AIG Downgraded to Underperform - Analyst Blog

Given the critical sustainability factor, we are downgrading our recommendation on American International Group Inc. (AIG) to Underperform from Outperform. The company's poor third quarter performance and the likelihood of more one-time charges in 2011 further justify the demotion.

AIG's third quarter loss of $1.47 per share came in dramatically behind the Zacks Consensus Estimate of $1.35 and the year-ago earnings of $2.42. The lower-than-expected performance was primarily driven by $4.5 billion of restructuring charges including loss from discontinued operations and reduced investment income.

Of late, AIG has been eliminating its significant debt to the government through vigorous asset disposals. This is not only reducing the company's global market share but is also heavily weighing on the operating earnings of the company.

AIG has been incurring tremendous amounts in restructuring charges, including loss from discontinued operations, which has even absorbed the operating earnings, thereby resulting in a consolidated loss for the company. We expect the earnings to be significantly hampered by these one-time non-recurring charges in the upcoming quarters as well.

Though AIG has been able to head off a collapse by getting government bailout, it continues to face a significant threat to its business model, customer base and distribution network as a result of the volatile financial market.

The company has experienced a decline in premiums and deposits over the last several quarters, which was due principally to lower sale of investment-oriented life and retirement services products as sales efforts remained challenged due to the lingering effect of negative AIG events earlier in the year and an overall decline in industry sales of investment-oriented life and retirement services products.

Though the company continues to implement several initiatives in order to generate sufficient capital to repay the bailout money, the concerns that need attention along with the repayment are an improvement in overall managerial efficiency, reinstalling confidence among the dispirited staff. Even after implementing the recent recapitalization program, the government is expected to take about 5–8 years before it can completely sell off its stock and exit AIG's board.

Despite the expiry of the share swap agreement between the buyers of the Taiwan deal and Chinatrust on June 25, 2010, which helped in easing out the political environment in Taiwan, AIG is yet to culminate a deal for its Nan Shan unit in Taiwan. Even after making certain alterations in June 2010 to comply with China's governmental policies, the Taiwan Investment Commission rejected the sale proposal in August 2010 to the interested parties, initiating skepticism on their efficiency to manage such a high profile business.

Although management expects to vend off this asset by the end of 2011 and is reportedly negotiating with the regulatory authorities and interested buyers, the Taiwan deal remains uncertain because there is every possibility that the buyers might pull themselves out of the venture, should government intervention pose further predicaments. Hence, we remain on the periphery till further development.

However, benefits, claims and expense control and asset disposals increase operating efficiencies while the execution of the recapitalization program also appears favorable for the book value growth. AIG will be better able to access the debt markets with the execution of the recapitalization plan.

Moreover, AIG continues to stabilize its core insurance operations and proceed with its restructuring plan. The equity market appreciation has also helped the company dispose of its redundant and risky businesses at attractive valuations, which in turn helped the improvement of total equity/total capital ratio to 68.9% at the end of the third quarter from 66.4% at the end of December 2009. Besides, on Friday, Fitch affirmed its “BBB” rating on all of AIG's senior debt, reflecting a stable outlook.

Overall, AIG is working vigorously to restructure its operations in order to increase leverage and generate capital to repay the government's bailout money. However, significant amount of non-recurring restructuring charges and the delay in the Taiwan deal along with AIG's extensive exposure to risky assets have significantly mitigated AIG's positive initiatives.

Going ahead, there's an increasing possibility of profound one-time charges that would severely impact the earnings of the company through 2011. We are apprehensive that these factors could also offer rival companies such as MetLife Inc. (MET) an undue competitive advantage.

On Monday, the shares of AIG closed at $41.95, down 0.5%, at the New York Stock Exchange.

 
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