F&G Annuities & Life: Another Solid Quarter, But Valuation Has Caught Up (Rating Downgrade)

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F&G Annuities & Life has seen a strong performance, gaining 47% over the past year, driven by favorable interest rates and high annuity demand.Q3 earnings beat estimates with $1.22 per share, up from ...

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Richard Drury  Shares of F&G Annuities & Life (NYSE:FG) have been a strong performer over the past year gaining 47%. FG was lower Thursday after reporting solid Q3 earnings, though this followed a significant post-election rally Wednesday given higher interest rates and hopes for an easier regulatory regime in the financial sector. I last covered FG in August, rating shares a buy, and since then, the stock has gained 25%, more than the market’s 14% rally. With shares at my $45 target and with new financials, now is a good time to revisit FG.   Seeking Alpha In the company’s third quarter, F&G earned $1.22, beating consensus by $0.13. This was up from $0.96 last year, thanks to ongoing balance sheet growth and improving net investment spreads in this favorable rate environment. Thanks to the favorable interest rate environment, demand for annuities has been elevated, allowing F&G to accretively grow its business. Results were adjusted for the fact that alternative investments underperformed long-term expectations by $41 million. Returns can be volatile quarter to quarter but should benefit from the ongoing rise in the stock market. F&G had net sales of $2.4 billion, which was up over 5% from last year. Year to date, sales are up over 21%, so there was a deceleration. There are two reasons for this. First, the retail channel was nearly 90% of sales. That high share was because F&G did just $400 million of pension risk transfer from $900 million last year. This reduced year-over-year growth by over 10%. Pension deals are by their nature large and lumpy, and so there can be considerable quarter to quarter volatility. After closing several large deals earlier this year, this quarter was a bit quieter, and I would not read too much into it. Additionally, late last year, retail annuity demand began to rise. This will continue to make YoY comps in the retail channel more difficult, and we are likely to see growth slow a bit as a result, even as the absolute level of sales stays high. F&G continues to have a fairly conservative product mix. 71% of reserves are in fixed indexed or fixed rate annuities, which are relatively simple to hedge and really investment spread products. The same is true of funding agreements and pension risk transfers. 93% of retail annuities are surrender protected, providing long-term stability these policies will stay in place. Thanks to strong demand, it continues to grow its business with AUM of $52.5 billion, up over 10%. Prior to the impact of flow reinsurance, F&G has $63 billion of assets, up 20%.   F&G Thanks to the strong demand for annuities, F&G has been able to focus sales on low-risk products, like indexed annuities, while also offering slightly lower yields. Elevated demand, all else equal, leads to inflation or pricing power, which in insurance products comes in the form of slightly lower yields to policyholders. As a consequence, F&G generated an adjusted return on assets of 1.32% from 1.20% a year ago. As you can see below, F&G is earning 5.37% on its asset base while paying out just 2.45% on its products. This net margin is now nearing 300bps, supporting enhanced profitability. One additional benefit to margins has been limited credit losses given the fairly benign macroeconomic environment. While the Federal Reserve has begun cutting rates, F&G is more exposed 5-10 years out the curve, and those yields have actually risen since September. In other words, this tailwind to ROA is likely to persist at least into mid-2025.   F&G While F&G has a relatively low-risk annuity book, it has a relatively risky investment book, which is how it generates its wide investment spread. F&G has a base of $20 billion of core fixed income, which is low risk and provides stability and liquidity. It then has $25 billion of more aggressive products.   F&G In particular, private debt and structured products are much less liquid, which can increase their price volatility. Given annuities are multiyear contracts, FG can take on this liquidity risk as it is highly unlikely to be a forced seller. An insurance company cannot face a “run” the same way a bank with deposits can, allowing it to hold less liquid assets. That is why I am comfortable with F&G’s investment approach. Still, during periods of volatility, its assets may exhibit more price sensitivity given less liquidity, increasing their perceived riskiness. As a hold-to-maturity owner, that is not overly relevant to F&G’s ultimate profitability. I would note, within this book of more aggressive investments, its credit quality is still strong. For example, its CLOs on average have 23% subordinations, and 67% are A rated or higher with just 8% high yield. Plus with a recession not my base case, I do not expect a large rise in corporate defaults, which would be needed to cause losses. Commercial real estate is a large focus, and that is the asset class that deserves the most scrutiny. Here again, I view credit risk as manageable. 83% of its real estate debt is the highest regulatory credit rating. Additionally, 56% of private real estate exposure is multifamily, and 39% of commercial mortgages are multifamily. Given my view rents are near a bottom for apartments, I am comfortable with its exposure. Office faces more risk, but at just ~1% of its total portfolio, any losses here will be manageable.   F&G F&G also maintains a solid balance sheet with 26.5% debt to capital. Alongside results, FG raised its dividend by 5% to $0.22, giving shares a 1.85% yield. I view the dividend as the primary source of capital return, with F&G retaining capital otherwise to support ongoing business growth. Given a 12% return on equity, this is an accretive use of capital. Currently, F&G has a $42.28 book value ex-AOCI. At a 12% ROE, F&G can justify a 1.2x multiple to book value, given my long-term required return of 10%. However, I continue to expect F&G to trade at a modest discount to this, given its riskier investment portfolio. I still see 1.1x as fair value, or about $47/share. That is just 5% above current levels, for a 7% total return after Thursday’s drop.  7% upside is a “market-like” return in my view, and falls a bit short of my 10% buy threshold. As a consequence, I am moving shares to a hold after their strong run. There is no rush to sell with the stock below fair value, but there is no longer is sufficient upside to maintain a buy.","kind":null,"is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.2","shortVersion":"4.29.2","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2481947116"}