Australia | Dec 05 2006
By Chris Shaw
For some time Insurance Australia Group (IAG) has not been among the preferred insurance plays on the Australian market, as evidenced by the FNArena Sentiment Indicator returning a reading of minus 0.1 on the stock.
In JP Morgan’s view this is because the stock is expensive relative to its peers, so justifying the broker’s Underweight rating. Following the company’s announcement of the acquisition of UK motor insurance company Equity Insurance for around $1.4bn the broker has not changed its rating, though like most in the market it has lifted its earnings forecasts.
The deal is seen as a good one, ABN Amro noting it will add immediately to earnings for the company. It suggests the price being paid is also attractive given it is pitched at less than 12x earnings this year, while synergies with IAG’s existing operations makes it even more attractive.
JP Morgan agrees the deal is a good one, though in its view the increase in earnings is a simple arbitrage as Equity Insurance is trading on a lower price to earnings (P/E) ratio than is Insurance Australia. Regardless, the broker has lifted its earnings per share estimates on the stock in FY08 by 12% to 45.8c, while ABN Amro has increased its forecast by 7% to 39.6c.
Credit Suisse has made a similar increase for FY08 and is not forecasting earnings of 40.1c, while SB Citigroup estimates earnings of 41.8c, up 13% from its previous forecast. Thomson One Analytics shows a median earnings per share forecast for FY08 of 40c.
One attraction of the purchase according to ABN Amro is the high margins Equity Insurance generates, while GSJB Were points out the company will be a good fit with the recently acquired Hastings as Equity Insurance is strong in underwriting and weak in broking, while Hastings is the opposite. Credit Suisse suggests the proposed synergy benefits of the deal are likely to prove conservative as a result.
Morgan Stanley also likes the deal, but suggests the key for the stock is the outlook for its Australian earnings, where things are not so rosy in its view. It continues to suggest there is downside risk to the company’s Australian profits, a view not at odds with that of Credit Suisse, which points to the company’s New South Wales bias and weak domestic growth profile as reasons to not get too excited by the UK acquisition.
ABN Amro is more optimistic though, suggesting the upgrades to earnings should continue to help sentiment towards the stock, suggesting this has been improving in recent months. Deutsche agrees, seeing a more positive outlook for the group’s personal lines in the Australian market.
Following the acquisition and reflecting the earnings upgrades flowing through, the average target price for Insurance Australia according to the FNArena database now stands at $5.70, up from $5.42 prior to the deal. This compares to a median price target according to Thomson One of $5.35.
The database shows little change to recommendations though, the stock being rated as Buy and Accumulate once each, compared to six Neutral ratings and two Sells. Insurance Australia Group shares are currently suspended as the company completes a capital raising as part of its funding for the acquisition.