ALIZY - Allianz: I Remain On The Sidelines

Summary

• I am a big fan of the Allianz stock, which has been in my broadly diversified portfolio for many years and where I keep buying shares.
• Even after the current rally, the dividend yield of more than 5 percent based on the next dividend increase is tempting.
• However, I remain on the sideline as the risk/reward ratio isn't attractive enough.
• The recent price rally has been at the expense of multiple expansions.
• Furthermore, I would like to see some more clarity on possible lawsuits against Allianz by investors who have lost their money regarding the Structured Alpha funds.

I am a big fan of the Allianz stock ( OTCPK:ALIZF ; OTCPK:ALIZY ), which has been in my broadly diversified portfolio for many years and where I keep buying shares. Last year, however, the company underperformed compared to the sector. In autumn, the performance of the share was even worse than that of the S&P 500. It was only at the end of last year that the share stabilized somewhat, and since then, it has put in a decent performance.

Bottom line: Allianz enjoys tailwinds from a rising interest rate environment

Well, insurance shares have done well in recent months. In particular, investors are pricing the current interest rate turnaround positively for financial companies and insurers overall.

This also applies to Allianz. Let's take a quick look at the life and health insurance, accident and damage insurance, and asset management divisions and start with asset management, which will, however, suffer from higher interest rates in the short term. Allianz, with its subsidiaries PIMCO and Allianz Global Investors, is one of the largest asset managers in the world. After weak years from 2014 to 2017, things started to look up again with significantly higher sales and profits. However, due to high-interest rates, investors are now withdrawing capital from asset management, leading to lower assets under management-driven revenues and performance fees. Turnover in 3Q 2022 was minus 1.4 percent. Operating profit even fell by 10 percent. In addition, in 2Q 2022, Allianz held most of its capital in bonds within the scope of asset management, at almost 1.7 trillion euros. Due to rising interest rates, the prices of bonds already in the portfolio are falling, leading to book losses. On the other hand, new bonds yield higher interest rates, from which Allianz's asset management benefits. Allianz also benefits from rising interest rates in the insurance business as it collects capital from policyholders' contributions and invests this money within the regulatory limits, including higher-yielding bonds. Somewhat surprisingly for me, Allianz even showed impressive resilience in asset management in Q3 2022, as CFO Giulio Terzariol emphasized in the earnings call :

Finally, on the Asset Management, yes, we have outflows. This is not surprising in an environment like this one, but when you look at the operating profit performance that’s resilient. We had an operating profit of €2.4 billion for the nine months, and this is more or less the level that we had last year when the market condition were much better. So this sign of resilience is definitely a positive message.

In addition, inflation makes damage claims more expensive, for example, because new purchases or repairs cost more than they did a few years ago due to increased prices and supply chain problems. While this may lead to higher costs in the short term, it will be absorbed by higher premiums in property and casualty insurance as outlined by CFO Giulio Terzariol:

The inflation point, because I think you ask about inflation, reality doesn’t need to be a negative for the expense ratio. Because yes, we are going to have higher cost, also higher salary cost, but the premium increases, they should indeed offset for the potentially higher expenses. So from that point of view, we don’t view inflation to be necessarily a negative for the expense ratio development.

The Alpha (Funds) Problem

Unfortunately, not everything is so rosy at Allianz, as the company has to deal with compliance problems. Allianz Global Investors is deep in a maelstrom of alleged investment fraud. Employees of Allianz Global Investors have made false promises to investors with Structured Alpha funds. Pension funds and other institutional investors sometimes invested up to USD 11 billion in these Structured Alpha funds. However, Allianz Global Investors deliberately glossed over the risks and even misled investors about the performance of these funds. In the Corona crash, Allianz Global Investors then had to liquidate and wind up the funds partially . Allianz must now atone for this trickery. So far, Allianz has paid billions in fines to the US Department of Justice and is not allowed to offer investment funds in the US for ten years through its subsidiary Allianz Global Investors. Accordingly, the management has dissolved the US fund business of Allianz Global Investors, incurring one-off additional costs of EUR 140 million .

But the risk is not over yet, because now there is the threat of a wave of lawsuits from investors who have been left with the losses. The internal compliance of Allianz, which did not uncover the machinations for many years, has to put up with the accusation of lacking supervision. As always, the actual risks of such proceedings are not fully foreseeable for investors. After all, Allianz has already reached several settlements, e.g., among others, with the health insurance organization Blue Cross Blue Shield .

But I remain skeptical. Despite the interim successes, I see the sword of Damocles hanging over the stock. How difficult it is to estimate the financial impact is already evident from the provisions that Allianz had booked concerning official proceedings and compensation. After a provision of EUR 3.7 billion in February 2022, Allianz booked another provision of EUR 1.9 billion in May 2022. In a press release , management expressed optimism that this provision would be sufficient for compensation payments to investors and authorities. However, a short time later, the penalty payment to the SEC alone of EUR 6 billion exceeded the provisions formed. Investors cannot rule out that Allianz will have to build up further reserves in the future and thus have less capital available for share buybacks and dividends. The previous provisions and penalties have already destroyed much shareholder value (and trust). In the first nine months of 2022, net income attributable to shareholders fell by 31.5 percent due to provisions. In this respect, I find it disappointing that further potential risks around the 3Q earnings call were not addressed.

The bottom line is that I am not only disappointed by the compliance breach itself, but also by the handling of it by senior management. I think the CEO is trying hard to keep the issue down, and in terms of share price maintenance, that may even be the right way to go about it. But as a long-term investor, I want to know my risks transparently. That's what I'm missing in Allianz's communication with investors.

Allianz is no longer attractively valued

Furthermore, Allianz is no longer fairly valued. Even with the expected dividend increase to EUR 12.12 per share and a dividend yield of 5.5 percent, the share is only just above the two-year corridor of 5.2 percent. We also see below that the recent price rally has been at the expense of multiple expansions. In recent years, there have clearly been better times to add shares to one's portfolio.

Conclusion

The dividend yield of more than 5 percent based on the next dividend increase is tempting. For me, however, the risk/reward ratio is not sufficient to put larger tranches of Allianz shares in my portfolio at the moment. For one thing, the share has already run very well and is slightly overvalued. In view of the blatant failures of internal supervision in connection with the Structured Alpha funds, I would also like to see a little more clarity that there were no further blatant compliance violations. Plus, I would appreciate more clarity on possible lawsuits against Allianz by investors who have lost their money. All in all, the share is currently only a 'hold' for me.

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