After the bell, American International Group (NYSE:AIG) reported quarterly results that continued the trend of improving results under CEO, Bob Benmosche. The stock has rallied 46% year to date, so it is not surprising that investors took some gains after hours, sending shares down 3%. However, this drop presents a buying opportunity for shareholders as the core story at AIG remains extremely positive.
Excluding one-time items, the company earned $0.96, just besting analyst expectations of $0.95. The important trend is that AIG continues to transform back into a "normal insurance company," focused on life and property/casualty. The company saw insurance operating income grow by 38% to $2.2 billion, and there remains room for improvement as the company expands margins.
As the company increases prices and takes advantage of the growth in reinsurance outfits, I expect the company to improve its combined ratio (underwriting profits). Under Benmosche, we have seen more prudent risk-taking with a focus on more consistent businesses whose risks are better defined and are more predictable. As a consequence, the PC combined ratio improved 2 points from 100 to 98, meaning the company is now earning a 2% profit on underwriting.
Impressively, even as the company saw higher severe losses, its commercial business improved substantially with a combined ratio of 100.2 vs. 106 last year. The company does continue to underwrite at a loss, though the trend is improving with the loss narrowing from $317 million to $8 million. With the company moving away from high-risk lines, I expect this improvement to continue in 2014 when AIG should be able to report an underwriting profit.
Unfortunately, this was a weak quarter in consumer insurance, with the combined ratio rising to 99.6 vs. 98.2 last year on higher warranty losses, though its automobile sub-unit has been progressing well. This data point was one excuse given to sell the stock after-hours. While a narrower margin is never positive, I wouldn't be overly concerned as warranty losses tend to be volatile and transitory, and the overall picture is improving underwriting standards. Not every unit in every quarter will perform perfectly, but as I will explain, this stock is far from pricing in perfection.
Most impressively, its life unit increased premiums by 76%, and as AIG continues to re-establish itself in this market, we should see continued growth. It is important to note that insurers make money in two fashions: underwriting profits and investment profits. As you pay insurance monthly but only make claims sporadically (if ever), the company can invest this float to generate additional profits. Life insurers are the best positioned companies in a rising rate world as their investments earn more money. If 2014 sees the 10 year treasury rise 1% (a modest projection), we could see higher investment income contribute an additional $1.00-$1.25 in EPS. AIG is earning about $4 in this low rate world, looking forward into 2014 and 2015, its core business by continuing to improve margins should add about 10% annually to earnings while rising rates could add another $1.00.
AIG is a company that should earn over $5 next year and upwards of $6 in 2015, giving it a very cheap 10x forward multiple. Moreover, AIG continues to trade at a discount to book with book value per share of $67 including AOCI. With the company still turning around, it should trade at a mild discount to peers who mostly trade at book value, making a fair target price $60 or 90% of book value. That still represents 20% upside and a forward multiple of 12x. AIG remains an improving business with a compelling valuation that can deliver strong future returns.