At the Computex conference in Taiwan late last week, Best Ideas portfolio holding Intel (INTC) revealed the most energy-efficient processor in history — its Core M line of processors. The goal of the Core M, which is based off of the Core i3, i5, and i7 processors, is to enhance processor performance (with less power consumption) in mobile products, and we think the firm will make a big splash with the new chip.
Picture: The first 14nm fanless mobile PC reference design from Intel; it has a 12.5 inch screen that is 7.2mm thin with keyboard detached and weighs 670 grams. The design is based on Intel’s next generation 14nm Broadwell processors. Named the Intel Core M processor, it delivers the most energy efficient Core processor in Intel’s history. Source: Intel at Computex Taipei 2014 Satellite Event
In recent past, Intel has faced myriad challenges in its efforts to gain traction in mobile against rival Arm Holdings (ARMH), which dominates the market. However, the Core M has changed all of this, and in our view, represents the first of many steps Intel will inevitably take to gain share in mobile. Most Intel ‘bears’ feel that Intel will fail in mobile, but we think the Core M throws cold water on that thesis. The new chip will be in tablets before the end of this year (just in time for the holiday season), and we’re looking forward to a number of new data points in coming months to assess the firm’s progress.
That said, the market is catching on to our thesis on Intel, with the firm recently registering fresh 52-week highs. Intel’s shares, trading at roughly $28 each, continue to approach our current fair value estimate of $30 each (as shown in the image below). Members should expect an upward bias in our fair value estimate if mobile progress at the company proceeds at a faster pace than embedded expectations. We continue to like shares of the chip giant (shares yield ~3.3%) and believe news of the Core M will serve to ignite Intel’s equity heading into the back half of 2014. The company remains a holding in the Best Ideas portfolio.
Let’s move on to AIG (AIG).
As Valuentum members know, we’re not big fans of the insurance industry. Still, for some companies, and one in particular, paying $0.80 for a $1 is always worth considering, especially if the company is exhibiting strong pricing momentum characteristics. Let’s first talk about the poor structural characteristics of the insurance industry and then dive into the prospects of AIG, which we consider to be a Valuentum stock (or an underpriced company that continues to go up in price).
The insurance industry is highly competitive, with rivals numbering in the thousands–including stock companies, specialty insurance organizations, life insurers, mutual companies, other underwriting firms, and banks. Though risk-acceptance criteria, product pricing, and service are some ways insurers can try to differentiate, we view the insurance industry as largely commoditized.
For one, most insurance products can easily be replicated by both existing peers and new entrants (at potentially value-destructive pricing), and sufficient financial strength (capital) is the only temporary barrier to entry. Any outsize economic profit opportunities will be competed away over the long haul, as capital will inevitably chase such an opportunity. Diversification across product lines and geography offer some large insurers stability, but such a strategy also exposes them to a larger variety of more complex risks.
Generally speaking, insurers are inextricably tied to the vicissitudes of the global stock and debt markets, as underwriting profitability (as measured by the combined ratio) can fluctuate wildly through the course of the economic cycle–and particularly during adverse or catastrophic events that result in large losses. In our view, the key portion of an insurer’s income is generated from its investment portfolio, but these returns are largely out of the firm’s control.
Under difficult economic conditions, for example, the assets held in an insurer’s investment portfolio can experience rapid declines in value and performance–not only threatening the capital position of the company but also hurting consumer confidence in the sustainability of the insurer (subsequently slowing demand for its financial and insurance products)—a “not-so-glorious” cycle. An insurer is also heavily dependent on its credit ratings that are issued by the major rating agencies, and any downgrade may force it to post additional collateral payments (especially if complex derivative instruments are held on its books), potentially hurting existing and future business.
With all of this said, we point to AIG as the highest-rated insurer on the Valuentum Buying Index at this time, with the company registering a 9 (equivalent to a “we’d consider buying” rating). Highly-rated firms on the index have strong valuation considerations and strong technical/momentum considerations. Said differently, high-VBI rated stocks are liked by a large variety of investors, and therefore, have strong valuation and pricing support.
On a fundamental level, AIG is now far-removed from its troubled past, and our fair value estimate of the insurer is nearly $70 per share. Shares are trading at roughly $55 each at the time of this writing, and we’re expecting pricing upside. AIG’s board seems to agree with our view, and it recently authorized the repurchase of an additional $2 billion of shares June 5, funded in part by the completion of its sale of ILFC. Since the end of the first quarter of 2014, AIG has repurchased more than $400 million of shares, and we’re very much in favor of any share buybacks completed below our fair value estimate of the firm.
Though the insurance industry is not without challenges (as outlined above), AIG is our favorite idea in the space at this time. The company’s book value per share stood at $71.77 at the end of the first quarter, advancing 6% on a year-over-year basis. This equates to a price-to-book ratio of 0.77.
This article was revised June 24, 2014, for clarification purposes.