We are downgrading our recommendation on American International Group Inc. (AIG) to ‘Neutral’ from ‘Outperform’ based on the current sustainability factor. The consistent weakness in the Chartis segment given the sluggish insurance dynamics is weighing heavily on the financials.
Losses at the Chartis segment are primarily due to higher-than-expected loss reserve charges, thereby overshadowing the marginal development from SunAmerica and ILFC. This has also resulted in rating downgrades from both Fitch and S&P earlier this year. Going forward, the consistent increase in adverse reserve development poses additional risk on AIG’s underwriting capabilities.
Additionally, the inability to generate cash flow from operations and a dangling capital position has been severely weighing on the share prices that plummeted over 50% between January and June 2011.
The higher-than-expected restructuring charges, catastrophe and investment losses coupled with adverse reserve developments are also marring the desired upside. We are also concerned about the company’s significant exposure to residential and commercial mortgage backed securities, which have been facing headwinds since the recession started in mid-2007.
On the flip side, AIG’s other divisions are gearing up. While SunAmerica helped in the modest growth of assets under management, losses at ILFC are also shrinking and aiding in the expansion of its aircraft portfolio.
In an effort to repay the bailout money, AIG has been working for the past several quarters to sell its unnecessary businesses. The financial crisis in 2008 crippled the company’s capital structure, post which AIG disposed of over 35 of its redundant assets and as on April 2011, AIG owes about $53 billion to government, shrinking from $182.3 billion loan taken in 2008.
The company is on its way to reduce the Treasury’s stake from the current 77%, which was further reduced from 92% when AIG raised $8.7 billion from a stock offering in May this year. Further, divestiture of assets has helped AIG gain some capital flexibility and also aided in focusing on its core life and property-casualty business.
The company’s first quarter earnings of $1.30 per share came in well ahead of the Zacks Consensus Estimate of a loss of 15 cents per share and earnings of 95 cents per share in the year-ago quarter. Results were driven by stability in core operations. Besides, asset disposals and repayment of a chunk of debt appeared favorable for the book value growth.
We believe that AIG is poised to accentuate its operating and capital leverage upon dilution of the government stake. However, the risk of execution continues to chase considering the company amid intense competition prevail post liberation. Arch rivals such as MetLife Inc. (MET) and Prudential Financial Inc. (PRU) pose a competitive environment for AIG. Several non-recurring charges, associated with the intense restructuring, are also expected to mar the desired upside in the upcoming quarters. This also justifies our neutral stance on the stock.
As a result, the Zacks Consensus Estimate for the second quarter of 2011 stands at $1.07 per share, down by a substantial 46% over the prior-year quarter, although earnings are expected to grow to $3.77 per share for 2011. This is significantly higher than the loss of $6.57 per share recorded in 2010.
Out of 10 analysts, 3 have revised their estimates downward in the last 30 days for the second quarter and full-year 2011, while no upward revision was witnessed.
While the long-term rating is Neutral, the quantitative Zacks #5 Rank (short-term Sell rating) for the company indicates downward pressure on the stock over the near term.
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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