Fallen Blue Chip Could Stage a Double-Digit Rally This Year
Here at Profitable Trading, we're always on the lookout for catalysts that can help deliver quick and robust gains for a stock. Oftentimes, these catalysts are hidden from view, and we have to dig pretty deep to spot them. Other times, these catalysts stare us right in the face. They are practically begging to be noticed, even as the rest of the market may be focusing elsewhere.
Robert Benmosche, the CEO of American International Group (NYSE: AIG), went on CNBC last May and laid out a pair of time-tested stock catalysts: "As we continue to work on our capital plan and work with the Federal Reserve, our next priority would be to put a dividend on the stock, because we think that will increase the potential buyers. We're also looking at potential stock buybacks, as we progress through the year."
Dig a little deeper and you'll understand why this insurer can afford to make those bold promises. AIG has emerged from the financial crisis of 2008 in far stronger shape than anyone could have envisioned. Five years ago, this insurer was mired in debt and in dire need of a government bailout.
Though the bailout ended up salvaging the company, and though it even paid back all the money it borrowed from Uncle Sam, it has been an arduous climb back to relevance. At the end of 2008, total debt stood at $193 billion, forcing the company into a series of asset sales just to stay afloat. A company that had a $79 billion revenue base back in 2007 is now half the size.
The good news: Total debt has fallen sharply, to below $50 billion, and the two remaining divisions, a U.S. life insurer (SunAmerica) and global property casualty insurer, are quite healthy, and throwing off prodigious amounts of cash flow.
It's hard to understate the impact of AIG's revamp on its balance sheet. At the end of 2008, at the depth of the financial crisis, tangible book value stood at -$9 a share. That negative figure, implying a shareholder deficit and no shareholder value, would usually mean a fatal blow for most other banks or insurers. But AIG was "too big to fail" thanks to its role in global finance.
Well, the company has subsequently rebuilt the balance sheet. Tangible book value rebounded to $17.35 a share in 2009 (due to those asset sales that fetched high prices), and ongoing free cash flow has pushed tangible book value $67 a share. Merrill Lynch's analysts see that figure rising to $85 a share by 2015.
Note that this stock currently trades near $45, meaning shares trade for just two-thirds of current book value. Any time you spot a company offering a share buyback when shares trade below tangible book value, you should pounce, as buybacks can push book value per share figures even higher (as the share count shrinks even faster than book value). With shares currently trading at such a deep discount to book, AIG's buyback is a no-brainer.
In an ideal world, AIG would simply focus all of its financial firepower on buybacks, right up until the shares trade at tangible book value. But as Benmosche noted earlier, both buybacks and dividends will be on the table in coming quarters.
What kind of buybacks and dividends are we talking about? Consider that AIG is generating roughly $7 a share in free cash flow to its balance sheet. If half of that is earmarked for a buyback and the other half for a dividend, AIG shares could offer a dividend yield of 7.8%.
AIG will soon meet with regulators to ensure that the balance sheet is now in fighting shape, so investors may see movement on this front as soon as this summer.
To be sure, management may start slow and fully part with its annual free cash flow in a year or two. Still, once investors do the math on what kind of dividend and buyback this insurer plans to pursue over the long haul, they'll snap up these shares quickly, pushing them toward book value.
On the heels of an expected dividend and buyback announcement, I believe shares could rise from a recent $45 to $60, representing more than 30% upside. That move could happen quickly or take several quarters to play out. That's why you should sit tight and be patient, even if shares only make a modest initial upside move. Regardless, you want to be in this stock before such plans are announced.
Recommended Trade Setup:
-- Buy AIG up to $50
-- Set stop-loss at $40
-- Set initial price target at $60 for a potential 20% gain in 3-6 months