Is AIG Still A Good Value?

In late August, we suggested that the consensus among hedge fund managers that American International Group, Inc. (NYSE:AIG) was a good stock to buy, combined with the fact that the stock was low priced in terms of both its earnings and the book value of the equity, made it a good value. Read our article on AIG. The government-rescued insurance company’s share price is up 5% since the beginning of September, carrying it to a 48% gain year to date. However, it has underperformed many financial stocks over the past couple months.

FAIRHOLME (FAIRX) Bruce Berkowitz

Bruce Berkowitz’s mutual fund Fairholme was heavily invested in American International Group, Inc. at the end of June. The fund owned about 88 million shares, giving it a position with a market value of nearly $3 billion. This made it by far the largest position in Fairholme’s 13F portfolio by market value (find more top stocks from Fairholme). Billionaire Leon Cooperman’s Omega Advisors more than tripled its stake in AIG during the second quarter to a total of 4.6 million shares, making it one of the ten largest positions in Omega’s 13F portfolio as well (see more stock picks from Leon Cooperman).

The company’s 10-Q for the second quarter of 2012 shows a small increase in revenue and a 27% increase in earnings compared to the second quarter of 2011. Premium revenue was actually down slightly, with top-line growth driven by capital gains. AIG’s revenue was also lower on a q/q basis, as was net income. In the first half of the year, cash flow from operations came in at $1.6 billion (versus a decline in cash flow from operations in the same period of last year) and cash flow from investing activities remained strong. In terms of multiples, American International Group, Inc. is still cheap. At a P/B of 0.6, it still trades at a large discount to book value. At 10 times forward earnings estimates and a five-year PEG ratio of 0.4, sell-side analysts are highly bullish on the stock as well. There’s considerable risk in staying with AIG (and its beta of 1.9 signifies substantial exposure to the market) but it still looks undervalued to us.

We would compare AIG to other property and casualty insurance companies such as The Travelers Companies, Inc. (NYSE:TRV), ACE Limited (NYSE:ACE), The Allstate Corporation (NYSE:ALL), and The Chubb Corporation (NYSE:CB). These companies are generally priced at similar multiples to AIG in terms of forward earnings estimates. Chubb has the highest forward P/E, at 13, and its business was generally unchanged in the second quarter from the second quarter of 2011. It certainly doesn’t seem to be as good a value as AIG, though its dividend yield and low beta of 0.5 give defensive investors at least some reason to own it. ACE, during the same quarter, saw its revenue and earnings come in considerably lower than a year earlier (net income was down 45%). It carries a forward P/E of 10, equivalent to AIG’s, with a lower expected growth rate in addition to its lower historical one. It seems to be overvalued relative to AIG as well.

Allstate and Travelers are in the same territory in terms of forward P/Es, at between 9x and 11x. Both of these insurers trade at slight premiums to book value as their P/B ratios are 1.1. So on an earnings basis they are even with AIG (though their expected growth rates are considerably lower) but on a book basis they are considerably more expensive. Their revenue growth rates in recent quarters have also been more modest (though, in its most recent quarter, Travelers managed to more than double its net income versus a year earlier).

We like AIG better than its peers in the insurance industry. Even if its growth rate slows, and falls below sell-side expectations, it should still be high enough to justify a slightly better stock price.

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