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Cabot Global Stocks Explorer 717

All eyes are on Washington this week as markets, which have risen over the last four trading sessions, are counting on lawmakers hammering out another stimulus bill. Our emerging markets market timer remains positive. Sea Limited (SE) shares soared again this week, from 119 to 146, as this stock has quietly become the world’s best-performing large-cap stock, up more than 880% in the past 18 months. Cloudflare (NET) moved ahead along with our strategic metals ETF, and NovoCure (NVCR) reported positive earnings. This week’s issue begins with an overview of the emerging high-tech rivalry between America and China, and highlights a new recommendation of a dominant company at the heart of that rivalry.

Cabot Global Stocks Explorer 717

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Semiconductors at the Heart of the New Tech Cold War
As the intense U.S.-China techno-rivalry continues, both countries want to protect and promote their national technology champions while still selling to each other. This is a tall order that will create both new risks and new opportunities for investors. To take advantage of it, you need to first understand this ever-changing geopolitical landscape.

To begin, it is important to recognize that America’s rivalry with China is of great consequence. It will determine whether America’s leading role on the world stage will be confirmed—or upended.

The competition will run across many countries and battlegrounds such as trade, finance, technology, freedom of navigation, cyber warfare, space, obscure rare earths and semiconductor chips – a market critical to advanced technology, and very much in the news recently.

Intel Corp.’s (INTC) announcement last week that it had fallen a full year behind schedule in the process of finding the technology needed to make its next generation of chip was disappointing. That the company is considering outsourcing to Taiwan Semiconductor (TSM) all of its chip fabrication is something that reverberated well beyond Silicon Valley, to Washington.

It also hit its stock price hard.

This development has to be viewed against the backdrop of the U.S.-China techno-rivalry.

One of the areas that China is still relatively behind the U.S. in is advanced chip technology, which runs across chip design, computer software and equipment. Semiconductors are crucial and the most strategically important technology because they are the materials and circuitry needed to produce microchips that are at the heart of everything from smartphones to advanced satellites. You might think of these microchips as the brains inside all advanced technology.

Alex Capri of the Hinrich Foundation has zeroed in on this vital battleground through an excellent report: Semiconductors at the Heart of the U.S.-China Tech War: How a New Era of Techno-Nationalism is Shaking up Semiconductor Value Chains.

Understanding microchips’ intricate and fragile supply chains is important for both policymakers and investors. The chief concern is that while most of the advanced chips are designed in America, only around 12% of all chips are manufactured here, and these tend to be the less advanced chips produced in older plants.

America is also a leader in the semiconductor equipment used to make and process wafers (a thin slice of semiconductor chip in the shape of a wafer), and is first in fabricating and assembling the final chipsets. According to the U.S. International Trade Commission, U.S. chip equipment firms, which have roughly 60,000 domestic employees, account for about half of global production. America is even more dominant in chip design software, controlling about 80% of the global market.

The challenge and dilemma for America is that it wants to protect its lead in semiconductor technology while U.S. companies also want to continue selling advanced chips to China. Day by day, this makes China a more formidable tech rival across the board as it gets more savvy about moving up the food chain.

The Semiconductor Chessboard
Many American chip designers, such as Nvidia (NVDA), Micron Technology (MU), Qualcomm (QCOM), Texas Instruments (TXN), and Advanced Micro Devices (AMD), outsource to Taiwan Semiconductor, Samsung or smaller players in Asia the fabrication of these chips. With the exception of Intel, most leading U.S. chip companies shut or sold their domestic plants years ago.

Chip Production - Asia

Taiwan Semiconductor (TSM) Dominates
One way to reduce America’s chip-making vulnerability would be to get Samsung or Taiwan Semiconductor to invest in more cutting-edge fabrication plants, which can cost more than $15 billion to build in the United States.

And that’s exactly what Taiwan Semiconductor is considering doing, as the world’s largest fabricator recently announced it is exploring building a new $12 billion facility in Arizona, adding to an existing and smaller facility in Oregon. Samsung already has an advanced chip plant in Austin, Texas, ensuring local supply of its chips for big customers like Apple.

The primary reason that Taiwan Semiconductor is successful at smaller transistor sizes is because of its scale in building billions of chips for smartphones, which require much larger numbers of microchips than personal computers and data centers.

Taiwan Semiconductor’s chief Chinese rival is SMIC, the largest chip foundry in China. Taiwan Semiconductor previously successfully sued SMIC over its alleged theft of trade secrets and in 2009 this resulted in TSM gaining an 8% stake in its rival.

Taiwan Semiconductor has at least 10 times more annual revenue than SMIC but SMIC receives Chinese government support equivalent to roughly 40% of its annual revenues, according to an Organization for Economic Co-operation and Development (OECD) report last year. In addition, China’s state-backed funds also recently increased their stakes in SMIC’s Shanghai plant after Taiwan Semiconductor cut off sales to SMIC to appease U.S. regulators.

Surprisingly, SMIC generated 25% of its revenue from orders from U.S. chipmakers last quarter, led by Qualcomm (QCOM). SMIC produces Qualcomm’s lower-end Snapdragon chips, while Taiwan Semiconductor produces Qualcomm’s higher-end chips.

As you can see, this is a complicated game very much impacted by geopolitics. This is but one of the four drivers behind my new recommendation.

New Explorer Recommendation
Taiwan Semiconductor (TSM)
The above overview already highlights Taiwan Semiconductor’s dominant role in the highly strategic advanced semiconductor fabrication business, and this is the core reason for my recommendation.

Its growth and market share will likely benefit from the recent missteps by Intel, which has publicly announced that it is considering outsourcing advanced chip production to Taiwan Semiconductor. Taiwan’s Commercial Times has also claimed that Taiwan Semiconductor had received an order of 180,000 wafers from Intel to produce its upcoming advanced chips, which nearly matched the 200,000 wafers ordered by Advanced Micro Devices.

Then there is the Apple effect. Apple accounted for 23% of Taiwan Semiconductor’s revenue last year as its largest customer. Apple’s first 5G iPhones, which may launch this September, would boost its smartphone chip revenues, which accounted for 47% of Taiwan Semiconductor’s top line last quarter. In addition, Apple recently decided to replace Intel’s chips in its Mac computers with advanced chips designed by Apple and manufactured by Taiwan Semiconductor.

Another reason to buy TSM is that the company generated 33% of its revenue from the high-performance computing (HPC) market last quarter, which translates to higher profit margins. These high-performance chips are linked to some power growth trends such as robotics, artificial intelligence, and internet devices.

The consensus expects Taiwan Semiconductor’s revenue and earnings to rise 28% and 34%, respectively, this year—impressive growth rates for a stock which trades at just 25 times forward earnings.

The chief risk for Taiwan Semiconductor is that geopolitics cuts both ways. This is a powerful company in a strategically important place so it has to diplomatically balance both customers and countries. For example, roughly 14% of its sales go to Huawei, and the U.S. Commerce Department announced that companies would require licenses for sales to Huawei of semiconductors made abroad with U.S. technology. This is probably why it announced just weeks ago the possibility of building a new chip plant in Arizona.

Taiwan Semiconductor is a dominant company in a critical area of advanced tech supply chains, selling at a reasonable valuation. I recommend you start with a half position and put in place a 20% trailing stop loss. BUY A HALF POSITION

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Model Portfolio

StockPrice BoughtDate BoughtPrice 8/6/20ProfitRating
Alibaba (BABA)1021/27/17265160%Hold
Cloudflare, Inc. (NET)244/30/204277%Buy
DBS Bank (DBSDY)504/2/205815%Hold a Half
Gilead Sciences (GILD)765/28/2069-9%Buy a Half
Global X Cybersecurity ETF (BUG)174/30/202334%Hold a Half
Kirkland Lake Gold (KL)396/25/205543%Buy a Half
NovoCure, Ltd. (NVCR)687/23/207815%Buy
Sea Limited (SE)152/8/19145879%Hold a Half
Swire Pacific (SWRAY)5.527/9/205.23-5%Buy
Taiwan Semiconductor (TSM)New82Buy a Half
VanEck Rare Earths (REMX)356/11/204423%Buy a Half
Virgin Galactic (SPCE)7.3412/5/1920175%Buy

Portfolio Changes
DBS (DBSDY) - move from BUY A HALF to HOLD A HALF

Updates

Alibaba (BABA) shares continued their uptrend in advance of the Ant IPO, as well as its next earnings report, expected around August 20, with its stock price going from 250 to 265 during the past week. Analysts expect Alibaba’s revenue to jump 46% in the quarter to $21.1 billion, so expectations are pretty high.

Alibaba is well positioned to thrive during the pandemic as the company operates China’s largest e-commerce marketplace as well as a fast-growing cloud-computing business. Later in the month, the company plans to take its Ant Financial business public. Ant owns the popular Chinese mobile payments network Alipay that 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. BABA is an Explorer legacy stock and I would think that shares will get a bump in valuation from the upcoming Ant IPO. HOLD A HALF

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Cloudflare (NET) shares increased 10% this week, reaching 42. The company’s total customer count is approaching 3 million, with roughly 89,000 paying customers across more than 160 countries. JP Morgan recently noted 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. This market is huge and growing. The White House Council of Economic Advisers estimates that cybercrime costs the U.S. economy over $109 billion a year. According to McAfee and the Center for Strategic and International Studies (CSIS), cybercrime costs the world an estimated $600 billion annually. I encourage you to buy NET if you have not done so. BUY A FULL

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Global X Cybersecurity ETF (BUG) has been a high-performing basket of cybersecurity companies, moving from 12 to 22 since March. 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

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DBS Bank (DBSDY) is expected to report disappointing earnings today as the shares are stuck at 58 with Singapore in recession and the banking sector struggling as this leading bank anticipates lackluster earnings. With the city-state facing its deepest recession ever, I think it’s best to move this stock to a hold given that it is likely to take some time for this high-quality bank’s stock to reflect its value as perhaps the best bank in Asia. After reviewing earnings and guidance, I’ll decide how long it will take for this stock to regain its footing and momentum. MOVE FROM BUY TO HOLD

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Gilead Sciences (GILD) reported earnings of $1.11 a share for the second quarter, below consensus estimate of $1.45. Sales were $5.1 billion for the quarter, below the $5.7 billion the company reported for the same quarter last year.

On the positive side, Gilead increased its earnings guidance for 2020, saying it now expects sales of between $23 billion and $25 billion, up from its original estimate of $22 billion. It expects earnings per share as much as $7.65, up from its earlier top estimate of $6.45.

A number of factors led to quarterly earnings below expectations. Gilead said that it had delivered the last of the 1.5 million doses of remdesivir it plans to donate to governments at the end of the second quarter. It is now charging $390 a vial to developed countries, and $520 a vial to U.S. private insurance companies. It is important to recognize that the company reported no revenue from remdesivir for the second quarter. If you haven’t yet purchased GILD shares, I encourage you to buy a half position. BUY A HALF

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Kirkland Lake Gold (KL) shares took a breather this week though the shares have gone from 42 to 56 in the last month. For what’s its 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

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NovoCure (NVCR) was up this week after reporting quarterly net revenues of $115.9 million, representing 34% growth versus the second quarter of 2019 and 14% growth versus the first quarter of 2020. Net income for the quarter was positive – $1.7 million compared to a net loss of $1.3 million for the same period in 2019. At the close of the quarter, the company had $346.7 million in cash, cash equivalents and short-term investments. In Greater China, net revenues grew 97% growth compared to the same period in 2019, and in Japan, net revenues grew 72%.

NovoCure is well positioned in the cancer treatment niche and the company’s main 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. NovoCure is a still a relatively small company with more than $300 million of cash. As more physicians and treatment centers come online, sales and profits will scale up. So should the stock. BUY A FULL

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Sea Limited (SE) shares soared again this week, from 119 to 146, and this stock has quietly become the world’s best-performing large-cap stock, up more than 880% in the past 18 months. Sea Chief Executive Officer Forrest Li has become a billionaire with an interesting story. Born in Tianjin, he worked for the local units of Motorola Solutions and Corning before enrolling in Stanford’s MBA program. He founded Sea, then known as Garena, in 2009 and took it public with backing from Tencent in 2017. Li named himself after Forrest Gump. Sea’s first self-made mobile game Free Fire has attracted as many as 80 million daily active users in more than 130 markets. Sea’s e-commerce and financial services units are now also important engines of its growth story. Meanwhile, SeaMoney has over 10 million mobile wallet users. Feel free to sell some shares to lock in profits, but we will continue to hold a half position with a 20% trailing stop loss in place. HOLD A HALF

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Swire Pacific (SWRAY), a Hong Kong deep value play, rose modestly this week.

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 Hong Kong-based company with expansive assets from property to retail to transportation not only in Hong Kong but also throughout the region. This blue chip is trading way off its 52-week high primarily due to the issue of its struggling Cathay Pacific airlines. The stock is trading substantially below its book (break-up) value and I encourage you to buy a full position with a six- to 12-month time frame. BUY A FULL

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VanEck Vectors Rare Earths/Strategic Metals ETF (REMX) shares kept moving from 40 to 42 as concerns escalate over fragile supply chains for these strategic rare earths and technology materials. A positive development is that a major Australian rare earths producer, Lynas, is considering building a rare earths processing center in Texas, but this is at least a couple of years off. 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

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Virgin Galactic (SPCE) shares were a bit volatile this week, settling at 20 after being moved by some positive news and then reporting a quarter that was a bit below expectations. Its second-quarter report reflected a loss of $0.30 per share, while Wall Street expected a loss of $0.26. That said, earnings don’t matter much for this concept stock because Virgin Galactic doesn’t generate sales yet.

On the positive side, the company expanded its waiting list for space flights, which are expected to begin in the first quarter of 2021. It also unveiled plans for a Mach 3 delta-wing aircraft with capacity for 9 to 19 people traveling at an altitude of 60,000 feet.

The company also signed a memorandum of understanding with Rolls-Royce, one of the world’s leading aircraft engine makers. Rolls-Royce was responsible for the engine of the Concorde, the only supersonic commercial aircraft ever used for passenger travel. Virgin Galactic also announced in May that it would be partnering with NASA to work towards high-speed, high altitude point-to-point travel for commercial airline passengers.

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. Take advantage of this week’s pullback to buy more shares. BUY A FULL

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SPCE travel


The next Cabot Global Stocks Explorer issue will be published on September 3, 2020.

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