J.P. Morgan is out with another major call on Assured Guaranty (NYSE:AGO) raising their price target to $42 from $28 following earnings announcement out last night.AGO reported op EPS in line with the pre-announced $0.45 per share. Included in its Q was a premium amortization schedule that was well above what JPM had previously modeled. In short, they were not properly accounting for the way FSA's premium revenue is recognized going forward as AGO purchased the company at a large discount to book. As such they are raising their estimates substantially and pushing their price target up to $42, using the same 7x multiple to their new 2011 estimate. With shares trading at half firm's target, they would be aggressive buyers.
Premium discount amortization significantly higher than modeled.
When AGO acquired FSA it booked ~ $1.6B of premium discount. A majority of the discount was applied to RMBS exposures that have a shorter duration than the overall portfolio. As a result, the discount amortization built into future premium earnings will run at a significantly higher rate than we had expected. AGO disclosed in its Q that deferred premium revenue earned will be ~ $1.1B over the next four quarters and gradually decrease ~15-20% annually over the next 3 years. This increased revenue does not change the economics of AGO’s business but will bolster regulatory capital dramatically.
RMBS loss mitigation efforts pay off.
AGO has been negotiating with mortgage originators to recover losses from improperly underwritten mortgages based on existing warranty covenants. In its 3Q earnings release AGO announced that they have reached an agreement to have $146M of mortgage loans repurchased by the originator and expect to put back an additional $804M of RMBS loans for a $527M total net benefit.
Additional capital to be raised by year-end.
As previously announced, AGO has initiated a capital plan in order to have its Aa3 rating affirmed by Moody’s. The plan includes external reinsurance, inter-company capital support, and $300M of new capital. The external reinsurance has already been negotiated, and the $300M of capital is expected to be raised by year-end. This capital may be a mix of common and preferred or convert/hybrid equity.
Significant earnings power increase.
JPM is raising their 2010 and 2011 earnings estimate to $5.00 and $6.00 per share from $3.00 and $4.00, respectively, to reflect significantly higher earned premiums and loss mitigation efforts.
Trading at just 3.5x JPM's normalized earnings estimate of $6, compared to the doubledigit multiple on normal earnings we had seen in the past, the stock is cheap in firm's opinion. Moreover, even if they penalize the stock for its ratings uncertainty, the lion’s share of the future earnings will come from amortization of back book of business; therefore, they believe there is little downside to the stock and reiterate their Overweight rating. JPM's new Dec 2010 price target of $42 is based on a historically low 7x multiple to their new 2011 estimate.
Notablecalls: So, today is 'Make Wilbur Ross Happy' day. The legendary distressed business investor owns around 16 million shares of AGO with an average price of ~$15-20 per share. He started buying AGO in February 2008 and has steadily increased his take since then.
I suspect AGO will fly high today following the results and the HUGE call from J.P. Morgan:
- I'm sure many of you saw how AGO reacted to the less ominous Moody's cut and J.P. Morgan comments last Friday. The stock shot up 4 pts from open and didn't give back much during the day. There was some serious buying going on.
- J.P Morgan has been and continues to be the Axe in the name. Their $28 price target was the Street high and the $42 target just mops the floor with other analyst covering the name.- The reasoning behind the $42 target isn't based on some quirky DCF-based analysis. The people at JPM realized they were being too conservative and are upping their 2011/2012 EPS estimates by a friggin mile.
This stuff is bound to get attention. How many stocks are there with 100% price targets and a blessing from the Axe?
So how high will AGO trade today?
I suspect we may see another 10%+ move in the name today. If you look at the chart the stock has broken out to a new 52wk high and there is really nothing stopping it (except maybe some of momo buyers from Friday taking profits).
This will put the $23 level in play with $23.50-$24.00 levels definitely not out of the question.
Let's see how it goes.
UPDATE: Based on pre-market action, I now think this one can trade $25+.
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