Cabot Global Stocks Explorer 725

A stimulus bill looks like it is right around the corner but we need to get through this winter before vaccines are widely available. Facebook faces a real challenge to break it up and accept legal liability for content. An EU-China summit is cancelled after China tried to limit speakers critical of China’s clampdown of Hong Kong. On the Explorer front this past week, MP Materials (MP) and NovoCure (NVCR) were particularly strong as Sea Limited (SE) briefly made a new high at 200. As promised, our new idea this week hails from Brazil and is a monopoly play on the most essential of all resources.

Due to the holidays, the next issue of Cabot Global Stocks Explorer will be published on January 7, 2021.

Cabot Global Stocks Explorer 725

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Second-Level Thinking: Marks on the Market
In investing, it pays to lean towards optimism and independent thinking, but sometimes it helps to consider a different view. This is especially true when it comes from somebody like Howard Marks, a legendary distressed asset investor.

In his book, The Most Important Thing, Howard Marks points out that most people are first-level thinkers, and that applies to the majority of investors. This has nothing to do with intellect. Rather, most people are either just too busy or complacent – not interested enough in going beyond conventional wisdom.

First-level thinking is a bit simplistic. After all, the first-level thinker needs only an opinion about the future. For example, regarding U.S.-China relations over the last four decades, first-level thinking led to engaging with China with the gamble that it might become a more open, responsible partner in Asia and the world. Now that China has become an authoritative and rather antagonistic near-peer rival, first-level thinking has shifted to focusing on bilateral trade numbers, a strategy of containing China, or just getting even by inflicting damage on China’s economy. Both approaches miss the mark by a wide margin.

This brings me to second-level thinking, which is deeper, more complex. Here are some questions a second-level thinker might ask: “What is our objective?”…What is the range of likely future outcomes?”... “Which outcome do I think will occur and what’s the probability I’m right?”... “What is the consensus opinion?”... “How and why does my thinking differ from the consensus?”

Whenever considering a course of action, second-level thinkers always ask themselves, “What comes next?” and look three or four steps ahead.

For many years Howard Marks, co-chairman of Oaktree Capital Management, has written regular memos to Oaktree clients, and I’m usually able to run them down. Below are some of his recent comments on a number of issues that might be useful to us as we plan for 2021.

“There is a big group in the middle of the country that thinks it hasn’t received enough attention from presidents of both parties. That’s a big issue, because we don’t want to go forward forever as if the U.S. is two different countries.”

“We’re in a lower-growth mode than we’re used to. This country and the world grew at a great rate in the latter half of the 20th century, and the outlook is for less growth than that. Then we’ll have the increasing effects of automation and digitization. As a combined result, we’ll have fewer jobs.”

“You have to worry about our debt load, as well. What are the long-term ramifications of what the Federal Reserve and Treasury have been doing by piling up additional deficits and debts?”

And finally, one last comment from Marks on investing to ponder on as we head into 2021: “Fear of missing out has taken over from the fear of losing money. If people become ultra-risk-averse, that’s how you get great bargains. Because they’re risk averse, they won’t buy. They sell at low prices. But if people are risk-tolerant and afraid of being out of the market, they buy aggressively, in which case you can’t find any bargains. That’s where we are now. That’s what the Fed engineered by putting rates at zero.”

We have some aggressive ideas in the Explorer portfolio that have done quite well. Don’t forget to take some profits from time to time. I recommend that you keep some cash on hand and balance out some of your high-flying stocks with some value ideas in industries that might seem a bit boring. And that brings me to today’s new Brazilian addition to the portfolio. You don’t get more basic than water…

New Explorer Recommendation
Companhia de Saneamento Basico do Estado de Sao Paulo: SABESP (SBS)
While we take an inexpensive and steady supply of water as a birthright, in much of the world, this is anything but the case. In America, water prices are heavily subsidized but in Switzerland, water prices are about four times those in America not because it costs that much more to produce clean water, but because it isn’t heavily subsidized. Americans as a group are water wasters, using 80 to 100 gallons of water per day, on average.

Water is a hot issue all over the world. The United Nations Environment Program has predicted that half the globe’s population could face severe water stress by 2030. Take China, for example. Waters originating in Tibet supply around 30% of China’s fresh water, but it is a long way from China’s arid regions in the industrial northeast. In Jakarta, Indonesia, roughly 40% of this sprawling city of 11 million-plus people have access to running water.

Water is also a key issue for many companies. Take one holding in the Explorer portfolio, Taiwan Semiconductor (TSM). Taiwan is a water-scarce area, so Taiwan Semiconductor recaptures and reuses their water three times because semiconductor plants gulp down huge quantities of water, and, though Taiwan gets plenty of rain, it has little ability to store it.

This brings us to SABESP, the largest water company in Brazil. This is a great monopoly opportunity that is majority owned by the state of Sao Paulo. The company has a monopoly on providing water and sewage services to over 26 million people in 365 of the 645 municipalities in the State of Sao Paulo.

I like SABESP because the company still has plenty of room to grow in its monopoly territory of Sao Paulo, with 18 million not yet connected to its services. Sao Paulo has a population over 44 million and accounts for more than 30% of Brazil’s total economic output. In addition, the company is expanding to other regions in Brazil, and even in neighboring countries. Second, the company has a stellar record over the past decade, with an annual earnings-per share growth rate of just over 19%.

The Brazil stock market is now back in favor as interest rates have fallen sharply, making fixed income (bonds) less attractive. As a result, capital and investors are shifting to its stock market and it is a matter of time before they start snatching up this monopoly opportunity.

In short, SBS is an undervalued, underappreciated and overlooked Brazilian stock. It is trading at about 12 times projected earnings—quite a bit off its 52-week high. While SBS is an excellent water play in a country with a stock market in a strong uptrend, I’m also tracking other growth ideas in the global water business. For example, there are exciting and innovative water technology companies that are developing breakthrough technologies to more cost effectively turn salt water into fresh water. I’ll keep you posted on what I find.

In the meantime, SBS is a conservative value play on water. Let’s begin with a half position.

BUY A HALF POSITION

Model Portfolio

Portfolio Changes
MP Materials (MP) from Buy a Half to Hold a Half

Updates
Afterpay (APT.AX) shares were flat this week even after achieving a new monthly sales milestone in November 2020 by delivering over $2.1 billion of underlying sales, more than doubling the $1 billion of underlying sales in November 2019 (up 112%).

The total number of customers that have signed up for Afterpay in the U.S. alone now exceeds 13 million. The U.K. continues to be a standout, with underlying sales growth up 315% through November with the number of merchants on the platform increasing by 800% compared to November 2019. If you have not already done so, I suggest you purchase Afterpay shares on the Australian stock exchange, which offers by far the best liquidity. BUY A HALF

Alibaba (BABA) shares appear to be trading in a holding pattern in the 260s pending two issues that are clouding its otherwise bright future. The first is the delay by regulators of the planned spin-off of its financial arm, Ant Group, which was set to IPO in Shanghai and Hong Kong. It was going to raise a record $37 billion, making it the world’s largest public listing. This would have valued the company at about $310 billion. The second issue is the legislation that passed in the U.S. House of Representatives last week that could lead to the delisting of stocks such as Alibaba from U.S. exchanges if they don’t comply with U.S. audit oversight rules within a three-year window.

I think it is probably premature to sell BABA but some investors may wish to switch to Alibaba’s Hong Kong listing (9988) to avoid this issue altogether. BABA remains a legacy hold and a key core holding for investors looking for a quality stake in the emerging Chinese consumer. HOLD A HALF

Cloudflare (NET) shares advanced from 74 to 77 this week after already more than doubling since early September; the stock has appreciated around 300% year to date. KeyBanc Capital Markets initiated coverage of Cloudflare with a price target of 87, highlighting that its platform could over time address a market size of $69 billion. Cloudflare recently reported third-quarter earnings and revenue growth accelerated at a year-over-year clip of 54%. I will keep NET a hold at these levels; if you are already sitting on a sizable return in the stock, sell a few shares to lock in some profits. HOLD A HALF

ElectraMeccanica (SOLO) shares end the week where they started, just over 7. There are some short sellers out there, and of course some profit taking given that the stock was up 169% in November. Electric vehicle stocks have pulled back as a group. Even so, we have a big profit so if you have not sold any shares, sell about half your position and book some profits. This is a speculative idea that will attract some serious media attention into 2021 and has a chance to scale up in America and beyond. If you have not yet bought shares, let’s hold off until we get a better picture of an uptrend. SELL A HALF, HOLD A HALF

MP Materials (MP) shares continued their strong performance this week, surging from 21 to 26. This makes sense given that the permanent metal rare earths they produce have also been surging. MP Materials is the only major rare earths resource in the Western Hemisphere. Its primary rare earth products are key ingredients in permanent magnets that power the traction motors of electric vehicles, robotics, wind turbines, drones and many other technologies. This is a speculative idea with a strong management team and represents a play on climate change tech and in particular clean energy such as wind power and electric vehicles. Based on its rapid climb, I’m moving this stock to a hold. HOLD A HALF

NeoGenomics (NEO) shares, added to the portfolio two weeks ago, have jumped from 45 to 49. NeoGenomics operates a network of cancer-focused testing laboratories in the United States, as well as laboratories in Switzerland and Singapore. The company is the world’s leading oncology testing company for doctors, pathologists and hospitals serving more than half a million patients each year. NeoGenomics’ strength is that it is entirely focused on cancer testing. The stock has been in a strong uptrend and revenue should accelerate in 2021 as pent-up demand drives catch-up testing. This is an aggressive play on a leading company in a critical, high-growth market. BUY A HALF

LogiQ (LGIQ) shares pulled back last Friday but have climbed back to where they started the week at 8.4. This fintech and payments stock has more than doubled over the last six months but can be a bit volatile. LogiQ is a New York-based leading global provider of e-commerce, mobile commerce, and fintech business enablement solutions for three big markets: Southeast Asia, Europe and the United States. LogiQ’s stock is trading at just over three times 2020-projected revenue. This is an aggressive idea and I suggest that investors that can handle some volatility buy shares if you have not already done so. BUY A HALF

NovoCure (NVCR) shares jumped this past week from 131 to 161 as investors look for its momentum to carry over into 2021. The company makes a cancer treatment device called Optune that uses electric fields at specific frequencies to interrupt cell division. By doing so, NovoCure hopes to stop cancer in its tracks. And NovoCure isn’t stopping at glioblastoma or mesothelioma – cancers of the brain and lungs, respectively – where it has Food and Drug Administration approval. The company hopes to open up its technology to more common types of cancer. In 2021, NovoCure is expected to unveil the results of Optune studies in cancers of the liver, lungs, stomach and ovaries.

In its third quarter, the company posted 350% growth in adjusted earnings, with sales jumping 44% to $132.7 million. Despite the big move, I still rate the stock a buy for long-term investors that have not yet purchased shares. BUY A FULL

Sea Limited (SE) shares breached 200 for the first time as the company announced it has been granted a license to operate a full-service digital bank by the Monetary Authority of Singapore. I would again recommend that investors take some profits here but this story will likely continue into 2021. Sea is Southeast Asia’s biggest internet platform with 40 million daily active users. The stock has benefited from strong tailwinds during the COVID pandemic, rising 4x in the last six months. Sea’s business operations are in the e-commerce, gaming, and payments space, which have seen strong user adoption over the last few years. HOLD A HALF

Taiwan Semiconductor (TSM) shares were steady at 104 as the company benefits from secular trends of advanced computing and 5G going into next year and beyond. In addition, the prospect of a widely distributed COVID-19 vaccine has analysts looking forward to an economic recovery next year.

This company is a dominant global semiconductor chip fabricator with tremendous economies of scale in a capital-intensive industry. The company delivered an impressive return on equity of 31% in its most recent quarter. I maintain a buy rating on the stock. BUY A HALF

Virgin Galactic (SPCE) shares have gone from 18 to 32 over the last five weeks after reaching 35 earlier this week. The window for Virgin Galactic‘s first powered test flight opens Friday. The test will complete data gathering for the final two FAA verifications that will allow commercial flights on SpaceShipTwo to begin. The flight will also include revenue-generating payloads as part of the NASA flight opportunities program.

As the only pure-play space tourism stock in the public markets, this remains your best way to add exposure to this megatrend. The company’s current plans include space tourism flights for the 700 future passengers who put down refundable deposits. Management plans that a second SpaceShipTwo vehicle will be rolled out for ground and flight testing in the first quarter of 2021, a delay from the end of 2020. A third spacecraft will begin final assembly in 2021. Feel free to take some profits if you bought near the recommendation level; new or aggressive investors can buy at these levels ahead of 2021 developments. BUY A FULL

The next Cabot Global Stocks Explorer issue will be published on January 7, 2021.

Cabot Wealth Network
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