Covering All Bases
In this edition of the Smart Investor newsletter, we examine one of the leading insurance and reinsurance firms in the U.S. But first, let’s delve into the latest Portfolio news and updates.
Important Note: Almost half of the Smart Portfolio companies are slated to report their results next week. Therefore, this week, we are not selling any Portfolio stocks, but instead taking a “wait and see” approach. This will allow us to study the companies’ results in depth, and, more importantly, scrutinize the outlook for their further performance. This analysis will serve as a basis for Portfolio rebalancing if it is determined as required based on the incoming data.
1
Portfolio Updates
❖ Taiwan Semiconductor Manufacturing (TSM) reported its Q2 2024 results, surpassing estimates for both the top and the bottom lines on surging demand for chips used in AI applications. TSM’s revenues rose 40% year-over-year, while profits rose 36%. The company expects continued robust revenue and earnings growth for the third quarter, supported by strong smartphone and AI-related demand.
❖ Amphenol Corp. (APH) announced a purchase of mobile networks business units from CommScope (COMM) for $2.1 billion in cash. The acquisition complements APH’s existing portfolio of wireless networks and supports its strategy of balanced end-market exposure across all areas of the electronics market.
❖ Super Micro Computer (SMCI) saw its shares drop over the past several days amid extreme volatility around the stock’s addition to the Nasdaq-100 index, which took place on July 22nd. Supermicro stock features one of the widest ranges of analyst outlooks and price targets. For example, Susquehanna analysts expect it to drop almost 60% to $325, while Loop Capital strategists expect it to soar by over 90% to $1,500. In other company news, SMCI has secured a $500 million term loan to bolster its working capital. The unsecured loan was facilitated by Bank of America and other lenders.
❖ Check Point (CHKP) has announced that its Board of Directors authorized a $2 billion expansion of the company’s share repurchase program, raising the total authorization to $12.5 billion. The program, approved in February 2023, is expected to be completed during the fourth quarter of 2024.
❖ Dover Corp. (DOV) has considerably amended its business portfolio. The industrial heavyweight announced that it has acquired Michigan flow-control component provider Marshall Excelsior for $395M in cash. In addition, Dover announced that it has acquired Dutch company Demaco, which provides critical flow control components for cryogenic applications. At the same time, DOV revealed that it divested its environmental solutions business, selling it to Terex Corporation (TEX) for $2 billion in cash. Analysts view these developments positively, as they consider them another step in Dover’s transition toward a more focused business model, which prioritizes higher growth, margin, and targeted areas.
❖ Broadcom (AVGO) is catching up to Nvidia (NVDA) in terms of positive investor sentiment, according to analysts from Citi. AVGO is now seen as a top investor pick in the AI theme, supported by new large customer acquisitions and strong revenue addition from VMware acquisition. Last week, Bloomberg reported that AVGO is discussing AI chip production for OpenAI (the company behind ChatGPT), which is looking to reduce its reliance on Nvidia.
❖ GE Aerospace (GE) reported its Q2 2024 results, posting revenue and earnings that surpassed analysts’ estimates. In addition, the company lifted its full-year EPS guidance. In other company news, GE and the U.S. Department of Energy have announced a new Cooperative Research & Development Agreement on supercomputing. The company and the DoE’s Oak Ridge National Laboratory will combine forces to design next-generation aircraft engine technologies.
❖ Visa, Inc. (V) saw its shares stumble after the company released its FQ3 2024 results. Visa’s EPS surpassed analysts’ expectations, as it did in all quarters since 2019. However, revenues slightly underwhelmed expectations, in a rare occurrence for the world’s largest payments processor. The miss came as a result of a slowdown in payments volume growth, as high interest rates weighed on consumer spending. Visa said it still expects to deliver on its full fiscal year revenue-growth target.
❖ Pentair (PNR) stock surged after its Q2 2024 revenues and earnings beat analysts’ estimates, with the adjusted EPS coming in considerably above forecasts. Following the blockbuster quarterly results, the water treatment company increased its full-year 2024 adjusted EPS guidance.
1
Portfolio Earnings and Dividend Calendar
❖ The Q2 2024 earnings season is in full swing, with almost half of the Smart Portfolio companies expected to release their results in the coming week. The reporting firms are General Dynamics (GD), Check Point (CHKP), Amphenol (APH), EMCOR Group (EME), Dover (DOV), Arista Networks (ANET), Howmet Aerospace (HWM), PayPal Holdings (PYPL), Merck & Company (MRK), American International Group (AIG), Texas Pacific Land (TPL), KKR & Co (KKR), and Airbnb (ABNB).
❖ There are no ex-dividend dates for Smart Portfolio companies in the next week.
w
New Buy: Arch Capital Group (ACGL)
Arch Capital Group Ltd. is a leading global financial services company offering specialty insurance, reinsurance, and mortgage insurance through its subsidiaries worldwide.
1
History of Efficient Expansion
Arch Capital is the successor to Risk Capital Holdings, which was originally founded in 1995. Arch was established in 2000 as an insurance firm and expanded into reinsurance following the terrorist attacks of September 11, 2001, to address the global demand for reinsurance capacity. The company entered the mortgage insurance business in 2015.
Over the years, Arch has grown through internal effort and acquisitions, expanding its geographical presence and adding new lines of business. ACGL’s latest notable acquisition of the U.S. MidCorp and Entertainment insurance businesses from Allianz was announced in April this year. The buyout of a stable business with regularly recurring premiums, valued at more than $100 billion, provides Arch with additional room for expansion and is expected to add a layer of stability to the firm’s revenues.
Arch Capital wields a market capitalization of over $37 billion; its 2023 revenues came in at $13.3 billion. ACGL ranks #13 among the largest U.S. insurers. The company’s stock, trading on the NASDAQ under the ticker ACGL since 2000, was added to the S&P 500 index in 2022. Arch comes in as #18 on the list of the most productive and efficient S&P 500 members, ranked by net income per employee – the third-highest rank for financial services firms in the index.
1
Wide Diversification and Flexible Business Model
The company, headquartered in Bermuda, operates through three segments: Insurance, Reinsurance, and Mortgage. The Insurance segment offers specialty product lines, including construction and national accounts, excess and surplus casualty, professional lines, property, energy, marine and aviation, and other insurance solutions. In 2023, the company derived 43% of total gross premiums written from the Insurance segment.
The Reinsurance segment is ACGL’s largest business line, responsible for 49% of total 2023 gross premiums. The segment provides specialty product lines, including casualty, marine and aviation, property, life reinsurance, and other products. The Mortgage segment, which is responsible for 8% of 2023 gross premiums written, provides mortgage insurance and reinsurance, mortgage funding and underwriting, and credit risk management solutions.
Arch’s flexible business model allows it to quickly shift to the most profitable business segments while increasingly diversifying in terms of geographies and business offerings. Its three-segment operations structure permits the allocation of capital contingent on each business segment’s cycle dynamics. While the Mortgage business is still small in terms of premiums written, its low loss ratios translate into higher underwriting income, serving as a strong source of cash generation. On the other hand, ACGL’s Reinsurance business has driven the company’s profit growth in recent years.
1
Strong Market Position and Pricing Power
Arch can effectively control risk and revenue volatility thanks to the wide diversification of its business. Its recent history of acquisitions supports this diversity and significantly contributes to the company’s client acquisition efforts. In addition, ACGL’s large global footprint allows it to spread risks and capitalize on growth opportunities in different economic and regulatory environments.
Furthermore, Arch Capital gains from robust premium growth and competitive pricing in its property and liability (P&C) and reinsurance operations. ACGL’s strong market standing allows it to leverage favorable pricing conditions as the insurance and reinsurance industry gears up for another devastating hurricane season this year. While many firms prepare for a surge in costs due to a spike in catastrophe claims by rising premiums, some – including Arch – can ride an increased pricing environment while having a manageable level of exposure to catastrophes.
1
Stellar Finances and Robust Earnings Growth
Despite several strategic acquisitions, Arch Capital boasts a strong balance sheet with very few liabilities, as it has reduced its debt-to-equity ratio from 24% to 17% in the past five years. Moreover, ACGL has more cash than its total debt.
The company’s financial resilience is recognized by the credit rating agencies and is reflected by its investment-grade ratings: “A-” at Fitch, “A2” at Moody’s, and “A+” at Standard & Poor’s and AM Best. Particularly, Fitch has applauded Arch’s “favorable business profile, very strong profitability, very strong capitalization with modest financial leverage, very strong fixed-charge coverage and strong reserve adequacy.” Meanwhile, AM Best has praised the group’s balance sheet strength, which the agency assesses as the strongest possible, as well as its “strong operating performance, favorable business profile, and appropriate enterprise risk management,” and said it expects the company to maintain its financial excellence thanks to its steady operational results, positive reserve development, and diversified business model.
The company’s stated business strategy seeks to increase shareholder value through the selective pursuit of diverse profitable specialty markets, maintaining flexibility and responsiveness to allow it to take advantage of market opportunities when they arise, and keeping a disciplined underwriting approach that enables the selection of risks while pricing them appropriately in all phases of the insurance cycle.
As a result of the successful implementation of this strategy, Arch Capital’s revenues have grown at a CAGR of 16% in the past three years, while its earnings per share surged at a CAGR of 46%. The company’s capital efficiency and profitability metrics are outstanding, with its ROE, ROA, and net profit margins coming in the top 10% of its industry. Since Arch Capital’s inception, it has increased its book value per share at an annualized rate of 15.4%. The company’s conservative investment strategy has allowed it to minimize investment risks while maintaining strong liquidity and achieving consistently superior risk-adjusted returns.
In the first quarter of 2024, the company’s EPS rose by 42% from Q1 2023, even though last year was record-setting in terms of Arch’s profitability, providing a tough comparison. Still, analysts expect this EPS growth to continue, with forecasts for Q2 EPS, which will be reported on July 30th, to come in at the double digits yet again. According to analysts, the company’s operating revenues will grow at ~20% in 2024 and 2025, about double the rate of the broader insurance and reinsurance industry.
1
Total Return in Focus
Arch Capital’s shares have returned 19% in the past 12 months, slightly underperforming the S&P 500. The stock had a strong run-up after the blockbuster Q1 earnings, reaching an all-time high on May 24th. It has given back some of the gains since then due to profit-taking and industry-wide market pressures. Still, according to S&P Global, Arch’s market cap has increased by 9.2% during the second quarter, with the largest gain in market cap among all U.S. insurers.
All in all, the stock’s ~7% decline from May’s peak provides an attractive entry opportunity. The stock is very attractively valued, featuring a large discount to the average Financial sector P/E ratio. Arch Capital’s valuation comes in at the bottom of the price range for its peers in the industry. In addition, based on the projected cash flows, the company seems to be ~55% undervalued.
In contrast to most large-cap financials, ACGL doesn’t pay dividends, with all of its excess capital allocated towards acquisitions and share repurchases, which are aimed at supporting shareholder value. Arch Capital repurchased its shares for $46 million during 2023, adding $37.4 million in buybacks over the first quarter. In April, the company announced a new share repurchase authorization of $1 billion.
Wall Street analysts rate Arch Capital’s stock a “Strong Buy,” with the average price target implying a ~15% upside in the next 12 months. However, Bank of America, Morgan Stanley, Jefferies, and Deutsche Numis forecast an upside of over 20% in the year ahead.
1
Investing Takeaway
In our view, Arch Capital is well-positioned to sustain its outperformance over its comparable insurance and reinsurance peers, thanks to its wide diversification, stellar finances, and robust business model. We view the stock’s recent decline as an attractive entry point and believe that ACGL can be a valuable addition to the Smart Investor portfolio.
1
1
Portfolio Stocks Under Review
❖ PayPal (PYPL) remains under review despite the dissipation of concerns regarding the potential impact of Apple’s features simplifying money transfers and expanding BNPL options. Although we believe that PayPal’s new management is capable of dynamizing the payments giant once more—and we have welcomed the news regarding its AI-powered advertising business plans—we have yet to see a strategic turnaround that would help it increase FCFs and maintain (much less grow) its market share. Analysts from Susquehanna have recently raised their rating on PayPal from “Hold” to “Buy”, saying that the company is now focused on profitable growth, which they believe will expand margins. Although this process could take some time, we are awaiting the company’s Q2 earnings report on July 30th for some signs that PYPL is indeed back on the growth path.
1
1
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 last week’s bloodbath in semiconductor stocks and broad-sector declines in technology shares, the list of Winners still includes 15 stocks: SMCI, GE, AVGO, ANET, EME, TSM, ORCL, AMAT, APH, GD, ITT, VRTX, PH, TPL, and CHKP.
The next in line to enter the lucrative club is still AIT with a gain of 27.2% since purchase. Will it close this minute gap, or will someone else outrun it to the finish line?
1
1
|
1
11
Disclaimer
The information contained in this article represents the views and opinions of the writer only, and not the views or opinions of TipRanks or its affiliates and should be considered for informational purposes only. TipRanks makes no warranties about the completeness, accuracy, or reliability of such information. Nothing in this article should be taken as a recommendation or solicitation to purchase or sell securities. Nothing in the article constitutes legal, professional, investment and/or financial advice and/or takes into account the specific needs and/or requirements of an individual, nor does any information in the article constitute a comprehensive or complete statement of the matters or subject discussed therein. TipRanks and its affiliates disclaim all liability or responsibility with respect to the content of the article, and any action taken upon the information in the article is at your own and sole risk. The link to this article does not constitute an endorsement or recommendation by TipRanks or its affiliates. Past performance is not indicative of future results, prices, or performance.
