Hartford Financial (HIG) and AIG are replete with risks and are more than 200% more volatile than the broader market. The Street currently views both insurers with hesitation, rating them a "hold". Based on my review of the fundamentals and multiples analysis, I find greater risk than reward at the current moment.
From a multiples perspective, Hartford and AIG are unstable. The former trades at a respective 19.5x and 5.8x past and forward earnings while the latter trades at a respective 2.7x and 11x past and forward earnings. The absence of meaningful risk-mitigating dividend yields further increases the downside.
At the third quarter earnings call, AIG's management noted challenges:
"Third quarter loss… is $4.1 billion that compares to a loss of $2.5 billion a year ago in our operating income, which is our principal non-GAAP measure was a loss of $3 billion for the quarter versus $114 million a year ago.
Chartis reported pre-tax operating income of $442 million affected by cap losses of little over $570 million in large part due from Hurricane Irene, which totaled little over $370 million for the quarter, as well as Tropical Storm Lee and Typhoons in Japan. Interestingly that compares to an unusually low level of caps a year ago which was about $72 million".
While lump sum debt repayment and dramatic restructuring has enabled the company to easily gain access to necessary financings, the fundamentals remain uncertain. Much of the insurer's business comes from P&C operations, which are vulnerable to catastrophes. The Capital Markets and Domestic Life operations, specifically, have been viewed cautiously. SunAmerica had operating profits that were less than half of what was anticipated as investment income and premiums fell. Additionally, the Fed's extension of low interest rates at least until 2014 will reduce industry-wide margins decline.
Consensus estimates for AIG's EPS forecast that it will turn positive at $0.77 in FY2011 and then hit $2.66 in 2013. Assuming a multiple of 7x and a conservative FY2012 EPS of $2.43, the rough intrinsic value of the stock is $17.01, implying 37.5% downside.
Hartford has restructuring decisions to mull in its own right. Management has expressed consideration of breaking up the P&C and life operations into 2 separate businesses. Billionaire shareholder John Paulson has been pushing for the firm to take this action. But management has stressed that a breakup would prove challenging in terms of retaining an attractive rating, especially with the life businesses assumption of a portion of the $6.8B holdco debt. In order to prevent ratings downgrade, management adds that it may need to take dilutive measures. But, in my view, the firm has decent leverage to implement the initiative. Going forward, ROE is expected to trend downwards by around 40 bps until 2012.
Consensus estimates for Hartford's EPS forecast that it will grow by 74.2% to $3.38 in 2012 and then by 10.4% and 26.3% in the following two years. Assuming a multiple of 7x and a conservative 2013 EPS of $3.68, the rough intrinsic value of the stock is $25.76, implying 19% upside.