AIG’s Fundamentals Remain Strong; Fairly Valued At $31

AIG (NYSE:AIG) put up a strong performance in the second quarter of 2012, with core businesses showing signs of sustainable and profitable growth. ^[1] Net income reported at $2.33 billion was up 27% over the second quarter of 2011. This is the third straight profitable quarter for the company, which was once branded a failure by the public.

AIG has recovered remarkably since its fall from grace, which led to a $182.5 billion bailout by the U.S. Treasury Department in 2008. We discuss below a few key metrics that influence our of $31 valuation of the AIG’s stock.

Check out our complete coverage of AIG here

Property & Casualty Continues To Remain Strong

Property & casualty insurance, more commonly known as the Chartis division, is AIG’s biggest bread-winner. The division accounts for more than 56% of the company’s stock value and has performed admirably through the last few quarters. Although the global insurance industry was hit hard by natural phenomena in the last three months, with storms in the U.S. leading to $328 million in catastrophe losses, (See Dallas Storms Are A Bad Sign For Insurance Companies) Chartis was able to improve its loss ratio from 104% to 102% through prudent underwriting.  ^[2]

Chartis was the name given to AIU Holdings LLC to dissociate it from the parent company following the 2008 disaster. However, the public opinion of the company has recovered to an extent that it is once again ready to use the name AIG for its property and casualty business. (See AIG Is Ready To Use Its Own Name Again For P&C Business)

Although AIG has sold of many of its foreign units, it continues to penetrate in emerging markets of Asia and Latin America. About 48% of the company’s net premiums were written outside the U.S. and Canada, with 10% in high-growth economies. Consumer insurance, which is primarily targeted at the middle income demographic, now represents 40% of total net premiums for AIG. As Asia and Latin America experience a boom in their economies, we expect global property and casualty insurance premiums to rise steadily through the next few years.

Variable Annuities A Risk?

SunAmerica, AIG’s retirement solutions unit, reported a 20% increase in variable annuity sales. Variable annuities have been selling like hot cakes in the last few years as they offer higher returns to customers. Above a certain guaranteed amount, these returns are variable based on the performance of the chosen investments. MetLife (NYSE:MET) was the leading seller of the product in 2011, generating $4.93 billion in sales. However, as the product is equity-linked, the insurer along with peer Hartford Financial Services Group (NYSE:HIG) believes that it is a risky proposition for the company in the present volatile market conditions and has reduced variable annuity sales this year.

AIG has adopted a different strategy by increasing the product sales. It recently purchased broker-dealer Woodbury Financial from Hartford in order to increase distribution. We believe that AIG will see a near–term increase in its share of the U.S. retirement solutions market. The profitability of this share however remains questionable.

AIG bought residential mortgage-backed securities with market value of $2.8 billion as part of the Maiden Lane II sale by the Feds, earlier this year. These bonds will yield an average of 10.4%.

The U.S. Treasury completed the sale of government-held AIG shares, worth $5 billion, last Friday. ^[3] AIG purchased about $3 billion worth of these shares, reducing the government’s stake in the company to 53%.  Although it does not affect the company’s fundamentals, the sale has inspired investor confidence. We believe that AIG’s stock is fairly valued as our price estimate of $31 on the company’s stock, in line with the current market price.

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1. American International Group’s CEO Discusses Q2 2012 Results – Earnings Call Transcript, 3^rd August, 2012 [↩]
2. Update: AIG Is Too Good A Long-Term Idea To Pass Up, Seeking Alpha, 3^rd August, 2012 [↩]
3. Enough Whining, AIG Deal Was a Winner: Street Whispers, The Street, 7^th August, 2012 [↩]