Sunday, March 18, 2007

AIG Analysis

In this segment, we will look at AIG, a Dow component and look at its prospects. AIG's business is described as follows in the 10-K.

AIG’s General Insurance subsidiaries are multiple line companies writing substantially all lines of commercial property and casualty insurance and various personal lines both domestically and abroad. Domestic General Insurance operations are comprised of the Domestic Brokerage Group (DBG), Reinsurance, Personal Lines, and Mortgage Guaranty.
AIG is diversified both in terms of classes of business and geographic locations. In General Insurance, workers compensation business is the largest class of business written and represented approximately 15 percent of net premiums written for the year ended December 31, 2006. During 2006, 8 percent and 7 percent of the direct General Insurance premiums written (gross premiums less return premiums and cancellations, excluding reinsurance assumed and before deducting reinsurance ceded) were written in California and New York, respectively. No other state accounted for more than five percent of such premiums.
The majority of AIG’s General Insurance business is in the casualty classes, which tend to involve longer periods of time for the reporting and settling of claims. This may increase the risk and uncertainty with respect to AIG’s loss reserve development.

Insurance, especially long tail insurance can make the earnings lumpy. So, in this segment, let us look at various business lines to see how things look like.

The various business lines of AIG are:


AIG’s primary Domestic General Insurance division is DBG. DBG’s business in the United States and Canada is conducted through American Home, National Union, Lexington, HSB and certain other General Insurance company subsidiaries of AIG. During 2006, DBG accounted for 54 percent of AIG’s General Insurance net premiums written.


The subsidiaries of Transatlantic Holdings, Inc. (Transatlantic) offer reinsurance on both a treaty and facultative basis to insurers in the U.S. and abroad. Transatlantic structures programs for a full range of property and casualty products with an emphasis on specialty risk. Transatlantic is a public company owned 59.2 percent by AIG and therefore is included in AIG’s consolidated financial statements.

Personal Lines:

AIG’s Personal Lines operations provide automobile insurance through AIG Direct, a mass marketing operation, the Agency Auto Division and 21st Century Insurance Group (21st Century), as well as a broad range of coverages for high net-worth individuals through the AIG Private Client Group. 21st Century is a public company owned 61.9 percent by AIG and therefore is included in AIG’s consolidated financial statements. During the first quarter of 2007, AIG offered to acquire the outstanding shares of 21st Century not already owned by AIG and its subsidiaries.

Mortgage Guarantee:
The main business of the subsidiaries of United Guaranty Corporation (UGC) is the issuance of residential mortgage guaranty insurance, both domestically and internationally, on conventional first lien mortgages for the purchase or refinance of one to four family residences. UGC subsidiaries also write second lien and private student loan guaranty insurance.

Foreign General Insurance:

AIG’s Foreign General Insurance group accepts risks primarily underwritten through American International Underwriters (AIU), a marketing unit consisting of wholly owned agencies and insurance companies. The Foreign General Insurance group also includes business written by AIG’s foreign-based insurance subsidiaries. The Foreign General Insurance group uses various marketing methods and multiple distribution channels to write both commercial and consumer lines insurance with certain refinements for local laws, customs and needs. AIU operates in Asia, the Pacific Rim, Europe, including the U.K., Africa, the Middle East and Latin America. During 2006, the Foreign General Insurance group accounted for 25 percent of AIG’s General Insurance net premiums written.

For followers of Berkshire, the AIG credit rating is not as good as Berkshires. In 2005, the AIG credit rating was downgraded and as a result, AIG had to put up significantl collateral. In contrast, Berkshire enjoys the top most credit rating that can be given.

2006 was an unusually good year for AIG as was the case for insurance companies in general because of the absence of major catastrophes in the world. In 2005, AIG paid out about three billion for the Katrina and other related catastrophes. AIG's business segment revenues and incomes were as follows for 2006.

General Insurance - 49.2 billion
Life insurance and retirement services - 50.1 billion
Financial Services - 8 billion
Asset management - 5.8 billion

The income was as follows:

General Insurance - 10.4 billion
Life Ins and Retirement Service - 10 billion
Financial Service - 0.5 billion
Asset Management - 2.3 billion

The major uptick in income came in the general insurance section where the income increased from 2 billion to 10 billion. Income from Financial Services declined significantly by about 2 billion in 2006 compared to 2005.

AIG is expanding aggressively in Asia and so far about 20% of its revenue is from Asia. The company is seeing growth opportunities in China, India and Japan.

One can expect the insurance rates to be soft this year - car premiums are staying flat or declining because of the decrease in accidents. The re-insurance sector is also expected to be soft this year because of catastrophe free year of 2006.

The value line investment survey published a survey of AIG. According to valueline, AIG's EPS will be 7.80 by 2011 and book value will be $60.00. Valueline thinks the share price will be 135 to 180 dollars per share in this time frame. However, this assumes the Price/Book and Price to earnings ratios to remain high or higher.

Overall, the value line forecast seems a bit aggressive to me including the low end. While AIG is a good company, my opinion is that Berkshire is a very compelling investment as well. Berkshire does insurance better than AIG and has other well diversified business and stock holdings. Currently berkshire is selling for about 28% discount to fair value.

Sunday, March 11, 2007

MMM (3M) Analysis

3M is a diversified technology company with a global presence in the following businesses: industrial and transportation; health care; display and graphics; consumer and office; safety, security and protection services; and electro and communications. 3M is among the leading manufacturers of products for many of the markets it serves. Most 3M products involve expertise in product development, manufacturing and marketing, and are subject to competition from products manufactured and sold by other technologically oriented companies.
At December 31, 2006, the Company employed 75,333 people, with 34,553 employed in the United States and 40,780 employed internationally.

The company is growing at around 7-8% year over year but is facing tough comparisons this year compared to last with lower EPS this year compared to last. This is one of the reasons the stock is down. The analysts are expecting flat to slight growth this year compared to the previous year. Next year is expected to be somewhat better with a growth of about 10-12%.

Let us briefly take a look at the revenues by geographic region and growth by geographic region. The revenues by geographic region look as follows:

US - 38.6%
Asia Pacific - 27.3%
Europe - 25%
Latin America and Canada - 9.1%

The EPS has grown at around 9% for the past ten years. The top line growth is more abysmal at around 4.5% per year for the past ten years. The operating profit has increased at the rate of 6%.

In the same period, the number of outstanding shares has declined by about 8%. One can expect the total number of shares to decline slowly in the upcoming years. The cash flow from operations continues to be strong - growing at around 10% per year. The debt has also increased in 2006 compared to 2005. The dividend has grown at around 8% per year for the past five years. One can expect this ratio to continue in the upcoming years.

Indian market overview

In the previous article, we looked at major India funds and compared their performance against the BSE Sensex Index. We found that the mutual funds werent doing well and were lagging the BSE Sensex by a large margin. When we analyzed the Chinese market, we found the results to be identical - the funds lagged the index by a large margin.

The BSE Sensex index went down by about 15% since its peak and it is a good thing. People may think that the market should go up but this isnt the case. A correction like the one we have seen is very healthy as it ensures the long term health of the market and killing excessive speculation.

Let us take a look at different funds to see how things look like. Let us compare the charts of the various India funds and EEM looks like when comparing against the BSE Sensex Index. The comparative charts of the funds and their performance is noted below:

Chart comparing BSE Sensex vs other funds

Even with this correction - the expected return for Indian stocks in a best case scenario is 10-12% for the next four - five years. A deeper correction will provide more upside if the economy is managed well in the next several years.

Thursday, March 01, 2007

Berkshire Hathaway (BRK) Valuation

Today, Warren Buffett's holding company, Berkshire Hathaway released its earning report. The results were stunning - with 16.9 billion dollars of net worth added.

The annual letter provides a lot of details and is a joy to read. The worlds best investor clearly delivered in 2006 while adding significant positions to the equity portfolio and buying companies outright.

In this section we estimate the intrinsic value using two methods. First one is book value * multiple. The second one is a multiple of the book value.

For the first method, we will use two multiples - 1.9 at the low end and 2.0 on the high end. This gives a per share value of 132.5K at the low end and 139K at the higher end. The mid point between these two is 135.75K.

The second method would involve investments + sub earning * multiple. This is 80636 + ( 3625 * 12 ). This gives a value of 124316. This assumes that the insurance operations are worth only the investments per share. If we assume the insurance businesses are worth atleast 10 billion on top of the per share investments, it adds 6,600 per share. This gives a value of 130916.

Either way, we are looking at a valuation of 125K+ and currently the shares are selling at a 25% discount to intrinsic value.