The share price of American International Group (NYSE:AIG) has experienced modest price weakness since reaching its 52-week high of $53.33 in October 2013, compared to an almost 6% gain for S&P 500 Index over the period. In my view, the recent price trend presents investors a great buying opportunity as the shares still trade at cheap valuation despite a 138% run-up since late 2011, and the company's long-term growth story remains intact.
Market's current concern is primarily on the lackluster performance of AIG's P&C business. For Q4 2013, the segment posted worse-than-expected earnings ($1.1B) and combined ratio (103.8%). As both metrics suggest a slowdown in P&C's margin growth, some investors were frustrated. However, I view the current sluggish margin growth to be temporary given that 1) P&C's expense ratio is likely to remain elevated in near-term as management continues to invest in IT infrastructure, but as this spending is going to diminish over the medium term, the resulting operating leverage should benefit margin; 2) P&C's loss ratio is positioned to decline over time owing to management's ongoing efforts to re-price products, expand higher-margin foreign businesses, and shift product mix towards consumer business which has lower loss ratio; and 3) management has expressed confidence that overall loss ratio would decline in 2014. As such, my view is that P&C's profit growth story remains, though the impact is likely to be felt gradually.
On the other hand, AIG's Life & Retirement business continued to demonstrate robust momentum in Q4 2013. The segment posted above-expected earnings and margin, driven by alternative investment income and deferred acquisition cost benefit. Looking forward, I expect the current growth pace to continue building as the segment's margin is likely to benefit from management's goal to drive higher cost efficiency, and current rising interest rate environment should buttress top-line growth due to reduced reinvestment risk.
The stock now trades at 9.8x 2015 forward P/E multiple, which is in line with the insurance comps ("comparable companies") average at 9.6x. However, by factoring in AIG's consensus long-term earnings growth estimate of 14.0%, which is notably above the comps average at just 10.0%, the stock's PEG ratio of 0.7x is at 30% discount to the comps average of 1.0x. Further, AIG only trades at 0.7x of its book value, compared to comps benchmark at 1.2x. Given that AIG's current ROE is fairly close to the comps' average and the figure is expected to continue growing based on my view, I believe the stock's low price to book ratio reflects market's bearish view on the company's ROE prospect and thus an upside can be easily realized as the company posts continued improvement on ROE (see chart below).
In Q4 2013, the company bought back 8.3M shares for a total value of $405M. Management also announced a 25% increase in dividend and raised the current share repurchase authorization to $1.4B. Over the medium term, I expect management to continue raising share buyback targets given the company's robust liquidity outlook. AIG currently has $17.6B in cash and cash equivalents (i.e. $13.1B cash and $4.5B short-term investments). Additionally, the company is expected to receive $3.0B cash from the sale of ILFC to AerCap (NYSE:AER) for $5.B (consisting of $3.0B cash and $2.4B AerCap stock). As the outlook for free cash flow generation remains healthy, I expect enhanced capital return to be very possible. Owing to the cheap valuation, the ongoing share buyback at favorable price should have meaningful impact on future ROE growth.
In summary, investors need to be patient as it appears the P&C business would take longer-than-expected time to improve. Fortunately, AIG's valuation stays very low and it should provide investors a fair margin of safety. As the company's medium to long-term recovery story remains intact, I recommend buying the shares now before the valuation picks up.
All charts are created by the author, and data used in the article and the charts is sourced from S&P Capital IQ, unless otherwise specified.