American Equity Investment Life Holding Company (AEL, $24.40): “American Equity Needs to Weather the Storm Before It Flies Again”
By: Sean Dole, AIM Student at Marquette University
Disclosure: The AIM Equity Fund currently holds this position. This article was written by myself, and it expresses my own opinions. I am not receiving compensation for it and I have no business relationship with any company whose stock is mentioned in this article.
Summary
• American Equity Investment Life Holding Company (NYSE: AEL) provides annuity and life insurance policies throughout the US. The company makes money from the returns on their investment portfolio and on fees from the sale of annuity products.
• The SECURE Act was passed by the Senate and signed into law by President Trump. Because of this act, AEL is poised to capture an increase in demand for annuities.
• AEL posted a strong Q4 earnings report because of expanding spread margins (the difference between the rates they pay to policy holders and their investment returns) and success in their new money investment strategy.
• Volatility and low interest rates pose a major risk in the current market because the company may misplace their duration in the market and the rates on their products.
Key points:
When AEL was added to the portfolio in October of 2019, the passing of the SECURE (Setting Every Community Up for Retirement) Act was its main driver. On December 19th, the Senate approved the act as part of the spending bill. It was signed into law by President Trump on December 20th. This act will make it easier for companies to add annuities into retirement plan contracts because it alleviates the legal repercussions on plan sponsors if the annuity company fails to meet its obligations. With this catalyst playing out, AEL’s path is clear to capture an increase in demand for annuities, which were previously in only 9% of 401(k)’s.
American Equity posted a strong Q4 earnings report that beat analysts’ EPS targets and caused some to raise their price targets. The main driver of their earnings was a higher than expected investment spread. In the fourth quarter, the investment spread was 2.77%, up from 2.75% last quarter and 2.56% a year ago. The increase in spread was mainly caused by a reduction in option costs. In the second half of 2019, AEL adjusted their investment strategy which may also be having a positive impact on their spread. This new strategy centers around buying more private asset-backed securities and infrastructure investments. They hope this will create non-correlated risk and a gain in yields.
Volatility is a risk to AEL because they are in danger of misplacing their investments and spreads in the market. As seen in Q4 earnings, their quality spread margin is one of their main drivers. The recent market shake-up due to the COVID-19 disruption puts this competitive advantage at risk. Also, the incredibly low interest rates in the market threaten the company’s ability to achieve a meaningful spread and attract new customers. When rates are low, people may not want to invest in annuities in fear that their return might not out-weigh fees or simply investing in the stock market.
What has the stock done lately?
After AEL reported Q4 earnings on February 12th, the stock jumped 12.5%. The earnings report suggested that AEL was fundamentally strong because of their increasing spreads. However, due to the recent market sell-off, the stock has dropped 25% since February 20th. The stock will need to weather through this volatile market before it returns to its post-earnings level.
Source: FactSet
Past Year Performance
In the first half of 2019, worries over low interest rates and slowing sales growth hindered analysts’ expectations for the company. This drove AEL’s stock price to a discount. As AEL delivered stronger than expected yield spreads and acted on their new money strategy, the stock started to recover in the second half of 2019.
Source: FactSet
My Takeaway
Before the market downturn due to the spread of COVID-19, American Equity showed strengthening performance and fundamentals. With the passing of the SECURE Act, they have a unique opportunity to capture an increase in demand for annuities. Volatility in the market and low interest rates pose a headwind to the company’s performance. The stock needs to make it through these tumultuous market conditions before the company becomes a top performer again. Therefore, the AIM portfolio should continue to hold AEL and give the stock the time it needs for its drivers to play out.
