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American International Group, Inc. (NYSE:AIG), which is a major player in the American Property and Casualty Insurance (P&C) space, has been at the receiving end of bad publicity ever since it got a $182.3 billion government bailout. Five years down the line, the company has not only managed to pay back the entire sum, but has been showing steady growth for the past three quarters. This has resulted in the insurance company becoming a favorite amongst hedge fund managers. The hedge fund data (as released by Goldman Sachs) is however open to a different interpretation than what appears at first sight. AIG's growth in its core portfolios and its current book value, coupled with its sale of ILFC to Netherlands-based AerCap augur well for the company's future growth prospects.

The turnaround story

One of the biggest bailout stories of the 2008 Recession was AIG, which sought and obtained $182.3 billion from the federal government. This created a negative impression regarding the company's future growth prospects, which naturally pulled down share values. However, the company has since undergone extensive restructuring coupled with good management, leading to the vital indices out of the red. This allowed the company to pay back the entire bailout fund amount to the government by December 2012. The company has shown strong growth over the last three quarters, so much so that it became the favorite of hedge fund managers.

Recent tailwinds

However, AIG is no longer the leader of the pack. It has slipped below the tech giants Apple, Inc. (NYSE:AAPL) and Google, Inc. (NYSE:GOOG), in terms of number of hedge funds investing in the company.

Company

No. of Hedge Funds

% of Equity Owned by HF

Total Return YTD

Apple

184

2%

0%

Google

165

3%

45%

AIG

163

12%

38%

General Motors (NYSE:GM)

154

10%

32%

Citigroup (NYSE:C)

139

3%

29%

(Source: Goldman Sachs Hedge Fund Trend Monitor Q3 2013)

Google has also overtaken AIG in terms of Total Returns Year-to-Date. That said; the percentage equity owned by hedge funds is still the greatest for AIG. This shows that hedge funds retain faith in the company's turnaround story. A Total Return YTD return of 38% is not bad either, considering the position it was in a few years back.

Robust growth in core portfolios, great book value

It may not be a great idea to depend on hedge fund analysis alone, but AIG shows equally robust growth in its core businesses of P&C and Life and Retirement Insurance. Its P&C income rose by 34.8%, whereas its Life and Retirement business grew by 79.2%. Further, its tangible book value, or the actual amount of money available to shareholders, grew by 25% in Q3 2013. These indicate that the company's growth rests on strong foundations.

Sale of ILFC to AerCap

AIG's aircraft leasing subsidiary ILFC (International Lease Finance Corp.) is the last of its non-core businesses. It is now finalizing talks with Netherlands-based AerCap for the sale of this 1,000+ aircraft owning and handling firm for a cash and stock deal. This would result in AIG gaining $3 billion in cash and 46% of AerCap's stock. With the whole deal valued at $5.4 billion, AIG will be able to focus more on its core portfolios while gaining ready cash and about 97.6 million of lucrative AerCap shares.

Additional Catalysts

From a valuation standpoint, AIG also looks attractive. AIG is currently trading at a Price to earnings ratio of just 9.9. This is particularly attractive when compared to an industry average P/E of 16.8, and a S&P average of 17.9. When comparing this P/E ratio to AIG's growth rate, the numbers become even more favorable. AIG's current PEG ratio is a miniscule .3, which would argue that AIG shares are very undervalued.

Insider transactions have also been substantial of late. In the past year, insiders have been scooping up shares, with few if any insider sales.

AIG has continued to live up to its promises since the financial crisis. AIG promised to pay back the full government bailout plus interest, which it did. AIG also promised to become a smaller more centralized company, which it has done and continues to do so with the sale of ILFC. AIG promised it would pay its executives based on performance, and it has adhered to that promise as well. If AIG continues to live up to its promises and continue its strategic path, things should continue to go well for the company.

Potential Downsides

The picture at AIG isn't 100% positive however, as all companies do face risks. There has been significant talk about where interest rates are going in 2014. Much of AIG's business is subject to interest rate risk. Unfavorable interest rates can negatively affect the performance of its investment securities and reduce the level of investment income earned on portfolios. This could potentially also impact AIG's ability to sell these securities.

Government regulations could also pose a major risk factor for AIG. AIG's businesses are subject to extensive Government regulation, which could potentially result in loss of revenues or penalties and fines. The US Patriot Act requires companies to know certain information about their clients and to monitor their transactions for suspicious activity. Although AIG has stated that it has instituted compliance programs to hedge against any potential government regulation violations, there are still risks associated with partaking in international transactions. This along with similar increased regulations could potentially lead to significant penalties.

What should the investor do?

As the above analysis makes clear, the company's turnaround story is not likely to end any time soon. The hedge funds' confidence in AIG is justified considering the growth in its core portfolios and its excellent growth in tangible book value. Add to these the benefits of the sale of ILFC and one can be confident about AIG's future growth story. As such, investors who hold AIG stock would be advised to hold on to it for now while those seeking long-term benefits may consider buying AIG stock.

Source: AIG's Turnaround Story Not Likely To End Soon