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Cabot Emerging Markets Investor 687

Market sentiment for emerging and global markets improved this week and we are putting some cash to work including a new recommendation that plays on Asia’s thirst for coffee. Sentiment for emerging and global markets improved somewhat this week as our market timer (EEM) turned neutral between its 20-day and 50-day moving averages. Uncertainty regarding China and Mexico is a headwind but institutional flows into emerging markets remains pretty robust.

Cabot Emerging Markets Investor 687

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Cabot Emerging Markets Timer

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The Emerging Markets Timer is our disciplined method for staying on the right side of the emerging markets. The Timer is bullish when the index is above the lower of its two moving averages and that moving average is trending up.


Our Emerging Markets Timer is still pointed down, but the next few days could tell us whether this recent upmove is the start of something more. Following its sharp May decline, you can see that the iShares EM Fund (EEM) rallied nearly two points off its lows and surged back above its lower (25-day) moving average.

However, for the intermediate-term trend to turn up, we need to see that moving average itself begin to trend higher. If EEM holds its ground for another few days, it could happen, and if it spikes from here, it could happen quicker. But we don’t anticipate—with the trend still down, going slow is still a good idea.

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Soaring Starbucks Has High Growth Challenger

Sentiment for emerging and global markets improved somewhat this week as our market timer (EEM) turned neutral between its 20-day and 50-day moving averages.

Uncertainty regarding China and Mexico is a headwind but institutional flows into emerging markets remains pretty robust

As such, I’m removing the inverse (EUM) emerging market ETF that served as a hedge for the portfolio, increasing an allocation to a current holding, and adding an aggressive idea to the portfolio.

This week markets welcomed even a cloudy respite from Mexico tariffs though it’s pretty clear that trade-related tensions are going to flare up sporadically through 2020.

Our speculative Largo (LGORF) play on electrical energy storage and infrastructure (Vanadium) surged 27% over the past week and continues to outperform.

I’ve taken a closer look at LexinFintech (LX) and have put this stock back on the buy list based on its very strong fundamentals.

As for new buys, these next two photos will tip my hand…

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Featured Stock

New Aggressive Recommendation:
Luckin Coffee (LK)

A Wager on a Starbucks Chinese Competitor

Coffee is trading below $1 a pound, less than half the value it fetched five years ago due to a flood of beans from leading producer Brazil.

Brazil’s coffee exports are being supercharged by a weaker currency.

This is but one reason Starbucks (SBUX) stock is on a tear despite becoming a mature cash-generating company in the U.S. market boasting a significant licensing revenue stream from global licensing partnerships such as Nestle.

Several years ago I highlighted Starbucks as a low-risk China play and as of March 2019, Starbucks had 3,789 stores in China, 17% more than a year earlier, making it the second largest market after America. China same-store sales rose 3% during its most recent quarter, up from 1% in the first quarter.

You may recall I suggested caution a few weeks just prior to Luckin’s IPO on the NYSE. The IPO was priced at 25, quickly lost steam, moving as low as 14, before climbing back to 18 and change.

No question this is a big growth story, with Luckin since June 2017 opening 2,400 coffee outlets in 28 cities and gunning for 4,500 by the end of 2019.

This would put the company ahead of Starbucks in China by the end of the year. Starbucks has a goal of having 6,000 stores in China by 2022 and has a deal with Alibaba to deliver coffee.

Keep in mind that Luckin’s model is very different than Starbucks’.

Luckin outlets are usually quite small delivery points with customers using apps to order and then pick up at a pre-determined time.

Luckin in 2018 had only $125 million in revenue and lost $238 million before taxes. One reason why: their coffee is priced at a 20% - 50% discount to Starbucks’ and they have so far given away a lot of free cups of coffee to get things moving.

The big attraction here is that history shows that with economic development and higher incomes comes higher consumption of coffee - even in tea drinking Asia.

The average Chinese only drinks between 5-6 cups of coffee per year. That’s per year—not per day!

For Taiwan, the number is 209 cups of coffee per year, for Hong Kong, 249 cups, and for Japan it is 279 cups of coffee.

You can see the upside, which is why Starbucks is making a major bet on China since opening its first store in 2000.

LK’s competitive advantages include:

1) exposure to a rapidly evolving coffee culture in China where the average annual consumption is only six cups per year;
2) limited direct competition;
3) low development costs;
4) better tech and data analytics than peers;
5) low per-unit cost structure, and
6) the ability to take its model to other markets in Asia.

Another plus is that three well-regarded investment firms have recently picked up research coverage of LK. Morgan Stanley has it rated a buy, Key Banc has a $22 price target, and Needham has it rated a buy. Several large hedge funds have reportedly also taking some significant positions.

Given that LK is a young company with a long way to go before becoming profitable, this is an aggressive recommendation and I suggest you put in place a 20% trailing stop loss. BUY A HALF POSITION.

Luckin Coffee (LK)

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Model Portfolio

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Prices as of 2:30pm

Updates

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Alibaba (BABA) shares picked up six points this week to break 160.

The company announced plans to raise as much as $20 billion through a listing in Hong Kong. This follow-on share sale to its 2014 NYSE listing would provide Alibaba with capital to fund its new initiatives, like cloud computing.

Alibaba is significantly expanding through acquisitions. These acquisitions always carry integration risks but analysts expect Alibaba to make $6.69 in earnings per share during the current fiscal year ending in March of 2020 – so the stock is trading at a very reasonable price-to-earnings ratio of 23.

I believe that BABA is a great core China holding. BUY A HALF.

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Daimler (DDAIF) was up 4% this week in a tough environment.

This premier automaker is trading at only eight times forward earnings and, given its cost-cutting program, positive growth revenue in emerging markets including China, expansion into electric vehicles, and a 5%-plus dividend yield, I’m moving DDAIF from a hold to a buy a half position. BUY A HALF.

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ICICI Bank (INB) gave up a little bit of ground this week but remains a solid India play in the wake of President Narendra Modi’s recent re-election. India offers investors a large and youthful population (50% under the age of 25) with potential “catch-up” growth as an urbanization rate of about 34% is about where China was two decades ago.

And there are still 191 million Indians without a bank account. ICICI is capitalizing on this emerging growth trend with a blend of 60% retail and 40% corporate business.

Its last quarter highlights its strength as retail loans were up 22% and core operating profit surged 26%. The bank has a healthy net interest margin of 3.72% and non-performing loans were down 50%. This is a solid bank in a promising market. BUY A HALF.

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LexinFintech (LX) had an up week and I went back to closely look at the prospects for this company again. Based on the below recap – I like LX even more now.

I do like its target market of 149 million Generation Zers (those born after 1995), who are increasingly the driving force behind China’s consumer market.

The company owns and operates Fenqile, a popular online shopping mall that also offers installment loans. In addition, it matches borrowers with other lenders such as commercial banks and consumer finance companies.

China represents the world’s fastest-growing consumer market with tens of millions joining its middle class each year.

These increasingly affluent consumers want everything we take for granted in the West: TVs, computers, smartphones, major appliances, beauty products, clothing and so on.

And they have adopted a core Western idea: Buy now. Pay later.

And while China has been mostly a cash-based economy, it is moving to more of a buy now/pay later mentality, which plays right into LX’s strategy.

LX acquired nearly 705,000 new active users in its last quarter while keeping its 90-day delinquency ratio at an ultra-low 1.42%.

The company also signed strategic cooperation agreements with 10 more large national banks, insurance companies and consumer finance companies – bringing the total number of partners to over 100.

Earnings per share soared 228% on a 95% increase in revenue. LX enjoys a sizable 42% profit margin with a 72% return on equity.

This high-growth fintech idea is currently trading at less than 10 times forward earnings projections. MOVE FROM A HOLD A HALF TO BUY FULL POSITION.

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ProShares Short MSCI Emerging Markets (EUM) moves opposite the MSCI Emerging Market ETF (EEM). This position is serving its purpose as a portfolio “shock absorber.” At this point, however, things seem to have calmed down a bit so I’m moving this to a sell. MOVE FROM BUY A FULL POSITION TO SELL.

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Sea Limited (SE) shares continue to show relative strength and benefit from target markets outside of China. SE operates three platform businesses in gaming, e-commerce and digital payments, primarily in seven Southeast Asian markets.

Revenue for the most recent quarter was almost triple that of the same quarter last year, mainly attributable to a strong growth in digital entertainment and e-commerce. In particular, Garena, its gaming platform driven by a partnership with Tencent, had a standout quarter with revenue jumping 169% year on year and 70% quarter over quarter.

If you bought on our recommendation, you should take some profits off the table now. The stock has weathered the recent turbulence but we’ll wait for a dip before moving to a buy. HOLD A HALF.

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Tencent (TCEHY) treaded water this week ending just above where it began the year due to regulatory headwinds and lower-than-expected (16%) revenue growth in its most recent quarter.

The chief culprit is heightened regulatory clampdowns on gaming from Beijing. Tencent and its peer NetEase, another Chinese gaming giant, collectively achieved $472 million worth of mobile games net revenue outside of China in 2018, a five-fold increase from the previous year.

It looks like Tencent and other gamers have learned the lesson of not going overboard in terms of gaming content.

This is a strong and dominant company. I encourage you to buy a half position at these levels if you have not yet done so. BUY A HALF.

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Van Eck Rare Earths/Strategic Metals (REMX), a basket of rare metal and rare earth stocks, was up marginally this week. This position is a hedge on U.S.-China tensions and indications that China may withhold these critical materials from U.S. companies. BUY A HALF.

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ZTO Express (ZTO) gained ground this week and has been holding up well amid all the U.S.-China trade tension following first-quarter earnings results, with top-line revenue up significantly year over year, to $682 million.

The company delivered a 31.5% year-over-year increase in its express delivery services unit plus a 41.6% jump in parcel volume to 2,264 million. ZTO is building an enormous, scalable platform that will further increase efficiencies and lower costs. BUY A HALF.

Speculative Portfolio Recommendation

Largo Resources (LGORF) was up 27% this past week and is trading at less than five times earnings as rare metals are once again in the media spotlight as China threatens to keep more of these key materials at home and potentially deny access to international companies.

Please keep in mind that this is an aggressive, speculative value-based idea and play on vanadium. I am moving it to a half position for speculators. Largo is the world’s lowest-cost producer of vanadium, which is used to strengthen steel, and is a key ingredient for large-scale grid electrical energy storage batteries. BUY A HALF.

Watch List

Baidu (BIDU) drifted a bit lower this week and is now trading within $2 of its 52-week low of 106. Now trading at less than 11 times forward earnings, the company is expected to grow revenues by 16% in the coming year. I will watch this stock closely anticipating that its recent relatively weak quarter was the result of sharp increases in development expenses.

NIO (NIO) is currently at its 52-week low with shares around 2.50 - after highs near 10 in Q1 of this year. Despite a positive report on sales in June, share prices continue to weaken.

In its latest quarter, NIO reported revenue of $243 million, down 52% from the fourth quarter of 2018. On the positive side, ES8 shipments were impressive, hitting a better-than-expected 3,989 for the quarter, with overall deliveries at 16,461 units.

You should avoid this stock until an uptrend develops.
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Send questions or comments to paul@cabotwealth.com.
Cabot Emerging Markets Investor • 176 North Street, Salem, MA 01970 • www.cabotwealth.com

All Cabot Emerging Markets Investor buy and sell recommendations are made in issues or updates and posted on the Cabot subscribers’ website. Sell recommendations may also be sent to subscribers as special alerts via email. To calculate the performance of the hypothetical portfolio, Cabot “buys” and “sells” at the midpoint of the high and low prices of the stock on the day following the recommendation. Cabot’s policy is to sell any stock that shows a loss of 20% in a bull market (15% in a bear market) from our original buy price, calculated using the current closing (not intra-day) price. Subscribers should apply loss limits based on their own personal purchase prices.

THE NEXT CABOT EMERGING MARKETS INVESTOR ISSUE IS SCHEDULED FOR June 27, 2019

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Cabot Emerging Markets Investor is published by Cabot Wealth Network, an independent publisher of investment advice since 1970. Neither Cabot Wealth Network, nor our employees, are compensated in any way by the companies whose stocks we recommend. Sources of information are believed to be reliable, but they are in no way guaranteed to be complete or without error. Recommendations, opinions or suggestions are given with the understanding that subscribers acting on information assume all risks involved. © Cabot Wealth Network 2019. Copying and/or electronic transmission of this report is a violation of the copyright law. For the protection of our subscribers, if copyright laws are violated, the subscription will be terminated. To subscribe or for information on our privacy policy, visit www.cabotwealth.com, write to support@cabotwealth.com or call 978-745-5532.

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