I love cheap stocks.  I love them even more if there is a good runway for growth.

Nothing is more exciting than finding a high-growth gem with a single-digit multiple. 

But the truth is, those are rare.  If you want to own growth, you are going to have to pay up.

This has been the case for years in the 3D printing business (I’m going to call it by its more technical name – additive manufacturing).  The big names in the space have tended to lose money and trade at expensive multiples.

But today, the market has wiped away a lot of that excess.

While I would not go so far as to say these stocks are “cheap”, they are certainly a lot cheaper than they have been in the past.

Stocks like Stratasys (SSYS – NASDAQ) have given up nearly all the gains of the post-COVID bubble.

Source: Stockwatch.com

With so much froth taken out of the stocks, the sector is worth a look.  Additive manufacturing is a business that looks like it has years of growth ahead of it.  The drivers of this growth are trends that  – for the most part – are irreversible.

But if I can see the trends, everyone sees the trends.  You can’t expect it to not be in the stock.   

While you want to get these names cheap, you can’t expect them to be too cheap. 

They might not be there yet.  But its getting close.  It could be that “cheaper than they’ve ever been” is cheap enough.
 

DEMOGRAPHICS IS GOING TO DRIVE TECHNOLOGY

 
Trying to talk about demographics and stocks can be a hard sell. 

Demographics are like tectonic plates to the raging river of the stock market. 

One moves slow, the other fast.  The market cares about the next quarter, at best the next year.
Spelling out a trend that will take decades to play out makes a trader’s eyes glaze over.

Yet there are demographic shifts that are going to create some big changes in the next few years. 

The population is aging.  The 2020s are going to be a tipping point.

According to a UN Report released in July, global population grew by less than 1% in both 2020 and 2021.
This is the first time this has happened since WWII.

Two-thirds of the world has a fertility rate of less than 2.1 births per woman, which is the level needed for stable population.

People are old and getting older.  30% of the population is over 65 in Japan.  In the United States, which has some of the better demographics (thanks to immigration), it is just under 20%.

In the manufacturing hubs of the world, the outlook is grim.  While China has only 15% over-65, their one-child policy makes it a virtual certainty that their labor force is going to go into decline.  They will be Japan by 2050.

In Korea, the birthrate has gotten so bad (only 0.81 per woman 2021) that the government is offering a $740 per month allowance for each newborn child!

If we want to get work done, we are going to have to do it without the worker.  Meaning more technology, more machines.

This is the sweet spot for additive manufacturing.

This is not the same technology as a couple of decades ago.

This is not plastic prototypes and trinkets.  Today’s additive technologies are about manufacturing end-use parts at scale.

Consider Stratasys, one of the biggest additive manufacturing names.  In 2020, 25% of Stratasys’s revenue came from end-use manufacturing.  In 2021, that increased to 29%.  Stratasys expects 20% growth in 2022.

Stratasys has a partnership with General Motors (GM – NYSE) and another high-performance OEM, Radford, to produce parts on the floor that go into the cars. 

Source: Stratasys Investor Presentation

It is not just cars.   Aerospace (Lockheed Martin), military (General Atomoics), and medical devices are all taking advantage of the customization and quick turnaround time of additive manufacturing.

Take medical device maker Stryker (SYK -NYSE) for example. 

Stryker manufactures its Tritanium implants, used for the knee, spine and hip, using additive manufacturing. 

In Q1 Stryker expanded the offering to include patient matched shoulder implants. 

These implants are custom made for the shape of each patient, manufactured with additive manufacturing.

Stryker can turn around a custom-made implant in 14 days.  They expect that number to get below 10 days by next year.

Stryker announced a new 156,000 square-foot facility with 600 high-tech jobs in Anngrove Michigan that will be dedicated to expanding their additive manufacturing capacity.

Nano-Dimensions (NNDM – NASDAQ) goes a step further, using additive manufacturing to create micro-devices.  Their DragonFly and Fabrica systems are micro-additive – meaning they can produce very small footprint devices.

Their systems fabricate the circuit boards, can add capacitors, transformers and coils, creating functional electronic devices on the fly.   These are used in smartphones, drones, cars and medical devices for use in the human body.

None of these examples are one-off prototypes.  We’re talking end-user and scale.
 

BRINGING IT ALL BACK HOME

 
While demographics is going to drive adoption over time, the process is going to be sped up by de-globalization.

COVID put the spotlight on supply chains.  Geopolitical tensions are amplifying that.  Together these forces strengthen the call for bringing manufacturing back home.

It is putting additive manufacturing at an inflection point.  

What we saw in 2021 was a faster transition from prototyping to production of end-use parts.

Yoav Zeif, CEO of Stratasys said that “the last two years opened up new markets” for Stratasys and have been a “catalyst to rethink how [companies] manage their product lifecycle.”

Zeif estimates that their opportunity set has doubled over that time.

The US Government sees it as well.  In May the White House announced the Additive Manufacturing Forward Program.  The program is aimed at “building more resilient supply chains” and “onshoring manufacturing”.

There are 5 initial participants in the program: GEO Aviation, Honeywell (HON – NYSE), Lockheed Martin (LMT -NYSE), Raytheon (RTX – NYSE) and Siemens Energy. 

These large manufacturers have committed to source a large percentage (between 20% and 50%) of their additively manufactured products from within the US.

The goal here is to establish the United States as a hub for small and medium manufacturers of additive products.

The Biden administration will support the program by providing low-cost access to capital that allows the manufacturers to build up their additive equipment base.
 

SOFTWARE CATCHES UP

 
Software has held back additive manufacturing applications in the past.

Until recently, the steps from designing a part to printing it were cumbersome.

Parts were designed on traditional CAD tools.  Solidworks, Autodesk, Pro-Engineer.  The design was then converted to a 3D-printer compatible tool, where it would be sliced and diced into increments that could be handled by the additive manufacturing process.

Today that process has been simplified.  Large names like Autodesk (ADSK – NASDAQ) and Solidworks (owned by Dassault (DSY – FR)) have integrated additive design tools. 

Tools like ANSYS now have options to evaluate the final part design, including choice of layers, to detect structural issues.

Materialise (MTLS – NASDAQ) has even built software specifically for additive manufacturing. 
 

RECESSION WATCH

 
The long run looks bright.  But in the short run, these stocks are going to be held back by recession.

2021 saw a surge in growth across the sector.

Stratasys grew 24-25% in Q2 and Q3 of last year after a number of years of flat to negative topline growth. 

3D Systems grew 44% YOY in Q2 2021 and 15% in Q2 2021, well above anything they had done before that.

The economy was hot and COVID restraints were driving investment. 
Now those tables have turned.

Nearly every additive manufacturing name printed slowing growth in Q2. 

Bigger names like Stratasys and 3D Systems pulled back on their growth estimates for the second half.

3D Systems saw declining revenue – down 14% in Q2. Stratasys saw revenue growth drop to 13% and their guidance dropped YOY growth to only 6-7% in the second half.

The slowdown has pummeled the stocks.  Every one of these names is down for the year, most by a lot.

Source: Stockcharts.com

Yet I don’t think the bottom is in just yet.

At the end of the day this is manufacturing folks.  What these companies are driven by is manufacturing capex – they need manufacturers to invest in their business and for that you need healthy growth.

That means that regardless of how good the tech is, if growth disappears, if orders are weak, there is no need to invest.

That’s the headwind.  It will last for as long as the economy is slow.  It won’t last forever.

Separating the long-term trend from the short-term is the trick here.   

These stocks may have further to fall. 

But some will turn out to be big winners once the recession passes.

US natgas prices have been trading near or above $9/mcf for a week now, while Canadian natgas prices actually hit ZERO for a short time recently—and on the main AECO benchmark no less!

ZERO, as in $0.00.  How can that happen you say, in a North American market where natgas is integrated remarkably well between the two countries.

Now, that would have only been for a trade or two where a producer was caught offside with too many molecules on the wrong day.  Believe it or not, natgas trading at zero or even negative in Canada—especially at the smaller Station 2 hub—was not unusual in August in Canada some years.

But now, when Europe is buying every molecule from around the world, how can Canadian natgas be at such a discount to the US.  The simple reasons are that

1. Production is now up over 17 bcf/d—an all time high, just when…
2. …Maintenance issues on Canadian pipelines are reducing capacity

And there’s a good chance this won’t be fixed until AFTER the big Freeport LNG facility in the US Gulf Coast restarts and sucks up another 2 bcf/d for export to Europe.

Now the good news is, Canadian prices are generally at $4/mcf now, not zero. But the bad news is, Canadian prices are generally at $4/mcf now, not US$9/mcf like down south.

Let me put this in a bit of context.
 

THE GOOD OLE DAYS AND THE BAD OLE DAYS—ARE BACK

 
Natural gas prices are back up at highs we have not seen in well over a decade.

Europe continues to scramble to get whatever LNG they can get their hands on. 

While EU storage is actually up year-over-year, and Germany just announced they reached their interim storage goal a couple weeks ahead of schedule, that has not helped bring down gas prices.

Contributing is that the summer in Europe has turned scorching hot.  

This and the looming threat that Russia shuts of the tap in the fall has driven natural gas prices above $70 per million BTU.

Those prices are ricocheting around the world, sending natural prices sky high.  In Asia, spot LNG prices have jumped to nearly $60 per million BTU.

Source: Bloomberg

In the United States the biggest impediment to natural gas prices rising – the shutdown of the Freeport LNG terminal – looks to be hitting its timeline on getting back online, which is only in a couple more months. 

The terminal shutdown has led to a decrease of about 2 bcf/d in LNG exports the last few months and kept a lid on US natural prices in the process.

Source: Bloomberg

I suspect that natural gas prices in the US are moving back up in part because the Freeport restart is getting close.  But there is more to it than that.  Even with lower LNG exports, the last few weeks have seen a drop in seasonal storage builds, which is telling you it’s a tight market in the US.

Source: Bloomberg

The economy is a concern but so far there isn’t a lot of evidence of demand destruction.   

Maybe we shouldn’t be surprised.  Even during COVID, natural gas demand – mostly for heating and air conditioning – proved to be remarkably resilient.

For now, average daily electricity generation from natural gas is sitting at all-time seasonal highs.

Source: NBF

So yes….the good old days are back.

Unless you produce in Canada.

Not that things have been that bad for Canadian producers.  Canadian producers have been getting far and beyond the price they got last year, likely well beyond anything they would have imagined getting ever again!

But it is far from what it could be.  And over the last few weeks it has gotten a lot worse.

The differential between the Canadian AECO hub price and US Henry Hub has blown out in recent weeks.

The issue is same the old foe that has plagued Canadian gas producers in the past—egress capacity.

Drilling is up across the Western Canadian Sedimentary Basin (WCSB).  That goes for both natural gas and for oil.  Most Canadian oil plays come with significant associated natural gas.

Source: RBC Capital Markets

More drilling means more gas.  WCSB production is now above 17 bcf per day.  Last year at this time production was a little under 16.5 bcf per day.  In 2020 it was only 15 bcf per day.  Much of this is coming from the Montney, in NE Alberta and NW BC.
 

THE REAL CULPRIT IS SUMMER MAINTENANCE

 
The increase in production comes at a time when investors are seeing a lot of pipeline capacity down for maintenance.

Station 2 natural gas prices – this is gas that has come south from Northern BC (the Montney) – dropped to 50 cents per mcf this week!  The most widely used benchmark for WCSB prices, AECO, was trading at around C$3.25/mcf before Thursday (not great), when it dropped to $0/GJ (really not great!).

The drop to $0 was due to additional maintenance south of Grande Prairie along the TC Energy Nova Gas Transmission Line (NGTL) which brings gas north to south across eastern Alberta.

The maintenance was on top of existing the maintenance work along the pipeline that is already being done and reduced volumes through the pipeline further.

Combining much higher volumes through the NGTL pipeline and maintenance reductions is a recipe for low (and negative!) prices.

Source: NBF

The #2 Canadian broker, BMO Capital Markets, does not see the situation improving until the late fall.

It all adds up to a massive discount in pricing for Canadian producers. NYMEX natural gas futures have been above US$9 all week long.
 

WHAT CANADIAN PRODUCERS ARE EXPOSED?

 
But not all Canadian producers are equal.  There are some with a lot of exposure to AECO, and others that have either hedged their exposure or have transmission to the United States hubs that bypasses the Alberta bottleneck.

Canadian mid-tier broker NBF put out a helpful table that shows the exposure of to AECO of various producers.

Source: NBF

NBF highlighted Birchcliff Energy (BIR -TSX) in particular.  Birchcliff is showing a 20% free-cash flow yield at current prices.  They are only marginally exposed to AECO prices.

Source: NBF

The other big driver for Birchcliff is that they are about to become debt free. 

When that is announced (expected Q4) expect cash flow to come streaming back to shareholders.

NBF estimates that with a 50-75% free cash flow payout Birchliff could be paying out as much as $1.75 in dividends.  Not bad for an $11 stock.

Nuvista (NVA – TSX) also looks interesting with very low AECO exposure and a 20%+ free cash flow yield.

Finally, it may still be a bit early, but at some point, the contrarian path could pay a big dividend to investors.

From what I’m reading, most of the collapse in differentials is because of maintenance.  Maybe poorly timed maintenance.  Come late fall, we should be looking at a more balanced picture.

One of the most exposed producers is Pipestone Energy (PIPE – TSX).  According to BMO 80% of their volume is priced at AECO.

This has likely been a factor in the stock underperformance.  While most natgas stocks are at their highs, Pipestone sits well below its June level.

Source: Stockwatch.com

In the third quarter Pipestone will take a hit on its natural gas pricing.  Their natgas selling price averaged over $8/mcf in Q2.

But once we see that the bottom is in for AECO and differentials narrow, Pipestone could see a quick re-rating back to the level of its peers.

Copper has had a tough go of it.  The stocks of copper producers have been even worse.

The biggest – Freeport McMoRan (FCX – NASDAQ), is down 40% since April.  Small copper producers like Capstone Mining (CS – TSX), Copper Mountain Mining (CMMC – TSX) and Taseko Mines (TKO – TSX) are all down 50-60% from their high.

The price of copper reflects all the worries about the global economy. After hanging around $4.50 for the first 5 months of the year, copper has gone into freefall, bottoming (for now?) at just above $3 per pound.

Source: Kitcometals.com

It is hard to buy copper stocks when they are down big.  The charts give you plenty of examples of when they went down even more.

Yet this could turn out to be an incredible buying opportunity.  Copper is a commodity with an extremely favorable long-term demand trend.

If you can look past the next 6-12 months, hold your nose if these stocks go lower, the growing use of renewables should become a massive tailwind for copper.

The demand from transmission lines, EVs, solar and wind will be one that sends copper prices to new heights – and copper producers along with it.
 

THE RENEWABLE TRAIN GAINS STEAM

 

This has been a spectacular 12 months for oil and gas stocks.   A great run.

But I’m not blind.  Renewables are the future.

Longer-term renewables will take share and capital.

The question is – how fast?

Maybe faster than we think.

Consider the June Investor Day presentation from Next Era Energy (NEE – NYSE).

NextEra is one of the more “progressive” utilities.  They have embraced renewables.

At their investor day NextEra outlined a very bullish case for renewables expansion.

Source: Next Era Energy Investor Presentation

NextEra iforecasts a dramatic increase in renewables over the next 14 years.  From a relatively modest 13% of generation capacity right now (solar is about 4%, wind about 9%) to well, well over 50% by 2035.

That forecast is based off of the IHS “fast-track” scenario. In 2021 IHS estimated a “fast-track” of renewable power generation that would allow us to hit IPCC decarbonization targets.  IHS saw 2,800 GW of installed solar and wind capacity in the United States by 2050. 

The rest of the world is expected to follow.  Morgan Stanley now expects 2,800 GW of installed solar capacity worldwide by 2030:

Source: Morgan Stanley

These are huge increases to installed capacity compared to today.  According to the EIA, renewable capacity in the United States in 2021 (again we are talking wind and solar here) was about 285 GW.   That is expected to increase by only 15 GW in 2022.

In other words, we have a steep hill to climb.  One that is going to require copper.
 

A WHOLE LOT OF COPPER

 
Copper is in the doghouse.  The metal has been hammered; the one-year chart has broken down hard.

Chances are we are going into a recession, maybe a deep one.  China has been in lockdown.  Housing starts have waned as interest rates have spiked.

None of this is good for copper.

But, BUT – if you can look past all this, there is reason to be optimistic.  Reason to watch copper closely for signs of a bottom.

Renewable demand is going to need A LOT of copper.  And that demand is going to hit very soon.

Morgan Stanley recently put out a piece on the impact of the renewable transition on copper demand. 

Source: Morgan Stanley

Morgan Stanley expects copper demand from power generation and automotives to nearly double from 2020 and 2030!

By 2030 demand for copper in electric vehicles alone will exceed what the entire power generation and automotive verticals use today.

It is hard to imagine the price of copper staying down with this sort of tailwind.
 

DR. COPPER?

 
It wasn’t that long ago that the copper bulls reigned. It was only three months ago that Goldman Sachs told us that copper was “sleepwalking towards a stockout”.

This was the title of a piece written by the team of analyst Jeff Currie (a guy that is no slouch).

In the research note Goldman argued that “‘Dr. Copper’ no longer existed – that ESG, geopolitics and chronic underinvestment” would drive copper fundamentals far more than overall global growth.

The note was badly timed.  Couldn’t have been worse. Copper has fallen off the cliff.  But the point they were making bares repeating.

In April Goldman saw larger and larger deficits coming from increased demand for renewables and the loss of production from Russia.

Source: Goldman Sachs

They also noted drought conditions in Chile, the worlds biggest copper producing country, leading to lower year-over-year production there. 

Source: Goldman Sachs

Left-leaning governments aren’t helping the supply picture.  Chile is proposing a mining royalty that would significantly increase costs of mining and deter future projects.

While the recession looms, global copper inventories remain extremely low.  Most of the inventory left is in China.

Source: Credit Suisse

None of this means the price of copper won’t keep going down in a recession.  It will.  That is just what commodities do.

But what it does mean is once we are past the recession, the bounce back could be fierce.
 

LOOKING PAST THE RECESSION

 
Yes, the next few months may look bleak. A recession could very well be on the horizon. Heck, we may already be in one!

But out of recessions and bear markets come new economic growth cycles and bull markets.  

New leaders come with it.

What are the secular trends that will lead us through the next cycle?

The renewable buildout is almost certain to be front and center.

The copper chart looks like death warmed over.  But that screams to me that we are coming up on a HUGE opportunity here.

Nine months ago, if you had told me I’d get another chance to buy copper producers at half price and without a real hiccup to the renewables story, I would have jumped at the chance.

Down here in the weeds that opportunity seems less certain.  It always does.

Demand is almost certainly going to come back strong once we get through this rough patch.  We may find that once we hit bottom, we are off on a super-cycle.

While in the short-run we may see a lull in renewable projects as capital tightens, the Russian invasion of Ukraine has only made governments more steadfast in their plans for a renewable buildout over the long-run.

The only way we hit those climate goals is with a whole lot of commodities, a lot of copper.

Timing is everything.  You can buy copper equities here – 50% off – but be forewarned, these producers could easily go down another 30% from here.  

But – they could also just as easily be back at their 52-week highs, or higher, a year from now.

Big risk, big reward.  That’s commodities for you.  But it is not too often that commodities are pricing in the risk while at the same time giving you such a clear picture of long-term demand.

I may not be ready to buy the copper producers just yet, but I am not going to let them get away from me once the turn comes.

Even though energy stocks have had a great year (up until June! ) they still trade at very low multiples–2-3.5x cash flow.
 
That means the Market is still seeing this sector as VERY volatile. But huge Q2 profit numbers out of EVERY sub-sector in energy (oil, gas, refiners, frackers, drillers, sand producers) sure lit a fire under the stocks this last week.
 
The Street KNEW all these numbers would be GREAT–but there still wasn’t much love around for these stocks.
 
But the across-the-board strength in energy stocks this week may be the turn. EXAMPLE–I have seen a lot of crazy things in oil, and what I saw on Thursday is close to the top.

The first two of the US refiners reported on Thursday morning.  Valero (VLO – NYSE) and PBF Energy (PBF – NYSE).  Both reported incredibly strong results, well above analyst estimates. 

PBF Energy reported earnings-per-share, excluding one-time items, of $10.58 per share.

PBF Energy is a $30 stock.  They trade at 3x earnings then, right?  Well, except, that $10.58 is for one quarter!

We knew the second quarter was going to be great for refiners.  But even analysts underestimated just how great.   The average analyst estimate going into the quarter was $7.50 EPS. The high estimate was $8.50.

Only one thing a stock can do after killing estimates like that?  Right?  Right – PBF Energy was DOWN for most of the day.  Down a buck at one point.   It did close up marginally, up 23c.  (It did have a good day Friday–finally!)
 

NO ONE BELIEVES THIS CAN LAST

 
To say that no one believes these energy prices are sustainable is an understatement.
The only way a stock can have a move like that after a number like that is if investors are betting on an imminent collapse.  In this case, in refining margins and, necessarily, oil prices.

To be sure, refining margins have fallen.  The crack spread has come in from ~$60/bbl to ~$40/bbl.  You see that at the pump, as gas prices have fallen from stratospheric to just plain, old high.

Yet crack spreads are still way, way above typical mid-cycle levels.

Source: Bloomberg

Of course, the big worry is that this is just the start of the downtrend.
 

HOW MUCH IS DEMAND DROPPING?

 
The narrative today is that there is massive demand destruction and we’ve only just seen the start of the collapse in crack spreads and oil.

The narrative is driven by the EIA, which reported two weeks of very weak implied gasoline demand in mid-July, peak driving season.  This was taken by investors as a signal that the collapse in demand, brought on by $5 gasoline, was on us.

Well, the latest EIA numbers, from this Wednesday, make that conclusion a little less certain. Below is the chart of weekly implied gasoline demand.

Source: Giovanni Staunovo

Gasoline made a dramatic comeback last week.  Right back on trend.

PBF Energy CEO Tom Nimbley chalked up the two weak gasoline datapoints to the way the EIA smooths their weekly and monthly data.

So there was some aberrance in the — coming out of the July 4th week, and that’s always questionable you do there. And then there was some true-up, I think, between the monthly EIA from June that get flowed into July. And perhaps that has run its course now and yesterday’s numbers were a little bit stronger.

While the EIA numbers have everyone worried about demand, neither Valero nor PBF Energy seem to see it.
Nimbley said this:

in our own business… our demand at the wholesale level is holding up, we’re at the same level we’ve been at for the last 90 days.

On the Valero call COO Gary Simmons echoed those comments.

I can tell you through our wholesale channel, there’s really no indication of any demand destruction. In June, we actually set sales records

On their own call, Exxon (XOM – NYSE) said much the same thing Friday. 
 

CAN SUPPLY RESPOND?

 
Exxon also took time to address the supply side.  Exxon pointed out that the refinery “closure rate during the pandemic was 3x the rate of the 2008 financial crisis.”

Source: Exxon Mobile Q2 Investor Presentation

We’ve lost over 3 mmbbl/d of refining capacity since the beginning of COVID.  In a ~100 mbbl/d market that, despite what we hear, is still growing, that is not chump change.

Exxon does not see the situation resolving itself for some time.

I’ve reproduced the entire answer that Exxon CEO Darren Woods gave to a question from Stephen Richardson at Evercore ISI, asking about his view on the refining outlook.  My underlines:

Outside of that, I don’t see a whole lot of additional expansions here in the U.S. …and then as we mentioned in the presentation, over the next 2 years, probably 1 million barrels a day of capacity, including the 250 [kbbl/d] at our site coming on in the marketplace, which is still fairly short of the capacity that came off. And so our view is we’re going to see what I say, the tighter supply and demand balance.

One of the real question marks out there is what happens with demand. I would tell you, even at 2019 levels, the market is relatively tight. And so I expect a tighter market and maybe elevated margins versus what the historical norm is. But I would expect much lower than what we’ve experienced here in the second quarter.

But — and then with time, we’ll see that capacity come back on out in Asia and the Middle East. And the world market is very efficient, and those barrels will flow to the demand centers and balance things off. And so I think this will be a few year price environment, and we’ll get back to what I think is a more typical refining industry structure.

Those “elevated margins” are going to be needed to
A. attract investment to close the gap and
B. to keep the high-cost refiners in Europe running.

The US refiners are playing with a big advantage right now.  Natgas prices in Europe are about 10x higher than the US.  European refiners are paying out big OPEX costs because of natural gas.

Source: BofA Capital Markets

Yet Europe is very much in need of distillate fuels.  Whereas the tightness in gasoline can resolve itself through higher prices/less driving, the distillate tightness is hard to fix.

Valero’s Simmons described the European dilemma like this:

It’s going to be a real challenge for us, Roger, to be able to supply a lot more diesel into Europe. If you look with the U.S. inventories where they are, the industry basically running all out, we’re getting back to where jet demand is recovering in the U.S., which is actually driving ULSD yields down a little bit. It’s very difficult for me seeing that there’s going to be a lot of flow from the U.S. into Europe.

 
NOTHING CAN GO WRONG

 
Look, no one on these conference calls is saying we are going back to the Q2 crack margin highs.  Every executive I’ve listened to says what we saw in Q2 was too high and not sustainable.

But the whisper is clear – crack spreads will be higher for longer compared to what we’ve seen in the past.

When the market sells down PBF Energy and Valero after producing stellar earnings, they are not factoring in this scenario: that this is “a few year price environment”.

In fact, the market is not pricing in much at all.

Higher spreads than the historical mid-cycle norm are with us for a while.  That is my takeaway.

But maybe more importantly is this: what if something goes wrong.

In oil we endlessly talk about one thing – spare capacity.

We never talk about that in refining.  Because it’s never been a problem—until now.

Right now, there is NO spare capacity in the refining market.  Nada.  The refining market is running full-out on the edge right now and it is barely keeping up.

That doesn’t mean much until something happens.  Then it matters a lot. In other words, if nothing goes wrong, then margins stay healthy, but not crazy high.  But, if something does go wrong…

Any little hiccup – remember what happened to natural gas when the Freeport LNG terminal went offline? – and refining margins are going to go much, much higher.

The market is pricing refinery stocks like this is not a risk.  I think that is a mistake. 

A poorly placed hurricane, an accidental fire or a well-timed terrorist attack and we are in a whole heap of trouble.

I REALLY hope that doesn’t happen.  But to price that risk at zero, seems a bit too optimistic to me.

Keith Schaefer

Renewable stocks are flying this week on the heels of a big new bill about to pass through Congress.

This deal–worth almost half a trillion in spending–is a long-time coming.  Democrats have been infighting about a spending bill since last year. 

Senator Joe Manchin has been the key hold out as he didn’t want to spend so much money, and wanted more support for fossil fuels.  Almost all the money is going to climate change and EV spending.

Many had given up on flipping Manchin. The move we are seeing in solar and EV stocks reflects that surprise.

Yet even though the stocks are soaring, in terms of dollars this isn’t a huge bill. Total spending from the bill is $433 billion.  Of that, $369 billion is tagged for climate and energy.

There is also a permitting reform bill that is aimed at speeding up permit approvals for clean energy projects.

The centerpiece of the bill is a $7,500 federal tax credit for electric vehicles, including a $4,000 tax credit if you purchase a used electric vehicle.

The deal lifts the cap on existing credits, so that now EV manufacturers can sell as many vehicles as they can and still qualify for the credit.

The bill does put a cap on price – it excludes electric cars above $55k and SUVs above $80k.

This is a particularly good bill for battery manufacturers with a US footprint.  It calls for 100% of battery components to be manufactured in the US by 2028.

EV’s already hit 5.6% of new car sales in the US in the second quarter. This bill is bound to accelerate that adoption.  (This should also be good for lithium stocks, longer term.)

However, it seems like some of the moves we are seeing are a bit overdone. 

Plug Power (PLUG – NASDAQ) was up 23% today! Canadian based Ballard Power (BLDP – TSX) is up 15%. Sunrun (RUN -NASDAQ), a US based solar installer, was up 26%!

What is odd to me is that the deal doesn’t seem to have a lot to do with what these companies sell.

Plug Power does sell EV’s, but they are hydrogen forklifts and tractors, not cars.  Sunrun is solar, which doesn’t seem to have much of a place in the bill, other than the knock-on of more EVs means more electricity demand.

What seems more likely is that the move is because these are heavily shorted stocks. Sunrun has been the target of a recent short report.  The bill, on top of dovish comments from Jerome Powell, is a good excuse for a squeeze.

Not surprising that Plug Power has a 13% short interest.  Sunrun is 14%.

The oil and gas industry got one small bone in the bill, but I’m not giving it much weight.

Manchin insisted on including more oil and gas lease sales on public lands, including the Gulf of Mexico and Alaska.  Yet to me, given the trajectory of EV adoption, I still find it hard to believe we will see big spending on long-lived projects like GoM and Alaska. 

IN OTHER NEWS–see oil up $5/b today on several factors–OPEC may not grant as big a production increase as originally thought next week, and the Market is quickly changing its opinion on Libya adding 1 million b/d production.  Halliburton is evidently stopping work there until they get paid.

The Market is shrugging off recession fears (it goes back and forth on a weekly if not daily basis) which is helping a lot.  The Market is also interpreting the Fed’s Jay Powell’s language as hinting that they are nearing peak inflation and future rate hikes MAY be less than expected.

I don’t know what else he would be expected to say after getting criticized two months ago for being too bearish, saying the Fed would do whatever it took to keep inflation low.  I expect him to continue to talk dovish but act hawkish. But his language did intimate that high oil prices were NOT in his crosshairs–which it has been for a few months now.

And the USD is slowly coming down off a $1.31 peak to the Canadian dollar; that helps.

No industry on earth has an existential problem like smoking.  They make billions of dollars (like, it’s getting close to $1 trillion) but kill millions of people.
 
The industry of course doesn’t want to kill the goose that lays the golden eggs—their customers—so they are always trying to find new ways to feed old habits.
 
Don’t get me wrong, harm reduction is a very real issue in the global smoking industry.  In fact, it’s kind of The Holy Grail for this $800 billion annual sector.
 
And this is an insanely profitable sector. After paying out billions of dollars annually in taxes, the Top 6 in the industry still made US$55 billion in 2018.
 
For venture capitalists, being able to tap into this revenue stream—even in a small way—means hundreds of millions of dollars. 
 
Look what happened to Podatech (PODA-CSE, now trading as IDLE.X-CSE) who sold a heat-not-burn product to Altria (MO-NYSE) for $100 million.  ONE HUNDRED MILLION DOLLARS for a well-engineered plastic product that allows smoking to continue but with only a very small fraction of carcinogens. (I covered PODA in early 2021.)
 
So when I saw Michael Saxon join TAAT Global Alternatives (TAAT-CSE) as CEO, I knew it was time to revisit this story.  He had been just an advisory board member for the last year, but jumped into the CEO role in May—right after TAAT bought its first tobacco distributor, ADCO, out of Ohio.

This immediately gave Saxon a much larger platform to turn TAAT into a large and much more profitable brand. It did US$87 million in revenue last year, and TAAT announced 2022 revenue guidance of $92 million.

As a former senior executive at both Philip Morris (PMI-NYSE) and Altria (MO-NYSE) Saxon knows the politics and business of smoking in Europe and North America.  He’s connected, he’s competent and he sees A Big Place for TAAT in the fast-growing harm reduction market. TAAT has no tobacco, no nicotine and 97% fewer chemicals.
 
“I think the TAAT product is part of the broader conversation in this space,” he told me over the phone this week. “When the product showed some early and promising signs that it was heading in a direction—that it could be part of the harm reduction conversation—that really piqued my interest.”
 
He says TAAT has a different strategy than the other junior entrepreneurs trying to break into this $800 billion market.
 
“Everybody so far in this harm-reduction conversation has tried to solve the problem with a ‘new-to-the-world-product’ as I like to call it.” (Think heat-not-burn or vaping…)
 
“But what our founder Joe Deighan did that was interesting was…other than those alternatives, he said there might be people who like the traditional form of cigarette. 
 
“I think our TAAT product looks and feels like the traditional product that smokers are already using every day. I think we’re asking for less of a hurdle in terms of the jump they need to make to make the switch to TAAT.
 
“This third version of our product has been refined to resemble the traditional smoking experience…all the hard work in product development has been done.”
 
Saxon is convinced that TAAT now has the right harm reduction product for this multi-billion dollar market—and the sales strategy to start making it pay almost immediately. In fact, urgency was the one theme that dominated our talk.  There is no existential angst here.  He is hitting the ground running, and fast.
 
“The key for a product like this is to make sure you’re available in the majority of the store—so that when they need to make that repurchase it’s easily available.

“You want to make it easy for them to find, and easy for them to purchase.  That’s  what we will be focused on over the next three months and that’s where we could make an immediate change here in my first weeks in the role.”
 
When you own a distributor, you get to quickly set your point of sales support, decide on pricing and be able to do whatever it takes to move product. 
 
TAAT paid just over $6 million for ADCO.  Big volume will bring EBITDA.  TAAT is meant to be even MORE profitable than traditional cigarettes. With no excise tax—because this is not a tobacco product—it can sell for a big discount to any other top-selling brand, and still generate huge cash flows.

Before ADCO, TAAT was selling its tobacco-free, nicotine-free “sticks” in 2500 stores and increasing sales at 10% per quarter—so they were doing OK.  And re-orders are often more than 50% of revenue—another great sign.
 
But to really ramp up product volumes and revenue, TAAT wants to be in tens of thousands of stores.  And to make that happen, TAAT needs to give the big distributors Big Data.
 
That’s what Saxon can direct ADCO to be doing.  They can now test marketing, product placement, product packaging and pricing across their own stores and the hundreds of other locations that they sell smoking products into.
 
TAAT can use ADCO to figure out what sales formats and strategies work best to get the volume and revenue up—and then pass that data on to much larger distributors. 
 
Those big distributors need that kind of sales data to KNOW that TAAT product sells strongly.  The big chains like Walmart, 7-11 and Circle-K don’t want to take chances on large product rollouts—they want to know it’s going to generate cash flow.
 
And now TAAT has the product, the CEO and the channel to make it happen—immediately.   Saxon has no existential angst; he’s on a harm reduction mission and believes he can hit some big revenue milestones in a hurry.

It’s a bear market.  That means that picking stocks just got a whole lot harder.

Bull markets are forgiving.  The trend of the market is up.  Most individual names will go up too.

Just stay away from the duds and in a bull market you can see your picks lifted along with all boats.

Not so in a bear market.  You are climbing up hill and lately it has been a steep one.  Today you fight both a higher chance of missing earnings and the chance that if a company does hit its target, the market sends it down anyway.

In this sort of market, you need to look for dislocations.  Where is the general dour mood of the market is causing too much bearishness – ignoring an easy win that you can exploit.

I came across what I thought was one yesterday.  At first glance it looked like an easy win – a layup. 

But nothing is easy in investing and that goes double for a bear market.
 

CERAGON NETWORKS – A PLAY ON 5G BACKHAUL

 
Ceragon Networks (CRNT – NASDAQ) is a name that I have been following for years. 

A 5G play!  Remember 5G?  It seems like for years 5G wireless has been hyped as the next big thing. 

I’m still waiting! 

But Ceragon is a small wireless backhaul equipment provider. They sell wireless receivers and gateways. 

Their customers are service providers, with their largest presence being in India.

Ceragon’s backhaul products are the middleman between the big base station towers and your phone. 

They handle the short leg of transmission to get the signal to the main trunk line where it can be routed.

They do it wirelessly, so they are used in areas where laying fiber is expensive or impossible.

Ceragon’s cell sites are placed on the side of a building, on a telephone pole, in a stadium, wherever there is traffic and where wireline transmission isn’t feasible.

I liked the idea of Ceragon because they are right in the middle of the 5G transformation.  They have a newly released 5G platform and other 5G products on the way.

But Ceragon has just never been able to get any traction.  COVID and a slow rollout of 5G has doomed the stock.

Source: Stockcharts.com
 

AN ALL-CASH BID

 
While I am seeing signs that 5G is back (baby?), where we are in the 5G rollout is now less important for Ceragon investors.

Why?  Because Ceragon received a takeover bid from Aviat Networks (AVNT – NASDAQ) yesterday – and its all-cash.

Aviat is offering $2.80 for Ceragon.  The offer represents a 34% premium to Ceragon’s price on Monday, and a 51% premium to the 60-day average.

That sounds great but….  a quick look at the chart tells you that bid is going to leave a lot of shareholders underwater.   Ceragon has traded a lot higher than $2.80 as recently as a few months back.

It is a low-ball offer right?  But is Ceragon seeing its business fall off the back of the truck, justifying it?  I can’t say that is the case.
 

CERAGON’S BUSINESS SEEMS CLOSE TO TURNING UP

 
In the first quarter Ceragon did miss analyst estimates.  Revenue came in at $70 million.  Estimates averaged $71 million with a high of $73 million.

But that miss was almost entirely due to supply chain issues.  On the call Ceragon said they saw “strong operating demand” and “exceptionally high bookings”, the highest in the last 4 years.

That doesn’t sound bad to me.

But Ceragon blew the quarter because they couldn’t deliver product. A well known story: component shortages and supply chain bottlenecks.

This is going to continue in the short term – Q2 will be weak. But Ceragon is projecting a better second half. 
While they reduced their fully year guidance – they did so only slightly – from a range of $305 – $320 million to a range of $300 – $315 million.

While the business is not booming, it is not falling apart either. Meanwhile 5G is gaining momentum – as slow as it may seem at times. 

A case could be made then when Ceragon traded below $2 in May and early June it was too cheap. 

Which means the bid premium is not as much as it seems.
 

WILL THE BID BE ACCEPTED?

 
Probably not.

Aviat has been targeting Ceragon since late last year.  In a letter to the Ceragon board, Aviat said that they had made offers in November and April.  Their Chairman and CEO went to Israel to engage with Ceragon a couple months ago.

It’s been a no-go.  The offers were rejected and Ceragon’s board was not responsive to requests to “engage in price discussions”.

Aviat is now going with a different approach.

Aviat holds ~5% of the outstanding shares of Ceragon. 

Because they exceed that 5% threshold, Aviat believes they have the right to nominate directors and have a special meeting called to vote.

They plan to nominate 5 directors for that meeting.

Right now, the Ceragon board has 7 directors.  The company bylaws allow for 9.

That means Aviat needs to win all 5 nominees to get a majority on the board.

 They need a 50% vote on these directors to get them voted in.
 

WHERE DO SHAREHOLDERS STAND?

 
Ceragon has a couple of large shareholders – the Joseph Samberg Trust and Zohar Zisapel.

Samberg owns a little less than 13 million shares, or 15% of the company.  The shares are held in a revocable trust, of which Samberg is the trustee. 

While the Samberg trust has owned shares of Ceragon since 2016, it substantially increased its holdings in late-2018 and early 2019.  This likely means he paid more for those shares than Aviat is bidding.

Ceragon filings are the only one’s the trust has made since 2019.  But I don’t see any indication that the Samberg Trust is involved in the daily business of Ceragon.  They appear to be investors in the stock.

Zisapel is a well-known Israeli investor.  He has big positions in many Israeli companies.  He is also Chairman of the board of Ceragon.  He owns 7.1 million shares or 8.5% of Ceragon.

Zisapel has sold shares in the past.  In 2020 he held 10.5 million shares.  He had reduced those down to the current amount in 2021, potentially during the blow-off period in early 2021.

Three of Ceragon’s 5 existing directors have close connections to Zisapel.   

They either have run or held high level positions in companies where Zisapel was chair.

It seems extremely unlikely that Aviat will be able to sway Zisapel’s vote. 

Samberg is a bit less certain, after all the trust seems to be an investor in technology stocks and while Ceragon has been a large investment, it’s conceivable they would sell at the right price.

The problem is that $2.80 is probably not the right price.  Most of the trust’s shares would be underwater. 

It is hard to imagine them accepting that.
 

IS THERE A PLAY HERE?

 
If there is, it is not for the faint of heart.

There is a case to be made that Aviat can pull this off, but it far from a sure thing.

What I am sure of is if Aviat wants to pull this off, it is going to take a higher price than $2.80.

I think that is the basis for a trade here.  It is not that this deal is going to get done – I think that is a coin flip at best – but that Aviat has every intention of trying very hard to do so.

The bears would argue that higher bid can’t happen, because Aviat just doesn’t have the resources.

It is true.  This is big acquisition for Aviat.  They are acquiring a ~$230 million company for cash when they themselves are only slightly bigger than that.  They don’t have a large war-chest at the ready.

On the other hand, Aviat would have been stupid to not think they would have to make a higher bid.  

In fact, they went to Israel with the intention of negotiating after the $2.80 was on the table. It seems pretty clear Aviat is willing to go higher.

That alone makes a trade on Ceragon intriguing.  But it all comes down to price and risk.

When I started writing this article the discount to the offer was 15%. Right now it is 10% (Ceragon is trading at $2.55 at the moment).

I’d feel a lot better about getting at least a 15% discount.

Like I said, this deal is far from certain.

Apart from Aviat there are a couple of hedge funds with a combined 4% that have been reducing and would presumably be open to a deal.

But weigh that against the 8% that Zisapel owns and the Samberg shares and its an uphill climb.

The next step for Aviat is going to be a higher bid.  But that won’t happen until Ceragon’s board inevitably rejects the current one.

When they do Ceragon’s stock may swoon.

If it swoons far enough, I will consider taking a position.  Not because of my conviction that a deal gets done. 

But my suspicion that Aviat is going to keep trying.