Risks In Hand At IAG

This story features INSURANCE AUSTRALIA GROUP LIMITED. For more info SHARE ANALYSIS: IAG

Insurance Australia Group is benefiting from cost reductions and hikes in premium rates which brokers expect will underpin the stock at current levels.

-Strong brand, margin tailwinds and further cost savings likely
-High quality player in a sector enjoying an upturn in the commercial insurance cycle
-Preference for further off-market share buybacks confirmed
 

By Eva Brocklehurst

Insurance Australia Group ((IAG)) is confident in its future and brokers greet the latest investor briefing positively, amid a focus on simplification, cost reductions and increased capital efficiency.

Medium-term targets of at least $250m in cost savings and 10% growth in earnings per share were reiterated and UBS notes the significance of the references to "customer" and "simplification" in the briefing.

The potential for disruptive challenges was acknowledged, but the broker asserts that the strength of the brand and margin tailwinds should mean the company can do what is necessary with its legacy systems to prepare for changes.

Despite forecast negative shareholder returns, Macquarie recognises the business is benefiting from cost reductions and hikes in premium rates and this should support the stock at current levels.

FY18 guidance for premium growth in low single digits was reaffirmed. The broker believes the consolidation of policy systems should be in focus, because of the increased trend in the industry towards automation across the supply chain and greater data collection relating to customers.

Citi incorporates the $250m in cost savings into its estimates by 2020. The broker also factors in a 2.5% reserve release in FY19 and FY20. The business looks strong but the stock's valuation is full and the broker maintains a Neutral rating.

While the company is likely to target further cost savings over and beyond those slated by 2020, Citi points out management understands the risk of re-investing such savings will then be higher and future growth initiatives will subsequently be required.

With returns on around one third of its book now locked in, IAG is envisaged as a less volatile, higher-quality play in a sector that is enjoying benefits from an upturn in the commercial insurance cycle.

Credit Suisse finds it hard to fault the management team, as growth is being delivered and opportunities assessed. Still, the external operating environment cannot be ignored. The premium rate environment is working favourably at present but the broker is cautious in terms of this unwinding by FY20.

For this reason, Credit Suisse incorporates only half of the targeted cost savings, in both FY19 and FY20. While there remains potential for an out another leg up in the share price on delivering cost reductions and capital management the broker is sceptical there will be enough confidence in the pricing environment until late 2018 or early 2019 and this would likely be the catalyst for earnings upgrades.

Autonomous Vehicles

Citi suggests the risks from other industry brands and their entry/involvement in the insurance sector may be a more immediate challenge than a longer-dated threat from autonomous vehicles. The company expects the motor insurance market to grow to 2030 with a change in mix away from personal to fleet insurance.

IAG suspects a long lead time before automated cars are approved for public roads, citing around 700 regulations that will need to be changed while the price of these vehicles is currently too prohibitive to be widely consumed.

Capital Outlook

Ord Minnett notes the company's capital position is currently very strong, above the common equity tier-1 target band, with further surplus capital to come from quota share deals, the unwinding of tax losses in New Zealand and, potentially, Asian divestments.

Management has advised it is not working on any further quotas share deals and confirmed a preference for further off-market share buybacks. Macquarie currently assumes $400m in the first half of FY19. Further capital management plans are to be provided in the second half of 2018.

FNArena's database shows two Buy ratings and six Hold. The consensus target is $7.45, signalling -1.9% downside to the last share price. Targets range from $6.45 (Macquarie) to $8.00 (Morgan Stanley, yet to comment on the update).

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