IAG Likely To Cut Earnings, Dividend Expectations

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This story features QBE INSURANCE GROUP LIMITED.
For more info SHARE ANALYSIS: QBE
The company is included in ASX20, ASX50, ASX100, ASX300 and ALL-ORDS

By Chris Shaw

He may have survived the approach from QBE Insurance ((QBE)) but Insurance Australia Group’s now ex-CEO Michael Hawker didn’t survive much longer, yesterday announcing his resignation from the company to be replaced by ex-Promina boss and preferred choice of many in the market, Michael Wilkins.

While the change is not totally unexpected it does suggest shareholders are in for an interesting ride in coming months, as most analysts covering the stock expect Wilkins to re-base earnings and dividend expectations to levels that are more achievable for the former and sustainable for the latter.

Such a deck-clearing exercise is common when a new CEO comes in, not least because they want to set expectations as low as possible to be able to outperform rather than to fail to deliver at a level in line with market forecasts.

Wilkins has plenty of options in this regard, with Merrill Lynch pointing out the carrying value of the group’s struggling UK operations need to be written down and dividends need to be cut, as they are simply unsustainable at the current level of earnings.

Deutsche Bank also points out Wilkins has a reputation for being conservative with respect to capital adequacy, so any restructuring charges could carry a capital cost. While seeing scope for further changes in senior management in coming months the broker also expects dividends will likely need to be lowered from current levels.

Citi agrees and suggests the likelihood of a re-basing of expectations means earnings risk for the second half of FY08 is to the downside, a view shared by JP Morgan. The latter at least sees Wilkins’s appointment as a positive for the group, while Citi makes the point he is something of an expert in dressing up a company for sale and this should be kept in mind by investors going forward.

While the broker rates the stock as a Hold both JP Morgan and Merrill Lynch regard it as a Sell, the latter pointing out any turnaround will take some time. As well, its valuation on the stock of $4.00 already implies a significant improvement in operating performance, so it sees outperformance in share price terms as unlikely at present.

Credit Suisse doesn’t agree and is happy to retain its Outperform rating given what it sees as scope for solid gains from operational improvements, with some likely measures including price increases for personal lines and cost cutting in the Australian business.

As well the broker suggests while there is certainly some potential share price pressure from a re-basing of the market’s earnings expectations this is offset to some extent by the potential for QBE Insurance ((QBE)) to return with another offer for the company given the accretive nature of its previous proposal. As a result, the broker sees the risk/reward scenario as attractive at current levels.

It is a view not shared by too many in the market as the FNArena database shows the company is rated as Buy twice, Accumulate once and Hold and Sell three times each, with an average share price target of $4.28. The range of targets is instructive, as Macquarie is the current low marker at $3.83 while Credit Suisse is among the leaders at $4.50. ABN Amro’s target of $4.80 has not been updated since QBE walked away from its offer.

Earnings and dividend forecasts for the company reflect the variety of views, as both have a wide range in the wake of the shuffle of CEOs. As an example Citi’s earnings per share forecasts for the period FY08-FY10 stand at 13.7c, 31.3c and 36.6c respectively, while Credit Suisse is at 21.8c, 37.9c and 40.9c and JP Morgan is at 20.5c, 27.6c and 29.9c.

Dividend expectations are similarly widely spread, with Citi forecasting 20c, 22c and 24.5c for FY08 through to FY10 against JP Morgan and Merrill Lynch at 27c each year and Credit Suisse at 29.5c each year. JP Morgan’s dividend forecasts have been lowered from 29.5c in both FY09 and FY10.

Consensus earnings and dividend forecasts according to the FNArena database stand at 19.8c and 33c for earnings in FY08 and FY09, while for dividends they are 27.4c and 27.9c. By contrast, the mean earnings forecasts according to Thomson One Analytics are 16c and 33c and the mean dividend estimates are 29c and 28c respectively, while it notes a median price target on the stock of $4.13.

Shares in Insurance Australia Group today are slightly stronger in a weaker overall market and as at 12.05am the stock was up 5c at $403. The company’s trading range over the past 12 months is $3.21 to $6.13.

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