In light of what has been a tremendous beginning to 2013 for American International Group (NYSE:AIG), and in light of the recent Goldman Sachs downgrade, I thought it necessary to revisit our position in the insurance giant, as initially discussed here.
Without being too much of a braggart, I would think it safe to say our analysis as discussed in the original article pretty much nailed the timing of the oncoming bull market, as well as the imminent run up in shares of AIG. The thesis was pretty simple, and while sometimes patience is required in order to see your investment thesis come to fruition, this one unfolded, and continues to unfold, in a way that is rewarding to both short- and long-term investors.
In beginning to evaluate where we stand today, I would first like to look at some of the analyst coverage for AIG, the good, the bad, and the horrendous. My initial interest in AIG as a tremendously undervalued investment began in the first few months of 2012. Around this time, Goldman Sachs placed the insurer on it's Conviction Buy List.
Over the following months, leading into the fall of 2012, many firms began jumping on the AIG bandwagon, as the story was simply too easy. To give credit where credit is due, Bernstein Research, has pretty much nailed the unfolding story, from fundamental thesis, down to the $45 price target, and the view that AIG was a once in a lifetime investment, which I absolutely agree with. FBR Capital has also done a decent job of staying on top of developments, and has been fairly accurate with its targets and expectations. Stifel Nicolaus has been useless, rating the stock a hold, even when it traded in the low 20s. Deutsche Bank has largely lagged the market, and simply upgrades the stock as it moves higher. Several firms, which claim to cover the stock, have been inexplicably behind, and even flat out wrong. The worst offender is Barclay's, which for some reason long believed the shares would trade at levels consistent with the Treasury still being a majority shareholder, and is probably better off not even covering the stock. Its pitiful "upgrade" on April 2 of this year, saw the price target almost pointlessly raised from $33, to $36. How it came to this valuation is beyond my reasoning, and can only be described as a lackluster attempt to provide investors with useless research.
In order of its thoroughness of work, and more importantly its accuracy, Bernstein Research has been the top AIG analyst. FBR Capital has been decent as well. I also see Goldman having the best timing with its ratings, although not always being as accurate with its reasoning. That said, I do agree for the most part with its recent downgrade, as the stock has had a very nice short-term move, and will likely need a dividend and share buybacks, along with the fundamental story continuing to improve, to warrant new accumulation above $45 a share. That said, I expect a dividend within the next 2-3 quarters, and buybacks shortly thereafter. It currently trades close to 75% of book, which is more in line with where it should be, relative to its peers.
The Overall Picture and Ongoing Investment
When I began accumulating shares of American International Group in the high 20s, and more aggressively in the low 30s, the reason for such aggressive accumulation lay on two very simple assumptions. The first was that its price to book, and price to future earnings was absurdly cheap. The fact that the company was so closely scrutinized due to its relationship with regulators and the U.S. Treasury, gave me reason to believe that the book value was accurate enough to provide a tremendous margin of safety in the events of a broader market sell-off. The second reason was even more simple. The U.S. Treasury breakeven price of around $29 a share had shown to act as a tremendous support for the stock. At the height of our investment in AIG, between the common shares, Tarp Warrants, and call options, the company represented close to 65% of our assets. Our conviction was validated by major hedge fund accumulation during the final two Treasury offerings, to the extent that AIG surpassed Apple as the most widely held stock amongst the hedge fund community. Our initial price target in which we would liquidate about 70% of our holdings, was $39.50 a share, as to us this represented enough of a distance from our margins of safety to conclude that while the stock did still hold significant upside, the risk-to-reward ratio had changed, and no longer warranted such a dramatic allocation. Our next target for liquidation was $45 a share, which represented our 2013 target for AIG in terms of its price relative to book, about 75%. Interestingly enough, the Goldman Sachs downgrade came a day after liquidating about 15% of our remaining position. Our remaining position will see out the re-institution of a dividend, as well as additional share repurchases, which is likely what will be required to take the stock into the mid $50s and beyond. A hold rating on the shares at these levels is fair, and any pullbacks in to the $40-$42 range represent an good point to add; an opportunity to acquire the shares sub $40, assuming the fundamental story does not change, would be an absolute gift.
Our assessment of the risks inherent in shares of American International Group can be broken down into three scenarios. The first risk, would be the company's difficulty in returning capital to shareholders as a result of being designated a Systematically Important Financial Institution, which is very likely. Now I do not see the Fed presenting too much of a hurdle for the company, as AIG is very well run, and seems to have a very strong ongoing relationship with regulators.
The second risk would stem slightly from the first, in that CEO Robert Benmosche has been the single most important person in regards to the turnaround of the once disgraced company. It is unclear as to how long Mr. Benmosche will continue to run the ship, and a successful transition, and adequate replacement is crucial to the continued turnaround at AIG.
The final risk, is the concentration of shares held amongst the hedge fund community. This does not strike me as a huge concern, however it would be naive to neglect this, as everyone is well aware of what happened to Apple Computers when the big boys decided it was time to exit. At these levels, I do not see this risk as that great, again due to the margin of safety provided by the company's discount to book, and ability to generate enormous amounts of cash. Should the stock pull back severely, I would be fairly confident our hedge fund friends would again find the mid- to high-30s as a phenomenal entry point. However I would be more concerned about this risk factor should the shares trade into the low $50s or beyond during the current calendar year.
American International Group has continued its transformation from one of the most hated companies in the world, to a respected, well run organization that has largely separated itself from the behaviors and businesses that once took it down. It is leaner and more efficient, and as it continues to focus on expanding its core operations and returning value to shareholders, it should continue to be a great investment.
Disclosure: I am long AIG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I am also long AIG Tarp Warrants, and AIG calls.