Date Issued – 22th August 2024
Courtesy of the Research Department at Balfour Capital Group

Fed Minutes Signal September Rate Cut: A Potential Turning Point

Market Highlights:

• Stocks on the Rise: Wall Street experienced an uplift as optimism about an imminent rate cut fueled by the Federal Reserve minutes and revised payroll figures. The S&P 500 gained 0.42%, nearing its all-time high, while the Nasdaq Composite advanced by 0.57%, marking nine gains in ten days. The Dow Jones Industrial Average climbed by 55.52 points. In contrast, the 10-year Treasury yield declined, and U.S. oil prices fell 1.7%, dipping below $72 per barrel.
• Fed’s Rate Cut on the Horizon: The latest minutes from the Federal Reserve’s July meeting indicate that officials are edging closer to a rate cut in September. The minutes reveal that the “vast majority” of members believe easing policy at the next meeting would be appropriate, provided economic data remains steady. Markets are now fully expecting a rate cut in September. Some officials had even suggested initiating cuts in July, citing positive trends in inflation and unemployment. Additionally, a downward revision of nonfarm payroll growth by 818,000 strengthens the case for easing monetary policy.
• Ford’s Strategic Shift in EV Production: Ford Motor Company is recalibrating its electric vehicle strategy, postponing the production of its next-generation electric pickup truck and canceling plans for a three-row electric SUV. Instead, the automaker is shifting its focus to hybrid models. This strategic pivot will result in a $400 million charge and could incur up to $1.5 billion in additional costs. Ford is also reducing its capital expenditure on EVs from 40% to 30% as it contends with slower-than-expected EV adoption and profitability challenges.
• Microsoft’s Controversial Recall Feature: Microsoft is set to roll out its Recall AI search feature for testing by Windows users in October. This feature, which captures screenshots of on-screen activity, has sparked security concerns regarding the potential exposure of personal information to cyber threats. While Recall will be disabled by default and Microsoft has pledged to bolster its security measures, the company has yet to announce a wider release timeline.
• Mixed Performance in Asia-Pacific Markets: Asian markets showed mixed results as investors weighed business activity data from Japan and Australia. Japan’s Nikkei 225 rose by 0.42%, and Australia’s S&P/ASX 200 edged up by 0.26%. Meanwhile, South Korea’s Kospi slightly decreased as the Bank of Korea kept interest rates unchanged but hinted at potential future easing. Hong Kong’s Hang Seng index saw a 0.4% gain, while mainland China’s CSI 300 slipped by 0.23%.

Pro Insight:

Defensive Growth Strategy: In light of ongoing market volatility and elevated valuations, Brian Arcese, a portfolio manager at Foord Asset Management, suggests adopting a defensive investment approach. He recommends focusing on four “defensive growth” stocks to navigate the current market conditions effectively.

Conclusion

This overview encapsulates the dynamic shifts in global markets and strategic corporate decisions, underscoring the importance of staying informed and adapting investment strategies accordingly.

Qualcomm: A Cornerstone of Future Connectivity

Overview and Legacy

Qualcomm (NASDAQ: QCOM), founded in 1985 by Irwin Jacobs and a team of visionary engineers, has been a driving force in the evolution of mobile communication. The company’s name, derived from “quality communications,” reflects its mission to be at the forefront of technological advancements in connectivity. From pioneering 3G and 4G networks to leading the current 5G rollout, Qualcomm’s innovations have been integral to the mobile devices we rely on today.

Qualcomm’s long history of deep research expertise and technical prowess solidifies its status as the world’s leading RF (radio frequency) chip manufacturer. While the explosive growth phase of smartphones may be behind us—every consumer today owns one, compared to the early 2000s—the company remains a dominant player in the mature mobile market. Qualcomm is now setting its sights on the Internet of Things (IoT), an emerging sector poised to drive the next wave of RF sales growth.

The Core of Qualcomm’s Business: RF Technology

To understand Qualcomm’s business, it’s essential to grasp the four critical components of the wireless communication infrastructure: RF chips, handsets, towers and satellites, and standardized communication protocols. Qualcomm’s business is primarily focused on two of these components, which are its highest-margin segments.

1. QCT (Qualcomm CDMA Technologies): This segment, which accounts for 86% of Qualcomm’s Q3 revenue, designs and supplies RF chips for smartphones, automobiles, and other connected devices. Qualcomm’s Snapdragon chips, a flagship product of this segment, exemplify the company’s technological leadership. Despite a challenging market, QCT maintains healthy EBT margins of 27%, reflecting its robust profitability.
2. QTL (Qualcomm Technology Licensing): This segment is the powerhouse behind Qualcomm’s intellectual property (IP) portfolio, which underpins mobile communication standards like CDMA for 3G, LTE for 4G, and NR for 5G. Companies seeking to build devices or infrastructure that utilize these technologies must license Qualcomm’s IP, which contributed 14% of Q3 revenues with an impressive 70% EBT margin.

Qualcomm also invests in future technologies through its QSI (Qualcomm Strategic Initiatives) segment, ensuring that it stays ahead of the curve in the fast-evolving tech landscape.

Growth Prospects

Qualcomm’s growth trajectory is marked by solid fundamentals. Over the past five years, the company has achieved a compound annual growth rate (CAGR) of 8.1% in revenue and 10.5% in income. Analysts project continued revenue growth of 7-10% and income growth of 11-19%, which is consistent with Qualcomm’s historical performance.

Despite a dip in book value in 2018 due to challenges like the failed NXP Semiconductor acquisition and debt repayments, Qualcomm has since rebounded, growing its book value at a 34.5% CAGR since 2019. The company’s cash from operations has also increased at a five-year CAGR of 9.2%, aligning with its income growth, underscoring its ability to generate consistent cash flow.

Capital Allocation and Financial Health

Qualcomm demonstrates prudent capital allocation, with a debt/earnings ratio of 1.5 comfortably below the threshold of 3. The company currently pays a quarterly dividend of $0.85 per share, yielding 1.97% annually. In addition, Qualcomm has been actively repurchasing shares, with $1.8 billion worth of shares bought back, representing nearly 1% of its market cap. This combination of dividends and share buybacks reflects Qualcomm’s commitment to returning value to shareholders.

Challenges and Risks

Despite its strengths, Qualcomm faces several challenges:

1. Low-End Market Competition: The commoditization of lower-end RF chips poses a risk. Companies like MediaTek can produce less sophisticated chips, which could pressure Qualcomm’s margins in this segment.
2. High-End Market Dependency: Apple, one of Qualcomm’s largest customers, is working to develop its own RF chips. Although Apple extended its contract with Qualcomm until 2027, the eventual loss of Apple as a customer would be a significant blow.
3. IP Legal Battles: Qualcomm’s lucrative IP portfolio has been the target of legal challenges, particularly from major customers like Apple. Although Qualcomm has successfully defended its IP rights, future challenges could impact its high-margin licensing business.
4. China Trade Tensions: Geopolitical risks, including trade tensions with China, could adversely affect Qualcomm’s operations, particularly in light of recent bans on certain IP technologies involving Huawei.

The Path Forward: IoT and Beyond

Qualcomm’s future growth potential hinges largely on the Internet of Things (IoT), a burgeoning market where connected devices from smart cars to household gadgets will require extensive RF connectivity. While the full realization of IoT is still on the horizon, Qualcomm is well-positioned to capitalize on this opportunity, given its expertise in RF technology.

If IoT grows as expected, Qualcomm could see earnings growth exceed 10% annually, providing significant upside for the stock. However, the timing and scale of IoT adoption remain uncertain, introducing an element of speculation into Qualcomm’s growth prospects.

Valuation Analysis

Using various valuation methods, Qualcomm appears to offer compelling value:

1. Margin of Safety (MOS): Based on conservative growth estimates, Qualcomm’s fair value is calculated at $127.63, with a buy price of $63.81 for a 50% margin of safety. Current prices suggest a slight overvaluation by this method.
2. Payback Time (PBT): Qualcomm’s free cash flow suggests a fair value of $322.46, indicating the stock is currently undervalued.
3. Ten Cap: This method also points to significant undervaluation, with a fair value of $328.20, implying a nearly 100% upside from the current price.

Conclusion

Qualcomm is a formidable player in the technology sector, with a robust business model and significant growth potential. While there are risks—ranging from competitive pressures to legal and geopolitical challenges—the company’s leadership in RF technology and its strategic pivot to IoT position it well for the future. With current valuations suggesting the stock is on sale, Qualcomm presents a compelling investment opportunity for those confident in the company’s ability to navigate the challenges ahead and capitalize on emerging opportunities.

Alibaba: Better Days Ahead?

Recent Performance and Quarterly Results

Alibaba (NYSE: BABA) has struggled recently, with its stock down 5% since May 2024, underperforming the S&P 500. In Q2 2024, Alibaba reported mixed results: while it beat non-GAAP EPS expectations, it missed revenue estimates by $1.15 billion. Revenue grew modestly by 3.8% year-over-year, but operating income and diluted EPS saw significant declines of 15.3% and 25.3%, respectively. This reflects ongoing challenges, with stagnant revenue and fluctuating earnings.

Key Challenges

• Slowing Growth: Once a growth powerhouse, Alibaba’s revenue and earnings have become volatile, raising concerns about its long-term prospects.
• Regulatory Pressure: Ongoing scrutiny, particularly from the Chinese government, continues to weigh on Alibaba’s operations and innovation.
• Economic Conditions: China’s economic slowdown and geopolitical tensions further complicate Alibaba’s environment, impacting core businesses.

Reasons for Optimism

• Diversified Model: Alibaba’s diverse businesses, especially its leading cloud computing arm, provide a strong foundation for future growth.
• Market Leadership: Despite challenges, Alibaba remains the top e-commerce platform in China, with a vast user base and competitive advantages.
• Strategic Investments: Initiatives in international expansion, digital finance, and AI could drive new growth areas, reducing reliance on domestic e-commerce.

Conclusion

Alibaba faces significant near-term challenges, but its strong market position and strategic investments offer long-term potential. While the stock remains volatile, long-term investors might find value, especially if Alibaba can navigate its current difficulties and return to steady growth.

Swiss Re: Strong Q2 Results Beat Expectations

Recent Performance

Swiss Re AG (SIX: SRENH) has posted impressive second-quarter results, continuing the positive trajectory seen in the first quarter of 2024. The company reported a net income of $996 million, surpassing consensus estimates by 7.6%. This strong performance reflects Swiss Re’s robust underwriting and investment strategies, showcasing its resilience in the reinsurance market despite some challenges.

Key Highlights

• Net Income and ROE: Swiss Re’s net income of $996 million exceeded market expectations, with a Return on Equity (ROE) of 20.1% for the first half of 2024. This high ROE underscores the strength of the reinsurance market, bolstered by favorable interest rate environments.
• Property & Casualty Reinsurance (P&C Re): The P&C Re segment reported insurance revenue of $4.815 billion, which was 5.2% below expectations. However, the segment’s performance was solid, with a combined ratio of 84.4%, significantly better than expected. Lower-than-anticipated natural catastrophe losses ($70 million against a forecast of $360 million) contributed to this positive outcome, despite the addition of $0.65 billion in reserves for US liability, which is seen as a strategic move to enhance long-term stability.
• Corporate Solutions (CorSo): This segment delivered strong results, with insurance revenue of $1.961 billion, surpassing expectations by 2.6%. The combined ratio of 87.6% was notably better than the anticipated 92.0%, driven by favorable premium volumes and a benign claims environment, indicating improved operational efficiency.
• Life & Health Reinsurance (L&H Re): While L&H Re’s insurance revenue was 10.0% below expectations at $3.893 billion, the segment’s net income was a bright spot, reaching $471 million—15.2% above consensus estimates. This was primarily due to positive mortality experience in the US, highlighting the segment’s resilience despite revenue shortfalls.

Strategic Reserves and Outlook

Swiss Re’s strategy of strengthening its reserves, particularly in response to US liability concerns, is viewed positively by analysts, who believe it will enhance the company’s long-term earnings stability. Despite lower-than-expected revenue in some segments, the overall profitability remains strong, driven by effective underwriting and prudent investment strategies.

The company has maintained its full-year guidance, targeting $3.6 billion in group net income for 2024, signaling confidence in its operational strength despite the looming hurricane season and other potential risks.

Market Reaction and Valuation

Analysts from RBC Capital Markets and Jefferies continue to support a price target of CHF 114.00 for Swiss Re, citing the company’s strong valuation model. While there is potential upside from capital returns, there are also downside risks associated with natural disasters and the prolonged impact of low fixed-income yields on investment returns.

Conclusion

Swiss Re’s strong Q2 results, marked by robust profitability and strategic reserve management, demonstrate its resilience and operational excellence in a challenging market environment. With a positive outlook for the rest of 2024, supported by a stable earnings forecast and a solid ROE, Swiss Re remains well-positioned to navigate potential challenges while delivering value to its shareholders.

French Economy Sees Temporary Boost from Olympics in August

Recent Performance

In August, France’s economy received a significant boost, primarily driven by the Olympic Games, as highlighted by a recent survey. The HCOB flash Purchasing Managers’ Index (PMI) for France’s services sector, compiled by S&P Global, reached a 27-month high of 55.0, up from 50.1 in July. This surge, well above the expected 50.3, indicates strong expansion in the services sector, a crucial development for the euro zone’s second-largest economy.

Key Highlights

• Services Sector Surge: The services sector’s PMI increase to 55.0 reflects a sharp upswing, driven largely by Olympic-related activities. This growth is a significant improvement from July’s figure and suggests that the Games have played a pivotal role in revitalizing the sector.
• Overall Economic Growth: The flash composite PMI for August, which includes both services and manufacturing, rose to 52.7, marking a 17-month high. This is a notable recovery from July’s contractionary figure of 49.1 and indicates a broader expansion in economic activity.
• Manufacturing Weakness: Despite the positive momentum in services, France’s manufacturing sector continued to struggle. The manufacturing PMI dropped further to 42.1 in August, down from 44.0 in July, signaling a deeper contraction. This decline was worse than the expected 44.4, reflecting ongoing challenges in the sector.

Temporary Boost from Olympics

The boost from the Olympics, while substantial, is expected to be short-lived. Economists caution that the positive effects seen in August are likely temporary. The surge in activity related to the Games has not translated into sustained improvements in employment or long-term output expectations. S&P Global highlighted that the underlying issues in the economy, particularly in manufacturing, persist despite the temporary lift from the Olympic Games.

Economic Outlook

France has been relying on the Olympic Games to stimulate its modest growth rate. The country’s statistics office had predicted a 0.3 percentage point boost to GDP from the Games, which concluded earlier this month. However, with the Olympics over, the focus will shift back to addressing the structural weaknesses in manufacturing and the broader economy.

Conclusion

August brought a temporary uplift to the French economy thanks to the Olympics, but challenges remain, particularly in manufacturing. The post-Olympics period will be critical in determining whether the economy can sustain this momentum or if the underlying weaknesses will resurface.

Find below some of our Buy/Sell Recommendations. Balfour Capital Group is a distinguished global boutique investment management firm with $350 million AUM and over 1000 Clients.

Disclaimer: This Buy/Sell Recommendations provides financial insights for informational purposes only. It does not constitute financial advice or recommendations for investment decisions.