A Red Flag for Chinese Shares Trading on U.S. Exchanges
Earnings reports have been mixed and market activity muted this week, but today the four technology giants will report after the market closes. Germany reported that its economy contracted the most on record, shrinking 10.1% in the second quarter.
The Cabot Global Stocks Explorer portfolio had a relatively quiet week, though Gilead Sciences (GILD) and NovoCure (NVCR) will report earnings today.
In the midst of the relative calm, I thought I would address an issue that some of you have been asking about – the Holding Foreign Companies Accountable Act, which has already passed the U.S. Senate and will likely become law by the end of the year.
The legislation’s aim is to bring Chinese companies listed on U.S. exchanges into compliance with Public Company Accounting Oversight Board policies regarding review of corporate audits.
The first question you probably have is: why was this situation permitted to occur in the first place? This exemption from oversight is a product of Chinese government regulation. The Chinese government has taken the position that allowing a foreign agency like the SEC to audit Chinese companies on Chinese soil is an offense against Chinese government sovereignty.
The initial response to this position was the SEC saying: then just send the audit reports to us in the U.S. and we will audit over here. The Chinese then took the position that the audit reports of Chinese companies constitute a Chinese government state secret. As a state secret, the audit reports cannot be allowed to leave China.
Keep in mind that the Holding Foreign Companies Accountable Act allows for an interim period of time for a Chinese company to become compliant before it would be delisted and forced to trade over-the-counter (OTC). This would have a negative impact on share price and trading volume for a stock like Alibaba (BABA). Thus, you may wish to consider Chinese stocks that are already trading OTC, or invest directly through the Hong Kong Stock Exchange.
If you are a holder of BABA I suggest that you hold it through at least the Ant Group IPO. I will continue to rate it a hold pending more information.
I will keep you posted as this legislation moves forward.
Position Updates
Alibaba (BABA) shares went sideways this week as the Ant Group, in which Alibaba has a 33% equity stake, officially began the IPO process on both the Hong Kong and Shanghai bourses.
Ant owns the popular Chinese mobile payments network Alipay, which has more than 900 million active users in China and handled nearly 54% of the country’s $29 trillion in mobile-payment transactions last year, according to market research firm Analysys.
Alibaba dominates its markets in China, holding about a 55% share of total online retail sales (according to Statista) compared to Amazon’s 44% share of American e-commerce sales. Alibaba’s AliCloud cloud services business is also the clear market leader in China, with a market share of about 46%.
BABA is an Explorer legacy stock and I expect shares will get a bump in valuation from the upcoming Ant IPO. HOLD A HALF
Cloudflare (NET) shares rose 8% this week to just short of 39. The company’s total customer count is approaching 3 million, spread throughout the world. JP Morgan recently published a 52 price target for NET citing Cloudflare’s easy-to-use single platform and freemium option, which allows customers to use the Cloudflare solution for free before deciding on premium options. The power trends behind the rising need for more cybersecurity services are clear. The White House Council of Economic Advisers estimates that malicious cyberactivity costs the U.S. economy over $109 billion a year. According to McAfee and the Center for Strategic and International Studies, cybercrime costs the world an estimated $600 billion annually.
I encourage you to buy NET if you have not already done so. BUY
The Global X Cybersecurity ETF (BUG) was up 4% this week on the back of simple business math: pandemic-fueled increases in online activity are boosting the more robust but affordable cybersecurity services. The companies in the BUG basket address online security and cybercrime, which has reached an all-time high in the midst of Covid-19. I’m fine with new subscribers buying BUG, which represents a conservative way to invest in a competitive fast-growing industry. You may also want to pair BUG with the above Cloudflare (NET) recommendation. HOLD A HALF
DBS Bank (DBSDY) shares pulled back from 60 to 57 this week as the Singapore government asked its banks yesterday to cap dividend payments this year to conserve capital and increase capacity to lend to businesses and individuals due to the economic outlook caused by the Covid-19 pandemic. With the city-state facing its deepest recession ever, the Monetary Authority of Singapore called on banks to cap total dividends per share for 2020 at 60% of what they paid out in 2019. DBS came into the Explorer portfolio at 50 so we are still in the black, though my near-term target price of 70 may take a bit longer to reach. I’m maintaining my buy recommendation despite the government’s action given that DBS’s share price is very close to its book value. BUY A HALF
Gilead Sciences (GILD) is expected to announce earnings this morning, with analysts anticipating earnings per share of $1.47 for the second quarter and sales of $5.3 billion, according to FactSet. In April, Gilead reported first-quarter earnings per share of $1.68, and first-quarter sales of $5.5 billion.
This week the FDA approved Gilead subsidiary Kite’s CAR T therapy for relapsed or refractory mantle cell lymphoma, called Tecartus. Meanwhile, the U.S. government has purchased Gilead’s entire stockpile of 500,000 vials of remdesivir for $195 million in new revenue. Gilead plans to produce up to 2 million treatment courses, and some analysts expect the company to post sales of the drug in the third quarter of about $1.2 billion, and sales in the fourth quarter could be as much as $1.8 billion. If you haven’t yet purchased GILD shares, I encourage you to buy a half position. BUY A HALF
Kirkland Lake Gold (KL) shares were up again this week as gold prices breached $2,000 an ounce briefly earlier this week. For what it’s worth, Goldman Sachs raised its 12-month gold price target to $2,300 per ounce from $2,000. A number of factors are pushing gold prices upward such as the weakening of the U.S. dollar and concerns about U.S. government finances and potential inflation, not to mention rising tensions in Asia. If you have not yet invested in Kirkland, I encourage you to buy a half position given its strong balance sheet, high value properties and quality of management. BUY A HALF
NovoCure (NVCR), the newest addition to the Explorer portfolio, gained modestly this week ahead of its next quarterly earnings, expected after the close today.
NovoCure is well positioned in the cancer treatment niche and the company’s product, Optune, is not a drug; rather, it uses specially tuned electrical fields (Tumor Treating Fields) to disrupt the growth and division of cancer cells in tumors. As NovoCure Executive Chairman William Doyle puts it, “Instead of one [cancer cell] becoming two... one becomes zero.”
The FDA approved the Optune system in 2015 and it is presently sold in the U.S., Germany, Austria, Switzerland, Sweden, Israel, China and Japan. The company has more than 180 patents and patent-pending applications. NovoCure is a still a relatively small company with a strong balance sheet and more than $300 million of cash. Sales grew during the last quarter at a 39% annual clip and the company anticipates posting a modest net profit for 2020. As more physicians and cancer treatment centers come online, sales and profits will scale up. So should the stock.
BUY
Sea Limited (SE) shares have, since Monday, gone from 104 to 118 after App Annie, a closely watched app data research platform, said that the Sea-owned title Free Fire was the third-most-downloaded gaming app in the world in the second quarter, and No. 5 in monthly active users. Overall gaming downloads were up 20% from a year ago in the second quarter due to the pandemic, and Free Fire was the fastest-growing title in the action category. In addition to Sea’s gaming and e-commerce growth drivers is its digital payments segment led by SeaMoney, with over 10 million SeaMoney mobile wallet users. Southeast Asia has 416 million internet users and e-commerce growth was 37% in the last quarter. For now, this is a juggernaut and we will hold our position. HOLD A HALF
Swire Pacific (SWRAY) is a new addition to the Explorer portfolio and a deep value play, whose shares held firm this week at just over 5 on no news. With roots back to 1816, Swire is active in a wide range of commercial activities throughout Asia including aviation, property and retailing. Swire is a broad-based Hong Kong play with expansive assets from property to retail and transportation not only in Hong Kong but throughout the region. This Hong Kong blue chip is trading way off its 52-week high and substantially below its book (break-up) value, and I encourage you to buy a full position. BUY
VanEck Vectors Rare Earth/Strategic Metals ETF (REMX) shares gained a little ground to just over 41 as concerns escalate over fragile supply chains for these strategic technology materials. One development is that a major Australian rare earths producer, Lynas, is considering building a rare earths processing center in Texas, though it’s at least a couple of years off.
This ETF basket has positions in 20 strategic metal and rare earth companies, with about half of them based and listed in China. I encourage you to buy a half position, as both a hedge on U.S.-China tensions and growth in advanced technology, if you have not already done so. BUY A HALF
Virgin Galactic (SPCE) shares, after surging 25% last week, cooled off a bit this week as the company outlined the final stages of a test-flight program before it starts commercial operations. It also unveiled the spectacular interior design of its cabin.
The company’s new CEO, Michael Colglazier, formerly president of Disney Parks International, and George Whitesides, Chief Space Officer, are overseeing the one or two rocket-powered test flights that remain before the Federal Aviation Administration can sign off on the final five of 29 requirements to license the vehicle. It is still possible that the inaugural flight of founder Richard Branson himself may take place this year, followed incrementally by a manifest of at least 600 passengers who’ve already paid $200,000 to $250,000 each for a ticket. An additional 400 passengers who’ve placed $1,000 deposits are on the secondary waiting list.
In addition to space tourism, Morgan Stanley believes that Virgin Galactic could be a key player in the hypersonic point-to-point market that could be worth $400 billion by 2040. For example, a flight from New York to Shanghai that takes 12 hours now might be shortened to as little as 40 minutes. I’m maintaining my buy rating for this fascinating concept stock. BUY
