, and the company gained a record 212 new large customers in the second quarter. I still believe NET is a buy since it is still down 50% from its high. BUY A HALF

Fanuc (FANUY) shares were down slight this week despite the fact that its global sales of industrial robots grew 27% year over year to a record in 2021, after two years of declines, according to the International Federation of Robotics. Jefferies estimates China’s working population will decrease by 35 million by 2025 from 2020 levels, which could hasten the pace of robot adoption, looking at the experience of Japan.

Fanuc is the world’s leading manufacturer of computerized numerical control (CNC) devices that are used in machine tools and also serve as the “brains” of industrial robots. Fanuc offers us a high quality stock that should be firm with its strong balance sheet with plenty of cash. My six-month price target for this low-risk stock remains 25. BUY A HALF

Ford (F) shares were down marginally even as the company announced intentions to introduce more electric trucks to the market in 2025 alongside the Ford Explorer, the Mustang Mach-E and the F-150 Lightning. The company recently announced initiatives for sourcing battery capacity and raw materials to reach its target annual run rate of 600,000 EVs by late 2023 and more than 2 million EVs by the end of 2026.

For July, Ford’s U.S. sales climbed 37% and Ford had a 70% bounce in SUV sales while U.S. sales of trucks climbed about 20%. Ford stock still stands out for its value as it trades at just over five times trailing earnings. BUY A HALF

Freeport-McMoRan (FCX) shares slid three points this week on recession fears prompted by Fed Chairman Jerome Powell’s hawkish comments in Jackson Hole.

The Phoenix-based global mining giant operates seven open-pit copper mines in North America. Freeport-McMoRan also owns two copper mines in South America and one of the world’s largest copper and gold mines in Indonesia (Grasberg). With a valuation of just under 10X earnings, I think we have upside potential but the current pullback makes me pause and I’m moving this to a hold until it develops an uptrend.

Freeport is a well-run company with and return of equity of 27%, return on assets of 12% and has an ample cash reserves of $9.5 billion. MOVE FROM BUY TO HOLD A HALF

Infineon Technologies (IFNNY) shares were steady this week as in its latest quarter the company posted 33% revenue growth and increased its revenue forecast thanks to auto-industry demand. This is in contrast to other semiconductor companies focused on markets such as computer laptops and cell phones. Infineon is a leading broad-based European chipmaker founded when the company was divided from its Siemens parent in 1999. BUY A HALF

MP Materials (MP) shares edged down three points this week, reflecting lower prices for some rare earths. The company recently reported earnings per share surging 139% from the prior-year quarter’s levels and generated revenues reflecting a year-over-year jump of 96%. I’m following rare earth prices closely as this will directly impact future performance.

MP is a way to play clean tech, defense, semiconductors and other advanced and emerging technologies through some of their basic inputs. MP currently ships more than 90% of its products to China for processing. In April, MP Materials and General Motors inked a long-term supply agreement commencing in late 2023 for GM’s EV programs. BUY A HALF

Oracle Corporation (ORCL) shares were off 3% this week as the tech sector was down overall. While Oracle and Microsoft recently announced a deeper cooperation of their clouds, allowing customers to more easily run projects across both platforms, this stock is not performing as well as the sector so I am keeping it at hold. Oracle is a conservative company with a decent dividend and has historically been one of the safest stocks in software. HOLD A HALF

Sociedad Química y Minera de Chile S.A. (SQM) shares gave back their 6% gains last week as the stock struggles to regain momentum on the back of surging demand and prices for lithium and fertilizer.

Investors and analysts may be concerned about comparisons going forward as SQM’s earnings for the second quarter were $3.01 per share, an increase of 857% compared to $0.31 per share for the second quarter of 2021. Revenues totaled US$2,598.8 million for the second quarter 2022, an increase of approximately 342% compared to US$588.0 million for the second quarter of 2021. SQM is a double play as the company is also the largest producer of potassium nitrate used for fertilizer so the stock offers two drivers of revenue and profits. HOLD A HALF

The next Cabot Explorer issue will be published on September 15, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld