Cabot Explorer Issue: December 5, 2024

Portfolio Changes: Move BYD (BYDDY) from Watch List to Buy a Half

Power Rivals: BYD and Tesla

This was a good week for Explorer stocks, and as we head into the end of the year, Sea Limited (SE) is so far up 190%, IBM (IBM) is up 48% and Dutch Bros (BROS) was up 62% in November alone.

Tariffs are topic one in Washington and the financial media. Markets don’t know how everything will work out. Mexico is America’s largest trading partner, followed by Canada and then China. America still imports 4 million barrels of crude oil a day from Canada, which is also a key partner on the critical minerals front. More than half of America’s imports of fruits and vegetables come from Mexico. Automakers, which have built factories in Mexico to produce vehicles for the American market, are at risk and their stocks are falling at the wrong time.

Tariffs can be viewed as both subsidies to producers and taxes on consumers.

This brings us to electric vehicles (EVs), which are at the bullseye of the tariff debate.

Despite giant subsidies, Rivian (RIVN) lost about $4 billion on the 37,396 vehicles it has sold in America during the first nine months of this year while Ford loses big money on each EV it sells.

China’s home market for car sales is the world’s largest – about the size of the American and European markets combined.

Besides the scale of its domestic market, China has made tremendous investments for almost two decades in developing electric cars to decrease its need to import oil, reduce pollution, and as a strategic move to capture a new auto technology.

Now, half of China’s car buyers choose battery electric or plug-in hybrid cars aided by subsidies like those America has belatedly put in place.

World electric vehicle sales could reach 73 million units in 2040, up from around two million in 2020, according to forecasts by Goldman Sachs. And the share of EV sales could be well over 80% in many developed countries.

In my opinion, this is a best-case scenario.

A better and more important question for investors is which company and stock will lead the EV revolution going forward? The auto and EV market is fragmented and the competition keen, with plenty of American, European, Chinese and other Asian automakers in the hunt. Tesla and BYD stand apart and seem well positioned to keep the lead.

Tesla (TSLA) may be in the driver’s seat right now and has been on quite a run since the election but China’s EV leader, BYD (BYDDY), can be clearly seen approaching at high speeds in the other lane. I readily admit that Tesla is a more valuable company than BYD now, but we need to ask ourselves two related questions.

Does it make sense that Tesla’s market value is over $1 trillion while BYD sits just over $100 billion? Should Tesla stock be trading at 96 times earnings while BYD stock is at just over 20 times earnings?

Many of you know quite a bit about Tesla so let’s turn primarily to today’s recommendation of BYD. My eyes are wide open that BYD will not be selling any EVs in America for some time, if ever. But BYD is quickly expanding into other major markets around the world.

New Recommendation

BYD (BYDDY)

A few years ago, BYD (for Build Your Dreams) switched to producing only all-battery electric vehicles (BEVs) and plug-in hybrid electric vehicles (PHEVs).

In both 2021 and 2022, BYD more than tripled sales from the previous year. That’s hyper growth and, including hybrids, BYD has already surged past Tesla in terms of sales.

Most of BYD’s sales are still in China but it has a big international expansion underway, including in the U.S., Europe, and Asian markets.

The company also supplies batteries, including to Tesla, and makes its own chips. This is vertical integration that would make Henry Ford proud and must keep Elon Musk awake at night, if he ever sleeps.

BYD is moving up the scale to more premium models while Tesla has announced big price cuts in China and key Asian markets as well as discounts in the U.S. and Europe. BYD has begun deliveries in Malaysia and India and entered Japan’s market two weeks ago.

But Tesla’s price cuts and other incentives seem to be working, forcing competitors to follow and making their core EVs very competitive from a pricing point of view. In addition, Tesla’s Model 3 and Model Y vehicles could be eligible for new U.S. tax credits of up to $7,500. Plus, the Cybertruck has finally arrived, which is Tesla’s first new model since the Model Y launched in early 2020.

Battery Technology

Turning to EV batteries, Tesla’s joint-venture partner Panasonic makes the cells and Tesla packages them. Tesla also buys lithium iron phosphate (LFP) batteries from China’s CATL and buys some batteries from BYD.

BYD is the world’s largest EV battery maker and, with CATL and others, is working on sodium-ion batteries. Much less energy dense than lithium batteries, sodium batteries should be much cheaper. BYD will also launch a next-generation Blade battery in 2025, with longer range and faster charging. That, along with various other models, could help rev up BEV sales growth next year. BYD expects solid-state batteries for high-end models by 2027, but not fully reaching lower-end models until 2030-2032. In addition, BYD is a major battery storage provider. It reportedly will be a supplier to Tesla’s Shanghai Megapack factory.

BYD makes its own semiconductor chips and is involved in several lithium mining projects – another indication of its goal to control the EV supply chain from the ground up.

The scale advantage of BYD can be best seen through the city of Shanghai which has a 10,000-yuan ($1,500) subsidy for residents who trade in vehicles in exchange for a purely electric vehicle. Shanghai is a big market for EVs including BYD, but also Tesla. For perspective, Shanghai has a population roughly equal to the population of America’s four largest cities (New York, Los Angeles, Chicago, and Houston) plus Montreal and Toronto.

One key issue is politics, which is both fluid and complex. Tesla has significant ties to China on the technology, production and sales sides. Washington is determined to keep BYD products out of the U.S. market and is also trying to keep BYD production out of Mexico using tariffs and political pressure. BYD’s only U.S. presence currently is making EV buses in California. This is probably the biggest risk factor, though BYD can still do quite well selling no cars in America.

Scale and Costs

But BYD has the advantage of scale and lower costs and thereby prices which is leading to impressive growth in emerging market countries around the world. Its dominant size, with 36% of China’s EV market, allows it to successfully push for lower prices from its Chinese suppliers.

Analysts at the bank UBS calculate that cars made by BYD cost 30% less to assemble than similar cars made by Western companies. Some of the biggest savings for Chinese companies are on batteries. China controls practically the entire supply chain for making electric car batteries including the mining and processing of critical minerals such as rare earths.

BYD’s Q3 earnings rose 16%, slightly above views. Sales jumped 29% to $28.7 billion, with growth accelerating for a second straight quarter but just missing views. However, BYD had more revenue than Tesla for the first time. For all-battery electric vehicles (BEVs), BYD seized the crown in Q4 2023 and is on track to lead again in Q4 2024.

BYD is pushing hard on the international front with its new Thailand plant, its first full-assembly plant outside of China, beginning deliveries. There’s also a knock-down plant in Uzbekistan, which puts together partially assembled vehicles. A Brazil factory is due to fully open in early 2025. The EV giant also intends to build factories in Hungary, Indonesia, Turkey, Cambodia, Vietnam, and Pakistan.

Turkey has a customs union with the EU. That, along with the Hungary plant, will be two factories for Europe.

Price and Valuation

Tesla stock has risen 40% in the last month while BYD is now selling just where the stock sat in February 2021 after a sharp run-up that got ahead of itself. The flip side of this and the leading reason for today’s recommendation is that Tesla’s market value is now well over $1 trillion while BYD sits just over $100 billion. Looked at through a different frame, Tesla stock is trading at 96 times earnings while BYD stock is at just over 20 times earnings. Expect some volatility, but it seems to me that the market will correct this imbalance.

BUY A HALF

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 a 20% trailing stop-loss in place.

Agnico Eagle Mines (AEM) shares were up a bit this week so there have been three weeks of continuous gains for this stock, though the stock is flat for the last month. A stronger dollar and higher interest rates are not helping gold, but Agnico has a strong cash flow and low gold price break-even point. Higher geopolitical tensions seem to be driving investors to safe havens such as gold. Buy a Half

Airbus (EADSF) shares were up nearly 12% this week as the company delivered 80 jets in November as it works to address a backlog of more than 8,600 orders to fill. Airbus last year beat Boeing for the fifth straight year and recently reported a 28% quarterly increase in net profit. Airbus’s new models will enable airlines to use cheaper narrow-body jets on long-haul flights to lower fuel costs and boost profits. Buy a Half

Banco Santander (SAN) shares were up marginally as the company announced investment in its information tech systems to support the bank’s fully digital bank operations in Spain and other markets such as Mexico. Banco Santander has added almost 5 million new customers over the last 12 months and has a total of 171 million customers. Banco Santander’s strength is in Latin America and Europe. Buy a Half

Centrus Energy (LEU) shares pulled back 6% this week as the U.S. continues to depend on Russian uranium. We will have to watch this uranium supply issue as well as regulatory issues closely. Interest in modular nuclear energy is increasing with AI needs for powerful data centers rising sharply, but opposition remains. Buy a Half

Cloudflare (NET) shares were up 8% this past week as Morgan Stanley upgraded the stock, calling it a compelling secular story and referring to its potential in AI markets. The company expects its revenue to grow 28% this year and analysts expect its adjusted earnings per share to grow 52% this year. Cloudflare sits at the center of cybersecurity and AI computing services. Buy a Half

Dutch Bros (BROS) shares gained a bit this week and were up 62% in November, hitting a 52-week high. The company recently reported revenue growing 27.9% year over year to $338 million in the third quarter. The drive-thru coffee chain enterprise has aggressive expectations to grow beyond its western base and investors have increased confidence it can meet its goals. Buy a Half

Sea Limited (SE) shares are now up over 190% for the year, so you may consider selling some shares to take profits off the table as I recently moved the stock to a hold. The company focuses on consumers in the Southeast Asia region and is well positioned to defend its e-commerce turf in a competitive market. The company’s digital entertainment group results are improving as well with 628 million users, up 15% from the year-ago period. Hold a Half

Explorer Dominator Blue-Chip Recommendations – More Buy and Hold

International Business Machines (IBM) shares were up again this week and have gained 48% so far this year. The company recently announced that it would be entering several AI partnerships with Amazon. IBM offers us a cutting edge but relatively conservative exposure to a blend of cloud computing, data analytics, cybersecurity, and artificial intelligence (AI). Buy a Half

Unilever (UL) shares were up marginally again this week as the company appears to be selling some of its food-related businesses. The Netherlands-based company has performed much better than European indexes, but we need to watch how tariff issues work out given that Unilever has major manufacturing bases in both Mexico and China. Buy a Half

Visa (V) shares are up nicely this year but have underperformed the S&P 500 index as the cloud of the U.S. government seeking to make the case that Visa is a near monopoly on the debit card side of the business weighs on shares. Visa is still very profitable with profit margins above 50%, while returns on equity are also around 50%. Buy a Half

Watch List – Stocks we like but do not follow week to week

ConocoPhillips (COP), Franco-Nevada (FNV), MOOG (MOG-A)

Explorer ETF/Fund Positions

Aberdeen Asia-Pacific Income Fund (FAX) is a closed-end 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 top Chinese-listed stocks. Buy a Half

Oberweis Micro-Cap Fund (OBMCX) fund stands out for several reasons. The fund’s sound investment process and strong management team earn it a rare Morningstar Medalist Rating of Gold. Over the past five years, it has posted an impressive average annual return of 18.9%. 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.

Agnico Eagle Mines (AEM) follows a conservative strategy and with a history spanning more than 60 years, and now operates a sizable portfolio of 11 assets located in four countries. Management forecasts gold production of approximately 3.45 million ounces in 2024. The company estimates it has about 54 million gold ounces of proven and probable reserves. Furthermore, Agnico Eagle has paid a dividend for 41 consecutive years with a dividend compounded growth rate of 23% per year since 2005 and plans to pay a dividend of $1.60 per share in 2024.

Airbus (EADSF), along with Boeing, is one of only two manufacturers that make the full-size commercial jets needed by the world’s airline industry. China’s COMAC is making gains but is probably a decade away from being a competitive rival. Boeing’s troubles are Airbus’s opportunity. Airbus, incorporated in the Netherlands but based in Toulouse, France, is making planes as fast as it can and has a backlog of more than 8,600 orders to fill. Airbus last year beat Boeing for the fifth straight year in the orders and deliveries race, with 2,094 net orders and 735 delivered planes. I visited its facilities recently and while it shares some of Boeing’s supply chain challenges, Airbus has a clear edge right now. Airbus is benefiting from its decision to deliver the fuel-efficient A321neo, a single-aisle aircraft with 180 to 230 seats. Fuel is one of the airlines’ biggest costs. Airbus’s new A321XLR model will also enable airlines to use cheaper narrow-body jets on long-haul flights.

Banco Santander (SAN) was founded in Spain in 1857. The bank’s U.S. headquarters is in Boston, but its strength lies in Latin America and Europe where it has more than 8,000 branches with 171 million customers as well as 58 million digital accounts. In the second quarter, it welcomed over 4 million new customers compared to the previous year. About 55% of deposits and loans are in Europe with the balance in Latin America. In its most recent quarter, Santander’s revenue was up 8% while net profits increased 16%.

BYD (BYDDY) switched to producing only all-battery electric 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 and has 950 stores as of the end of the third quarter, including 38 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 29 consecutive years of dividend increases.

MOOG (MOG-A) supplies advanced primary flight controls on the most modern military aircraft. That includes the Lockheed Martin F-35 Lightning II and the Future Long Range Assault Aircraft program. The company’s major platforms include the 787, A350, Joint Strike Fighter (F-35 Lightning II). The company also supplies primary flight controls for the Boeing 787 and Airbus A350 widebody aircraft, as well as business and regional jets from Embraer (ERJ) and Gulfstream, owned by General Dynamics (GD).

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.

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 December 19, 2024.

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