MAR.24 TPDEARR Squad

MAR.24 Trans-Pacific Dynamic Equity Allocation Research Report

Thank you for accessing the MAR.24 TPDEARR Squad! Please use the analysis in this report wisely and in conjunction with the MAR.24 Articles.

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MAR.24 Squad

The following equity assets make up the MAR.24 Squad for the MAR.24 TPDEARR issue:

Invesco PHLX Semiconductor ETF – (NASDAQ: SOXQ)
Encore Capital Group – (NASDAQ: ECPG)
Hitachi Zosen Corporation – (TYO: 7004)
Himalaya Shipping Ltd. – (NYSE: HSHP)
Visa Inc. – (NYSE: V)
Ormat Technologies, Inc – (NYSE: ORA)

Strategy and Future Disposition of MAR.24 Squad

The MAR.24 Squad is a collection of equity assets suggested as a micro-portfolio for investors for an intermediate-term investing horizon of 4-6 quarters. Investors who take up positions in the MAR.24 Squad by purchasing equity shares on the open market can look to hold their positions until around Q2 2025 – Q4 2025, before realizing their gains and recognizing a lower, long-term capital gains taxation. Strategizing how to deposition each Squad is an important aspect of realizing gains and calculating the proper taxation and profit. Investors are highly encouraged to coordinate the timing of sale of equity assets in a Squad with the timelines of other Squads that they may deploy, in order to ensure a consistency of realizable equity revenue, as well as to minimize unnecessary taxation on capital gains. Further analysis for the MAR.24 research report is distributed across the MAR.24 articles on this website. We find that this collection of equity assets in the MAR.24 Squad represents a potential micro-portfolio of highly enticing investments with independently substantiated geopolitical and macroeconomic evidence.

Investors should consult with their financial advisor before allocating capital.

Taking positions allocating USD$100,000 across these assets in proportion to individual measures of risk tolerance, and sufficient diversification efforts, puts an investor in a strong position to realize returns over the intermediate-term horizon of 12-18 months. The assets are selected specifically for this timeframe in order to maximize both the tax benefits of longer-term holding, as well as the sanity of the investor. A longer holding period nullifies the impact of daily volatility and allows broader market impacts and trends to hold greater relevance in asset selection.

The research and analysis in this issue are provided to you in order to contribute to a more comprehensive understanding of the myriad economic, geographic, and environmental factors involved in investments in the trans-Pacific economy. Each asset is further detailed below:

1. Invesco PHLX Semiconductor ETF- (NASDAQ: SOXQ)

The SOXQ ETF is a relatively new fund (established in June 2021 by the issuer Invesco) that closely tracks the PHLX semiconductor index, measuring the market performance of the top 30 US-listed firms that operate in the semiconductor industry. As we have analyzed in this TPDEARR issue’s Macroeconomic Evolution, Demographic Trends, and Geopolitical Shifts articles, the relentless forces of competition and security provision are powerfully propelling semiconductors forward through a shared techno-future—there is no modern society without the proliferation of computational ability; i.e., semiconductor-powered processing embedded in every possible item of use.

Semiconductor manufacturing and implementation are non-negotiable aspects of the modern economy, and it’s not just the funds and capital flows of private industry that are powering the increasing adoption. Governments around the world are all clamoring for their slice of the computer chip pie to power their militaries and economies, with the largest and most capital-rich ones (like the US) shoveling in USD$Billions in public funds to accelerate the establishment of greater manufacturing capacity. It is only the most-advanced nations which have the ability and capacity to make the chips that are in such high demand.

The companies producing the chips we all covet, such as NVIDIA, Qualcomm, Intel and AMD, are pouring capital into the construction of new fabrication facilities—”fabs”— which are primarily located in the US, or on US-friendly territory, and will still take a couple of years to come online and begin contributing to advanced chip supplies. The increases to market capitalization that these expansions to productive capacity will entail are still somewhat withheld from the equity value, as long timelines bring hesitancy for many types of investors, so many market watchers of the semiconductor firms are still waiting to see how much additional value will be incorporated by the market once the fabs come online and procurement relationships surface.

Furthermore, we are promoting this ETF now, as opposed to a single-play equity in the space, as the underlying technology renders its advancements useful in commercial collaborations between firms. In other words, it is the contractual partnerships between the semiconductor chip producers and the technology companies who utilize the processors that indicate the “value” that can be achieved through chip upgrades. A particular advanced chip, such as NVIDIA’s new Blackwell-architecture GPUs (which each hold >200 billion transistors apiece) could be used for a consumer-forward AI application, or for a military or surveillance-related purpose with the US Department of Defense. Because it’s still uncertain how commercial relationships will evolve as new chip technologies enter the market, and how smaller players with novel applications will get acquired and folded into larger operations from the tech giants, it’s unclear which firms will be the most dominant in 2 years; only that the chip technology itself will be in no less demand.

We recommend SOXQ over a similar semiconductor-focused ETF, Blackrock’s SOXX, which tracks a larger swath of the industry than just the top 30 players (though it holds many of the same assets, and in similar proportions,) but has a higher expense ratio at 0.39%, compared to the SOXQ’s 0.19%. SOXQ is trading at ~1/5 of the share price of SOXX, and at ~136% of the NAV of the fund, which is significantly higher than the ~108% above NAV that SOXX is trading at, so the market pricing considers the growth potential of SOXQ much more significant by comparison.

2. Encore Capital Group – (NASDAQ: ECPG)

Encore Capital Group is a prime choice of financial services company in the current market environment, particularly for its position in the debt collection sector, collecting on non-performing loans. Encore specializes in collecting from consumer credit debtors and “returning economic value” to the financial system after it’s been written off by banks. The market opportunity for this business is enormous right now.

As we analyzed in the MAR.24 Macroeconomic Evolution article, credit usage, particularly in the US, is at all-time highs. Encore, along with its competitors in the industry (i.e., PRA Group), identify the current credit situation as having a “strong supply” for their business in the intermediate-term; in other words, there are a lot of credit users who are currently struggling to pay back their bills, and who will continue to struggle in the foreseeable future, contributing to the growing pool of non-performing loans that are purchasable for a collection portfolio.

We point to ECPG this quarter because intermediate-term growth for the equity asset is well-positioned based on macroeconomic and demographic factors, particularly in the US. The company’s stock recently took a big hit as there was a large write-down of goodwill ($238M) at the end of 2023. Because such an accounting procedure isn’t indicative of revenue collections behaviors over the coming 12-18 months, some extra value may also be incorporated into the current share price.

Encore has steadily increased its portfolio purchases since the COVID downturn (in which consumers were able to use stimulus funds to pay down and manage their credit, keeping non-performance low) with substantial growth in the potential value it may be able to realize from collections of the portfolio, known in the industry as Estimated Remaining Collections (ERC); adding nearly USD$2B in ERC in 2023 alone. In consideration of the unprecedented volume of absolute credit usage, the “supply” of new portfolio assets available for purchase, as well as the ERC available from future supply, are both expected to grow significantly. Established players in the field, like Encore, will be able to use more resources than new entrants to leverage purchase of the new supply, aggregating further market share.

Furthermore, some organizational aspects of the company merit additional consideration in Encore’s current investment attraction. The firm transacts across the trans-Pacific with collections operations throughout the US, Mexico and India (as well as Europe and Central America.) Executive leadership within the company also has appealing diversity with less than half of the group represented by White males (4/9), indicating a healthier diversity of opinion in the upper levels of management. Additionally, Encore is strongly committed to ESG principles and abides by an industry-first “Consumer Bill of Rights”, both of which are behaviors that indicate the company isn’t shying away from accountability, depressing the likelihood of large-scale fraud or deception existing internally.

In one final note, Encore has been excelling at mastering the new retail nexus (such as we’ve covered in the MAR.24 Demographic Trends article), finding success engaging with its customers digitally. Increases to engagement have occurred both in communications and collections, with the number of initial digital payments by customers doubling over the four year period ending in 2023. These findings support the legitimacy of taking the nexus seriously, as well as Encore’s boosts to success in doing so.

Overall, Encore Capital Group is poised for profit in the intermediate-term period, and a strong contender in the MAR.24 Squad.

3. Hitachi Zosen Corporation – (TYO: 7004)

Hitachi Zosen, a Japanese firm traded on the Tokyo Stock Exchange, is a machine technology company with business segments in Environmental Systems, Machinery and Infrastructure, and Carbon Neutral Solutions, each offering multiple operational processes and advanced technologies. Categorized as a Heavy Industry firm, Hitachi Zosen is no longer a kieretsu of the the Hitachi vertical business group, having spun off from Universal Shipbuilding Corporation in 2002. The company retained its advanced laboratories studying industrial materials and offers numerous business technologies in factory automation, film and precision casting, electronic control systems and disaster prevention, as well as marine and plant equipment, electrolytic and methanation facilities, and wind power generation, fully tapping into sustainable initiatives around the world, including the offering of Green Bonds in participation with the UN’s Sustainable Development Goals.

As we’ve discussed in this quarter’s Natural Elements article, a particularly exciting set of operations offered by Hitachi Zosen is its desalination and water purification technology and services; including a series of “container-type” reverse osmosis seawater desalination plants, in three different output capacities, which can, like the name suggests, be quickly and efficiently packed up and shipped around the world via standard shipping containers for rapid dispersal under rental or ownership terms. Further water-based operations are included with its subsidiary, fellow trans-Pacific firm Osmoflo, based out of Australia, which has designed and built over 600 water and wastewater treatment solutions around the world. Hitachi Zosen is currently operating dozens of large-scale desalination plants globally, with a heavy presence in the severely water-stressed West Asian/Middle Eastern region, producing more than 2 million cubic meters of freshwater daily, a market which is only going to continue to grow in size and urgency.

Hitachi Zosen has a great-looking sheet of financial fundamentals to invest in at the current time. Over the past three years, the firm has seen year-over-year increases in operating income, net sales, total assets, and shareholders’ equity, with a near-doubling of return on equity (ROE) and return on assets (ROA) over the same period. Earnings per share (EPS) has increased seven-fold during the same period, and the firm is a consistent dividend-payer. Not only all of that, but Hitachi Zosen has mouth-watering free cash flows and is now sitting on a pile of >USD$80B in cash; more-than-ready to weather any upcoming storm in the intermediate-term.

Order intake for Carbon Neutral Solutions at Hitachi Zosen is more than double what it was through the same quarter last year, with net sales from its environmental segment overall growing to more than double the value of all its other segments combined. This trend draws focus to the company’s alignment with global environmental goals; a very positive correlation, especially for investors eager for ESG-friendly opportunities.

Macroeconomically, the recent rise out of negative-interest-rate territory in a key rate, as approved by the nation’s central bank, the Bank of Japan, is the first rise in 17 years and ends a decades-long stricture within the national economy, introducing a new level of vitality to Japan’s markets. Though the actual negative rate only ever applied to a small subset of interbank depositors, the positive move sends signals to all market players about upward-adjustments in growth outlook and the strength of the yen, as well as of the currency strength of companies primarily operating with the yen and in Japanese markets. Hitachi Zosen has been steadily decreasing its load of interest-bearing debt over the past 4 years and doesn’t appear positioned to take any substantial financial blows from a strengthening yen and Japanese market environment.

4. Himalaya Shipping Ltd. – (NYSE: HSHP)

Himalaya Shipping is a new company; this fact needs to be established at the outright as it comes with a high risk of catastrophic (investment) failure. That having been said, the potential profitability of this new entrant into the dry bulk shipping industry has not yet been “baked into” the share price of this excellent small-cap opportunity.

To be clear, some of the serious risks of failure that face new shipping companies operating in international trade are due to the level of competition, specifically, larger competitors who might enter the market and deploy unmatchable flows of capital to offer clients lower costs, gobbling up all the available clientele market share and cornering out smaller (and, frequently, newer) players. Shipping companies typically derive the majorities of their revenues from a limited number of charterers with the right kind of shipping demands to fit the vessel, so the loss of a major client can have devastating consequences, especially if no new charter can be arranged and the vessel goes idle. Nonetheless, as per Himalaya Shipping’s own 2023 annual report, “The dry bulk market is highly fragmented.” Healthy opportunity exists; competitors will compete for it. The dozens of risks to HSHP’s “results of operations and financial condition” exist for all competitive participants.

That having been said, HSHP has a brand new fleet of 12 Newcastlemax dry bulk ships, which are some of the largest bulk vessels in the world, and they were all delivered (or about to be) in the past 18 months and so all have their entire useful lives ahead of them. Newcastlemax ships, like this one, can hold over 200,000 DWT, and are critical in transporting vital commodities like coal and grain around the world, but particularly from resource rich areas like Brazil and Australia (wherein lies the Port of Newcastle, for which the ship class is named, and which happens to be the largest coal port in the world) to, primarily, China. Brazil-China and Australia-China are, not coincidentally, the two routes that the HSHP fleet is primarily chartered to service over the next few years.

The fleet of HSHP’s new, modern vessels are technically and technologically advanced. The ships are all virtually identical at delivery and have dual-fuel systems in place, enabling them to be one of the only fleets in the world that can make a full round-trip of the Brazil-China route without bunkering up to refuel at some point along the way—an attractive feature to potential charterers. The remaining few ships that are scheduled to be delivered between the initial publishing of this MAR.24 TPDEARR Squad and June, 2024 are all being constructed in Dan Hua Port, Jing Jiang City, Jiangsu Province, PRC by New Times Shipbuilding Co., Ltd., a Chinese shipbuilder and excellent business connection for the new firm.

Himalaya Shipping, which will continue to operate primarily in and around the trans-Pacific major commodity trade routes, was listed on the New York Stock Exchange after forming in 2021. With its headquarters in the notorious profit-harbor of Bermuda, and with plenty of warnings about anti-takeover provisions and the limited rights of shareholders in certain situations, the company is clearly aiming to maximize profitability without losing control; potential investors should be aware that activism will likely be squelched should it ever be whiffed. None of this, though, suggests flaws in the firm’s ability to maximize shareholder return.

HSHP is untested as a new entity, but management has decades of experience in the dry bulk sector, and there is steady global demand growth in the three goods most heavily transported by large dry bulk vessels: coal, iron ore, and bauxite/aluminum. Regarding concerns about large-scale trans-Pacific trade between “Western powers” and China, each commodity has its own geopolitical relationship:

Iron ore – considered “critical” only by the PRC—import demand will continue; Australia and Brazil, the two primary departure points for the HSHP fleet, are the world’s two largest providers of iron ore.
bauxite/aluminum – considered “critical” by both the PRC and the US; Australia, Brazil and the PRC are historically three of the four largest producers of bauxite globally; global demand will persist.
coking coal – not considered “critical” by either superpower; global demand will wane as more environmentally-friendly fuel alternatives rise in market share and popularity, but the PRC, along with other developing economies like Vietnam and Indonesia, control more than two thirds of the global demand, and so will have “the last word” as to how quickly that demand dissipates. The PRC is the largest user of coal; replacement power generation takes time (years, really) to install.

Moreover, the vessels can certainly be repurposed for other commodities should the global demands actually shift that far.

As a new firm, anything could happen, but Himalaya Shipping only has up to go if it can avoid unexpected calamities. In coordination with our TPDEARR Squad intermediate-term deployment timeline, now is a great time to take a position before larger-scale operations unfurl with the completed deliveries of the remainder of HSHP’s fleet in the coming months.

5. Visa Inc. – (NYSE: V)

The “average” consumer in a highly-developed market economy can be called many things, but one of them is certainly the title of Credit User; as in: one or more aspects of their life is funded with borrowed money and a debt to repay. The ubiquity of this scenario is actually a more-recent occurrence than it may appear. To young people today, credit usage seems like a given, but the amount of credit usage in America has actually doubled in just the past 20 years. It may then also come as a surprise that one of the leading forces and household names in the game, Visa, didn’t even make its market debut until an IPO in 2008!

Visa is a credit card company that has figured out how to excel in a still-newly-developing financial arena. It’s still a “wild west” our there; always changing. While companies like Chase and American Express are doing very well in the business of distributing cards to users (while those user-consumers have racked up >$1T in purchases for each!), Visa has become a world leader in terms of network dominance, able to benefit from the distribution and usage of cards from many different issuers across their payment network, VisaNet, which typically covers more than half of all combined annual credit transactions domestically.

When focusing in on the US consumer market with its broad access to credit and relatively high absolute prices, and without even including other types of loans or real estate debt instruments (such as student debt, mortgages and car loans), the total volume of credit card debt has ballooned to over USD$1T. Credit card companies, such as Visa, have profit fundamentals derived from users’ activity in both opting for credit usage and the amount of credit used by consumers; it is a numbers game, and the numbers are all generally growing. Where issuers may have to take losses on held balances when consumers can’t pay, Visa doesn’t suffer from those risks from consumer overconfidence.

Remember, all this market behavior is being perpetrated by humans and human-produced systems, which include everything from the macroeconomic background provided by central bank behaviors, to the irrational sentiment and whims of investors and traders. Using credit gives an individual more access to the modern world via monetary pathways; this reality for human opportunism will not automatically fade over the coming intermediate-term period, nor is it feasible that the type of broad-reaching policy that could reign-in widespread consumer behaviors could be sufficiently confirmed and applied in the current atmosphere of political hyper-partisanism. Though uncertainty always exists, Visa’s network penetration is flexibly positioned to absorb and adopt adaptations to new circumstances as they emerge.

As digital and mobile commerce continue to spread globally, raw transaction volumes will increase in tandem, creating a wave that Visa will continue to ride as the basic technology proliferates through developing economies’ financial infrastructures. In tandem, Visa has been actively incorporating new ideas from the swirling pool of FinTech innovation (such as the acquisitions of PROSA MX, Pismo, Payworks, Tink, or Currencycloud, to name a few) in order to keep ahead of the constantly evolving technology environment.

There is a lot to look forward to in an industry segment with a Net Profit % of >50%. The average consumer credit card debt balance is growing >10% YoY, and the total domestic credit card debt is growing by >17% YoY. Visa is a power player in a popular game and we look forward to watching it’s growth over the coming 12-18 months.

6. Ormat Technologies, Inc – ORA (NYSE)

Ormat is a firm at the forefront of the next-generation geothermal energy generation movement. The company is a vertically-integrated renewable energy pure-play with operations in geothermal power plants, recovered energy/waste heat solutions, and energy storage, as well as an expanding array of solar PV facilities and greenfield opportunities. According to the company’s most recent annual report, Ormat has seen capacity expansions over the last three years in each of its geothermal, storage, and solar segments, while also sporting a steadily increasing backlog (now in excess of USD$150M) due to strong growth in demand.

While the COVID downturn was crippling for many companies, Ormat’s financial management was robust during the difficult market environment, even establishing record high revenues with each passing year in its electricity segment. Longer-term tolling agreements for electrical power, which are accruing in number, also provide a strong source of recurring revenues apart from new installations. Furthermore, as the international sentiment for renewable and sustainable energy solutions continues to mount, a lot of that impetus gets transformed into capital flows through policy action, providing economic tailwinds that support even wider-spread adoption of desirable next-gen technology, such as Ormat’s, often with government funding.

ORA has had a difficult year in the markets, which is likely due to investors’ hesitance with free cash flow difficulties, but we don’t find that the equity performance is consistent with the growth opportunity the firm presents. The company’s market valuation has grown nearly 300% in its 20 years of operation, while total revenue and net profit have fully recovered from the COVID downturn. As the firm’s income is heavily dependent on recurring revenues from power purchase agreements, and because new power plant/energy installations can take years to come online, the success of Ormat’s recent and ongoing capacity expansions are more indicative of future income potential than one might infer from only looking at cash flow characteristics; the current depression of the share price represents an additional value opportunity as it is counter-indicative of the market expansion potential the company sees in the coming years, looking past any near-term uncertainties that upset traders and investors with shorter trading windows, “technical” chart indicators, and no patience.

As we discussed in this TPDEARR issue’s Natural Elements article, Ormat already has assets online across the US and Canada, as well as throughout the Asia-Pacific region, including in Japan, China, Indonesia, the Philippines, Thailand, and New Zealand, as well as a dozen other nations we don’t specifically cover in the TPDEARR. The firm is are already thoroughly placed around the trans-Pacific enough to engage in new partnerships and continuing operations to very electricity-hungry communities, and the hot rock underground is not going to get any colder any time soon, so the future geothermal “supply” is virtually guaranteed. We are watching you, Ormat! Good luck in the coming years.

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