Top trade ideas (Tues, Nov 7)

Clearwater Analytics is a leading provider of investment portfolio reporting and analytics solutions. It uses advanced data and analytics to serve as the book of record across many asset classes for investment managers, corporations, insurers, and pension funds. The company analyzes and reports on over $6.4 trillion in daily assets across numerous accounts. Their software simplifies operations and ensures accuracy, speed, and scalability, adding significant customer value while reducing complexity. We believe the company is poised to sustain its robust growth trajectory, achieving annual top-line growth of 20% with meaningful margin expansion over our 5- year investment horizon. Clearwater is a great example of a Flywheel company with a unique and sticky product, high net recurring revenue, a significant runway for growth, and a business model and competitive advantage that strengthens with scale.

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Eversource's recent earnings report showed an adjusted EPS of $0.97 for Q3 2023, slightly down from the previous year. The company is maintaining its $74 per share fair value estimate and a no-moat rating. The drop in earnings was attributed to revenue timing, but year-to-date adjusted EPS is up 7% from the previous year. Management's full-year EPS guidance aligns with estimates. The stock has faced challenges related to its offshore wind investment, but it appears set to exit these projects, making the stock potentially undervalued by 25%. Eversource's core utility business remains strong, with a 5%-7% annual long-term growth rate and a $17 billion capital investment plan. Massachusetts offers additional growth potential, while Connecticut presents regulatory challenges.

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Ferguson is the nation’s leading distributor of plumbing supplies and is growing in the related field of HVAC (heating, ventilation and air conditioning). It’s a good business: pipes, valves, boilers, water pumps and the like are mostly unbranded products. There are a lot of manufacturers with limited pricing power. On the other side, plumbing and HVAC contractors are mostly small businesses without a lot of negotiating clout. The distributor sits in the middle with more buying power than the manufacturers and more pricing power than the plumber. It’s a competitive industry, not a monopoly, but Ferguson is #1 in most of its categories. With its size, it offers good service and a deep inventory position to contractors. Earnings have compounded steadily over time, but likely will be flat in the coming year, partly because residential home construction is off. We bought the stock for about 15 times 2024 earnings and feel like that’s a good value given Ferguson’s financial strength and long-term outlook.

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Lithium stocks, such as Albemarle, Livent, and SQM, recently faced a broker downgrade predicting lithium prices would fall to $15,000 per metric ton in 2026, below our view of the $20,000 marginal production cost. Despite this, we consider these stocks materially undervalued, with Albemarle and Livent trading at about 40% of their fair values and SQM at nearly 50%. Even if lithium briefly hits $15,000, we anticipate a swift correction due to supply constraints. Long-term, we are optimistic about lithium, expecting prices to stabilize around $20,000 per metric ton in 2024 and rise in 2024 due to increased demand, reduced battery producer destocking, and supply delays. Lithium Americas, focusing on the Thacker Pass lithium project, faces typical construction risks but offers significant potential for expansion and benefits from growing lithium demand. We assign Lithium Americas a no-moat rating, with a fair value estimate of $20 per share, subject to Very High Morningstar Uncertainty Rating due to project execution risks and price volatility. The company maintains a sound balance sheet, utilizes debt for construction, and has a neutral capital allocation strategy, prioritizing investments over dividends or share buybacks.

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PureCycle Technologies, backed by a SPAC, emerged with a $2.8 billion valuation in 2021, aiming to commercialize a licensed polypropylene recycling process from Proctor and Gamble. Despite $308 million in equity and $730 million raised previously, the venture has faced multiple hurdles. The process, involving high pressure and temperature melting of plastic mixed with butane, aimed to produce recyclable pellets. However, after $500 million in capital expenditure and several delays, commercial scale production declared in June at its Ohio plant has been problematic, as per former employees' testimonials. The facility has been described as poorly constructed with significant operational issues, leading to high waste and environmental impact comparable to traditional polypropylene production. Despite a media blitz following an alleged initial production, insiders sold over $13 million in shares and placed $250 million in convertible bonds, while the actual commercial-scale production remains unverified. An August power outage was blamed for failing to meet bond milestones, but mechanical failures seem to have been persistent since April. The company is now entangled in a $17 million lawsuit with its plant design and construction contractor, and its proprietary process, reliant on dangerous butane gas, presents operational and safety risks. Regulatory and interview evidence suggest that the facility has yet to start genuine commercial production, contradicting company claims. The company's bond agreement with the Southern Ohio Port Authority stipulates rapidly approaching production targets, failure to meet which could trigger loan default. Amid these challenges, PureCycle's technology remains unproven at an industrial scale, casting serious doubts on its viability and the accuracy of its representations to investors. We have shorted shares of PureCycle Technologies as a result.

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On July 26, Regal proposed a non-binding indicative offer (NBIO) for $PAC.AX at $10.77/share (2.2 GQG + $7.50 cash), and made an agreement with PAC's largest shareholder, River Capital, who desired a 50% stake in other boutique stakes, valuing PAC's Victory Park interest at $206m, significantly above PAC's $80.4m valuation. River agreed to fund Regal with $95m for a 49.9% interest in a new JV excluding GQG and Victory Park. Following this, GQG too expressed bidding interest. On September 28, Regal withdrew its bid due to alleged lack of engagement from PAC, while maintaining its valuation and strategic interest in PAC. On November 1, GQG bid $11 cash/share for PAC, though River didn't accept. GQG’s willingness to explore alternative transaction structures implies a possible accommodation for River's interest, albeit less than the 49.9% as with Regal, due to the strategic value addition from PAC's distribution network. The scenario hints at a potential re-entry of Regal/River with a competitive or premium bid to GQG’s $11 offer, especially since the Regal/River agreement suggested a ~$11.50/share valuation for PAC, higher than Regal’s initial bid. The complex bid dynamics, with no binding deal yet and a decent ~18% spread, presents an uncertain but interesting speculative scenario for $PAC.AX.

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