Cabot Explorer Issue: August 15, 2024

Portfolio Changes: None

Sea (SE) Up 26% while Super Micro Rebounds 17%

A Century of Perspective

Lower inflation numbers certainly point to the likelihood of a forthcoming interest rate cut.

Quarterly earnings are being scrutinized for signs of higher-than-expected growth.

But from time to time, it is useful to take a step back from the daily and weekly market commentary and look back a long, long way.

America has been a “stock superpower “since the 1920s.

In the post-WW II era, you can see from the below chart that only Japan was able to push back on U.S. dominance in the late 1980s. It is odd that China hardly registers given its stellar economic growth over the past four decades.

Another aspect of U.S. stock price trends over the last century is the breadth of industries and sectors that have upward trajectories. Tobacco has led the way, but shipping and other basic industries also had a nice trajectory.

It is interesting that railroad stocks dominated the markets in 1900 even more than tech does today, as you can see below. The same goes for the London market, which was the leading financial market in 1900 and has a broadly based sector allocation with tech stocks barely registering in its 2024 pie chart.

The current tech stock relative outperformance compared to the world is of course a new phase for the market that has a lot of momentum behind it.

Today, we look beyond tech to coffee – a commodity that has been prized since the 17^th century in Europe and since the 18^th century in America.

Many believe it is the fuel that drives America’s economic engine.

New Recommendation

Dutch Bros (BROS)

The financial media has been full of stories about coffee king and premier brand Starbucks’ (SBUX) struggles with overall weak sales leading to some quarterly losses.

Starbucks’ U.S. sales have been crippled by slowing consumer spending and people working remotely as well as competition from local boutique coffee roasters. Comparable sales declined worldwide as its prices are high relative to faster-growing competitors in America and abroad in China.

Compounding the challenge is that Starbucks has made a major bet on China’s emerging coffee market where the economy is weak and competitors are emerging left and right. All this led to a pullback in Starbucks (SBUX) stock and a historically low valuation.

I was planning this week to add Starbucks as an Explorer Dominator stock. But on Tuesday, Starbucks shares surged on news that the company will soon have a new CEO – Chipotle’s popular leader, Brian Niccol. The market is betting that his savvy marketing skills will “create brand buzz” for Starbucks and produce a new look at its strategy.

Given the 20% jump in Starbucks stock following the announcement, let’s consider two smaller coffee competitors that present us with a classic conundrum between a dominating company such as Starbucks or disruptive competitors growing much faster and offering cutting edge, distinctive strategies, as well as lower prices.

One such upstart is Luckin Coffee (LKNCY).

Luckin has more of a kiosk, delivery, and technology-driven retail strategy blending quality, high convenience and high affordability. Sales were up 41% in the first quarter as it opened more than 7,000 outlets in 2023 – equal to the total number of Starbucks in China. The company also boasts prices that are roughly half of its premium Starbucks competitor.

Luckin Coffee was founded in 2017 and started out of the gate fast only to run into some serious accounting and management problems. After regrouping, it has resumed a torrid growth trajectory. The company opened 2,342 new stores including two in Singapore in just the first quarter of this year.

China’s languid economy and stock market makes Luckin Coffee a speculative pick so let’s consider a stock a bit closer to home.

A smaller disruptive coffee chain, Dutch Bros (BROS), has demonstrated some impressive growth over the last few years. The company follows to some degree the asset-light, internet-focused convenience of the Luckin model – without the China risk.

An operator and franchisor of drive-through coffee stores, the company has about 900 locations across 17 states in the U.S. Dutch Bros has seen its share price soar but in the last month its stock has pulled back from 42 to 29 due to a combination of some profit taking and guidance from management that growth may moderate a bit.

Revenue soared by 92% from 2021 to 2023, and after some heavy losses, Dutch Bros was able to manage a small net income of $1.7 million for 2023. Dutch Bros looks well positioned to continue growing as the company plans to open between 150 and 165 new stores this year.

With strong brand recognition from its member rewards program along with two successful product launches during the most recent quarter, Dutch Bros looks like a stock you may want to keep for the long term.

Dutch Bros has more than 900 stores as of the end of the second quarter, including 36 that it opened in the quarter. It’s expanding at a steady pace, expecting up to 165 new stores this year, and it envisions up to 4,000 stores over the next 10 to 15 years.

Customers like its concept, which is why it has been able to successfully open many new stores. Total revenue increased 30% year over year in the last quarter. It’s steadily increasing profitability as well. Net income increased from $9.7 million last year to $22.2 million this year.

Something I didn’t even realize right away is that Dutch Bros only recently rolled out mobile ordering. It was live in 38 stores in the second quarter and is already live in 200 more since then. I find it impressive that it was growing fast without a mobile feature, and this should be a strong new growth driver going forward.

Growing pains are normal for younger growth companies so management must be at the top of their game. New CEO Christine Barone has been there for about a year, and she has completely rebuilt the C-suite.
I see this situation as an opportunity to buy Dutch Bros (BROS) on the pullback before the stock potentially climbs much higher.

BUY A HALF

Explorer Weekly Stock Commentary

Centrus Energy (LEU) shares pulled back 13% this week despite recently reporting a strong second quarter with $189 million in revenue for the quarter ended June 2024, representing a year-over-year increase of 92%. Earnings per share more than doubled. In addition, the company’s backlog is $2.7 billion, and this extends as far out as 2040. This stock remains a buy as it tracks the emergence of new and safer nuclear power technology. Buy a Half

Cloudflare (NET) shares were up 6.8% this past week following a strong quarter with revenue up 30% and a net loss of $15 MM representing an 84% improvement over a year ago. This cybersecurity company powers 80% of websites and blocks billions of threats every day for its expansive client list. Cloudflare does a lot more than secure and speed up websites, offering full cloud applications without the challenge of managing servers. Cloudflare is still a small company relative to the cloud giants. Buy a Half

Neo Performance (NOPMF) shares were up 4% this week but remain on the edge of being removed from the portfolio. Quarterly earnings reported this week include revenue down 37% while net income improved but is less than $1 MM. While Neo is a key player in rare earths processing, prices remain weak, and the timing of a turnaround is uncertain. Hold a Half

Novo Nordisk (NVO) shares rebounded 12.3% this week. In the second quarter, the company continued to grow quickly while remaining profitable. Demand for Wegovy is still high in the U.S. despite considerable ongoing investments in expanding manufacturing output. Ozempic sales surged 30% to $4.26 billion while Wegovy sales were up 69%. Hold a Half

Sea Limited (SE) shares jumped 26.4% this week after another positive quarter confirmed positive trends for the company and stock. Revenue was $3.8 billion, up 23% year-on-year, and net income was $79.9 million. All three of Sea’s major segments are moving in the right direction. Buy a Half

Super Micro Computer (SMCI) shares were up 17.2% this week after we upgraded the stock from a hold to a buy. Supermicro is a key supplier to many cloud computing giants, which are spending billions of dollars to bulk up their computing power. Supermicro’s market position is incredibly important due to the artificial intelligence (AI) race. The AI infrastructure buildout is well under way, buoyed by accelerating spending on AI data centers. Buy a Half

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

International Business Machines (IBM) shares were up 3% this week and have risen 21% so far this year. IBM, with a return on equity of 36%, has consistently led in AI research, with numerous AI patents and pioneering technologies in machine learning, natural language processing, and AI-driven analytics. IBM’s AI backlog has grown to more than $2 billion. Buy a Half

Unilever (UL) shares were again steady this week at 60 following comparable-sales growth being up 3.9% in the second quarter. The company, established in 1929, is a British multinational created from the merger of British soap maker Lever Brothers and a Dutch margarine producer. It is one of the world’s largest producers of consumer goods and offers a wide range of products in the fields of beauty, personal care, home care, nutrition with a focus on emerging markets. Buy a Half

Visa (V) shares were steady this week but the stock has pulled back a bit from its recent high, so I encourage you to buy if you haven’t already done so. Earnings grew by 11% and payment volume by 8% in the first quarter, even as consumer purchasing power came under pressure. Visa is the world’s largest credit card, debit card, and payments network, serving 4.5 billion credit/debit cards. Buy a Half

Watch List – past recommended stocks that I still like and keep an eye on

BYD (BYDDY), ConocoPhillips (COP), Franco-Nevada (FNV)

Explorer ETF/Fund Positions

Aberdeen Asia-Pacific Income Fund (FAX) is a close ended fixed income mutual fund launched and managed by Aberdeen Standard Investments (Asia) Limited in Singapore. Buy a Half

Grayscale Bitcoin Trust (GBTC) offers investors a way to track very closely to the day-to-day or “spot” movement of bitcoin prices. For aggressive investors comfortable with volatility. Buy a Small Allocation

iShares MSCI India Small-Cap ETF (SMIN) This is a $960 million fund that holds a basket of about 500 small-cap India stocks. It is nicely diversified with the top 10 stocks accounting for just 12% of assets. The lead sector is industrials at 25%, followed by finance at 15%, consumer goods at 14%, basic materials at 13% and healthcare at 10%. Buy a Half

JPMorgan Equity Premium Income ETF (JEPI) offers double-digit yield coming from both option premiums and dividends using a value-focused strategy. Buy a Full

Morgan Stanley China A Share Fund (CAF) offers exposure to a basket of the largest Chinese-listed stocks. Buy a Half

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’s Japan Hedged Equity ETF (DXJ) offers exposure to a broad basket of dividend-rich Japanese stocks hedging for yen currency fluctuations. Buy a Full

Model Portfolio

ETFs

Explorer Stocks Summary

Brief company summaries that will not change week to week.

Watch List: 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.

Centrus Energy (LEU) based in Bethesda, Maryland, supplies nuclear fuel and services for the nuclear power industry in the United States, Japan, and Europe. Centrus Energy is building an enrichment facility in Ohio and would be very likely to benefit especially if federal funding moves forward to support this and other nuclear projects. I believe Centrus stock will benefit from increasing demand for its services, and that downside risk is low while upside potential is significant.

Cloudflare (NET) is both an aggressive and dominator recommendation offering products and services in four cutting-edge fields, though cloud computing is its bread and butter.

Its global reach is breathtaking as 20% of all web traffic runs through Cloudflare’s network and over 95% of internet users from 180 countries worldwide access the company’s services each day. And it reaches these users within 50 milliseconds. The firm’s client list includes more than 30% of Fortune 1000 companies and the ability to efficiently move and connect data – from where it is located to where it is needed (edge computing) – is a massive business opportunity in which Cloudflare already excels.

Watch List: 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.

Watch List: Franco-Nevada (FNV) is a company with more than half of its revenue coming from gold, but it also offers exposure to platinum, silver, and oil and gas. Franco-Nevada’s focus on royalties and streaming reduces risk and enables it to sidestep the huge capital costs that impact traditional miners. It enjoys cash flow and profits as its mining partners finance and complete exploration and expansion projects. That cash flow enables it to invest in new deals, pay a dividend, and operate debt free. Franco-Nevada has increased its dividend each year since its IPO in 2008.

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 permanent magnets and powers many modern of these technologies and advanced industrial materials. These include magnetic powders and magnets, specialty chemicals, metals, and alloys – all using rare earths and minerals critical to permanent magnets. 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.

Neo also has ample cash and very low debt levels. The stock also offers us an excellent hedge on China/Taiwan risk, a forward 5.4% dividend, and incentives are aligned with about 20% of the outstanding stock held by management.

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 its increasingly popular weight-loss drugs, Ozempic and Wegovy, this well managed, highly profitable company with an excellent growth profile and potential to develop new products has limited risk.

Sea Limited (SE) has three core businesses: 1) digital gaming/entertainment, 2) e-commerce, and 3) digital payments and financial services, known as Garena, Shopee, and SeaMoney, respectively. Garena is a leading global online games developer and publisher. Shopee is the largest e-commerce platform in Southeast Asia and Taiwan. SeaMoney is a leading digital payments and financial services provider in Southeast Asia. Some of you may recall this stock was an Explorer recommendation in the fall of 2019 at around $30 and became more than a 10-bagger to its 2021 high.

Super Micro Computer (SMCI), commonly known as Supermicro, manufactures enterprise computer server hardware for cloud computing, artificial intelligence, data storage and telecommunications. Super Micro stock looks relatively inexpensive right now for the growth that it has been delivering. The company trades at just two times sales. Super Micro has two larger rivals, Dell (DELL) and Hewlett Packard (HPE), but it is forecast to grow five to 10 times faster. Furthermore, both Dell and HPE have relatively high debt whereas Super Micro has a net positive cash position. This is an aggressive pick in a sector experiencing extraordinary growth.

Unilever (UL) is a dominant consumer goods giant with a trove of 400 recognizable brands in its diversified portfolio – from Vaseline to Dove – that it sells in over 190 countries. However, 30 “power brands” account for almost 75% of Unilever’s total sales. It is a steady, stable stock for an uncertain environment and for a change, its stock is selling at a rare discount, trading at just over two times sales. Two other reasons I like Unilever are that 78% of its sales are outside North America and almost 60% are from emerging markets that offer higher consumer sales potential due to better demographics.

Visa (V) doesn’t extend credit but provides the plumbing for financial payments and communications throughout the world. 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 August 29, 2024.

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