Relief As IAG Sells UK Assets

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-UK assets sale welcomed
-IAG outlook improved
-Stock fully priced
-Asia provides opportunity

By Eva Brocklehurst

Insurance Australia Group ((IAG)), Australia's largest general insurer, has announced the sale of its business in the United Kingdom for a total of $295 million, to a chorus of welcome from brokers. The history of the IAG ownership has been fraught. The company took a balance sheet hit on the sale price, having paid around $1.8 billion in 2006 for these UK assets but there's a sigh of relief that this business is off the radar, although the implied aggregate write down and accrued losses is around $1.5bn over six years.

BA-Merrill Lynch notes the sale was well flagged in all aspects – other than the price. IAG has had to top up the capital position in the UK by an estimated $30m, retain the UK defined benefit pension fund and top that up by $60m. According to the broker, IAG has paid $90m to get back $130m on a business which had $200m of net tangible assets at 30 June 2012. Despite this, for most brokers, the shares remain fully priced. In BA-ML's opinion, therefore, the stock gets a Sell rating and a price target of $4.10. The theme is that IAG shares have rallied strongly this year on the prospect of better profitability from lower catastrophe experience, rising net premium rates and low claims inflation. Nevertheless, BA-ML prefers stocks which are equally exposed to this theme but have a stronger capital position and are fundamentally cheaper. Its preference is Suncorp ((SUN)).

Echoing the sentiment, CIMB welcomed the removal of lingering UK concerns but sees the stock fully priced, maintaining its Hold rating but raising the price target to $4.31. The loss on the sale was above this broker's expectations, affected by the $60m pension liability adjustment, the loss of diversification benefits and an $80m foreign currency translation reserve impact. Therefore, CIMB downgraded earnings forecasts by 1% for  FY13 and 4% in FY14. The reason the target was raised is that there is reduced business risk from the disposal of these UK assets. So, IAG continues to shape up for a strong first half and capital also remains strong.

Citi sees the impact as fairly immaterial for earnings. Citi's spot valuation for IAG falls to $4.25 from $4.35 and the target is steady at $4.50, marginally expanding the premium between target price and valuation, given the likelihood of first half earnings upgrades if the weather does not turn adverse between now and 31 December 2012. While there is a risk IAG's price could track higher, the premium to the current share price is hard to justify on existing numbers, hence Citi retains a Hold rating. The broker also sees the sting in the tail from the defined benefit pension fund liabilities and retaining these on its books, meaning it is still subject to potential fluctuations. The broker understands IAG will look for ways to remove these items from its balance sheet in due course. Its remaining Australian and NZ based operations all seem to be good, according to Citi.

Deutsche Bank also sees the pension deficit as the biggest liability but, given IAG has taken the opportunity to revalue these obligations at more conservative discount rate, the $60m pension liability top-up was considered a modest surprise. Sentiment towards the stock should improve and the broker does not see the transaction adversely impacting FY13 dividends. A target price of $4.65 and Hold is retained. Goldman Sachs also retained its target ($4.55) and Hold rating and has not adjusted earnings forecasts, noting the UK only contributed 2%-3% to pre-tax profit forecasts. For UBS the story is also largely neutral for the share price. IAG's total capital position is expected to improve modestly. UBS has left its price target at $4.30 with a Hold rating. Credit Suisse has not changed its forecasts or price target either, but highlights the positives, including strong dividends and earnings growth. On the FNArena database the consensus dividend growth forecast for FY13 is tracking at 30.1%.

JP Morgan asks whether Asia will be a different story for IAG. The company has reiterated its target for Asia to represent 10% of gross written premium by 2016. The broker believes the difference to the UK experience lies in the fact that the Asian investments are diversified and small in individual size. Moreover, the company is buying exposure into markets which are developing and where it can add value. The broker cites Malaysia where there is a solid JV partner. JP Morgan expect strong trends continuing in Australian Direct, and very strong rate rises in New Zealand, and some benefits in CGU Insurance. Earnings forecasts are reduced but the price target increased. A Buy rating is maintained, making it the only broker on the FNArena database with such a rating. Macquarie re-rated the stock earlier this month, noting that a Buy could no longer be justified despite the positives and moved to a Hold rating..

The consensus target price on the FNArena database is $4.42 consisting of a range of $4.00 (Credit Suisse) to $4.88 (Macquarie). There are six Hold recommendations, one Buy (JP Morgan) and one Sell (BA-ML). 
 

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