AFGC - Buffett's Great Success: The Power Of Insurance Dividends

2023-07-28 07:35:00 ET

Summary

• Warren Buffett is a consistent buyer of rich and discounted cash flows.
• Investing like Buffett is different from investing in/with Buffett.
• Two +6% yields from Berkshire's favorite industry.

Co-authored with “Hidden Opportunities.”

In 2022, Berkshire Hathaway’s ( BRK.A , BRK.B ) insurance operations brought in $75.6 billion in total revenues, representing a quarter of its top line. Holdings include GEICO, Berkshire Hathaway Primary Group, and Berkshire Hathaway Reinsurance Group. Warren Buffett, the Oracle of Omaha, has a long love affair with insurance companies, which he calls cash-generating machines.

Insurance companies collect fees upfront (premiums) before providing their service (paying out insurance claims). They sit with large piles of cash known as "float" that are available to deploy until it is required to settle policyholders' claims. Mr. Buffett notes this as "money we hold and can invest but that does not belong to us.” These represent an excellent form of leverage for Berkshire, so they don’t have to employ traditional methods of leverage as retail investors or other institutions do.

Warren Buffett is also known to make lucrative fixed-income security deals to provide a much-needed cash infusion to distressed companies. His deals with Goldman Sachs ( GS ), Bank of America ( BAC ), General Electric ( GE ), Dow Chemical ( DOW ), and Kraft Heinz ( KHC ) in the aftermath of the Global Financial Crisis proved very rewarding in the long run, with consistent income and significant capital upside, despite appearing sour at the start.

Mr. Buffett’s wealth and influence amongst institutions give him access to develop customized deals that are out-of-reach for the average investor. As such, we study the markets and identify opportunities that we consider excellent bargains for our income needs. Today, we discuss two deeply discounted fixed-income securities from renowned insurance firms that offer rich income streams for your passive income needs. Let’s dive in!

Pick #1: Athene Preferred Shares - Up to 7.8% Yields

In this rising rate environment, annuity sales are hitting new records , and industry experts are projecting the sales of these retirement products to remain strong at least through 2027. By 2030, all Baby Boomers (~73 million people) will be over the median retirement age of 65, positioning retiree-focused financial products on the path to growing adoption.

Athene Holding Ltd. is a wholly-owned subsidiary of Apollo Global Management, Inc. ( APO ), a high-growth alternative asset manager with asset management and retirement services capabilities. In its own merit, Athene is a leading retirement services company that issues, reinsures, and acquires retirement savings products. Notably, Athene was ranked the second-best company in America for fixed index annuities by the Secure Retirement Institute.

Industry tailwinds and strong execution led to Athene being ranked #1 in Total Fixed Annuity Sales for FY 2022 by LIMRA . The company maintains an excellent balance sheet, rated A+ by leading credit agencies. Source .

Now let's look into the company’s preferred securities that are deeply discounted and sport large yields.

• Athene Holding 6.35% Fixed-to-Float , Non-Cumulative, Series A Redeemable Perpetual Preferred ( ATH.PA )

• Athene Holding 5.625% Fixed Rate , Non-Cumulative, Series B Redeemable Perpetual Preferred ( ATH.PB )

• Athene Holding 6.375% Rate-Reset , Non-Cumulative, Series C Redeemable Perpetual Preferred ( ATH.PC )

• Athene Holding 4.875% Fixed Rate , Non-Cumulative, Series D Redeemable Perpetual Preferred ( ATH.PD )

• Athene Holding 7.750% Rate-Reset , Non-Cumulative, Series E Redeemable Perpetual Preferred ( ATH.PE ).

ATH-D presents an excellent bargain for fixed-rate seekers, offering a rich 7.3% yield and 49% upside to par. ATH-C provides a 6.8% yield at a modest discount to par for those seeking floating-rate exposure and has a very high base floating-rate after its call date in September 2025.

Athene has five public preferreds that pay qualified dividends with a range of attractive discounts to par value. During Q1, Athene reported $1.2 billion in net income, $47 million on preferred dividends, and $374 million in common dividends to its parent company. The company’s execution shows that the preferreds enjoy substantial dividend coverage.

Athene will host a Fixed Income Investor conference call on August 16th to provide updates on current business trends, new business origination, the investment portfolio, and capital.

Pick #2: AFG Baby Bonds - Yields 6%

American Financial Group, Inc. ( AFG ) is a Property & Casualty insurance leader with origins dating back to 1872. The company offers a wide range of insurance products to customers across industries and occupations. It is notable that AFG recently completed the acquisition of Crop Risk Services from American International Group, Inc. (AIG), further strengthening its market leadership in this niche segment. Source .

The company has an industry-leading Specialty P&C combined ratio (losses from claims to premiums collected) of under 94% for 10 years, indicating high-quality underwriting and sustained profitability over the long term. AFG carries financial strength ratings of A+ by leading agencies while its senior notes are rated A-, and its subordinated notes – the baby bonds discussed in this report carry investment-grade BBB+ credit ratings.

AFG common stock performance is highly indicative of a prosperous company, with 134% price gains over the past 10 years.

The company has also created substantial value for shareholders, with regular share repurchases and a 12.4% CAGR dividend growth in the past decade. AFG has raised common dividends consistently for the past 14 years.

In FY 2023, AFG expects its operations to generate significant excess capital, positioning the P&C leader well to deploy ~$500 million towards share repurchases and special dividends, in addition to the capital return to shareholders during the first quarter of 2023. Notably, AFG insiders and employees own almost 24% of the outstanding shares, indicating strong management alignment with the interests of shareholders.

During Q1 2023, AFG reported a healthy combined ratio of 89.2% (a 5.2 point improvement YoY) and excess capital of ~$1 billion. The company purchased $24 million of its common stock during the quarter, paid a substantial special dividend (costing $340 million), and spent $54 million on regular common dividends. Additionally, AFG repurchased $18 million of its senior notes during the quarter.

AFG ended Q1 2023 with $857 in cash and cash equivalents. The company has no debt maturities until 2030 and no borrowings on its available credit line, indicating strong flexibility with its liquidity position and excess cash flows to continue shareholder stewardship.

The company spent $19 million on interest expenses in the first quarter, a $4 million decrease YoY because of the retirement of its 3.50% Senior Notes in 1H 2022. This expense represents a tiny fraction of the amount AFG spends on buybacks, and common stock dividends, indicating a high degree of safety to your income stream. Interest expenses will continue to reduce, given the company is utilizing its excess cash flows to repurchase its senior notes.

AFG baby bonds present safer income opportunities at deeply discounted prices. AFGE presents a solid 6.1% yield and presents up to 36% upside to par value. Remember, AFG baby bonds traded up to 15% above par value in the midst of the yield-less market in 2021, and this price performance can easily repeat in the years ahead. AFG baby bonds mature 30+ years from now but are callable starting 2024.

• 5.875% Subordinated Debentures due March 30, 2059 ( AFGB )

• 5.125% Subordinated Debentures due December 15, 2059 ( AFGC )

• 5.625% Subordinated Debentures due June 1, 2060 ( AFGD )

• 4.500% Subordinated Debentures due September 15, 2060 ( AFGE ).

Today, these baby bonds offer CD-beating interest income with substantial upside when the Fed reverses course on monetary policy. Up to 6.2% yields and 36% capital upside from this A+ rated insurance leader.

AFG reports earnings on August 2nd.

Conclusion

Fifty-five years ago, Mr. Buffett spent $8.6 million to acquire National Indemnity, a property and casualty insurance company based in Omaha. This transaction opened the door for Berkshire to become a beneficiary of significant cash flows generated by this industry, which the conglomerate could put to work as it sees fit.

We often get asked this question – “if you want to invest like Buffett, why not just buy BRK.B?”

While it is a reasonable recommendation, there is a big difference. As an investment, Berkshire doesn’t pay dividends to produce cash flows for the investor but collects them with both hands. Its portfolio companies pay billions of dollars in annual dividends. As someone seeking cash flow from my invested assets, this investment doesn’t suit my needs. So I am not investing in or with Mr. Buffett, but I choose to invest like him. And that can lead to several differences in the securities I buy and hold for my income needs.

This article discusses two deeply discounted fixed-income instruments from leading insurers that offer up to 7.8% yields and significant capital upside for a winning portfolio. These picks only represent a tiny fraction of over 65 preferreds & baby bonds in our Model Portfolio, which our subscribers have exclusive access to along with weekly recommendations. Seizing this unique market downturn, where high-quality fixed-income investments are being sold at significantly reduced prices, presents an extraordinary chance to secure substantial yields at a fraction of their true worth. Recognizing the potential, I am acquiring these undervalued assets before Mr. Market wakes up. What are your plans?

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