IAG Dividend Under Threat

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This story features INSURANCE AUSTRALIA GROUP LIMITED, and other companies.
For more info SHARE ANALYSIS: IAG
The company is included in ASX50, ASX100, ASX200, ASX300 and ALL-ORDS

By Greg Peel

What’s with this weather?

For the sake of readers outside Sydney Australia, the last three weeks here have produced a mixture of high humidity and damaging thunderstorms interspersed with cool and blowy Southerlies. Apparently it’s La Nina’s fault, and right now it’s not just those hoping for summery conditions who’d like to grab her by the throat. Okay – so the rain’s helpful, but not all at once please.

Last weekend one of Sydney’s thunderstorms became a hail storm in certain parts, with icy cricket balls raining from the sky. Insurance companies have to date received 13,000 claims for damage to houses and cars. It’s the sort of stuff that makes insurance executives peer into the heavens with sheer dread.

Macquarie analysts suggest the storm will likely cost Insurance Australia Group ((IAG)) some $100m based on average estimates, just at a time when IAG really doesn’t need it. There has already been a sustained downturn in commercial insurance pricing of late, and IAG doesn’t see this recovering until at least 2009. To make matters worse, the hoped for recovery in UK underwriting is yet to eventuate, and stock market returns on premiums held have not been very helpful.

There is a real danger, Macquarie suggests, that IAG will not be able to sustain its dividend.

If the analysts work off their forecast for FY08 adjusted earnings, IAG’s near term payout ratio is an unsustainably high 99%. Even the medium term, if you assume no change to the dividend profile, is unsustainable at 87% on an FY09 basis. In fact, taking today’s levels and working into time, IAG will not again see a payout ratio within its own target range of 50-70% until 2013.

Various bolt-on acquisitions haven’t helped, including the recent 50% stake in National Transport Insurance. But the real problem facing IAG is staying above the minimum capital ratio (MCR) required to maintain an AA rating with Standard & Poors. The current MCR is barely above the 1.65x required, Macquarie notes, and is trending lower. The analysts doubt whether S&P will grant interim relief to drop the MCR to 1.55x.

Even if S&P comes to the party, Macquarie suggests it might turn Native American giver and rescind the significant gearing ratio concession it previously handed out for the CGU Insurance acquisition.

So not only is capital tight, earnings are trending down. Sounds like a US investment bank.

In response, the Macquarie analysts have lowered their dividend forecast to 29.5c from FY09 onwards, representing no absolute dividend growth. An Underperform rating will stay in place irrespective of what the share price has done and might yet do, at least until such time as IAG rebases its dividends, and perhaps earnings guidance. Macquarie will also wait for rival QBE Insurance ((QBE)) to announce some offshore acquisition, which will further weaken IAG given the premium built in for a potential takeover by QBE.

With the stock trading this morning at $4.42 (down 3%) the broker nevertheless retains a 12-month target of $4.95. The FNArena database currently shows IAG with a B/H/S ratio of 3/5/2 and an average target of $4.99.

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