(AIG) American International Group Upped to Neutral

Last week, we upgraded our recommendation on American International Group Inc. (AIG) to Neutral from Underperform based on its improving capital flexibility. Besides, asset disposals and repayment of a chunk of debt appears to be favorable for the new stock buyback program.

AIG reported third quarter operating loss per share of $1.60, which came in way higher than the Zacks Consensus Estimate of a loss of $0.08 and $0.84 reported in the year-ago quarter. Consequently, operating loss of $3.0 billion increased drastically from $114 million in the year-ago quarter.

Results reflected weak performance across all operating segments based on the challenging macro economic environment. Though AIG has been able to head off a collapse by getting government bailout, it continues to face significant threat to its business model, customer base and distribution network as a result of the volatile financial drivers.

This also exposes the company to ample competition from the peer group, which includes stable growth companies such as MetLife Inc. (MET) and Prudential Financial Inc. (PRU).

This included volatile equity markets, widening credit spreads, reduced interest rates along with higher property catastrophe losses, which again surged radically to $2.8 billion in the first nine months of 2011 against $873 million in the prior-year period. Going ahead, we expect the trend to continue as earnings are likely to be hampered by more one-time non-recurring charges substantially in the upcoming quarters as well.

Even ILFC, in its transition phase, has been generating sizeable losses, thereby raising significant execution risk. This has also impelled management to consider an initial public offering (IPO) for the segment in the near future.

As a result, huge declines were witnessed in the market valuation of American International Assurance Co. Ltd (AIA), estimated future cash flows and reduced investment income from Maiden Lane III LLC and Maiden Lane II LLC. Alongside, these factors also affected the book value per share adversely.

Nevertheless, the severe losses witnessed in most of 2011 were primarily related to increased catastrophe losses and other economic factors. AIG’s ongoing business restructuring process has enabled it to focus on quality insurance and investment products and services.

Moreover, stability has also retained through improved premiums at both SunAmerica and Chartis. Meanwhile, the positive pricing trends and continued improved momentum at SunAmerica has helped in the modest growth of retirement and variable annuity products along with assets under management.

Despite the financial upheaval within AIG, it enjoyed the leading insurer position in 2011, according to Fortune 500, given its diversified and unique franchise in both domestic and international markets. Meanwhile, AIG also managed to reduce its Treasury loan to about $50 billion from $182.3 billion in 2008, repaying about $45 billion in 2011 itself. However, the full liberation from the Treasury’s stake is expected to take a couple of years.

Additionally, the successful recapitalization in January last year has enabled AIG to access the debt and stock markets to raise funds when necessary.  The company has also enhanced its capital efficiency by raising about $2.9 billion from the public stock offering and refinancing a couple of bank credit facilities worth $4.5 billion in 2011.

Meanwhile, the recent $1.0 billion share repurchase program sanctioned by the board of AIG should further infuse confidence among the shareholders, thereby adding to earnings, ROE and book value per share.

Going ahead, AIG’s ongoing restructuring and re-pricing initiatives are expected to improve the earnings growth in the foreseeable future. This is further evident from the company’s long-term goal of achieving mid-teens earnings growth along with +10% growth in ROE by the end of 2015, from $2.62 per share and 6.2% ROE, respectively, at the end of 2010.

Given the pros and cons, the Zacks Consensus Estimate for the fourth quarter of 2011 currently stands at 60 cents, up 111% year over year, reflecting improved core insurance portfolio and enhanced capital flexibility. For 2011, we expect AIG to earn 78 cents, up from operating loss in 2010. Additionally, the Zacks Rank for AIG is #3, implying a short-term Hold rating, while the long-term stance is placed at Neutral.

AMER INTL GRP (AIG): Free Stock Analysis Report

METLIFE INC (MET): Free Stock Analysis Report

PRUDENTIAL FINL (PRU): Free Stock Analysis Report

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