Being the leading U.S. insurance company, American International Group (AIG) has attractive valuations, a fortress balance sheet, and a strong liquidity position, which make us bullish on the stock. The company has sufficient liquidity of $11 billion to buy back its stock. However, the stealth bailout package that the company is said to be receiving might come to an end, as the government completely exits AIG. With a price target of $46, we are bullish on American International Group's stock.
Company Overview and Ownership Structure
American International Group operates as one of the largest insurance companies in the U.S., with operations is over 130 countries. The company provides a comprehensive set of insurance products to individuals, commercial and institutional customers. For the purpose of reporting, the company is organized into the following four business segments, Chartis, SunAmerica Financial Group, Aircraft Leasing and Other Operations. Each business segment's contribution has varied over time, however, Chartis has remained the top contributor with over 50% of revenues coming from this business segment, followed by SunAmerica at around 20%. Over 63% of the total revenues accrue from the company's domestic market, while 13% come from the Asia/Japan regions. The remaining come from other foreign markets. The U.S. Department of Treasury still owns a major stake in the company since its record $182 billion bailout during the U.S. financial meltdown. The government's 92% stake has now reduced to 61%, as AIG continues to buy back more of its stock from the Treasury Department, while only 6.1% of the shares outstanding are classified as free float. A complete government exit might mean an end to the stealth bailout. The recipients of the Troubled Asset Relief Program (TARP), including Citigroup (C) and American International Group, are allowed to make use of the prior year's operating losses to shield current income from taxes. The second quarter ended up with strong liquidity for the group. Experts believe the company will use much of this liquidity to purchase some of its stock.
The company reported stronger than expected performance for its most recent quarter (2Q2012) on August 2, 2012. The insurance company was able to beat consensus estimates for earnings by a significant margin, largely on a tax allowance release of $1.28 billion. Growth in operating income across various insurance businesses also contributed to this improvement. The insurance group was able to beat bottom line expectations of $0.57 by 86%, and post EPS $1.06.
Growth in the second quarter's bottom line was significant when compared sequentially. The company reported net income of $2.33 billion, 27% above the prior quarter's net profit of $1.84 billion, while the top line witnessed a surge of 8% over the same time span.
The table above illustrates the performance of each of AIG's business segments. Revenues from the Other Operations business segment doubled as compared to the previous quarter, while revenues from Chartis and SunAmerica witnessed a decline of 2% and 12%, respectively. After-tax operating income for Chartis and SunAmerica surged 20% and 29% over the prior quarter to $936 million and $933 million, respectively.
Chartis, the group's global property insurance segment, witnessed a 2% decline in revenues, which was attributed to a decline in net premiums written. However, a continuous improvement in the business portfolio and product mix, lower loss ratio, growth in the business of higher value lines and improved pricing of products benefited the segment. The business segment continued to restructure loss-sensitive businesses, which improved capital efficiency. The loss ratio for this business segment improved from 74% in the prior quarter to 68.9% in the second quarter. The combined ratio for this segment also improved from 104% to 102.4% over the same time period.
SunAmerica, the domestic life insurance segment, experienced a 12% decline over the prior quarter in revenues, which was primarily associated to the prevailing record low interest rate environment and the resultant decline in individual fixed annuity deposits, partially offset by higher sales of other less interest sensitive products, individual variable annuities and retail mutual funds. The continued low interest rate environment, which is anticipated to continue until 2014, will have an adverse impact on SunAmerica's earnings. 2012 pre-tax operating income from this segment could decrease by $10 million, while 2013 and 2014 earnings could take a hit of up to $60 million and $125 million.
The Aircraft Leasing segment witnessed a 3% increase in revenues over the prior quarter. Rental revenues largely remained flat during the second quarter at $1.1 billion.
Capital & Liquidity Position
The company has a strong capital position, with a 12% financial debt to capitalization ratio. The book value for American International Group increased 5% to $60.58 at the end of the second quarter. The company has a strong liquidity position, and as mentioned above, it will use most of this liquidity to buy back its shares worth $5 billion during 2012.
When compared to most of its peers in the U.S. Insurance industry, American Capital Group's P/B value multiple of 0.54x is at a discount of 20% and 10% to Prudential Financials (PRU) and MetLife (MET). With a book value multiple of 0.63x (historical average) and a book value estimate of $73.14, our price target for the stock is $46. This represents an upside potential of 35%.
Based on the aforementioned thesis, we maintain a bullish stance on AIG.