Drilling for Profits
In this edition of the Smart Investor newsletter, we examine a fast-growing, undervalued independent energy company. But first, let’s dive into the latest Portfolio news and updates.
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Portfolio Updates
❖ The outgoing Biden administration is moving quickly to implement new rules on AI chip exports in its final days. On Monday, the U.S. government announced that the regulations will classify countries based on their relationship with the U.S., with the closest allies receiving unrestricted access to AI chips, while others will face varying levels of restrictions. The rules will also curtail the ability of hyperscalers, such as Microsoft (MSFT), Amazon (AMZN), and Alphabet (GOOGL), to establish data centers in countries where AI chip exports are restricted. The announcement led to widespread declines in AI and semiconductor stocks, as investors reacted to the potential impact on global supply chains and revenue. Nvidia criticized the last-minute restrictions, stating they would “harm the U.S. economy, set America back, and play into the hands of U.S. adversaries.”
❖ Microsoft (MSFT) is forming a new engineering group named “CoreAI – Platform and Tools,” dedicated to developing AI applications and providing tools for both internal use and third-party customers. CEO Satya Nadella emphasized the importance of AI in reshaping application categories, stating that the goal is to create an “AI-first app stack” across the company, positioning Azure as the infrastructure for AI.
❖ Alphabet (GOOGL) has recently received multiple upgrades from leading Wall Street analysts. Price targets for GOOGL were raised by firms including Morgan Stanley, Wells Fargo, Stifel Nicolaus, UBS, KeyBanc, and others. Stifel analysts specifically highlighted Alphabet’s dominance in search and described the company’s “long-term growth opportunity” in both AI and digital advertising. Additionally, Stifel noted that Alphabet and Meta Platforms are well-positioned to capture the majority of advertising dollars reallocated in the event of a TikTok ban, which is currently under review by the U.S. Supreme Court.
Meanwhile, Morgan Stanley emphasized the role of GPU-enabled tools and Generative AI (GenAI) adoption in driving growth across the North American Internet sector, with Alphabet positioned as a key player. The company is leveraging its Google Cloud Platform (GCP) to offer AI and GPU-powered services, while also integrating GenAI to enhance personalization and productivity within its YouTube and Search businesses.
❖ While affirming Alphabet’s importance in the growth of AI-driven tools and technologies, Morgan Stanley named Amazon (AMZN) its new “Top Pick” among the North American Internet group. The firm cited Amazon’s GPU-related investments, which it believes will boost the company’s retail advantage, enabling it to gain market share more profitably. Additionally, HSBC analysts significantly raised their price target for Amazon, forecasting that its AWS cloud unit will add $20 billion in revenue in 2025, with GenAI serving as a key growth driver.
In other company news, Amazon has introduced a new product called “Amazon Retail Ad Service,” which allows external retailers and e-commerce companies to utilize Amazon’s advertising technology on their own websites. This service enables these retailers to display contextually relevant ads, including in search results, leveraging Amazon’s advanced machine learning models trained on extensive shopping data. This initiative mirrors Amazon’s strategy with AWS, where the tech giant leveraged its infrastructure to provide services to other businesses, establishing a lucrative revenue stream beyond its core marketplace operations.
❖ Taiwan Semiconductor Manufacturing (TSM) reported an impressive 57.8% year-over-year growth in its December sales, driven by surging demand for AI chips amid increased spending on data centers and AI infrastructure. According to analysts, TSM’s net revenue grew by approximately 34% in 2024, surpassing the company’s growth target of 30%.
As the world’s largest and most critical chip foundry, TSM is actively expanding its global manufacturing capacity to enhance supply chain resilience and reduce risks associated with geopolitical tensions, particularly China’s ambitions toward Taiwan. TSM’s new facility in Arizona has started producing advanced 4-nanometer chips for U.S. customers. The company also announced plans to build a second fab in Arizona, with production expected to commence in 2028, reinforcing its commitment to supporting global technology leaders while diversifying its manufacturing footprint.
❖ ASML Holding (ASML) has received a notable price target upgrade from Wells Fargo, underscoring the firm’s positive outlook on ASML’s market position and growth potential. Jefferies analysts have also raised their price target on the stock of the world’s leading supplier of advanced chip-manufacturing equipment. According to Jefferies, ASML is expected to start receiving higher order volumes in the coming quarters, primarily from Taiwan Semiconductor (TSM) and Samsung Electronics. These market leaders are ramping up production to meet surging demand for advanced chips, including those needed for AI and data center applications. Additional demand for ASML’s equipment is anticipated to stem from a recovery in the consumer electronics market, with increased chip production for smartphones, personal computers, cars, and gaming consoles driving growth.
❖ Visa (V) has received several price-target upgrades in the past few days. Bernstein analysts included the payments giant in their list of “favorite ideas,” along with its competitor Mastercard. The firm said that while the U.S. market for consumer card spending is maturing, there’s still significant potential for growth internationally and concerns about slowing card spending in the U.S. are overblown. Bernstein added that foreign exchange volatility is expected to benefit these companies in 2025, and there’s potential for price increases in various services. Between the two market leaders, Bernstein has a modest preference for V over MA in 2025. Meanwhile, Seaport analysts gave a strong preference to Visa over Mastercard for 2025, citing the former’s lower international exposure and better valuation.
❖ Uber Technologies (UBER) has been selected as Delta Airlines’ new SkyMiles partner, replacing Lyft, which has served as Delta’s ride-sharing partner since 2017. The partnership, set to launch in April, will allow Delta SkyMiles members to earn miles by using Uber services, including rides to and from airports as well as orders through Uber Eats. Delta’s SkyMiles program, one of the largest airline loyalty programs with millions of members, represents a significant opportunity for Uber. In addition to boosting its visibility among Delta’s loyal customer base, Uber is expected to benefit from increased exposure through the airline’s marketing channels, loyalty program promotions, and customer communications. This partnership is anticipated to enhance Uber’s competitive position in the ride-sharing market, drive increased ridership, and bolster customer loyalty among frequent travelers—a particularly valuable demographic.
❖ EMCOR Group (EME) saw its stock surge after the company announced it will acquire Miller Electric Company for $865 million in cash. This acquisition is strategically important for EMCOR, since Miller Electric will enhance EMCOR’s presence in high-growth sectors such as data centers, manufacturing, and healthcare. In addition, Miller generates about 90% of its revenue from Florida and the Southeastern U.S., areas where EMCOR previously had limited presence. The acquisition is expected to be modestly accretive to EMCOR’s EPS in 2025, with further accretion anticipated in subsequent years.
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Portfolio Stocks Under Review
❖ We are placing Oracle (ORCL) under review for potential sale. While ORCL is one of the Smart Portfolio’s longest-held stocks and a high-conviction holding, it has come under pressure recently due to the increasing likelihood of a TikTok ban.
Oracle provides cloud infrastructure services to ByteDance, TikTok’s parent company, hosting all U.S. user data since 2020. This arrangement was established after U.S. regulators scrutinized TikTok’s Chinese ownership, citing national security concerns.
The U.S. Supreme Court is currently deliberating a law that requires ByteDance to divest TikTok’s U.S. operations by January 19, 2025, or face a nationwide ban. Analysts broadly expect the court to uphold the legislation. If this occurs, Oracle could lose a significant client for its cloud services.
According to Evercore ISI estimates, TikTok contributes between $480 million and $800 million annually to Oracle’s cloud revenue, representing approximately 5% of Oracle Cloud Infrastructure’s (OCI) sales.
While this impact is less substantial in the context of Oracle’s total annual revenue – where it accounts for at most 1.5% – the loss of a high-profile client amid heightened market volatility could harm investor sentiment, potentially leading to significant short-term declines in Oracle’s stock price.
On the other hand, Oracle’s long-term case remains intact, supported by its AI-focused initiatives and strategic collaborations with technology majors. Thus, the company has a long-standing cooperation with Microsoft’s (MSFT) cloud through Database@Azure, which allows customers to access Oracle database services directly within the Microsoft Azure environment.
Oracle recently expanded its collaboration with Amazon (AMZN) by launching “Oracle Database@AWS,” enabling direct access to Oracle Exadata Database Service on Amazon’s cloud platform. At the same time, Oracle expanded its partnership with Nvidia by introducing new GPU options and AI infrastructure services on OCI, strengthening its position in the AI space. Moreover, in December, Meta Platforms selected Oracle’s AI Cloud Infrastructure to develop its AI Agents, further validating Oracle’s capabilities in AI and cloud services.
We will monitor the stock closely for further developments, carefully weighing Oracle’s strong long-term growth potential against the notable short-term risks posed by the TikTok situation.
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❖ GE Aerospace (GE) remains under review. One of the Smart Portfolio’s longest-held stocks, it had been our star performer through mid-October, when it reached an all-time high. Since then, the stock has been under pressure, both from the general Industrial sector underperformance over that period, and due to investor worries – based on market dynamics and company-specific issues like supply chain constraints – that GE shares may have outrun their fundamentals.
Trump’s plans to slash government spending have weighed on firms like GE. However, GE’s low exposure to the U.S. government’s defense spending should alleviate these concerns. The company derives about 16% of its revenues from defense-related activities, with the lion’s share of the total – over 70% – coming from services, a recurring, resilient, and higher-margin source of revenue.
Leading Wall Street firms rate GE Aerospace a “Strong Buy” with an average price target implying an upside of over 22% in the next 12 months. According to analysts, recent worries about aftermarket services growth are overblown, and GE remains fundamentally strong with robust prospects in both the aftermarket and OE segments. The company’s strong performance in Q3 and a hike to its full-year EPS and cash flow guidance are a testament to this strength.
Deutsche Bank analysts have slightly lowered their price target for GE, maintaining a “Buy” rating on the shares. Despite the PT reduction, the firm maintained the positive outlook for the sector overall, noting that GE Aerospace’s strategic positioning suggests potential for continued growth. In addition, Bernstein analysts marginally lowered their PT on GE’s shares while confirming a “Buy” rating due to a slightly lower outlook in Defense sector’s margins in 2025.
We believe that GE remains a solid investment, which took a hit along with the broader industry and was impacted by investor anxiety as a result of the stock’s price appreciation. Still, we plan to follow company news closely going forward to understand whether the sentiment has improved.
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Portfolio Earnings and Dividend Calendar
❖ The Q4 2024 earnings season is officially starting this week, with Taiwan Semiconductor (TSM), Interactive Brokers (IBKR), and Amphenol (APH) scheduled to report their quarterly results in the next several days.
❖ The ex-dividend date for EMCOR Group (EME) is January 16th, while for Dell Technologies (DELL) it is January 22nd.
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New Buy: Matador Resources (MTDR)
Matador Resources Company is an independent energy company engaged in the exploration, development, production, and acquisition of oil and natural gas resources in the United States. The company focuses on unconventional oil and gas extraction, primarily operating in the Delaware Basin, the Eagle Ford shale, and the Haynesville shale and Cotton Valley plays. Additionally, the company conducts midstream operations and provides natural gas processing, oil transportation services, natural gas, oil, and produced water gathering services, and produced water disposal services to third parties.
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Drilling Down on Growth
Matador Resources Company traces its origins to 2003 when it was founded in Dallas, Texas, as an independent energy company focused on the exploration, development, and production of oil and natural gas. The company initially targeted conventional oil and gas plays before transitioning to unconventional resources, specifically shale oil and gas, in response to advancements in drilling technologies and evolving market opportunities. Extracting these resources requires the use of advanced techniques like horizontal drilling and hydraulic fracturing (fracking).
In 2012, Matador completed its IPO, raising approximately $170 million to support its growth initiatives. This milestone enabled the company to expand its operations in the Delaware Basin, a sub-section of the Permian Basin, which has become its primary focus area due to its rich reserves of shale oil and natural gas, particularly in formations like the Wolfcamp and Bone Spring in Southeast New Mexico and West Texas.
Strategic acquisitions and leasehold expansions have driven Matador’s growth. Notable milestones include the 2018 acreage expansion, the 2023 acquisition of Advance Energy Partners Holdings, and the 2024 purchase of a subsidiary of Ameredev II Parent. Collectively, these transactions added tens of thousands of net acres of producing properties, undeveloped acreage, and midstream assets, significantly enhancing Matador’s operational footprint and production capacity in the northern Delaware Basin. The integration of these assets allowed Matador to increase production and improve operational efficiencies.
To support its growth, Matador invested heavily in midstream infrastructure through its subsidiary, San Mateo Midstream. Established in partnership with a private equity firm in 2017, San Mateo provides critical services, including oil, natural gas, and water gathering and processing. This vertical integration has enhanced Matador’s operational flexibility and generated additional revenue streams.
Today, with a market cap exceeding $7.8 billion and robust production volumes, Matador Resources Company is a leading operator in the Delaware Basin. It remains focused on disciplined growth, operational efficiency, and sustainable resource development, positioning itself as a key player in the U.S. energy sector.
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Capitalizing on Shale Potential
Matador’s success is deeply rooted in its ability to capitalize on the immense potential of its principal operating areas. At the heart of its operations is the Delaware Basin, spanning Southeast New Mexico and West Texas. Widely regarded as one of the most prolific oil and natural gas regions in the United States, this basin benefits from continuous advancements in drilling and completion technologies, unlocking additional reserves and offering vast opportunities for growth.
In South Texas, Matador operates in the Eagle Ford play, a region celebrated for its high-quality crude oil, natural gas liquids (NGLs), and dry gas. With mature infrastructure and favorable economics, the Eagle Ford remains a reliable contributor to Matador’s production. While more developed than the Delaware Basin, it continues to offer opportunities for targeted drilling and production optimization, ensuring its ongoing significance in the company’s portfolio.
Further diversifying its operations, Matador maintains a strong presence in Northwest Louisiana, where the Haynesville Shale and Cotton Valley formations offer exceptional potential. The Haynesville Shale stands as one of the largest natural gas fields in the country, notable for its high gas content and proximity to major demand centers and LNG export facilities. The Cotton Valley formation complements this by providing additional production opportunities for both gas and liquids. With rising global demand for natural gas, particularly for LNG exports, this region has become increasingly valuable, supported by enhanced drilling efficiencies and strong pricing dynamics.
By leveraging the unique strengths of these three regions, Matador has built a diverse portfolio of high-potential assets. This strategic balance between oil, NGLs, and natural gas production allows the company to adapt to market dynamics while driving sustainable growth and maintaining its competitive edge in the energy sector.
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Horizontal Drilling, Vertical Integration
A key element of Matador’s success lies in its vertically integrated business model, which reduces operational costs and generates additional income through gathering, processing, and transportation services provided to third parties. The company operates through subsidiaries that enhance its capabilities and revenue streams. San Mateo Midstream, for instance, supports Matador’s exploration and production activities by offering natural gas processing, oil transportation, and water gathering and disposal services. Pronto Midstream, focused on oil gathering and transportation, further streamlined operations when it was consolidated into San Mateo in December 2024.
MRC Energy Company serves as Matador’s primary arm for exploring, developing, and producing oil and natural gas resources, while Matador Production Company ensures efficient extraction and output. Longwood Gathering and Disposal Systems plays a vital role in managing produced water and other byproducts from drilling, and Greyhound Resources contributes to overall operational efficiency through resource management and development.
This integration of midstream and upstream operations not only enhances Matador’s profitability but also maximizes returns through advanced drilling and completion technologies. By efficiently extracting resources from complex shale formations like the Wolfcamp and Bone Spring, Matador remains competitive in an industry increasingly driven by technological innovation.
Matador’s disciplined financial approach further bolsters its business model. By managing capital expenditures carefully and maintaining a balanced portfolio of producing and undeveloped assets, the company ensures consistent cash flow and profitability. Strategic acquisitions in 2023 and 2024 have significantly expanded its production base and contributed to economies of scale.
The company’s ability to capitalize on favorable market conditions also strengthens its revenue streams. With a production mix heavily weighted toward oil, Matador benefits from strong commodity prices, while its natural gas operations provide diversification and stability.
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A Well of Growth
Matador’s net debt-to-equity ratio of approximately 70% may seem high, but it is typical for energy producers due to the capital-intensive nature of the industry, the cyclicality of commodity prices, and other sector-specific dynamics. MTDR’s strong cash flows counterbalance its liabilities, enabling the company to fund capital expenditures, pursue strategic acquisitions, and maintain a healthy balance sheet.
The recent increase in debt from the Ameredev acquisition added high-quality assets to Matador’s portfolio, aligning with its historically strong free cash flow (FCF) generation and positioning the company for further growth. This development contributes to the sharp surge in equity over the past several years, driven by the post-pandemic recovery in energy demand, strategic acquisitions, operational excellence, and favorable market sentiment.
Matador’s growth rates have consistently exceeded most industry peers, supported by strong profitability and capital efficiency metrics. The company ranks among the top 25% of its industry in ROE, ROA, and net profit margin, while its operating margin places it in the top 10%. Over the past three years, revenues have grown at a CAGR of 29%, while EPS surged at a CAGR of 47%. In Q3 2024, revenues rose 9.8% year-over-year, while EPS increased by more than 33%.
Matador generates substantial, albeit volatile, free cash flows, demonstrating significant growth over the past three years. For the twelve months through the end of Q3 2024, FCF surged by 134% compared to the prior period. In the last reported quarter, Matador achieved a 32% year-over-year increase in net cash provided by operating activities and a 36% rise in adjusted FCF. The company uses this adjusted FCF primarily to repay outstanding borrowings, pay dividends, and fund acquisitions.
During Q3 2024, Matador achieved record production on its existing properties while continuing to implement new strategies to improve operational efficiencies and reduce costs. These efficiencies positioned the company above industry peers in terms of net revenue and profit per barrel of oil equivalent (BOE), a standard measurement of energy content in the oil and gas industry.
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Growth at a Value Price
Matador Resources’ stock has risen by approximately 19% over the past year, significantly outperforming the broader energy sector as represented by the Energy Select Sector SPDR Fund. It also surpassed the performance of the smaller Vanguard Energy ETF, which includes Matador among its holdings. Analysts project a similar upside of around 19% for the next 12 months.
Despite its strong performance, MTDR remains undervalued across multiple metrics. The stock trades at a roughly 30% discount to the Energy sector’s average trailing twelve months (TTM) and forward price-to-earnings (P/E) ratios. Among its closest peers, MTDR’s valuation sits in the middle range, even though the company outperforms most peers in profitability and growth metrics. Additionally, when future cash flows are accounted for, Matador appears to be undervalued by approximately 50%, placing it firmly in the “deep value” category.
Matador is committed to delivering shareholder value, complementing stock-price appreciation with consistent dividend growth. The company initiated dividend payments in 2021, and the annualized payout has increased tenfold since inception. The most recent dividend hike was announced in Q3 2024, with a 25% increase in the payout. Although Matador’s dividend yield of 1.39% is modest compared to the Energy sector average, it is poised for rapid growth in the coming years.
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Investing Takeaway
Matador Resources Company is a leading independent energy producer, specializing in unconventional oil and gas extraction across the lucrative Delaware Basin, Eagle Ford, and Haynesville Shale. Its vertically integrated business model, supported by robust midstream operations, enhances profitability and operational efficiency. Matador delivers exceptional earnings growth and consistent free cash flow generation, while maintaining strong capital discipline. Despite outperforming the broader energy sector, MTDR remains undervalued, trading at a significant discount to sector averages. Its recent strategic acquisitions bolster production capacity and position it for sustained growth. A tenfold dividend increase since 2021 reflects its shareholder-focused approach. With a blend of fast earnings growth and deep value, Matador offers a compelling investment opportunity in the energy sector.
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New Sell: Arch Capital Group (ACGL)
Arch Capital Group Ltd. is a leading global financial services company, providing specialty insurance, reinsurance, and mortgage insurance through its subsidiaries worldwide. Reinsurance is Arch Capital’s largest business line, accounting for approximately half of its total annual gross premiums. The segment offers specialty products, including casualty, marine and aviation, property, life reinsurance, and other tailored solutions.
As a reinsurer, Arch Capital provides insurance to primary insurers, sharing in the risks associated with catastrophic events. This structure exposes ACGL to financial impacts from natural disasters, such as the ongoing wildfires in California. While primary insurers like Allstate, Travelers, and Chubb bear the initial brunt of property catastrophe claims, reinsurers are expected to face significant losses as their clients file claims. Current estimates place insured wildfire losses at up to $20 billion, with Arch Capital and RenaissanceRe among the reinsurers most affected.
According to JPMorgan estimates, Arch Capital’s wildfire-related losses are expected to be lower than in previous years due to tightened underwriting criteria, use of advanced risk models, diversified risk portfolios, and lower exposure to risk-prone areas such as California. Despite these mitigating factors, losses for Arch Capital are still expected to be significant, given the scale of the disaster.
The non-life insurance and reinsurance sector has been facing sustained challenges, with conditions worsening internationally following the Spanish floods and domestically due to the California wildfires. Analysts project slower growth in commercial and specialty premium writing, coupled with higher reinsured catastrophe losses. These trends create a more uncertain operating environment for reinsurers.
Arch Capital remains an industry leader, supported by its strong balance sheet, a large global footprint and significant market share, strong pricing power in the reinsurance market, and robust profitability metrics and solid risk-adjusted capitalization. While Arch Capital is well-positioned in the long term, its significant exposure to casualty and property reinsurance leaves it vulnerable to financial impacts from large-scale catastrophes, such as the current wildfires. This exposure, combined with deteriorating investor sentiment in the sector, presents a notable short-term risk to the stock.
Given the current headwinds, including heightened catastrophe risks and industry challenges, we find it prudent to sell the stock at this time. However, Arch Capital’s strong fundamentals and market position could make it an attractive opportunity in the future, warranting a potential re-evaluation down the line.
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Smart Investor’s Winners Club
The 30% Winners Club includes stocks from the Smart Investor Portfolio that have risen at least 30% since their purchase dates.
Despite the volatility in the markets in the past weeks, our exclusive club’s membership remained unchanged, still including 16 stocks: AVGO, GE, ANET, EME, TPL, TSM, ORCL, HWM, PH, APH, IBKR, ITT, PYPL, PNR, CRM, and KKR.
The first contender is still AMZN with a 21.28% gain since purchase. Will it close the gap, or will another stock outrun it to the finish line?
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Disclaimer
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