AIG is a big hairy monster of a company, kind of like the Gossamer of the insurance industry. I'd be a fool to say that I fully understand all of AIG's numerous divisions and subsidiaries. That said, I think the stock is valued attractively enough to account for the risks inherent in analyzing such a large and diverse company. For the most part, bigger is better when it comes to financial services companies since the larger companies are able to withstand major financial shocks. And AIG is proof positive that bigger is better. The company has endured numerous scandals, hurricanes, and other losses only to return to a strong growth path.
AIG is the world's leading insurance and financial services organization with operations in more than 130 countries and jurisdictions. The company has four major divisions:
1. General insurance. In the U.S., AIG is the largest underwriter of commercial and industrial insurance. This segment offers everything from property insurance to kidnap-ransom insurance for expats.
2. Life insurance and retirement services. Following its acquisition of American General, AIG is the second largest life insurer. AIG also has one of the largest U.S. Retirement Services businesses through AIG SunAmerica and AIG VALIC.
3. Financial Services. The company engages in aircraft and equipment leasing, capital markets transactions, consumer finance and insurance premium financing. AIG's growing global consumer finance business is led in the U.S. by American General Finance.
4. Asset Management. AIG provides asset management for individual and institutional markets with specialized investment management capabilities in equities, fixed income, alternative investments, and real estate.
Like I said, AIG is a beast. In the late 1990s, a mutual fund manager for a major US fund admitted to having a giant "map" of AIG's 100+ subsidiaries on his wall in an attempt to better understand the company. What a waste of time. I have done no such "in depth" analysis. But what I have done is summarized my findings from reading through the 10-k, 10-q and several analyst reports. Here are the important points I think you need to know:
AIG's balance sheet makes the company a financial Juggernaut. AIG's size is an advantage in terms surviving disasters, accessing cheap capital and generating operating leverage. You can absorb a lot of losses from hurricanes, floods and earthquakes if you have AIG's balance sheet. Even AIG's asbestos losses, which have been a chain around the company's neck, are likely to begin declining over the next five years.
And you can also overcome a lot of mistakes when you're that big. AIG recently took about $180 million reserve on problems with its subprime lending division. That's barley a blip on the company's $103 billion in equity or $14 billion in net income last quarter.
Once this giant starts running, it picks up speed. The operating leverage AIG can gain from its worldwide operations should allow it it maintain industry leading margins and returns on equity. There are few, if any, insurance companies that come close to matching AIG's competitive position and absolute growth opportunities in Asia over the next several years. AIG has the only wholly owned Chinese insurance subsidiary. This is a huge competitive advantage that should allow AIG to gain a foothold in many of China's fast growing financial markets.
AIG has relatively stronger growth prospects than its peers given that nearly 60% of total earnings are generated in fast-growing foreign markets. AIG’s franchise is not easily replicated and its strong presence in leading and emerging international markets is a catalyst for future growth. Also, AIG is expecting double-digit earnings growth in Japan as Edison Life and Star Life, AIG’s two operating companies in Japan, merge together and the Company works to rebuild the book of business and grow its insurance in force.
And this monster is getting leaner. The company recently underwent a company-wide capital review, which indicated it had $15-$20 billion of excess capital. As a result, AIG's Board of Directors has expanded AIG's existing share repurchase program by authorizing the repurchase of up to $8 billion in common stock. As part of this authorization, AIG intends to repurchase $5 billion in common stock during 2007. In addition, the company will increase its common stock dividend by approximately 20% annually. In May 2006, AIG raised its quarterly cash dividend 10% from $0.15 per share to the current quarterly dividend of $0.16 per share.
AIG has retained its results-oriented management culture. Even though hard-charging Hank Greenberg is no longer at the helm, the company has retained many of the competitive advantages that he instilled. Most upper level managers at AIG are paid bonuses based on their three year performance numbers, not their quarterly or yearly results. That provides some incentive for not doing something stupid in the short term just to "make the numbers."
The company has been scrubbed clean. Between the New York Attorney General, the SEC and Insurance regulators, I believe no Fortune 500 company has been so closely monitored for the past two years. Ever since the company became one of the biggest targets of the re-insurance scandal, I believe that management has taken steps to make sure the operations are as clean as possible. Combined with the reporting requirements from Sarbox, AIG's top management should have a better handle on the business than ever before.
Given these positives, I think the main risks in owning AIG are the same as with any other insurance company. AIG has written a fair amount of policies in the energy sector so another Katrina-like hurricane would obviously cause losses. The domestic life insurance business has been highly competitive for several years now and AIG hasn't written as many policies because pricing has been under pressure. And a declining bond market will initially hurt the company's portfolio of investments, although the higher yields will benefit the company over the long term.
The Company reported 30% growth in EPS during the first quarter of 2007. Earnings per share were $1.68 vs $1.29 the year prior. The company had a strong showing in foreign life insurance, financial services and asset management. In addition, the General Insurance segment remained strong with premium growth in the energy, environmental and construction lines.
The company had difficulty in the highly competitive US life insurance business. However, foreign life insurance sales remain strong in Asia. Overall, it was an impressive quarter especially in the foreign market segments.
I've looked at AIG's valuation on a historical basis and as a sum of the parts valuation. Either way the stock still looks cheap.
Since AIG is such a complex beast, I decided to value each division separately as compared to its respective peer group. For each division, I calculated the valuation based on the peer groups price/last twelve months sales, price/last twelve months after tax operating income and price/2007 estimated after tax operating income. I then averaged these three values to derive a price for each division. Based on my sum of the parts valuation, I believe AIG is worth $83 today. Having said that, I would add that I believe the company deserves a premium valuation for some of its divisions because of their high growth rates and high ROEs. However, to remain conservative, I'll stick with the mid $80s as a target.
AIG is also cheap relative to its own history despite the fact that the fundamentals seem to be improving consistently over the past four quarters. The stock currently trades at 10.9x forward earnings, which is at the low end of its history and in line with its peers. If the stock traded at its 20 year median forward P/E of 16x, the stock would move well into the $100s.
The stock is also trading at the low end of its historical price to book value. The chart below shows that AIG is currently trading at 1.8x book which is at the very low end of its range.
I believe AIG deserves a higher multiple because of its superior return on equity and relatively high growth rate. The company's ROE of 17.0% is actually much better than the company's multi-line insurance industry peers, despite the fact that AIG is overcapitalized.
And along with a high multiple, I believe that earnings estimates can also continue to go higher. The consensus estimates for this year have moved from $6.27 to $6.53 in the first half of the year.
The stock chart reminds me a lot of General Electric (GE), another hairy monster of a company. Like GE, AIG came down from a premium valuation and spent the next seven years consolidating. GE recently broke out of its long-term consolidation. I believe that AIG could do the same.
Based on the company's improving earnings, strong growth prospects in Asia, strong balance sheet, and great looking chart, I believe AIG will be a good addition to The Unlucky Seven.