Aside from Sea (SE), which zoomed from 80 to 88 this past week, Explorer stocks were largely flat, which to some these days is a good week. This week we look at the history of market pullbacks and some encouraging analysis on bounce-backs and trade before getting to a new recommendation from Shanghai.

Cabot Explorer Issue: June 9, 2022

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Aside from Sea (SE), which zoomed from 80 to 88 this past week, Explorer stocks were largely flat, which to some these days is a good week. This week we look at the history of market pullbacks and some encouraging analysis on bounce-backs and trade before getting to a new recommendation from Shanghai.

Shanghai Reopens
That Shanghai is reopening this week is not only good news for China but for the global economy as well. It is a huge, dynamic city with a population of about 25 million. For comparison purposes, the combined population of America’s four largest cities--New York, Los Angeles, Chicago, and Houston—is only 18 million.

As tech stumbles, the S&P 500’s information technology sector is off about 20% in 2022, its worst start to a year since 2002, while the broader S&P 500 is down 14%. Remember, the stock market has weathered pullbacks in 2020 (-34%), 2008 (-56%), 2000 (-49%), 1990 (-20%), 1987 (-34%), and 1980 (-27%), but it recovered to all time-highs each and every time.

Valuations of some high-flier stocks have pulled back sharply. For example, Shopify (SHOP) traded over 30 times revenue at one point but currently trades at 10 times revenue. Some of this pullback is overdue, though for all the talk of supply chain disruptions, global trade is still expanding. The value of global trade reached a record $28.5 trillion last year. That’s a 25% increase over the value in 2020. And it’s 13% higher than the pre-pandemic 2019 number.

The biggest beneficiaries of global trade back in the 1970s were the G7: the United States, the United Kingdom, Canada, Italy, France, Germany, and Japan. These countries accounted for about 70% of global GDP in the early 1990s. Today, the share of global GDP generated by G7 countries is lower than it was in 1900. The big difference is the rise of emerging markets and especially China, which alone represents about 17% of annual global economic output, with the U.S. at about 23%. In 2000, it was 3% for China and 28% for America. And so it is to China and Shanghai we go for today’s recommendation.

New Explorer Recommendation
Nio (NIO)
Some of you might remember Nio, which went on quite a ride several years ago and will report earnings this morning. Based in Shanghai, Nio is considered one of the top Chinese electric vehicle makers.

Nio reported a somewhat mixed quarter this morning and will likely open this morning about 5% down, which I believe is an opportunity since NIO stock will be down about 40% so far in 2022. Nio reported a narrower-than-expected first-quarter loss and revenue that exceeded expectations, but a contraction in gross margin. The lockdown in Shanghai and supply chain and vehicle delivery challenges impacted operations in Q1.

The near mania over anything touching electric vehicles (EVs) has long worn off but the fundamentals of the industry have never looked stronger as gas prices have surged along with advances in technology. Furthermore, the working number used by most analysts has been for EV sales to go from 6 million cars in 2021 (double that of 2020) to 15 million in 2025, but I noticed that this estimate has soared to 20 million.

I have always liked Nio, and this is an excellent time to reconsider the stock as dynamic Shanghai comes out of its Covid lockdown. Meanwhile, the South China Morning Post reported last week that demand for electric cars looks strong as Covid restrictions begin to lift. Nio’s deliveries shot up 38% in May.

Taking a step back, electric vehicles are a winning proposition for China because they help solve two big problems. First, the Mandarins in Beijing have a powerful incentive to push EVs due to political pressures to reduce smog in major cities.

Second, EVs can generate significant jobs and help the country capture the commanding heights of the global economy, the key goal of its China 2025 strategic plan.

Already, China’s share of global electric vehicle production has gone from 1.2% in 2013 to 22.6% in 2017 to 53% in 2021. Many expect China to represent about half of global EV sales going forward and they also have a commanding share of EV batteries and the rare and strategic metals necessary to make EVs.

And China has a huge advantage over America that Japan never had – tremendous scale due to its population of 1.4 billion people. Remember: Shanghai alone has a population of about 25 million!

Nio had previously mentioned expanding across Europe and it already has a solid presence in Norway. The company plans to open another Nio House in Norway soon. Further, it has plans to enter the Netherlands, Germany, Denmark and Sweden this year. Besides Europe, Nio plans to set up a factory in the United States.

Finally, Nio is competitive in the EV technology game along with Tesla. Its recently launched ET7 and ET5 models offer battery upgrades with ranges of 621 miles on a single charge – better than Tesla’s Model 3 and Model S. Furthermore, since 2020, it has offered consumers its battery-as-a-subscription service whereby buyers can swap batteries rather than wait for recharging. Nio receives a subscription fee for this service and locks down loyalty and recurring revenue.

I think Nio is one of the top EV makers with massive growth potential and my target is for this stock to go from current 20 per share level to 40 in the next year if we have a decent market. BUY A HALF POSITION

Model Portfolio

Portfolio Changes
Novonix (NVNXF, NVX) - MOVE FROM BUY TO SELL

Updates
CVS Health Corporation (CVS) shares were largely unchanged this week. This is an excellent stock for a struggling economy in that CVS Health is one of the nation’s leading healthcare companies with 300,000 employees including more than 40,000 physicians, pharmacists, nurses, and nurse practitioners. It has almost 10,000 stores and is viewed in a different category than retail companies such as Target. Nearly 70% of Americans live within three miles of a CVS and it has more than 102 million pharmacy plan members. CVS stock is still a buy and my price target is 100. BUY A HALF

Fanuc (FANUY) shares were steady this week the fact that the Japanese Yen is trading at a 20-year low against the U.S. dollar portends well for future earnings growth for this export-oriented company.

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 is building a new factory near Tokyo to double its domestic output capacity of machine tools to produce parts of smartphones. CSLA estimates Fanuc’s U.S. market share at 50% and in China about 20%. Exports account for 90% of Fanuc’s sales.

Fanuc’s stock offers investors a great balance sheet, zero debt and $7 billion in cash. Fanuc is a high quality, profitable play on a clear growth trend and my six-month price target for this conservative stock remains 25. BUY A HALF

Ford (F) shares were marginally lower this past week on no news. Tesla, which was founded 100 years after Ford, enjoys a clear cost advantage so Ford is considering reducing or eliminating dealer inventories and following Tesla in selling some vehicles directly to customers. China’s BYD has advantage over both of them as it has battery and semiconductor chip units in house. Where Ford stock stands out is its price. Trading at about four times trailing earnings, this is perhaps the best value of the leading EV makers so I encourage you to buy if you have not already done so. BUY A FULL

Novonix (NVNXF, NVX) shares were down a bit again this week so I’m moving this to a sell to make room for new ideas. While we have already taken some profits in this Australian stock, it is at least a year away from profitability and it seems out of step with market sentiment, which is not favoring great stories that need time to play out. We will watch this stock and may be back in it down the line. MOVE FROM BUY A HALF TO SELL

Oracle Corporation (ORCL) shares were unchanged. Oracle is a conservative software company and historically been one of the safest stocks in software. Oracle provides us with both safety and growth and this is a solid, conservative tech stock for an uncertain market. Oracle databases are required to run essential business transactions for large corporations and that should be more difficult to cut than other discretionary software expenditures. BUY A HALF

Rio Tinto (RIO) shares added a point this week and deliver a current 10% dividend yield. Based in London, Rio has a cash position of $15.3 billion and employs more than 47,000 people across 35 countries on six continents, and supplies the world with gold, diamonds, aluminum, copper, titanium, iron ore and other industrial metals. Regarding the Oyu Tolgoi gold and copper mining project in Mongolia in which the Mongolian government owns 34% of Oyu Tolgoi, Rio controls 66% but announced this week it is planning to acquire the rest from the government.

Over the past five years, Rio has generated cash flow of $5.78 per share, according to Morningstar, and the stock trades at only five times trailing earnings, which is about half of its historical valuation.

Finally, It takes four or five times as much copper to make an electric vehicle as a regular car. Copper also goes into charging stations, solar panels and wind turbines. However, at present, in light of escalating annual cleantech demand Goldman Sachs thinks this could go up 5X by 2030, which would be very good for RIO shares. BUY A HALF

Sea Limited (SE) shares zoomed from 80 to 88 this week and have had about a 50% bounce off the near-term low back in April. Sea’s e-commerce business Shopee is looking better as its losses are declining while revenue growth remains strong. Sea also has a massive growth opportunity targeting Southeast Asia, a dynamic, rapidly digitizing economy with a youthful, tech-savvy population of 660 million – 2X the United States. Meanwhile, revenue from SeaMoney, Sea’s digital financial services unit, more than quadrupled to $236 million.

Fortunately, Sea raised $6 billion in equity and convertible debt late last year, when the stock was in the 300s. With more than $10 billion in cash now on its balance sheet, it appears Sea can easily make it through the next few years without cutting back on investing in growth.

This is still a buy for aggressive investors. BUY A HALF

Sociedad Química y Minera de Chile S.A. (SQM) shares went from 102 to 98 this week but are up 33% in the last month. In the first quarter, the company reported revenues of more than $2 billion, more than four times the comparison with the previous year. Revenue from the lithium segment surged more than tenfold. SQM’s lithium output is almost 20% of global lithium output and lithium demand, sales, and prices have been going in the right direction. Russia’s fertilizer exports that normally account for about 25% of world exports are down sharply, leading it to companies like SQM to fill the gap. This stock has clear momentum and remains a buy. BUY A HALF

The next Cabot Explorer issue will be published on June 23, 2022.

JUST PUBLISHED — New book from Chief Analyst Carl Delfeld

Analyst Bio

Carl Delfeld

Carl Delfeld is a member of the Cabot investment team, and chief analyst of Cabot Explorer.

He received his Masters in Law and Diplomacy at the Tufts Fletcher School; worked for the First National Bank of Boston (now Bank of America) in London, serving as director of the Japan and South Korea Group; served as vice president at the investment bank Robert W. Baird & Company, developing new business in Tokyo, Hong Kong and Sydney; was Asia advisor to the U.S. Congressional Joint Economic Committee, the U.S. Finance Committee and the U.S. Department of the Treasury; wrote for Forbes Asia and the Far Eastern Economic Review; served as a member on the U.S. National Committee on Pacific Economic Cooperation and the Japan-U.S. Friendship Commission; was chairman of the Asian Pension Forum and wrote a book, titled, Red, White & Bold; the New American Century.