Thursday, February 28, 2013

Is Now the Time to Buy AIG?

On Tuesday I went to hear Josh Stirling, who covers Property/Casualty (P&C) insurance stocks for Bernstein Research.

I have only seen Josh a couple of times, but I have been impressed with his knowledge of the industry and of the companies he follows.

P&C insurance stocks have done well in the last couple of years. While earnings growth has been reasonable for most of the stocks, investors who want exposure to the financial sector but have been wary of the bank and brokerage stocks have found a refuge in the P&C insurance group.

Their relative outperformance has driven valuations on many of the P&C insurance stocks to the upper end of their historic ranges.  According to Josh, many of the stocks may continue to perform well, but it is less likely that we will see the strong relative performance that has characterized the group - an assessment that I largely agree with.

That said, there is one stock that Josh has a "table pounding" buy on:

American International Group (AIG).

AIG, of course, was in such tough shape during the financial crisis that the government had to inject billions of dollars to keep the company afloat.  If it hadn't, AIG surely would have failed, and its vast size and huge credit exposures would have been catastrophic.

In 2012, however, the Treasury sold its stock in AIG (at a profit) and the company is once again totally owned by public shareholders.

Current management of AIG is determined to restore its reputation, and has already started the long process to getting the company back to business.

However, its troubled past, and the fact that AIG remains a very difficult company to analyze, has left its stock trading at just 0.5x tangible book value. Most of the other stocks in the PC insurance space, by contrast, are trading at a modest premium to book value.

If AIG can get its operations together, it is not out of the realm of possibility for the stock to trade in-line with its peer group, which would mean big profits for shareholders (in its heyday AIG traded at 4x book, but this would seem unlikely to occur again).

That said, the AIG story still carries significant risks. Although Treasury no longer owns a part of the company, AIG's business operations are still being monitored by the Federal Reserve, making it less likely that it will be able to earn the mid-teen's ROE that many other large PC companies are achieving.

In addition, AIG remains a "show me" story in terms of its operations.  On paper it would seem likely to be able to improve returns, but it is not yet clear that it has the team in place to do this. The current low valuation of its stock reflects the market's skepticism.

Josh, however, feels that for the intrepid investor AIG could be a double or triple in the coming years.  I want to do more work on the stock, but I am definitely interested.

Josh is not the only one who thinks that AIG could continue to work in here.  I came across this piece on the blog Seeking Alpha - here's an excerpt:

The discount from book value for shares in AIG will shrink as the company continues to improve its coverage ratio, which in turn would improve AIG's rating. AIG also has a goal of being investment-grade in 2015. Such a goal will support the view that AIG shares will keep rising. Resuming a share buyback and initiating a dividend would signal management confidence in AIG's interest coverage ratio. This in turn would attract more buyers for AIG shares.