BAM - American Equity Investment Life: Takeover Candidate + 15% Buyback Yield

Summary

• A significant increase in the company's net investment income resulted from a rise in interest rates.
• AEL announced a $400M increase to its share repurchase authorization, bringing the total to $594M, which is a significant growth driver for the share price.
• Earnings per share and dividends per share both rise as a result of repurchasing shares, and over the coming year, dividends are projected to rise by 5%.
• The stock price is attractively valued, and the business is a takeover candidate.
• I believe the stock is a good investment.

Introduction

American Equity Investment Life ( AEL ) specializes in the sale of fixed index and fixed rate annuities. In a rising interest rate environment, the corporation stands to gain more from its investments, strengthening its financial position.

Interest payments on the corporation's investment portfolio, which includes fixed-rate bonds, will rise when interest rates rise. More money will likely flow in from the company's investments, which could mean more money will be distributed to the shareholders. With rising interest rates come better yields on bond investments and higher returns on the company's insurance policies, which in turn means more money for the corporation to reinvest.

There is little chance of a rate drop from the Federal Reserve in the foreseeable future, and the combination of a higher investment yield and the successful implementation of AEL 2.0 boosts profits in the short and long run.

If we look at the stock's total return over the past 10 years, we find that it performs similarly to the S&P 500. Probably because of its low valuation relative to the S&P 500 index, AEL has also been an attractive takeover target in recent years.

AEL Is A Great Potential Takeover Opportunity

Several companies have made offers to acquire American Equity Investment Life, making it a possible acquisition target. AEL rejected a recent offer from Prosperity Group to acquire the company for $45 per share in cash most likely because it grossly undervalued AEL.

Raymond James recommends buying American Equity Investment Life because it has recently completed a restructuring strategy and because of its takeover potential. Wilma Burdis, an analyst at Raymond James, wrote the following:

Brookfield Asset Management ( BAM ) appears committed to holding on to its ~18.5% stake in American Equity ( AEL ), but is constrained by its standstill agreement with AEL that stays in place until 2025. "But, BAM could attract a third-party activist, and given it can vote its first 9.9% as it wishes, it could have considerable impact if a third party threatens a proxy fight to vote out board members or management," Raymond James analyst Wilma Burdis wrote in a note to clients. Even without that scenario, AEL 2.0 "remains compelling,".

An earlier 2020 offer from Athene, MassMutual ($36 per share) to acquire American Equity Investment Life was also turned down . Instead of accepting the offer, Brookfield Asset Management acquired a significant stake in the business.

The successful implementation of their restructuring strategy and the company's cheap stock valuation make American Equity Investment Life a desirable investment. Due to its promising future, I anticipate an increase in takeover bids or, at the very least, a rise in its share price.

If AEL 2.0 is implemented as intended, the Board appears confident that shareholders will benefit from a rise in the company's value.

AEL 2.0 Is A Strong Growth Catalyst

American Equity Investment Life unveiled its new strategy, AEL 2.0, in 2020, which it expects to boost profitability for years to come.

A strong growth forecast was presented at the December Investor Symposium 2022 , with the average yield projected to increase to 4.8% in 2025 and beyond from 4.3% in 2022, and investment spreads projected to increase to 2.9% in 2025 and beyond from 2.6% in 2022.

It is projected that the new business IRR will be between 12% and 14% in 2022, and between 12% and 15% in 2025 and beyond.

Using third-party reinsurance from outside parties and improved investment yields, the company is well on its way to achieving fee-based earnings.

Strong results were achieved in the third quarter of 2022 due to increased yields from the investment portfolio as the company continued to increase its allocation to privately sourced assets. Also, the company maintained its share repurchase activities, in line with its capital return targets for the year.

Net investment income increased $83 million from the comparable quarter in 2021 due to an increase in average yield on investments due to strong returns from partnerships, the benefit from higher short-term interest rates on its floating rate portfolio, lower cash balances, and the increase in allocation to higher yielding privately sourced assets to 18.4% of the investment portfolio. American Equity's investment spread was 2.73%, up from 2.64% in the previous quarter and 2.40% in the previous year's third quarter.

American Equity Investment Life is in a strong position to grow as a result of the favorable conditions given by the current high interest rate environment.

Dividend Growth And 15% Buyback Yield

In light of American Equity Investment Life's recently announced $400M share repurchase program, the company's total share repurchase authorization stands at $594M. When compared to the $4 billion market cap (buyback yield of 15%), this is a sizable amount.

A high buyback yield indicates that the company is repurchasing a significant amount of its stock, which can be a positive signal to investors. By reducing the number of outstanding shares while maintaining the same level of earnings, share repurchases can boost earnings per share for AEL.

American Equity Investment Life's stock repurchase program is an indication to investors that the company is optimistic about its future and believes its stock is undervalued.

Along with share repurchases, the dividend was increased by 9.1% annually on average over the past decade. At the present dividend rate of $0.36, the dividend yield is 0.78%.

Looking at the company's cash flow history, we can see that it has repurchased a sizable number of shares during this time period. However, just 28% of the company's free cash flow was used for share repurchases and dividends. Potential dividend increases are high due to the substantial cash flow compared to shareholder return.

Looking ahead, we are optimistic about dividend growth and shareholder return because of the $594M in share repurchases that should also help boost dividends per share and the potential for share price gains. For the coming year, analysts predict a growth in dividends of 5% per share.

Stock’s Valuation Is Cheap

According to YCharts, the stock's valuation appears to be favorable, with a PE ratio that comes in at 3.4. The price-to-earnings ratio at the present time is significantly lower than the five-year average of 7.1. The YCharts graph reveals that the stock is trading at a low price relative to its historical average. As a result, it should not come as a surprise that AEL has rejected multiple acquisition offers.

YCharts displays the price to earnings ratio based on GAAP, but Seeking Alpha displays the price to earnings ratio based on non-GAAP. The current price-to-earnings ratio (non-GAAP) is 11, and over the next several years, 9 analysts have revised their earnings per share predictions upward. These analysts anticipate an annual growth in EPS of almost 20% on average.

Last but not least, we take a more in-depth look at the price to book value. This shows that the stock is valued expensively when compared to its historical PB ratio. However, this is not an accurate comparison because interest rates have significantly increased, which has led to an increase in the company's profitability. Since it is not anticipated that interest rates would drop any time soon, a greater price to book value is justified in my view.

Conclusion

A significant increase in the company's net investment income results from a rise in interest rates. As inflation remains elevated, the likelihood of a rate drop from the Federal Reserve is low. Successfully implementing AEL 2.0 boosts profits both immediately and over the long run. As the corporation proceeded to grow its allocation to privately sourced assets, the investment portfolio began to generate higher yields, which contributed significantly to quarterly profitability. AEL also announced a $400M increase to its share repurchase authorization, bringing the total to $594M, which is a significant growth driver for the share price. The buyback yield of 15% is substantial. Earnings per share and dividends per share both rise as a result of repurchasing shares, and over the coming year, dividends are projected to rise by 5%. With fewer shares in circulation and greater demand, the high buyback yield should lead to an increase in the stock price. The stock price is attractively valued, and the business is a takeover candidate. I believe the stock is a good investment.

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