Cabot Explorer Issue: August 29, 2024

Portfolio Changes: Sell Super Micro (SMCI); Buy Half Position of PDD Holdings (PDD)

Nvidia Reports Another Strong Quarter, Super Micro and PDD Pull Back Sharply

While there are a lot of healthy signs of growth out there, stocks that do not meet high expectations are being punished.

Super Micro Computer (SMCI) was off 29% this past week after some allegations of faulty accounting by short sellers was followed by the company reporting yesterday that it was postponing filing of its annual report with the SEC to assess “internal controls over financial reporting.”

Given the uncertainty, we have little choice but to sell the stock. We took some profits earlier this year, and the stock is still up 43% so far this year. My guess is that we will be back to Super Micro at some point, and I will watch this stock carefully.

Meanwhile, Nvidia (NVDA) beat all but the highest earnings expectations yesterday, reporting $30 billion in quarterly revenue, up 122% year over year. Earnings were up 168%. Adjusted operating income for the quarter more than doubled year over year to $19.9 billion. Still, the stock was down as much as 6% after hours. There are still some production issues regarding its new Blackwell chip, which may also be weighing on the stock.

China faces broad pressure to limit exports and to increase consumption at home to offset slowing investment and a slumping property sector. Consumers account for only 40% of its economy while most countries are over 50% and the U.S. is over 70%.

Gold reached a new record high this week over $2,500 an ounce on rising hopes for a U.S. interest-rate cut and rising geopolitical tensions.

I remain cautious on Chinese stocks, but this week’s recommendation seeks to capture, at the very least, a potential trading opportunity as markets overreact.

New Recommendation

PDD Holdings (PDD)

Another stock that got hit rather hard this week was China’s e-commerce sales platform and owner of the high-flying Temu brand, PDD Holdings (PDD).

PDD retreated 39% in the last week.

PDD just reported a solid quarter, but management warned of slower growth ahead. This stems largely from concern about the Chinese consumer and that PDD’s recent rapid growth may slow down. Looks like management is trying to lower expectations.

This spooked the market and, given that the stock and the company are outperforming both Alibaba (BABA) and JD (JD) and shares are trading at just 8 times forward earnings, I recommend that aggressive investors buy the stock as it is growing much faster than its competitors. Its return on equity is a stunning 49%.

PDD was only founded nine years ago (as Pinduoduo), and it has carved out a niche with its discount marketplace, which targets shoppers in China’s lower-tier cities. PDD also encourages its shoppers to team up on social media channels to score bulk discounts. In addition, its farm-to-table channel allows it to sell fresh produce at lower prices than traditional supermarkets.

From 2023 to 2026, analysts still expect PDD’s revenue to grow at a compound growth rate of 38%. That growth should be driven by its market share gains in China and by Temu, its cross-border marketplace that connects Chinese sellers to overseas buyers.

This is a competitive market in China watched closely by regulators. In 2021, China’s antitrust regulators hit Alibaba with a record $2.75 billion fine and forced it to halt its exclusive deals with merchants and pull back its loss-leading promotions.

PDD has largely escaped intense scrutiny because it is China’s third-largest e-commerce company by annual revenue. However, Temu, PDD’s popular international bargain site, is in the crosshairs of regulators and lawmakers in the West.

At issue is that small shipments from Chinese companies such as PDD are exempt from some U.S. tariffs. Earlier this year, Temu launched a new program to recruit sellers with inventory overseas to reduce the risk if legislation does change regarding the amount that can come in tariff free.

There are other issues. PDD is facing some supplier pushback regarding slim margins, and they are also cutting some merchant fees. Yes, it is possible that growth may slow a bit if China’s consumers pull back.

Taking all this under consideration, the almost 40% haircut with the stock plummeting from 150 to 89 in one week seems unwarranted to me. This is a speculative stock right now, but downside risk is somewhat limited since the stock is trading at such a low valuation.

Plus, consumers will still be looking for deals even if China’s overall economy slows.

BUY A HALF POSITION

Explorer Weekly Stock Commentary

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.

Explorer Disrupter Recommendations – need to watch more closely and have 20% trailing stop-loss in place

Centrus Energy (LEU) shares were off 4% this week and are relatively quiet after the company reported that earnings per share more than doubled in its second quarter. Its earnings estimate for the next quarter has been raised 17% in the last month, according to Zacks. Centrus remains a buy as an excellent proxy for existing and new nuclear power technology. Buy a Half

Cloudflare (NET) shares were down 3% this week. Cloudflare operates the fastest cloud network in the world, powering about 20% of the web. The company has more than 210,000 paying clients and about half of its revenue comes from outside the United States. The Wall Street analyst consensus is that the company’s sales will grow at 28% annually through 2027. Buy a Half

Dutch Bros (BROS) shares are up marginally since becoming an Explorer recommendation. This is an operator and franchisor of 912 drive-through coffee stores as of the end of June, while Starbucks runs 16,730 stores in the United States alone. It is expanding at a steady pace, expecting up to 165 new stores this year. A Cowen analyst reiterated a buy rating this week with a price target of 47 (it currently trades at 31 a share). Buy a Half

Neo Performance (NOPMF) shares were up a bit more after last week’s 9.2% gain following the announcement that the company was selling its China-heavy rare earths processing business for $30 MM in cash. It turns out that the buyer is China’s Shenghe. Shenghe is also an equity partner and processor for America’s only rare earths mine, owned by MP Materials (MP). Hold a Half

Novo Nordisk (NVO) shares were down 2% this week as competitor Eli Lilly launches discounted versions of obesity drug Zepbound. It is not clear how Novo will respond. Demand for its products is still high with Ozempic sales up 30% to $4.26 billion in the last quarter while Wegovy sales were up 69%. Hold a Half

Sea Limited (SE) shares pulled back 2% this week following up weeks of 6.8% and 26.4% after reporting a good quarter. During the second quarter, Sea’s Shopee e-commerce platform processed about 2.5 billion orders, which was a 40% increase from the year-ago period. The company is focused on improving the efficiency of its logistics and all three of Sea’s major segments are moving in the right direction. Buy a Half

Super Micro Computer (SMCI) shares, up 25% in the previous two weeks, were off 29% this past week after some allegations of faulty accounting by short sellers followed by the company reporting yesterday that it was postponing filing of its annual report with the SEC to assess “internal controls over financial reporting.” Given the uncertainty, we have little choice but to sell the stock. We took some profits earlier this year, and the stock is still up 43% so far this year. My guess is that we will be back to Super Micro at some point, and I will watch this stock carefully. Supermicro is a key server supplier to Nvidia and many cloud computing giants as it supports the AI infrastructure buildout. Move from Buy a Half to Sell

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

International Business Machines (IBM) shares approached the 200 level this week as the company announced it was closing its China research and development group. IBM is primarily a consulting and cloud company and has also consistently led in AI research, but a new IBM mainframe computer will soon hit the market. The Telum II will have four times the AI computing capacity of the original Telum processor which was launched in 2021. Buy a Half

Unilever (UL) shares were up 3% this week and have so far this year delivered a return four times that of the FTSE 100 index which is a basket of Europe’s top 100 companies. The company offers a wide range of products in the fields of beauty, personal care, home care, and nutrition with a focus on emerging markets. Buy a Half

Visa (V) shares were up a bit again this week and the stock should benefit from lower interest rates unlike the broad banking sector. Since Visa doesn’t face the loan/credit risk of a bank, it has historically traded at a premium valuation to the broader financial sector. Visa essentially benefits from transactions and would prefer that consumers use cards to buy and then pay off the full amount each month to keep the ball rolling. 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) 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.

Dutch Bros (BROS) is 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. 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.

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.

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.

The next Cabot Explorer issue will be published on September 12, 2024.

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