Australia | Aug 27 2007
By Greg Peel
“Woman and children first” was the heading on this morning’s profit result report on Insurance Australia Group (IAG) from JP Morgan. While Merrill Lynch managed a more circumspect “Is the glass half full or empty”, JPM pretty much caught the mood.
Just as fast as IAG’s clients have been sand-bagging their properties against storm and tempest, management has been sand-bagging against losses by releasing large amounts of reserves. ABN Amro notes domestic storm losses were $374m, while reserve releases totalled $485m. There was little guidance pertaining to how much might be left over for further losses. More than one analyst noted that this disparity meant the result was a lot worse than it even appeared at face value.
Said JP Morgan: “On the earnings front, this was the most distorted result we have seen in some time, but one thing is clear, and that is the underlying result was below the reported result, given that level of unsustainable reserve releases was greater than the abnormal storm losses and also that there was a large one-off performance bonus in the fee business.”
It is a necessary evil of the insurance game that what customers actually insure against occasionally happens, but as the weather just seems to get wilder a greater level of uncertainty creeps into to the outlook. IAG is now in real danger that the reductions in its capital base (a base that was once a highlight of IAG’s value) could lead to the loss of its S&P AA rating. One problem, as more than one analyst has pointed out, is that IAG has pushed its dividend payout ratio too high. The company now has to have its next dividend reinvestment plan underwritten.
In order for the dividend payout to match actual earnings growth, notes JP Morgan, the dividend would need to be rebased into the low 20c range rather than the 29.5c it has retained. However, it would be suicide to slash dividends so IAG is stuck with maintaining the absolute figure. It is thus very unlikely the dividend will now grow for some time.
And the company is just not getting any support from margins. In Australia, the commercial line insurance margin was 25.5% in the first half, notes Credit Suisse, and only 10.6% in the second. But that wasn’t even the biggest disappointment. IAG’s great white hope – UK auto insurance – has proven a real fizzer. Analysts were looking for about 10% margins in this game but 5.5% was recorded.
So IAG is stuck between a rock and a hard place, and needs to rely heavily on the UK to improve and other international operations to contribute to earnings growth in a time when the insurance cycle is in a down phase. In the meantime, brokers have slashed their forward earnings expectations by anything from 5% to 20% depending on where they started.
IAG went into the result with a 4/4/2 B/H/S ratio. Three downgrades have transpired this morning, taking the ratio to 3/3/4. Notably, the three Buys – Aspect Huntley (Accumulate), Deutsche Bank and UBS have not reported this morning, so that ratio is still very much under threat of further reduction. The average target price has fallen from $6.21 to $5.74 but again – Deutsche and UBS are likely distorting the average, each holding a $6.80 target ahead of reappraisal. The target will undoubtedly fall closer to the $5.16 the market has put on IAG this morning.
If you want insurance, try QBE (QBE), the analysts are suggesting, and if you want wealth management, try AMP (AMP) or AXA Asia-Pacific (AXA). IAG is bailing out the boat to keep it floating, and it will be dead in the water for some time yet.