We downgraded our recommendation on American International Group Inc. (AIG) to Underperform from Neutral based on the critical sustainability factor given the weak global cues, sluggish insurance dynamics and consistent cash outflow.
Despite raising funds in the past few quarters and repaying a chunk of its debt, AIG is yet to attain capital flexibility. 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 July 2011.
AIG’s operating cash flow has been declining to an outflow of $3.5 million from cash generation of $16.9 million in 2010 and $18.6 million in 2009.
Additionally, AIG has limited sources of raising funds at this juncture, now that Treasury’s stock offering has also been locked for at least 120 days and given the poor market price performance, the full liberation from the Treasury’s stake is expected to take a couple of years. Hence, absence of any near-term fundamental growth catalyst casts a shadow on the outlook of AIG in the coming months.
AIG has also been incurring enormous catastrophe (CAT) losses and restructuring charges, including loss from discontinued operations, which has even absorbed the operating earnings in the past several quarters. CAT losses and restructuring charges swung AIG to a consolidated loss in the first quarter of 2011, whereas CAT losses again widened 80% year over year to $539 million in the second quarter.
These factors question the company’s claims paying ability, earnings visibility and long-term growth from core operations. Although AIG witnessed some bottom-line recovery in the second quarter of 2011, it is too early to define a trend as we expect earnings to be substantially hampered by more one-time non-recurring charges in the upcoming quarters as well.
Furthermore, AIG continues to face significant threats to its business model, customer base and distribution network as a result of the volatile financial drivers and intense competition in the market.
The company has experienced a decline in its top-line growth due to reduced premiums and deposits over the last several quarters, principally due to lower sales of investment-oriented life and retirement services products as sales efforts remained challenged due to the lingering effect of negative AIG events and an overall decline in industry sales of investment-oriented life and retirement services products.
Additional concerns hover around AIG’s execution risk particularly once the government takes back all support. While the asset disposals have helped the company repay a chunk of its debt, it has also shrunken AIG’s portfolio and global market share. 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).
Countering these downsides are some positive risks that could help AIG gain strength in the long run. AIG continues to stabilize its core insurance operations and progress on its restructuring plan. Additionally, stable ratings outlook on the company’s debt and the recapitalization enabled AIG to access the debt and stock markets to raise funds. These factors have also been driving the ROE and book value per share growth, albeit at a lower pace.
Earnings Review
AIG reported second-quarter operating earnings of 69 cents per share that lagged both the Zacks Consensus Estimate of $1.15 per share and $1.18 per share reported in the year-ago quarter, due to an additional 1.655 billion shares issued to the U.S. Treasury Department on January 14, 2011. However, operating income of $1.3 billion jumped 60.9% from $793 million in the year-ago quarter.
Results reflected retention of stability through American International Assurance Co. Ltd (AIA) coupled with its insurance operations managed to drive the premiums, pro forma book value per share and ROE during the quarter. These were, however, offset by higher catastrophe losses, underwriting losses and other unrealized losses amid the ongoing business restructuring process.
However, third quarter earnings are expected to be 73 cents per share, up from a loss of $1.47 per share, while revenue growth is expected to decline about 37%. Additionally, the quantitative Zacks Rank for AIG is currently #4, indicating slight downward pressure on the shares over the near term.
Hence, given the multiple factors and slow pace of growth, we currently recommend an Underperform stance on AIG, while we await the clearance of smog over the stock.
AMER INTL GRP (AIG): Free Stock Analysis Report
METLIFE INC (MET): Free Stock Analysis Report
PRUDENTIAL FINL (PRU): Free Stock Analysis Report
Get all Zacks Research Reports and be alerted to fast-breaking buy and sell opportunities every trading day.
Be the first to comment