AIG - AIG's Lean Operations Create Value

2023-11-14 02:23:55 ET

Summary

• AIG's 2022 spin-off of Corebridge Financial has been beneficial thus far.
• Concerns abound over commercial real estate exposure.
• The firm's focus on its legacy business lines should continue improving earnings quality and business-level growth.

Investors should buy shares of American International Group, Inc. ( AIG ).

Government bailouts tend to not sit well with people, and AIG's debacles during the 2008 Global Financial Crisis are an excellent example of this. The firm has not regained its trading highs of 2006-2007 but has still rebounded nicely from its darkest days.

AIG's current strategy seems to revolve around selling many of its low-growth assets and business lines to plow the subsequent earnings into its core insurance product lines. This is best evidenced by the firm's 2022 spinoff of Corebridge Financial ( CRBG ). My last article on AIG focused on whether or not the Corebridge spinoff would be successful. Since then, it seems that the Corebridge spinoff has indeed been a success. During AIG's Q3 2023 Earnings call, CEO Peter Zaffino commented :

September marked the one-year anniversary of Corebridge's initial public offering. And since the IPO, Corebridge has returned approximately $1.4 billion to shareholders and is well on track to its committed payout ratio. With respect to our remaining ownership of Corebridge, we continue to evaluate options that are aligned with the best interest of shareholders and our other stakeholders. We're very proud of the achievements that Corebridge has delivered towards its operational separation as a public company, and we remain committed to reducing our ownership and eventually a full separation.

If AIG can continue building upon the success of the Corebridge spinoff, then the firm can further bolster its operations and improve its competitive advantage throughout the competitive insurance industry. However, there are concerns surrounding the firm's exposure to commercial real estate and fixed income investment securities.

Outlook

There are several important factors that investors should consider prior to purchasing AIG shares:

1. Operating Performance

AIG has demonstrated strong performance throughout 2023, with respectable year-over-year pre-tax income growth. Moreover, the firm has increased the total number of insurance premiums written between 3Q 2022 and 3Q 2023. This was ideally not accomplished using lower underwriting standards but has still helped AIG's underwriting income nonetheless. AIG's leadership team has demonstrated a common tendency to quantify operating performance via a non-GAAP adjusted return on common equity metric. The firm's returns have subsequently been positive in this area, and the firm has continued plans to fortify returns through a bolstering of underwriting income.

2. Commercial Real Estate Exposure

AIG's CRE exposure is important given rising lending rates worldwide. The firm has "focused on multi-family, industrial, and non-traditional office origination." Of these loans, AIG's $8.8 billion office exposure is most concerning. The firm reports a decent allowance for credit losses in the case of bad debt, and has taken many steps to reduce its risk. Many of the loan covenants include debt service coverage ratios of at least 2x with an approximately 65% loan-to-value ratio. Moreover, 78% of AIG's loans are class A properties that are still in demand despite work-from-home trends. Investors can find solace in the fact that AIG's leaders have been intentional in their investments and have not resorted to low lending standards to improve the firm's profitability.

3. Investment Securities Portfolio

AIG's leadership team touts a "$273B high quality investment portfolio with asset duration that aligns with the liability profile of the business." While the firm's fixed income assets are theoretically safe, there is some concern over the pricing of these securities. It is true that the yields of these securities have risen, but this has been expense of price in line with the traditionally inverse relationship between price and yield. Available-for-sale securities must be carried on AIG's balance sheet at their fair market values, which reflects that a forced liquidation could cause the firm quite a few realized losses. This is a key risk area that should be monitored going forward.

Valuation

Companies in different industries require distinct valuation methods. While a discounted cash flow model may be appropriate for firms in high-growth industries, it is more appropriate to value insurance firms based on their balance sheets. Issues with U.S. GAAP accounting are partially to blame for this distinction, but this is remedied by the fact that many of each insurance firm's assets are carried on the balance sheet at their fair values. Therefore, AIG was valued through a combination of a peer group price to tangible book value multiple and a dividend discount model.

AIG's peer group was selected with respect to market capitalization, geographic distribution, and total deposits. Based on these characteristics, a comps list of Chubb ( CB ), The Hartford ( HIG ), Allstate ( ALL ), Aflac ( AFL ), MetLife ( MET ), and Travelers ( TRV ) was used to value AIG. Using return on common equity, return on assets, market capitalization, and price to tangible book value data, the average and median of these values for the peer group were calculated to provide a good relative comparison to AIG. The 2.5 times price to tangible book value peer multiple implies that AIG is worth $123 per share instead of $64. However, multiples valuation alone is not sufficient to prove whether a firm is fairly valued since forming a peer group is quite subjective.

A dividend discount model was used to find the firm's intrinsic value. AIG has a history of paying dividends to shareholders, and these cash flows were used to value the firm. The inspiration for using a DDM was taken from David B. Moore, a CFA with Marathon Capital Holdings in San Diego, California. Mr. Moore published a guide on valuing community banks whereby he argues the merits of using a DDM to price financial stocks.

Based on the firm's future discounted dividends, AIG has an intrinsic value of $168 per equity share. This can be further amended to a target range of $137 to $203 per share, which implies significant upside. With respect to assumptions included in the base-case model, a 9.5% discount rate was used in addition to earnings and dividends estimates taken from Capital IQ. Moreover, a second-stage growth rate of 1% was used along with a terminal price to earnings ratio of 10.5. Please remember that these are estimates and are meant to illustrate a reasonable base case that does not consider a significantly negative or positive event.

Summary

Despite past turbulence, AIG has demonstrated remarkable resilience through slow, yet consistent, growth in its competitive advantage. Stability appears to be the goal of current CEO Peter Zaffino, and continued intentionality surrounding the acquisition and disposition of various business lines should help the firm over the long term. However, investors must be wary of the firm's exposure to commercial real estate and the intricacies of the bond market.

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