In the last week, record cold weather hit most of the United States (US), causing gas and power prices to spike across the country, from less than $3/btu to over $600. Texas regulators ordered rolling blackouts as the cold weather froze wind turbines, and snow and ice reduced solar energy production. Some experts were quick to blame renewable energy as the cause of these blackouts. Even if the growing use of wind and solar energy meant the grid may be less reliable, Texas still produces over 50% of its electricity from non-renewables, and that was also affected as gas was in short supply and water pipes froze. In this commentary, we will provide an update on the situation regarding renewable energies.

In 2020, more US states mandated renewable energy targets.

With or without these mandates, 2020 was another record year around the world for the growth of renewables. In the US, 78% of new electrical generating capacity commissioned was renewables, according to a review by the Federal Energy Regulatory Commission (FERC). Combined, it accounted for 22,451 megawatts (MW) or more than 78.09% of the 28,751 MW of new utility-scale capacity reported to have been added last year. Wind (13,626 MW or 47.4%) and solar (8,543 MW or 29.7%) each contributed more new generating capacity than natural gas (6,259 MW or 21.7%).  

Current capacity of renewables is now above 24% of total capacity in the US and should exceed 30% by 2025.

We often hear that renewables require subsidies to compete with oil and gas, coal and nuclear. Let’s take a look at the total cost and production cost of these various sources. The costs include capital costs, operations, maintenance, and de-commissioning and remediation. Recent major global studies of generation costs note that wind and solar power are the lowest-cost sources of electricity available today.

What about the reliability of wind and solar energies? If they could never represent 100% of generating capacity, what should the base load be? We can see in the above chart that geothermal energy is also attractive in terms of costs. It’s clean and renewable, and better yet, is available 24/7, meaning it could be a base load energy. However, in 2019, geothermal only represented 0.5% of US electricity generation. 

There are signs that things could change. A report released in May 2019 by the Department of Energy suggested that US geothermal power capacity could increase by more than twenty-six times by 2050, reaching a total installed capacity of 60 GW, thanks to accelerated technological development and adoption. This is turn would greatly reduce costs. 

Since 2008, we’ve held Ormat Technologies in our portfolio, a world-leading geothermal energy company. Ormat Technologies (ORA US, ORA IT) was founded in Israel in 1965 to pursue its objective to further develop renewable energy. Active in the geothermal field since the early 1980s, the Integrated Two-Level Unit (ITLU) was a vital development in maximizing the thermodynamic efficiencies of lower-temperature resources. The patented ITLU design revolutionized the industry and, to this day, distinguishes Ormat from other companies. The company has been public since 2004, and has established its headquarters in Reno Nevada. Further, Ormat is an energy producer with 933 MW of production globally. Another important achievement is regarding the world’s largest single binary geothermal power plant – the Ngatamariki in New Zealand – that began its commercial operations in 2013.  Ormat provided the engineering, procurement and construction for the 100 MW geothermal project that delivers sustainable energy to power 80,000 homes annually.

In addition to its geothermal expertise, Ormat is now a leading player in the field of energy storage and management. Its solutions started from energy and demand response management, and energy storage systems. The company provides grid operators with the power to enhance grid performance, stability, and responsiveness, while delivering capacity at the right time and the right price. It also provides commercial, industrial and municipal clients with reliable and good quality power solutions, as well as peak shaving and demand charge management solutions to lower their utility bill and, in the unregulated markets, provide ancillary market services to generate revenue.

Coming back to Texas, last August, Lone Star Demand Response, LLC and Viridity Energy Solutions, Inc. signed a new five-year business-to-business agreement to continue the delivery of first-class demand response (DR) curtailment management services throughout times of high electricity demand. This will bring Lone Star Demand Response into a position to carry on with protecting the various generation and transmission systems from overloading during peak times and to fine-tune the demand to match the available supply. While Lone Star Demand is not part of the portfolio, Viridity is owned by Ormat.   

In short, geothermal and energy storage may be the solutions to increase the reliability of electricity production while keeping with the goal of increasing renewables and reducing the environmental impact.

In the blink of an eye, the month of January is behind us. Despite the fact that most indices have barely moved (MSCI World Index -1.05%, Nasdaq 0.29%, S&P 500 -1.11%, MSCI World Small Cap 2.03%, MSCI EAFE Small Cap -0.42%, and Russell 2000 4.85% – as of January 31, 2021), the year has gotten off to an eventful start. A “David and Goliath” phenomenon is taking shape on social media and it is wreaking havoc on the stock market.

Retail investors are targeting certain stocks, which happen to be the most shorted by top global hedge funds. Spreading their message across social media, these investors have created a ripple effect, which has impacted the fundamental structure of the stock market. Many media outlets are calling this wave “the battle of David and Goliath”.

The Great Short Squeeze?

Like many brick-and-mortar retailers, GameStop (GME) was battling to survive in the ecommerce world. Not surprisingly, given the challenges the business faced, its stock price was steadily falling. Because of poor fundamentals, GME became one of the favourite shorts of many hedge funds, resulting in over 100% of the outstanding shares being sold short. What followed was a textbook example of a short squeeze. A few traders started the trend and it quickly created a snowball effect as retail investors on social media sites (like Reddit) jumped on board.

As more people started to buy GME shares, the short sellers had no choice but to cover their positions, creating further demand and leading to higher prices. This resulted in chaos. According to Reuters, estimated losses from shorting GME have topped over $1 billion. That number skyrockets to $71 billion if we include all the shorts in the United States (US) so far in 2021. And, this is just the tip of the iceberg. An army of over 2.8 million Reddit users, from a group called WallStreetBets, continues the hunt for other highly shorted stocks.

In the beginning of January, three large hedge funds, Melvin, Maplelane and D1, saw their assets drop over 25%. The drop in their NAV may have breached International Swaps and Derivatives Association

This report is provided solely for informational purposes and nothing in this document constitutes an offer or a solicitation of an offer to purchase any security. This report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient and does not constitute a representation that any investment strategy is suitable or appropriate to a recipient’s individual circumstances. Global Alpha Capital Management Ltd. (Global Alpha) in no case directly or implicitly guarantees the future value of securities mentioned in this document. The opinions expressed herein are based on Global Alpha’s analysis as at the date of this report, and any opinions, projections or estimates may be changed without notice. Global Alpha, its affiliates, directors, officers and employees may sell or hold a position in securities of a company(ies) mentioned herein. The particulars contained herein were obtained from sources, which Global believes to be reliable

(ISDA) triggers, which in turn would lead to mass liquidation by their prime brokers. Melvin got a

$2.75 billion capital injection from Citadel and P72 to meet capital requirements, without which we may have seen an even larger meltdown.

This wave has gone Global

Hitting Wall Street like a tsunami, the ripple effect is being felt around the world. A Goldman Sachs basket of the most heavily shorted stocks has surged over 50% in January – its biggest monthly gain since at least 2008 (index start date).

An online community called Bursabets is the Malaysian version of Reddit. It has over 8,000 members who are targeting shares of glove makers. This sector was the most shorted as Malaysia lifted its short selling ban in 2021. Plus, with vaccine roll outs in the news, yesterday’s COVID pandemic winners are quickly turning to losers.

On Stockal, an Indian trading platform, GME shares are over 15% of trading volume and among the top five most-traded names on the platform. In India, leverage is not allowed while trading foreign stocks, so people are risking their savings hoping to cash in on the trend.

The situation is no different in China, where chat rooms frequented by retail investors are showing similar trends. GME and AMC Entertainment are the most-traded US names on Futu Holdings, a trading platform used by individual investors in China and Hong Kong.

Fundamental Impacts on the market?

Brokers – This increased trading also impacts the basic infrastructure of the financial system. The Depository Trust & Clearing Corporation (DTCC) is a post-trade financial services company providing clearing and settlement services to the financial markets. The DTCC has demanded large sums of collateral raising industry capital requirements to $33.5 billion, an increase of 29% in just one week.

This capital increase impacted all brokers including Robinhood, who has been forced to draw millions on its credit lines, and raise over three billion to meet higher margin requirements. Robinhood had no choice but to comply.

Options market – As a levered instrument, the short-squeeze also impacts the options market. There has been an increase in small trades (less than 10 contracts) in the option market, leading to a bullish feedback loop. As most option sellers trade volatility and hence are short gamma, they are hedging this risk by buying the underlying security when it goes up in price. This creates the bullish feedback loop as dealers buy the underlying stock as a hedge.

This report is provided solely for informational purposes and nothing in this document constitutes an offer or a solicitation of an offer to purchase any security. This report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient and does not constitute a representation that any investment strategy is suitable or appropriate to a recipient’s individual circumstances. Global Alpha Capital Management Ltd. (Global Alpha) in no case directly or implicitly guarantees the future value of securities mentioned in this document. The opinions expressed herein are based on Global Alpha’s analysis as at the date of this report, and any opinions, projections or estimates may be changed without notice. Global Alpha, its affiliates, directors, officers and employees may sell or hold a position in securities of a company(ies) mentioned herein. The particulars contained herein were obtained from sources, which Global believes to be reliable

Is there a bubble brewing somewhere else?

SPAC-tacular – There is an increase in special-purpose acquisition companies (SPAC), which are shell companies that raise money through initial public offerings (IPO) to acquire a private company, which then merges with the SPAC and becomes public.

To put in perspective, in 2014, SPACs raised $1.8 billion in US IPOs, based on the data from SPAC Research. In 2021, SPAC IPO have already raised $16 billion compared to $4 billion raised across nine traditional IPOs in the first three weeks in 2021. In 2019, SPACs represented 59% of total US IPO capital raising $76 billion in equity proceeds. The movement of billions of dollars in SPAC may highlight people’s real fear of missing out (FOMO), by jumping on the bandwagon.

Over The Counter (OTC) – It should come as no surprise that the lightly regulated OTC market is not immune to day trading effects. As penny stocks are back in vogue, over one trillion shares have changed hands on the OTC market. Many penny stocks have seen trading volume in billions of shares.

Will history repeat itself?

At the moment, euphoria has set in and everyone is having a good time, but not thinking of the consequences of excessive indulgence.

Tech Bubble – The environment today is similar to what investors saw before the tech bubble in 2000. Back then chat rooms were used by day traders as a source of ideas. Unprofitable company stock prices skyrocketed, as fundamentals did not matter. A new breed of amateur day traders poured their life savings into companies they knew very little about. Stock markets became the world’s largest casinos. When the music stopped, many companies went bankrupt and many retail investors lost everything.

The great financial crisis of 2008 – Back then home prices were expected to only appreciate. So individuals started buying houses they could not afford by leveraging themselves with freely available credit. We are seeing a similar phenomenon with the “David and Goliath” effect. Many retail investors think stock prices will continue going up forever. However, over the long run, stock prices are driven by fundamentals not speculation.

Unsurprisingly, many retail investors do not even know what they are buying. For example, an Australian company called GME Resources with the stock ticker GME (same as GameStop) jumped up 60% as its volume increased by 2,000% driven by retail investors who thought they were buying the real GameStop.

This report is provided solely for informational purposes and nothing in this document constitutes an offer or a solicitation of an offer to purchase any security. This report has no regard to the specific investment objectives, financial situation or particular needs of any specific recipient and does not constitute a representation that any investment strategy is suitable or appropriate to a recipient’s individual circumstances. Global Alpha Capital Management Ltd. (Global Alpha) in no case directly or implicitly guarantees the future value of securities mentioned in this document. The opinions expressed herein are based on Global Alpha’s analysis as at the date of this report, and any opinions, projections or estimates may be changed without notice. Global Alpha, its affiliates, directors, officers and employees may sell or hold a position in securities of a company(ies) mentioned herein. The particulars contained herein were obtained from sources, which Global believes to be reliable

Portfolio Impact

While every media channel is overly focused on GameStop, the reality is the market cap is a very small percentage of the total US market capitalization. Could GameStop be the canary in the coal mine?

Many hedge funds are being forced to delever and right size their portfolios. This is leading them to sell higher quality names to cover the shorts, and giving fundamental investors an opportunity to buy quality companies at attractive valuations.

According to Goldman Sachs, there are over 265 SPACS with over $82 billion in equity currently searching for acquisition targets. Combined with leverage this would equate to over $410 billion, or 12% of US merger and acquisition (M&A) volume during the last two years. Corporations and private equity firms are also sitting on trillions of dollars of cash on their balance sheets – an optimal situation for increased M&A activity. Historically, our portfolio has seen a few acquisitions almost every year, and as the M&A market picks up, it is possible that more of our names may get acquired.

Our ability to be highly selective and nimble in our portfolio holdings leaves us well positioned to enter a period of great opportunity for fundamental stock pickers. Our focus on high-quality companies with defensible business models and strong balance sheets should help outperform our small-cap benchmark. As we reflect on the state of markets and the fundamentals of our target companies, we are excited about the current environment and future growth opportunities.

It is common knowledge that the fashion industry has a significant negative impact on the environment, yet the extent may still be underestimated. Did you know that after the oil industry, fashion is one of the largest polluters in the world? The fashion industry accounts for 10% of global carbon emissions. Some of the processes in the production of clothes are highly energy intensive and some of the facilities are still powered by coal. Synthetic fibers are more energy intensive than natural fibers, given they are made from fossil fuels. In this age of fast fashion, we are generating more textile waste than ever. The average western family discards around 30 kg of clothing each year. Of this waste, almost all is landfilled, with synthetic fibers, such as polyester, taking decades to decompose, or it is incinerated. A small fraction is recycled or donated.

Additionally, another serious impact the fashion industry has on the environment is its consumption and pollution of water. An incredible amount of fresh water is used in the dyeing and finishing process of fabrics used for clothes; as much as 200 tons of fresh water is used to produce a ton of dyed fabric. Cotton itself is an extremely water intensive crop to grow and 20,000 liters of water are needed to produce just 1kg of cotton. In terms of pollution, it is not just the dyeing process that involves the heavy use of chemicals, bleaching and wet processing are also contributors. Unfortunately, the countries that produce the majority of the world’s apparel and fashion products have either loose regulations or weak enforcement of said regulations. Wastewater from the dyeing process contains harmful substances, that when released into bodies of water is hugely damaging to the people and wildlife reliant upon them.

The encouraging news is that there is a greater focus on sustainability in fashion. There are solutions to combat some of these problems, and Coats (COA:LN), a recent addition to our portfolio, is doing its part. Coats is the world’s leading industrial thread company and operates under two divisions – apparel and footwear, and performance materials. In apparel and footwear, Coats is a supplier of premium thread (as well as zips and trims) and services (software solutions) to the global apparel and footwear industry. In performance materials, Coats designs and supplies high tech and high performance threads and yarn used in a range of industries (automotive, household and recreation, medical, health and food, safety, telecoms, oil and gas, conductive and composites).

While thread is only 1% to 2% of the cost of a typical garment, it is a critical component in the overall performance of the garment and efficiency of the production process. In apparel and fashion, Coats has a 21% market share by dollar value, more than double the nearest competitor. This is a strong and defendable core business representing about 77% of group sales. The company has been consistently increasing market share in stable markets, experiencing steady yearly gains, due to a combination of reasons, such as trade tariffs, Environmental, Social, and Governance (ESG), and COVID. This means that customers are constantly reviewing their supply chain. Coats has the largest global footprint of any thread maker, and can accommodate changes a customer may wish to make.

With a Coats thread, customers can have confidence that the thread will be identical wherever it is sourced. The quality of the thread is vital. It has to be durable and long lasting as manufacturing processes for apparel and footwear are increasingly automated, and any breakages in threads results in costly downtime. Coats also has an advantage in terms of digitalization. Thread manufacturing is still a relatively antiquated industry. Coats was the first company to launch an e- commerce platform while most in the industry still take orders by telephone. The e-commerce platform also makes sample and delivery time quicker, which is very important for fast fashion.

As for ESG, there is an increased focus on sustainability within the apparel and footwear industry. Coats is a western company with western sustainability standards. Coats is considered the market leader in ESG with initiatives, as they make sustainable threads from plastic bottles. Sourcing threads from Coats provides companies with the assurance their manufacturing base is working with a responsible and environmentally compliant supplier. Further, the company has committed to a number of environmental targets, such as a 40% reduction in water usage by 2022, a 7% energy reduction while transitioning to a 100% renewable energy supply, and polyester being 100% recycled by 2024.

Moving forward, the increasing environmental restrictions and sustainability requirements are squeezing the long fragmented tail of thread suppliers. This should enable Coats to leverage its size and scale to gain further apparel and footwear market share. Consumers are willing to pay a premium for products containing environmentally friendly or sustainable materials, so the industry is making more of them. The shift from ‘fast fashion’ to ‘sustainable fashion’ is happening and Coats is at the forefront of meeting changing industry needs, such as speed, productivity, innovation, quality, responsibility and sustainability.

It has been a year since COVID-19 emerged, and the world is still struggling to contain the virus. In the past year, the nations and regions that had better control over the virus have seen faster economic recovery. China, for example, announced that their 2020 Q4 GDP grew by 6.5% year-on-year, which has surpassed the GDP growth of 6% in Q4 2019. This brings China’s 2020 GDP growth to a total of 2.3%. By comparison, the United States (US), Eurozone, and Japan are forecasted to contract by 3.6%, 7.4%, and 5.3%, respectively.

For China, industrial production was the growth engine, increasing by 2.8% in 2020, as global demand for medical equipment, home improvement products, and home office electronics was strong. Despite overall consumption lagging production, online retail sales posted a solid 15% growth. Online channels accounted for one quarter of total retail sales, up from just 4% in 2019. Companies we hold in our portfolios also benefited from the strong online retail growth in China. L’Occitane, for example, is a maker of natural and organic ingredient-based cosmetics and well-being products. Their online sales in China grew by 83.5% in the six months ending September 2020, and accounted for approximately 32% of their total China sales. It was ranked the number 1 brand for body care and hand care on T-mall, the largest ecommerce platform in China. Similarly, online sales of Asics, a manufacturer of sports shoes and sports apparels, more than doubled in the nine months ending September 2020, and accounted for over 30% of its sales in China. Also, profits of the beverage manufacturer Vitasoy increased by 27%, as online and home channels delivered strong results.

The fast growth of ecommerce also boosted logistics demand. According to the State Post Bureau, China’s total express delivery volume rose by 37% in December 2020, following the 37% and 43% growth in November and October 2020, respectively. Kerry Logistics, a third-party logistics service provider we own in our portfolios, has benefited from the surging domestic and cross-border shipping volume. The number of cross-border ecommerce consignments they handled in the first half of 2020 increased by 24% compared to last year. In addition, the strong overseas demand has driven the cost of shipping from China to Europe and the US to triple or quadruple in recent weeks. As one of the few Asia-based global freight forwarders, Kerry Logistics has leveraged its unique market position to capture the growing demand. Its international freight forwarding segment profits increased by 40% in the first half of 2020. Another positive update on Kerry Logistics is the completion of the spin-off of its subsidiary, Kerry Express Thailand, in late December. The listing was well received by investors, with its shares rising as much as 161% from the IPO price in debut. In addition to ecommerce, the potential distribution of COVID-19 vaccines could also help drive the company’s revenue and profit growth. Kerry Logistics has nearly one million square feet of cold chain facilities in Hong Kong, and is well equipped to handle drugs, including vaccines, antibiotics and insulin.

China has been leading the world on the digital payment front, with the highest mobile payment penetration rate of 32.7%, versus 15% in the US. The Chinese government has taken a step further to start testing the use of its own digital currency, Digital Currency Electronic Payment (DCEP), which is a digital version of its official currency, Yuan. Pilot projects have been ongoing in Shenzhen, Xiong’an, Chengdu, and Suzhou since August 2020. The official rollout could be as early as 2022. DCEP’s share of China’s digital payment market is expected to reach 9% in 2025, and 15% in 2030. To be launched domestically first, the digital Yuan will help smooth monetary policy transmission and help policymakers regain control over money flow and consumer spending data from Alipay and WeChat Pay. Eventually, it could be used to promote the Yuan’s global status and become China’s preference for cross-border payments, bypassing the Swift network amid rising tension with the US.  

On the political front, we don’t expect the US-China relationship to improve significantly under the Biden administration, although the two countries might collaborate on matters such as fighting climate change and COVID-19. Meanwhile, the delisting of Chinese stocks in the US seems to have had a positive impact on the Hong Kong stock exchange, as investors in mainland China are shifting attention to the cheaply valued Hong Kong listed stocks. This helps the Hang Seng Index to be among the best performers in the region so far this year. This trend is expected to continue, with investors shifting out of A-shares to H-shares. We continue to have high convictions that the companies we hold in this region will outperform, supported by their competitive product and offerings, and solid balance sheet. 

Early reports about COVID-19’s impact on marriages in the United States (US) indicate that marriage rates were lower than expected in 2020. Recent trends show that the opposite has been true for corporations, with the second half of the year seeing an unprecedented surge in corporate merger and acquisition (M&A) activity. This surge comes after M&A volumes dried up by more than 50% following the initial lockdowns in the spring of 2020, causing executives to re-evaluate opportunities, given the uncertainty.

Although total deal value is still down 6% to $3.5 trillion for 2020, more than two-thirds of the activity happened between July and December^[1]. The fourth quarter of 2020 alone saw a 39% year over year increase in announced M&A deals from 2019. Further, December was the fourth strongest month in history for M&A revenue. It is not just a high volume of small transactions; mega deal announcements have been all over the news. Such examples include the S&P Global acquisition of IHS Markit for $39 billion, the Salesforce acquisition of Slack for $27 billion, and AON’s acquisition of Willis Towers Watson for $30 billion.

So, how is 2021 looking, compared to the second half of 2020? It appears unlikely to be any different. As management teams begin reflecting on what a post-COVID future looks like, we expect that companies will reposition themselves to adjust to shifting consumer behaviour, created by COVID. A quarterly survey of global CEO confidence reached a high of 64 in Q3 2020, after bottoming to 36 at the beginning of the year (like with Purchasing Managers’ Index (PMI), ratings above 50 are positive and below are negative)[2]. That same report highlighted that of the CEOs surveyed, 36% plan to increase their capital spending over the next 12 months, compared to their previous expectations. Given the recent political changes in the US, it appears likely that the next CEO confidence survey will show even more optimism.

Furthermore, many industries, such as travel, entertainment and energy, are still near their multi-year low; this makes companies attractive targets at their current valuation. While the initial expectation was that many names in these industries would go bankrupt, all-time low interest rates and massive liquidity injections made it so that they only had to load their balance sheet with more debts to stay afloat. These factors make it likely that the record high of $1.5 trillion cash that private equity funds currently hold will be put to work during the year. As opportunities become clearer, we will see a record year for M&A and other investment banking activities.

As for the important question on everyone’s mind: how is Global Alpha getting exposure to this? We own Rothschild & Co (ROTH PA), among other names. Founded in 1838 by the famous Rothschild family, Rothschild & Co is one of the world’s largest independent financial advisory groups, with headquarters in Paris, France. The company provides M&A, strategy and financing advice, as well as investment and wealth management. With 50 offices and 3,500 employees, the company has a foothold in over 40 countries, and it is still more than 60% family-owned. As a boutique firm, Rothschild also benefits from a favorable reputation in comparison to larger banks, as well as the trend of using more advisors to conduct individual deals. In 2019, boutique firms accounted for 22% of advisory deal value versus only 9% in 2000; its share is expected to keep increasing over the next decade.

Historically, the firm’s activities centered on its global financial advisory and its wealth and asset management businesses. A little more than a decade ago, Rothschild added a new private equity business that now represents 8% of their revenue, but 17% of their profit share, representing a new growth driver for them. It is also the reason that Rothschild is able to maintain a better margin profile than its peers. Additionally, this allows the firm to deploy its own capital alongside their institutional clients and incorporate strong ESG principles in its investment decisions.

Within its global financial advisory business, Rothschild employs more than 1,100 advisors, and derives two-thirds of its revenue from pure M&A, with the balance from capital markets financing. Rothschild ranks sixth in revenue globally and first in Europe for its investment banking business. We are confident that the company will be able to benefit from the current environment.

SWOT:

Strengths

• Leader in the European Union, consistently gaining market shares
• Best in class talent and solid reputation

Weakness

• M&A is highly cyclical
• High family ownership is a risk for shareholders

Opportunities

• US market share can double in size
• Emerging markets expansion

Threats

• Departure of key bankers
• Weak M&A cycle

[1] 4Q20 Independent Financial Advisor & Regional Broker Earnings Preview, Piper Sandler, January 13, 2021