While the rest of the market has rallied during the first few months of this year, shares in American International Group (AIG, Financial) have struggled thanks to a large, unexpected reported loss for the fourth quarter of 2016.
For the fourth quarter, the company reported a $3 billion loss, thanks to $5.6 billion of loss provisions. Claims on commercial insurance contracts have continued to be much bigger than anticipated when the policies were written. In other words, American International Group is still trying to make up for its past mistakes nearly a decade after its financial crisis bailout of $185 billion. The company has divested 17 businesses were a total of $13 billion as part of a two-year turnaround plan, which began a year ago.
Turnaround plan
Under the plan, then-CEO Peter Hancock pledged to return $25 billion of capital to shareholders and last November, the company told investors it was aiming for a “normalized” return on equity from its primary insurance business of 10% – up from 7.8% last year. However, alongside the massive unexpected loss reported in February, management said the return on equity target was being lowered to 9.5%.
And now Hancock has decided to step away from the business, American International Group’s future looks even more uncertain. It’s no wonder shares in the insurance group are down 3.1% year to date, underperforming the Standard & Poor's 500 by around 8.5%.
The question is, has this selloff presented investors with an excellent opportunity to get into the business while it is still in the process of its turnaround?
Time to buy?
At first glance, it looks as if value investors should consider the business. Shares in American International Group are trading at 0.8 of book. This low valuation is arguably correct given American International Group’s low return on equity and substantial losses.
If the business can hit its ROE target of 10% and is consistently profitable, it should trade at book value, but until consistent profitability is achieved, the firm deserves a discount. There’s also now the big question of management to consider. Hancock was American International Group’s fifth CEO since “Hank” Greenberg stepped down in 2005. If a successor is found it will be the group’s seventh CEO in 12 years; that does not bode well. Any new candidate will have to bear this in mind and will also have the likes of Carl Icahn (Trades, Portfolio) (who is American International Group’s fourth-largest shareholder with a holding of 4.7%) to please. Pressure from activist investors will likely make the job of turning around an unwieldy mess of an insurer like AIG a tough task not for the fainthearted.
Without direction
While the search for a new CEO takes place, American International Group is rudderless; as it is only halfway through the two-year plan that was supposed to return the business to health, it is reasonable to assume the insurer’s recovery will be pushed back further. And even when a new CEO is found, it’s likely he will bring his own plan to the table. American International Group’s turnaround plan has effectively been put on hold indefinitely.
Ultimately, without a strong management team in place, it's hard to see American International Group as a value investment. The insurer still needs to do a lot of work before it can claim to have returned to health. The business just can’t run on autopilot yet so without a figurehead directing the restructuring the company will founder, lackluster returns will continue, and shareholders will suffer.
Hancock is going to remain in place until his successor is found, but he is unlikely to want to rock the boat anymore having effectively been forced out by shareholders who disagree with his approach.
If a new CEO is found who has the skills and staying power required to steady the ship, granted, American International Group’s shares could rally, but this may take some time. In the near-term uncertainty prevails and the shares might get cheaper still.
Disclosure: The author owns no share mentioned.
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