American International Group (AIG – yield 2.1%), a diversified insurance company operating in over 100 countries, reported a larger-than-expected fourth-quarter reserve charge of $5.6 billion on the afternoon of February 14. The market was expecting a $3 billion charge.
In the January 24, 2017 issue of Cabot Undervalued Stocks Advisor, I discussed the fourth quarter reserve charge:
“On January 20, AIG announced that it will pay Berkshire Hathaway’s National Indemnity Co. unit $9.8 billion plus interest, and in return, the Warren Buffet company will provide a maximum of $20 billion of insurance coverage on future insurance claims at AIG. The transaction will bring a large fourth-quarter 2016 charge to AIG, in return for lower future reserve risk, lower earnings volatility and management’s intent to give shareholders higher capital returns.”
The Berkshire agreement covers insurance liabilities from a wide variety of claims, some of which are decades old.
There is also good news in the earnings report. The company announced an additional $3.5 billion share repurchase plan. Share repurchases and dividend payments in 2016 and 2017 are targeted to total $25 billion. Investors should note that companies do not spend cash flow on dividends and stock buybacks when they are in poor financial condition; therefore, the quarterly reserve charge was disappointing, but it does not harm the company’s future outlook.
Operating profits for AIG’s consumer-insurance businesses rose 56%.
Management has an ongoing focus on reducing its core loss ratio in order to achieve a 2017 return on equity (ROE) of 9%. The 2016 core loss ratio improved by 4.1 basis points in 2016 to 66.7%, with a low 60s target during the next few years.
AIG has strong future earnings growth projections, a low P/E, a nice dividend and a relatively low debt ratio. The full-year 2016 loss per share from continuing operations was -$2.93. The market is expecting 2017 and 2018 earnings per share of $5.34 and $6.45, which is why I added the stock to the Growth Portfolio in October.
The market punished the stock today, pushing the price down to about 61. I would absolutely buy additional shares at the current price. I still expect insurance companies to be one of the best-performing industries in the stock market in 2017. Strong Buy.
Stocks I’d buy today: Archer Daniels Midland (ADM), Dollar Tree (DLTR), Exxon Mobil (XOM), Goldman Sachs* (GS), Martin Marietta Materials (MLM), Molina Healthcare* (MOH), Quanta Services* (PWR), Royal Caribbean Cruises* (RCL), Schnitzer Steel* (SCHN), Total (TOT), Vertex Pharmaceutical (VRTX) and Whirlpool* (WHR).
*Appears immediately capable of rising.
GameStop (GME – yield 5.8%) has some upside resistance, just above 26. If you were in it for a short-term trade, plan your escape. Everybody else will likely see additional capital gains this year, because despite the stock’s slow-growth scenario, it’s still undervalued. Hold.
Kraft Heinz (KHC – yield 2.6%) will be this afternoon’s wild card, set to report fourth-quarter EPS of $0.88-$0.89. The company is on track for aggressive earnings growth, but it’s currently fully-valued. The stock broke out of a very steady trading range this month, and could therefore easily rise a pleasing amount in the coming weeks as long as today’s earnings report is fair-to-good. Hold.