Australia | Aug 25 2008
By Andrew Nelson
It was a terrible year for IAG, one that was capped off with $261 million loss for fiscal 2008 compared to a $552 million profit in the previous year. But the market didn’t blink an eye, it was no worse than expected.
So the question is, how did expectations get so low?
Three straight years of falling profits, a bungled expansion into the UK, the complete failure to address the global credit crunch and knocking back a takeover offer from QBE – a company that knows how to make money in the UK and was willing to take on IAG, warts and all, at a price that still looks pretty attractive three months later. And that’s just the beginning.
The above list saw the departure of CEO Mike Hawker in May and saw replacement CEO Mike Wilkins promptly issue a worst case profit warning in July that accurately set the stage for last week’s “poor result” (his words).
So, no one batted an eyelash at about $342 million written off the books from IAG’s ill-fated expansion in the UK over the past two years and another $60 million for a restructure at its Australian businesses. Insurance margins fell from 11.4% to 6.1% and widening credit spreads cost the company $122 million, while returns on its investments fell by $277 million.
That’s not even taking into account some of the more mundane negative aspects, like a 22% rise in natural events-related claims, experienced across the entirety of the Australian insurance sector.
But it was all priced in, so the market focused on the future, because at $3.82, the share price really can’t go much lower. Or can it?
CEO Mike Wilkins said the bottom line will strengthen in 2008-09 and the full-year dividend will at least be maintained at 22.5c a share. The fact IAG paid a dividend at all this year is a pretty good sign the board sees better days ahead and that the company actually has enough money to spare.
Management said that it would scale back its operations in the UK, and reduce operational costs in Australia by $130 million a year from 2009. Underlying gross written premium revenue is to increase 3% to 5%, and the insurance margin will be brought back above 10%. These are the key factors that brokers are focusing on in making their assessments for the future.
JP Morgan is one of the more pessimistic brokers covering the company as one of three brokers on the FNArena database that has a Sell on the stock. Yet the analysts see the margin target as achievable. Although, they point out, it would need substantial upside from rates and significant cost savings, leaving little room for error. But the broker points out that rates seem to be headed the right way and IAG could get a break from high fuel prices, with reduced motor vehicle use expected to see a reduction in claims costs.
All in all, the broker does see a turnaround in the making, but it isn’t likely to bear fruit until the second half of the current fiscal year. Proposed cost savings are also possible in the broker’s view, but there is a real risk of cultural clash and as yet unforeseen losses from the reduction of synergies as the company divests its UK operations. All in all, even if the company does start to turn around, there is significant risk, while most of the potential upside is already factored into the stock, suggests JP Morgan.
On the the other side of the coin is Credit Suisse, who is the only broker in the FNArena database that still has a Buy on the stock. Although Credit Suisse agrees with JP Morgan in so far as the cash position is tight, and there is little margin for error, it feels the cost savings are achievable and believes the margin outlook for FY10 will likely be better than FY09.
ABN Amro (Morgans) is of a similar, if more cautious view, saying the benefits are achievable, but won’t be crystallised for at least 12-18 months and even then it all comes down to execution. UBS echoes the sentiment, saying it will require a marked operational turnaround, and it wants to see some clear signs this is happening before it changes its neutral view.
In fact, the commentary from most brokers runs along the same lines. The back to basics plan looks achievable, but the underlying profitability outside of the core Australian personal lines looks less convincing. Given the lack of progress to date on the sales of the group’s problematic UK assets, it makes anything but a wait and see approach unlikely.
All in all, the FNArena sentiment indicator is sitting at a negative 0.2 (the best score being a 1 and zero being neutral), with 3 Sells, 4 Holds and 1 Buy from Credit Suisse. Target prices range from $3.60 to $4.50 (again Credit Suisse) and consensus EPS targets are 30.8 in FY09 and 34.5 in FY10.
Today, shares in IAG were trading 9c higher at $3.84 versus an average target price of $3.92 and a trading range over the last 12 months between $5.34 and $3.21.