Aegon (NYSE:AEG) is a survivor in the insurance business. The company, in its present form, was founded in 1983 with the merger of AGO and Ennia. Both of those companies, in turn, had been in business since the 1800s. Unfortunately, merely surviving hasn’t meant much for investor returns. AEG stock, which peaked at $60 in 1998, is down 90% from those levels twenty years later.
The stock traded at $20 as recently as 2007, but has never made it back to the double digits since the financial crisis. Will Aegon finally be able to chart a new path to prosperity?
Or will AEG stock continue toward another decade of dismal returns? Here’s what you need to know.
Shifting Market Focus
Aegon’s bread and butter has long been the insurance market. Its most important business segment has been the U.S. insurance, retirement, and pension provider Transamerica. It also has insurance businesses around the globe, with operations as far-flung as Latin America, South Africa, and Eastern Europe.
In recent years, however, Aegon is moving toward a more fee-based business model. Since the financial crisis, Aegon has been undercapitalized, and as a result, has made the strategic decision to rein in its insurance exposure while adding more fee business. Since 2010, fee-based revenues are up to about 40% of the mix, compared to under 20% previously.
One of these big new pushes is with its new (founded in 2012) direct bank Knab. Knab is an online banking model focused on crowd-funding. In its home market, in combination with Aegon Bank, they’ve already obtained the #3 market share in crowd-funding, and continue rolling out new apps and partnerships to expand this fintech subsidiary.
While the bank is still a tiny fraction of overall business, it shows Aegon’s ability to move toward new and potentially more profitable opportunities.
Strong Yielder, with a Caveat
The most obvious appeal to AEG stock is its strong dividend policy. The company has raised its dividends (as measured in Euros) every year dating back to at least 2013.
The 2017 full-year payout of 27 Euro cents per common share translates to 31 American cents, representing a 5.2% dividend yield at today’s prices for AEG stock. That figure could rise again assuming Aegon continues with its modest annual dividend increases.
That said, the dividend is far from the safest in the insurance industry. Aegon’s Dutch operations have been undercapitalized for years now. That has prevented the Dutch subsidiary from paying dividends back up to the Aegon corporate parent, leaving the holding company reliant on its overseas operations to fund payments to shareholders.
On top of that, a reversal of the strong US dollar would cause profits from its US operations to decline as measured in Euros, potentially putting a halt to the company’s ability to keep its dividend growth streak alive.
Aegon’s Big Problem: Low Profitability
For the company’s pivotal US operations, Aegon is set to do well if interest rates keep rising. A combination of persistently low interest rates and mediocre management execution has left Aegon’s US insurance business with low profitability.
A Return On Equity ratio running under 5% in recent years explains much of the lack of performance in AEG stock. A general benchmark for insurers is that ROE should be somewhere closer to 10%.
On top of that, a rule of thumb is that an insurer should trade at about one-tenth of its ROE percentage on a price/book value basis. Thus, an insurer with an ROE of 10% should trade at 1.0x book value, 15% would support a 1.5x book value, and so on.
Given Aegon’s anemic return on equity, it’s not surprising that the stock only fetches 0.44x book value now, and the argument that it is cheap purely on a book value basis is incomplete without acknowledging its low profitability.
Insurance Profits Should Pick up
Aegon has had to deal with low interest rates, as have other insurers. However, many life insurance companies have still managed 8-10% ROEs in recent years, and thus have their stocks trading near book value, rather than at less than half book.
MetLife, Inc. (NYSE:MET) is a good example of a typical American life insurer performing up to industry standards and being valued as such.
Aegon has created some self-inflicted issues, however, that have it running below average. A major scandal in the Netherlands years ago seriously dinged its reputation there.
The Netherlands in general has a fairly unattractive market given the country’s aging demographics, and the scandal didn’t help matters. However, that major issue occurred a decade ago, and with the passage of time, Aegon should be able to fare better there.
In general, management has prioritized cost-cutting in recent years. The company is divesting underperforming assets and is trimming costs aggressively.
A better cost structure, paired with rising interest rates, should help Aegon finally earn better profit margins going forward. The Fed’s rate hiking campaign shows no signs of slowing down, based on Mr. Powell’s most recent commentary. Life insurers stand to benefit, as returns they can earn on their investments rise along with interest rates while liabilities are generally more fixed.
AEG Stock Verdict
Aegon’s management team still has a lot to prove. The stock has been dead money for two decades. In more recent times, life insurers have admittedly faced a difficult market due to low interest rates. However, Aegon has fared significantly worse than its industry as a group.
The company is making some solid moves to try to get back on track. The fintech online bank lending model could be a transformational operation over time. And its core cost-cutting and asset divestitures should help improve profitability, especially as interest rates rise. Still, unless you are buying purely for the dividend, it’s hard to get too excited about AEG stock here.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
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