How Much IAG Upside From CGU Restructuring?

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 – IAG has updated investors on CGU restructuring
 – Focus now on costs and margins
 – Some upside potential relative to guidance
 – Stockbrokers views on IAG remain mixed

By Chris Shaw

Last week Insurance Australia Group ((IAG)) briefed the market on plans for improving growth and profitability at its CGU division. The division is significant, accounting for 31% and 29% of 1H12 premiums and insurance profit respectively.

RBS notes the next phase of restructuring at CGU will be a cost cutting story, with the focus being consolidating key processes such as underwriting, claims and account management. The process is likely to see a net reduction in head count of around 600 over the next three years.

The target is pre-tax synergies of $65 million by the end of FY15 and will involve implementation costs of $75 million. As these had already been announced at IAG's recent interim result, forecasts across the market have not seen significant adjustments post the latest briefing.

Further upside is possible in the view of Citi, particularly from increased cross-selling of group products given a move to more of a whole-of-account coverage structure. This should help strengthen relationships with insurance brokers and see delivery of a more uniform service according to Citi.

UBS agrees there is scope for additional upside assuming CGU can execute its changes cleanly and if pricing risk in the market continues to firm. On UBS's numbers, an additional 2% increase in “Intermediated” margins could translate into a cash earnings per share uplift of around 5%.

As BA Merrill Lynch notes, at the same time as IAG is making some progress with its CGU restructuring, premium rates are also trending higher. As well, interest rates and credit spreads have likely bottomed and claims inflation appears manageable.

This tide of better market conditions has the potential to 'lift all boats' including IAG in the view of BA-ML, though the broker continues to suggest there is limited valuation upside in IAG relative to fair value. This is reflected in the fact BA-ML's price target of $3.50 is not far from last week's closing price for IAG of $3.29.

Most in the market agree value upside in IAG is limited at present, as the FNArena database shows IAG is rated as Buy twice and Hold six times, with a consensus price target of $3.51. This is up from $3.49 prior to the update.

RBS Australia is one to agree IAG is trading around fair value at current levels. While recent margin improvements at CGU have been impressive, FY12 earnings guidance remains something of a stretch and the group's capital position remains tight. This suggests to RBS further evidence of progress in terms of improvements in margins is required before any re-rating of the stock in the market can be expected.

In contrast, the potential for more upside is enough for Citi to retain a Buy rating on IAG, as the expectation is margin improvements and premium growth will most likely roll through into FY13 and FY14. The other positive for Citi is broker views on premium growth are higher than the numbers being assumed by IAG, which suggests some conservatism on the part of the company with its guidance.

JP Morgan takes a similar view, expecting the initiatives being undertaken in terms of improving performance at CGU will eventually pay off. This implies upside, as evidenced by JP Morgan's above consensus price target of $4.00. Citi is similarly positive with a target for IAG of $3.95, while UBS is the most conservative with a target of $3.25.

UBS sees better value elsewhere, preferring to invest in either QBE Insurance ((QBE)) or Suncorp Group ((SUN)) to play the improving insurance sector thematic.

Shares in IAG today are unchanged with a last sale at $3.29, which compares to a range over the past 12 months of $2.74 to $3.66. The current share price implies upside relative to the consensus price target in the FNArena database of around 6%.
 

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