Cabot Explorer Issue: September 7, 2023

Portfolio Changes:
Umicore SA (UMICY) – Move from Buy a Half to Hold
Pfizer (PFE) – Move from Buy a Full to Hold

China Goes from Growth to Turnaround Story

China’s economy is struggling due to lackluster growth, falling property prices, high local debt, poor demographic trends, and lack of consumer confidence. In some ways, my thought is – join the club. The U.S. may be facing 2% GDP growth and has its own challenges such as excessive federal spending and national debt. My point is that we should remain skeptical but not discount China coming back strong with the right policies. In my view, China is both strong and brittle.

In the first 19 years of this century right up to the pandemic, the American economy grew on average about 2% each year. That means expected growth for the U.S. is about where it’s been for the past two decades. China’s economic growth trajectory had to flatten at some point. The economy expanded on average 9% a year from 2000 to 2019. Now China’s growth seems to be slowing to about half that pace.

But there is one thing working in China’s favor from an investment perspective: Stocks rarely have been this cheap compared with the U.S. China’s entire weight (the market value of all China’s publicly listed companies) in a global benchmark is smaller than that of Apple (AAPL) stock.

There is some irony here because Apple gets a fifth of its sales from China and has a huge manufacturing base in the country. And yet, Apple is bigger in the MSCI All Country World Index global benchmark than China.

This shows in stock valuations. MSCI China, which includes Hong Kong stocks, trades at just 10.8 times the next 12 months’ earnings estimates, about half the 20 times earnings of both the S&P 500 and MSCI USA.

This is just one reason why the Cabot Explorer heads to China for this week’s contrarian recommendation.

New Recommendation: Alibaba (BABA)

Alibaba 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 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.

A great majority of Alibaba’s revenue from retail comes from marketing services and other fees charged to merchants, but the transaction values from Taobao and Tmall make up half of China’s e-commerce market. After seeing revenue for the commerce group dip 3% in the fiscal year ended in March, Taobao and Tmall reported double-digit growth in the last quarter, indicating a strengthening economy in China. Another growth area is the international digital commerce group, including results from AliExpress, where revenue surged 41% year over year last quarter.

Like Amazon, Alibaba has a web of businesses, including revenue streams from cloud services, entertainment and logistics. Alibaba basically facilitates transactions between buyers and sellers. The company is a huge data-gathering network, which is a competitive advantage and moat. It uses all the data gathered from communications and transactions across all its various business units to improve productivity and growth.

Importantly, Alibaba has announced it will split into six mostly independent pieces, with businesses such as logistics and smart retail set for initial public offerings.

Its cloud business is a thriving operation and China’s closest comparison to Amazon Web Services. Founded in 2009, the business known as Alibaba Cloud provides data processing and storage services to thousands of businesses, developers, and government organizations in more than 200 countries and regions, according to its website. It contributed $11.2 billion of revenue to Alibaba in the 12 months ended March 31, excluding payments from other businesses within the group.

Last month, Alibaba opened its own artificial intelligence model to third-party developers, as the Chinese e-commerce giant aims to increase the use of its product and take a leading role in technology.

The move pits Alibaba against U.S. tech giant Meta which has made a similar move, and both pose a potential challenge to OpenAI, the firm behind viral AI chatbot ChatGPT.

Alibaba stock’s forward price-to-earnings ratio is about 10 which is starting to attract attention. Considering that the cloud business reported a 106% year-over-year increase in adjusted operating profit last quarter, Alibaba might be on the verge of a long stretch of profitable growth over the next decade. Investors are getting a bargain on one of the world’s leading technology firms.

This is a contrarian recommendation in a high-quality company selling way behind its high and presents us with attractive upside potential despite all the concern regarding Chinese economic growth. BUY A HALF

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

BYD (BYDDY) shares added a point this week as BYD now supplies batteries to Tesla, making the two rivals and frenemies. China’s top-selling EV maker boosted head count by over 50% to more than 630,000 in the 12 months to June and hired around 31,800 graduates in 2023, with more than 80% of them hired for research and development. BYD remains confident of selling 3 million EVs this year despite economic challenges and an intense EV price war. Buy a Half.

Neo Performance (NOPMF) shares were steady this week on no news. A recent quarterly financial report showed solid revenue, $2.5 MM of net income, and a cash position of $126 million. Neo manufactures advanced tech and industrial metals and materials such as magnetic powders and magnets, specialty chemicals, metals, and alloys. Buy a Half.

Novo Nordisk (NVO) shares in the last month have zoomed from 157 to 191 to become Europe’s most valuable company. The pharmaceutical giant has had a strong year thanks to its hugely popular diabetes and weight loss drugs, Ozempic and Wegovy, respectively. Last month, Denmark-based Novo Nordisk reported that profits surged 43% in the first half. On Tuesday, the company launched Wegovy in the U.K., further boosting its stock. Hold a Half.

Tesla (TSLA) shares were flat this week as Tesla launched its revamped Model 3 in China at a higher price while slashing Model S and X prices in China and America. Tesla earnings rose in Q2, with ongoing price cuts and easy comparisons fueling big sales gains vs. a year earlier but earnings per share are expected to fall in Q3 and for the year. Buy a Half

Umicore SA (UMICY) shares were unchanged this week. This resource and refining multinational is a major producer of battery materials for automakers such as such as Volkswagen. It is not performing well so I’m moving this to a hold. Move from Buy a Half to Hold

Explorer Multinational Blue-Chip Recommendations - More Buy-and-Hold

ConocoPhillips (COP) had another good week, going from 118 to 123 as oil prices reached a 2023 high. The company is among the lowest-cost producers and delivers a relatively strong cash flow. Buy a Half.

International Business Machines (IBM) shares again gained a couple of points this week as in Japan a new partnership was launched between Rapidus, which is backed by the government and Japan’s biggest corporations, and IBM to develop advanced chips. Last week, IBM unveiled Watsonx, a cutting-edge enterprise-focused AI and data platform designed to harness the power of advanced AI capabilities for businesses. Buy a Half.

Pfizer (PFE) shares gave back three points over the last week despite some drugs advancing through the rigorous FDA approval process. It looks like major institutional investors — which account for up to 70% of all market trades – are not buying into the Pfizer story without accelerating earnings and sales growth so I’m moving this stock to a hold. Move from Buy a Full to Hold.

Visa (V) shares were steady in their second week as an Explorer recommendation. The global payments industry has promising growth prospects as the Boston Consulting Group predicts the industry will experience 8% annual revenue growth reaching $3.3 trillion in annual revenue by 2031. Chinese state-owned UnionPay is the biggest global player, but Visa is everywhere and backed by Berkshire Hathaway, which owns a $2.1 billion stake in the company. Visa has the largest card network in the U.S., processing $14.5 trillion of payment volume in just the last 12 months. 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.

BYD (BYDDY): In 2022, China auto giant BYD (for Build Your Dreams) 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.

Neo Performance (NOPMF) manufactures the building blocks of many modern technologies and advanced industrial materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys – all using rare earths and minerals critical to the performance of many important products and emerging technologies. Based in Toronto with offices in Denver, Singapore, and Beijing, the company is organized along three segments: Magnequench, Chemicals & Oxides, and Rare Metals. 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.

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.

Umicore SA (UMICY) is a materials technology company based in Brussels. The venture is set to begin production in 2025 and is slated to process materials for enough batteries to power 2.2 million fully electric cars a year. The company has a long history in mining and has evolved into more of a processing and recycling company. Umicore’s leading battery materials technology portfolio consists of nickel, manganese, cobalt technologies, manganese rich lithium and solid-state battery technologies. The company delivers a 17% return on equity and is a rather conservative way to play critical metals on the refining rather than mining side.

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 September 21, 2023.

PUBLISHED — New book from Chief Analyst Carl Delfeld