American Equity's Growth Strategy: Playing Out According To Plan
Summary
- American Equity's stock has significantly outperformed the broader market over the last year. Additionally, the company's recent earnings results show that management's growth strategy is already bearing fruit.
- The takeaway: this insurer is well-positioned for 2022 and beyond, even if volatility is expected to pick up over the next few quarters.
- We are considering purchasing shares of American Equity.
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American Equity Investment Life Holding Company's (NYSE:AEL) stock has performed extremely well lately, as it has outperformed the broader market by almost 30bps over the last year.
Additionally, AEL shares are also outperforming the S&P 500 (SPY) on a YTD basis.
I believe the strong stock performance for this company is a direct result of investors' positive view of how management has this insurer positioned for the future. In my opinion, American Equity is well-positioned financially and operationally for 2022 and beyond.
It also helps the bull case that the company's ambitious growth strategy, AEL 2.0, is already bearing fruit as this insurer continues to report impressive operating results and growth metrics.
The Plan, AEL 2.0
American Equity's management team launched their AEL 2.0 initiative in late 2020 and, so far, the growth strategy has been playing out as planned.
The strategy called for this insurer to rethink how it approach its overall business from top to bottom. AEL 2.0, as management describes it, is a flywheel that starts with the end goal (i.e., capital efficient returns) in mind.
American Equity's Investor Day
Source: American Equity's Investor Day Presentation, Feb. 17, 2022
There are 3 main pillars to this strategy:
- Go-to-Market: Focuses on how the company designs and distributes its products, especially the insurer's key growth driver, Fixed Index Annuities ("FIA"). Management's objective is to redesign the company's products so that they can be distributed through attractive channels (e.g., independent marketing organization [IMO]) and reinsure more risk to its business partners.
- Investment Management: Management views their operations as a spread business with the focus being on creating fee-like revenue streams instead of piling on risk to grow the company. As such, the management team is laser focused on increasing the spread between what the company earns on its investments compared to the associated costs, while also shifting the holdings of its investment portfolio to more attractive assets, e.g., private assets.
- Capital Structure: The focus here is to create financial flexibility by utilizing internal and external reinsurance to off-load some of the risk associated with the company's growth strategy.
The AEL 2.0 strategy, in my opinion, definitely adds risk to the American Equity story but I also believe this growth strategy could create a tremendous amount of value, if risk is properly assessed, measured and managed.
Based on my review of the company's recent operating results, management has made great progress over the last few quarters as it relates AEL 2.0, and Q1 2022 was no exception.
The Latest, Q1 2022 Results
On May 4, 2022, American Equity reported EPS of $5.73 on revenue of $147.8mm.
American Equity's Q1 2022 Financial Supplement
The highlights:
- Net income increased by ~$283mm, or 104%, YoY as the company benefited from the derivatives in place
- FIA sales accounted for 98% of the company's total first quarter sales of $902mm, which is in line with the company's long-term growth strategy
- Net Investment Income ("NII") increased by $70mm, or 14%, YoY fueled by improved yields on the investment portfolio (more on this below)
- Repurchased $253mm worth of common stock on a YTD basis through April 30
There was a lot to like about American Equity's Q1 2022 report but, most importantly, it showed that management is making real progress when it comes to the 3 pillars of the AEL 2.0 growth strategy.
Go-to-Market
The company's first quarter sales were $902mm, which was mostly made up of FIA sales (98% or $883mm). The quarterly FIA sales were a 33% increase from the same period of the prior year and continues the positive growth trend for the company's in-focus annuity product.
Additionally, management highlighted the expansion of the North End Re business relationship to include additional American Equity products. This expanded partnership will allow for American Equity to accelerate the fee-like revenue stream that management is so focused on at this point in time.
Investment Management
The company reported an investment spread of 2.51% for Q1 2022 as compared to 2.00% reported in the year-ago quarter.
American Equity's Q1 2022 Financial Supplement
There were several drivers for the increased investment spread but management spent the most time during the conference call highlighting the positive impact of shifting the portfolio to holding more private assets. More specifically, management noted that privately sourced assets now make up 15.4% of invested assets as of Q1 2022 compared to 14.7% at year-end 2021.
The portfolio shift may not seem like much but, as noted above, the move resulted in American Equity being able to generate $70mm in additional NII - this is meaningful for an insurer this size.
Capital Structure
As mentioned above, American Equity entered into an expanded agreement with North End Re to create an additional $6bn in capacity under the reinsurance treaty signed between the two companies in 2021. I believe that this was another step in the right direction as American Equity continues to evaluate how much risk the company will take on to growth its business.
The company's Q1 2022 results were strong almost across the board, and most importantly, the earnings material and management commentary showed that the long-term investment thesis for American Equity remains intact.
Valuation
Based on American Equity's historical metrics, the stock is currently trading at the higher end of the P/Bv range.
However, AEL shares are trading well-below Morningstar's calculated fair value for the stock.
Morningstar
While American Equity is not as attractively valued as it was a year ago, I believe that investors would be wise to be patient as the company's growth story continues to play out.
Risks
The biggest risk for any insurer, including American Equity, is the sufficiency of the company's reserves. The company will likely have immaterial one-off reserve charges on a somewhat consistent basis, but any material adjustment could negatively impact the stock price.
Additionally, investors need to also consider what is shaping up to be a challenging macro environment. A deteriorating economy would eventually negatively impact the financial sector. As such, American Equity's stock would likely be under pressure if the U.S. entered a recession.
Bottom Line
This under-the-radar insurer is a name that investors should get used to, as I believe the AEL 2.0 strategy has great potential in the changing insurance space.
It is looking more likely that the second half of 2022 could turn out to be a bumpy ride for investors as inflation and geopolitical concerns are starting to take center stage but, in my opinion, American Equity's management team has this insurer positioned to emerge from any potential pullback in a way that could great a tremendous about of value for shareholders. The stock may experience volatility over the next few quarters due to broader market concerns, but I believe investors with a long-term perspective should consider adding AEL shares on any significant pullbacks.
Disclaimer: This article is not a recommendation to buy or sell any stock mentioned. These are only my personal opinions. Every investor must do his/her own due diligence before making any investment decision.
This article was written by
Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, but may initiate a beneficial Long position through a purchase of the stock, or the purchase of call options or similar derivatives in AEL over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.