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Last Thursday, AIG reported third quarter EPS of $0.96 in line with the consensus. However, the EPS included a 12 cent benefit from a favorable tax settlement. Sans this benefit the company missed the sell side expectation primarily due to poor performance in the Property and Casualty (P&C) business. However, I believe the poor performance of the P&C business in the last quarter was an anomaly and not a trend. AIG's stock is headed higher going forward thanks to improving fundamentals. Here's a look.

P&C segments results were an anomaly not trend

The company's Property and Causality earnings were affected by an extraordinary number of "severe" losses in the last quarter which are not expected to recur. AIG classifies "severe" losses as losses greater than $10 million. During the last quarter AIG booked $211 million in "severe" losses which was significantly higher than what it has seen in any of the last six quarters. "Severe" losses in the last six quarters ranged between $38 million to $140 million, and averaged at $71 million. I believe the current quarter losses which were $140 million higher than the average were an outlier rather than a trend.

"Severe" Losses in P&C business

Quarter

3Q13

2Q13

1Q13

4Q12

3Q12

2Q12

1Q12

Number of events

8

3

3

4

12

5

2

Total severe losses (MN)

211

38

60

63

140

81

42

Average severe losses from 1Q12 to 2Q13

71 mn

Last Quarter severe losses

211 mn

Variance from average

140 mn

Life and Retirement business is likely to continue its strong momentum

The Life and Retirement business segment of the company posted $1,144 million in operating profit last quarter which was ahead of sell side expectations. The company's variable annuity and mutual fund sales remain robust and the company witnessed very strong net fund flows. Retirement income solution and retail mutual fund deposits were up 10% sequentially and 130% year over year.

Going forward, the company's topline is expected to benefit from improving market conditions while expenses are expected to remain flat. This bodes well for the company as it will help in upward revision in Deferred Acquisition Cost (NYSE:DAC) balances.

Buybacks can ramp up substantially

One of the big positives for AIG this quarter was resumption of its stock buy backs after one year. Although the amount of buy back in the last quarter was relatively small, I believe it will significantly ramp up in 2014-15. The biggest catalyst for the company which will help it increase its buy back is the sale/IPO of its ILFC business. AIG has already written down assets of this unit. Sale of ILFC will not only bring additional cash to deploy for buy backs but will also eliminate the credit strain AIG is facing because of this business and free up more liquidity. As of last quarter, AIG had $16.9 billion of liquidity resources with $12.7 billion of cash and unencumbered fixed income securities. I believe the company can buy back $4 billion to $5 billion worth of its stock over the next couple of years if its ILFC sale is successful.

Valuations

AIG is trading at 11.25x forward PE and at 23% discount to its book value (excluding AOCI). It appears that investors are ignoring the fact that AIG has significantly de-risked its business and strengthened its balance sheet since the last financial crisis. Given the significant undervaluation, improving fundamentals and potential of ramp up in buybacks, I believe AIG offers a classic value buying opportunity.

Source: AIG: Why Recent Correction Is A Buying Opportunity

Additional disclosure: GS Analytics is a financial research firm providing customized research services to US hedge funds. This article was written by one of our Research Analyst. We did not receive compensation for this article (other than from Seeking Alpha), and we have no business relationship with any company whose stock is mentioned in this article.