Yesterday, we upgraded our recommendation on American International Group Inc. (AIG) to Outperform from Underperform based on increased optimism about gaining capital flexibility. Despite the financial upheaval within AIG, it enjoys the leading insurer position, according to Fortune 500, given its diversified and unique franchise in both domestic and international markets.
While asset disposals and repayment of a chunk of debt have increased operating efficiencies, the execution of the recapitalization program also appears favorable for book value growth. Even the fourth quarter loss was slightly lower than the Zacks Consensus Estimate as core insurance operations generated stable results.
The federal aid has warded off a collapse and the company now appears to have pulled itself together again. However, some of the metrics are still deteriorating, albeit at a reduced pace. We expect the company to benefit from its scale of operations with a recovery of the economy in 2011 and beyond.
AIG continues to stabilize its core insurance operations and progress on its restructuring plan. Over the last several quarters, the company disposed of more than 30 assets, divested a U.S. auto insurer, more than 50 aircraft from its plane-leasing unit and Israeli and Canadian mortgage guarantors among other major ones, while also streamlining its operations in an effort to repay the bailout money.
For this, it expects to use earnings from business operations and from disposing other redundant businesses, such as the Nan Shan unit in Taiwan.
Besides, with an appreciation in the equity market and a gradual recovery in the economy in the upcoming quarters, we expect AIG to recoup the value of its investments. This has also helped the company dispose of its redundant and risky businesses at attractive valuations.
Recently, Fitch rating agency affirmed its “BBB” rating on all of AIG’s senior debt, reflecting a stable outlook, while S&P Ratings upgraded its outlook on AIG and subsidiaries to stable from negative.
Due to this improved trend, the debt markets have become more accessible to AIG, with the execution of the recapitalization plan. During the fourth quarter, AIG raised more than $5.5 billion of new, non-government debt through a debt offering, a contingent capital facility and new bank facilities.
AIG’s unique operational focus and management discipline even amid a challenging economic and intensely competitive environment has helped its businesses to be back on track sooner than expected. While Sun America helped in the modest growth of assets under management, losses at ILFC are also waning and aiding the expansion of its aircraft portfolio.
Meanwhile, operations at the capital markets are also gearing up driven by changes in credit spreads on the valuation of derivatives. Even premiums at Chartis have started showing up and UGC has also swung to profit, during the fourth quarter of 2010. Going forward, these operations are expected to shore up the core growth and help mitigate operational risks, making AIG financially flexible once again.
However, AIG has been incurring tremendous amounts of restructuring charges, including loss from discontinued operations, which has even absorbed the operating earnings, thereby swinging the company to a consolidated loss. We expect the earnings to be significantly hampered by these one-time non-recurring charges in the forthcoming quarters as well.
Further, although AIG has been streamlining its operations and focusing on core insurance business, the weak property-casualty market has become detrimental to the company’s growth. We are also concerned about the company’s significant exposure to residential and commercial mortgage backed securities, which have been facing headwinds since the recession that started in mid-2007.
These factors have also been resulting in losses at the Chartis unit, which is plagued by higher-than-expected loss reserve charges. As a result, in February 2011, both Fitch and S&P downgraded their ratings on Chartis to “A” from “A+”. Going forward, the consistent increase in adverse reserve development poses additional risk on AIG’s underwriting capabilities.
AIG is working rigorously to restructure its operations in order to increase leverage and generate capital to repay the government’s bailout money, which will in turn liberate the company from pay restrictions.
Overall, with the help of a reviving economy and the appreciation in the equity market in the upcoming quarters, we expect AIG to accentuate the value of its investments. Hence, we recommend an ‘Outperform’ stance with a Zacks #1 Rank in the short term.
On Monday, the shares of AIG closed at $37.10, down 0.8%, on the New York Stock Exchange.
AMER INTL GRP (AIG): Free Stock Analysis Report
Zacks Investment Research
