I hope everyone had a nice weekend!
DC Makes Waves This Week
While market commentary and cable business media talking heads were focused on arguing about the definition of a recession and whether the US economy is currently in one this week, there were notable developments in the back half of the week that came from DC that have significant market implications moving forward. The arguments back and forth of whether or not we are in a recession is classic noise that investors should be tune out as GDP figures released this past week are backwards looking and the labeling is simply used as signaling for political points. First, Federal Reserve Chair Jay Powell delivered the expected 75bps of interest rate increase this past meeting, but his comments were interpreted by many that the period of significant outsized hikes of 75bps are now behind us and that lower hikes will soon follow for the remainder of the year. Just a few hours after the Fed meeting, breaking news of a long-awaited fiscal tax and spending deal was announced between holdout Senator Joe Manchin and Senate Majority Leader Chuck Schumer that will provide a fresh round of $370B of clean energy spending stimulus. Additionally, a 15% corporate minimum tax will be introduced and the carried interest tax loophole would be closed.
This agreement seemingly came out of left field after months of stalled and failed negotiations and caught everyone by surprise. The bill details includes various tax and investment credits for various pockets of the energy sector including solar, nuclear, and wind. This led to rounds of massive buying volumes the rest of the week in the solar energy sector (TAN) in names like Enphase, Maxeon, Shoals Technologies, First Solar, SunRun, and others. The proposed bill also extends the $7,500 tax credit for the purchase of a new EV and $4,000 for the purchase of a used EV. After going on a turbocharged (almost 90 degree) run off the COVID-19 pandemic low bottom in 2020, could we see the same leadership group emerge in the second half of this year? The one issue with this leadership group I see is that the general basket of “clean energy” is filled with potholes of highly speculative, high debt, pre-revenue companies so stock selection is of utmost importance. The SPAC mania of 2020 was littered with these types of companies whose business plans were nothing more than fancy powerpoint presentations (i.e. Nikola, etc.) lacking any viable sound business substance.
Next, it was also revealed that President Biden is yet again considering extending the student loan repayment deferral prior to the current restart date of August 31. After continuing to punt on making a decision, all signs point to President Biden finally making up his mind before the end of August deadline. Specifically, Politico this past week reported that the Secretary of Education has laid out all the paperwork and plans to President Biden for him to provide up to $10K of student loan relief to eligible borrowers in an unprecedented mass loan forgiveness program which would fulfill one of his central campaign pledges. This program would represent yet another highly stimulative program that would make the Federal Reserve’s job of lowering demand that much more difficult and provide another round of juice to the housing market. The internal Education Department presentation cited by Politico indicated that the student loan relief would apply to both undergraduate and graduate student loans for income thresholds up to $125,000 for individuals and $250,000 for families, which are among the figures that have been previously reported as under consideration.
Some interesting charts from this past week:
1) 10 Year Treasury Yield- Change in Character This Week
The yield on the 10 year US Treasury broke some persistent support this week and 10 year bond yield remains in a free fall from the mid-June peak level of 3.49%. This week saw a breakdown lower from the right head-and-shoulders neckline. The 10-year treasury yield is 2.68%, the lowest since early April. Is the bond market signaling we have hit peak yields? Next support level is down to 2.5%. This could have major implication in coming months for growth stocks and the market in general as the bond market appears to be picking up on slowing forward looking high frequency economic data and global economic weakness.
2) Quarterly Free Cash Flow
After reporting its earnings results last week, Exxon just overtook Alphabet in quarterly free cash flow for the first time in four years. Exxon has benefited from surging oil and gas prices and high refining margins during the quarter.
3) Morgan Stanley “Deflation Enablers” Stock List
Morgan Stanley recently published a research note of specific stocks which serve to reduce inflation and thus should increase in value going forward. Per Morgan Stanley stated, ““In an inflationary world, we believe companies that have developed deflationary products/services will become increasingly valuable .. We have developed a global shopping list of Overweight-rated stocks that provide such deflationary solutions..”
Stocks I’m Watching
1) Livent Corporation (LTHM)
Livent Corporation manufactures and sells performance lithium compounds primarily used in lithium-based batteries, specialty polymers, and chemical synthesis applications in North America, Latin America, Europe, the Middle East, Africa, and the Asia Pacific. The company offers lithium compounds for use in applications that have specific performance requirements, including battery-grade lithium hydroxide for use in high performance lithium-ion batteries; and butyllithium, which is used in the production of polymers and pharmaceutical products, as well as a range of specialty lithium compounds, including high purity lithium metal, which is used in non-rechargeable batteries and the production of lightweight materials for aerospace applications. It also provides lithium phosphate, pharmaceutical-grade lithium carbonate, high purity lithium chloride, and specialty organics; and lithium carbonate and lithium chloride for use as feedstock in the process of producing performance lithium compounds.
Last week, Livent signed a significant long term contract with GM to source its battery-grade lithium hydroxide over a 6-year period starting 2025 for use in its electric vehicles lineup. A month ago, Goldman Sachs published a “doom and gloom” report indicating that a glut of lithium would soon arrive and lithium prices would crater in the near term which led to selloffs in names like Livent and Albermarle to name a few. However, unlike other commodities which have seen significant downward price corrections this year, lithium carbonate prices have risen slightly to 476,500 yuan/tonne in the end of July, and have remained near the record-high of 500,000 from March and are shockingly 430% higher year-on-year amid high demand and tight global lithium supplies. During Tesla’s 2Q earnings call, CEO Elon Musk said that constraints on availability of lithium that have pushed prices higher are not the result of scarcity of raw materials, but because of limited global capacity to deliver ultra-high purity battery-grade hydroxide and carbonate chemicals into battery supply chains. Musk went so far to say that lithium refiners had a “license to print money” and had “software like margins”. Unlike other speculative and development stage battery metals companies, Livent has established lithium extraction and refining operations and is investing in rapidly scaling its lithium production along with a sound balance sheet. Livent is on track to add 10K metric tons of lithium carbonate capacity by Q1 2023, with another 10K tons of lithium carbonate capacity expected to be added in Argentina by year-end 2023. Livent trades at a forward P/E of just 13X forward earnings while estimates call for revenue to increase 90% this year with ~40% EBIT margins. Last quarter, Livent posted a beat and raise and ran up 30% after its earnings report. Livent reports this upcoming week (8/2 AH) and is has been in a nice base consolidating around the $20 level. Strong reports by Livent and Albermarle this week, along with clean energy theme emerging given DC headlines, could send both stocks screaming higher.
2) Step Energy Services (STEP.TO)
STEP Energy Services Ltd., an oilfield service company, provides integrated coiled tubing, fracturing, and wireline solutions to service the oil and gas industry in Canada and the United States. It also provides chemical laboratory solutions; fluid pumping services for coiled tubing operations and standalone projects; and nitrogen pumping solutions for coiled tubing and hydraulic fracturing operations, as well as cased hole wireline and open hole wireline services.
While trading at just 3X EBITDA, 4X forward P/E, and a 35% free cash flow yield, Step Energy remains a highly undervalued oilfield services player. STEP specializes in high-performance fracturing and coiled tubing in Canada and the U.S. As a reference, the big three oilfield services juggernauts Schlumberger , Halliburton and Baker Hughes currently have a EV/EBITDA multiple of 9.0-10.0X, while Canadian peers Total Energy Services and Trican Well Services are valued at 4.3X and 5.3X, respectively. Over the past two weeks, the oil majors and other industry players have indicated that the oilfield services market remains extremely tight and effectively sold out for the remainder of the year, which benefits STEP’s rates. STEP is scheduled to report on 8/11.
3) Otter Tail Corporation (OTTR)
Otter Tail Corporation, together with its subsidiaries, engages in electric utility, manufacturing, and plastic pipe businesses in the United States. The company’s Electric segment produces, transmits, distributes, and sells electric energy which generates electricity through coal, wind and hydro, and natural gas. Its Manufacturing segment engages in the contract machining, metal parts stamping, fabrication and painting, and production of plastic thermoformed horticultural containers, life science and industrial packaging, and material handling components, and extruded raw material stock for recreational vehicle, agricultural, construction, lawn and garden, and industrial and energy equipment industries. The company’s Plastics segment manufactures polyvinyl chloride pipes for municipal water, rural water, wastewater, storm drainage and water reclamation system, and other uses. This segment markets its products to wholesalers and distributors through independent sales representatives, company salespersons, and customer service representatives.
Otter Tail reported another blowout quarter last week and is approaching its weekly breakout level after reporting revenues increased 43% with a 30% EPS beat led by booming margins from its plastics/pipe division. The company is making significant investments in renewable power with its Hoot Lake solar plant and wind farms in Ashtabula. Otter Tail Corporation is substantially less leveraged than its utility peers due to its manufacturing business, trades at a forward 13X P/E, and has a 2.3% dividend yield. Chart looks solid for continuation higher is market conditions cooperate.
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