AIG: The Making Of A Cash Flow Machine

2) The Price/Sales metric for AIG is 37% less than for BRK-A.[5]

If I wanted to buy a piece of AIG, I would be inclined to buy on a pullback or consider a bull put position with a strike of $45 or less ($45.50 was where the price was before the earnings report).

Breaking down the sources of the quarter’s earnings, I found these statistics interesting:

1)    42.8% From the life and retirement unit;
2)    40.6% From the property casualty unit;
3)    13.9% From investments in Private Equity and Hedge Funds
4)      2.7% From the mortgage insurance unit.

I was personally surprised by the almost 14% from private equity and hedge funds. But that reflects my prejudice about big financial companies (that were bailed out) engaging in proprietary trading. Once I thought it through, I realized that what AIG is doing is not that unusual.

Finally, my eye was drawn toward a very sizable accrued tax benefit that will provide AIG management with some financial flexibility moving forward: “Net Deferred Tax Assets” of $16.7 billion.[6]   And AIG reports it is still working on the sale of its plane-leasing unit to a Chinese group for $4.23 billion. That sale does not impact present or future earnings because that business has already been backed out of the figures reported for Q2!

INVESTOR TAKEAWAY: Even if you are not interested in being a shareholder of AIG or trading its stock or options, the transformation of this “Bail Out Icon” from “too big to fail” to a (relatively) slim and trim cash flow machine is remarkable and well worth noting. For some of you, its relative value and the commitment of AIG management to enhance shareholder value through a dividend and a huge share buyback could be a compelling draw. We have already seen, on multiple occasions, the very beneficial impact of share buybacks and dividends on the price of a company’s stock.

FIX ECONOMY, DAMMIT!

As you know, the U.S. Federal Reserve (FED) had it monthly meeting on July 30-31. In my earlier article, I alerted you regarding what to watch for in statement issued following the meeting. “Will we be Fed or Fed up?”

The level of “Fed Angst” felt by the market since May of this year (precipitated by Ben Bernanke’s injection into our daily investment lexicon of the term “taper”) cannot be overstated. Take a look at this chart of the CBOE 10 Year Treasury Note Rate Index (TNX). We moved from a 1.639% rate on May 1^st to 2.715% on July 5^th… then to as low as 2.488% on July 22^nd.[7]  Particularly noteworthy is a look at how “itchy” traders’ “trigger finger” got on the morning of the Non-Farm Payroll release on Friday (August 2) – when, fearing a “good” unemployment number (eg. new jobs over 195,000) the rate was pushed up to the edge of a breakout above 2.73%!

However, once traders applied rational thought and analysis to the reported 162,000 new jobs and discerned that the decline in the unemployment rate to 7.4% (lowest rate since 2008) was enabled by another sizeable “exit” from active job hunting, traders’ anxiety eased – thereby leading to a rate decline to 2.602%by the close. Other notable metrics in the report included the following: CHART I (below)

1)    Hourly earnings decreased by 0.1%;
2)    That goes hand-in-hand with a seemingly growing trend toward new job creation occurring predominantly in lower-wage categories;
3)    Another trend (that some associate with corporations trying to limit healthcare costs imposed by the “Affordable Care Act”) that was continued in this report is an increase in the share of part-time hires.  [See Chart I – from U.S. Bureau of Labor Statistics (USBLS)]
4)    The “Discouraged Workers” metric increased (See Chart II—USBSL)

CHART II
5) Here is a metric that shows how much longer the current unemployment duration is vis-à-vis prior recessions! (USBSL). [8]

Let’s review that statement released by the FED following the mid-week meeting. We had alerted you to the fact that it would be a stretch if the FED had changed their June characterization of economic growth from “moderate” to anything higher. If the only GDP number you heard from this past week’s report was the 1.7% growth ascribed to the second quarter, you would surely have thought that I had “missed” something important – since the “expected” number had been just 1%. However, with all government numbers, you need to keep any “headline” number in perspective be hunting (very quickly) for any/all “prior period adjustments”!  In this quarter’s GDP report, that was the crucial metric – since the Q1 number was cut from 1.8% to 1.1%!  Therefore, the first half GDP came in at 1.5%, so far below the FED’s own projection for FY 2013 GDP that the U.S. will not reach the FED’s projection unless the second half experiences GDP growth between 3.1 and 3.8%.[9]

In light of all the above, the FED actually changed its growth adjective from “moderate” to “modest”![10]  Also of note, the FED added language to the effect that a risk exists for “persistent below-target inflation”. Because that risk was precisely the risk that prompted Fed Governor Bullard to dissent from the June FOMC statement[11], Bullard did not dissent from this month’s decision.

Those are the “essentials” from the FED’s statement. It turns out that our article was very much “on target”. That being said, I learned something of significant import this past week about the U.S. economy since the depths of the “financial crisis”. I will try to be brief in sharing what I learned.

Politicians, commentators, investors, and the “average citizen” have grown accustomed to verbalize our economy in terms of phrases such us “as we strive for recovery”, “waiting for recovery”, “what is Congress doing to speed our recovery”, etc.  In light of that, consider this graph of “Real Gross Domestic Product”, in billions of dollars:

Do you see anything surprising? It is right there in front of you!

What happened in Q2 of 2011?

Yes, our economy exceeded the 2007 (prior) high level of GDP!

This means that, technically, we “recovered” in that quarter!  Ever since then, we have, technically, been “expanding”!

Settle down now, folks!!  It’s not healthy for your face to turn bright red as your blood pressure rises and you scream at me: “Expansion! Expansion! We don’t have any frickin’ ‘expansion’! You are full of _____ (fill in the blank).”

Yes, folks, that is exactly how I felt when I saw this graph. Throwing the “technicalities” out the window, I think most of us agree that this does not “feel” like an “expansion.”

Now look at this graph of GDP growth from quarter to quarter. Notice that, following the steep “jump upward” in Q2 of 2011 (when we technically achieved “recovery”) our growth has been tepid and very irregular.  For the purpose of visual perspective, a reasonable long-term “average” for US GDP growth would fall approximately at the horizontal gridline shown on the graph’s left axis at “0.6”.

Therefore, as you can see, we have been spending a lot of time “below average”, and most recently, just above “zero”.  No wonder we use the phrases we currently use to characterize our economy!! “Tepid” hardly feels like an “expansion”!

INVESTOR TAKEAWAY: I wish I could say that the markets will now turn their attention away from the FED to other, more normal and traditional “inputs” with regard to the current market “value” of stocks and bonds.  Alas, as the “trigger finger” of bond traders illustrated on August 2^nd, that is so unlikely to become true that I (and you) should put it out of my mind (but not out of my dreams).

In this world awash is government provided liquidity (FED, BOE, ECB, BOJ), our markets have developed an addiction to that artificial liquidity. The rational among us know that these regular money “injections” (market mainlining, so to speak) will not and cannot be sustained forever. But until the markets, at some future point in time[12], reach a more sustainable equilibrium – it behooves us to stay closely in tune with central bank policy.

DISCLOSURE: The author does not presently own AIG or BRK-A. Nothing contained in the above article is intended to be a recommendation to buy or sell anything. Always consult with your financial advisor before buying or selling any security. Finally, the FED regularly ignores the author’s advice.; but he takes comfort in the fact that, someday, it will come around to his way of thinking.

Submitted by Thomas Petty MBA CFP