Insurance Australia Group (ASX: IAG) was one of the surprise packages of 2013. The insurer and its peers benefitted from a relatively disaster-free world climate and delivered an incredible insurance margin of 17.2% for financial year 2012-13, well above the 7% to 11.5% of the previous five years. It also delivered an unexpectedly high 11.8% rise in gross written premiums (GWP), compared with between 0% and 4% in previous years.
IAG delivered a 180% rise in earnings-per-share, from 17.8 cents to 49.9 cents, and a 111% rise in full-year dividend from 17 cents to 36 cents. The dividend yield increased from 4.5% in 2012 to 6.7% in 2013. The result was a 31% total return in calendar-year 2013.
2014 company outlook
Interestingly however, the share price rose strongly in the first three months of 2013 before treading water for the rest of the year. The main contributor, I believe, was the downbeat 2014 forecast given by Managing Director Mike Wilkins. The group has forecast a return to its long-term insurance margin average of between 12.5% and 14.5% and GWP growth of 5% to 7%. Investors therefore (perhaps rightly) assumed that the 2013 result was a once off, which has limited the interest in the stock from income-focused investors.
2014 dividend outlook
If the company's guidance is used, and we assume the insurance margin comes in at the high end of the provided range, the estimated net profit for the 2013-14 financial-year will decrease from $1.06 billion to around $1.0 billion (the decline in insurance margin is largely offset by increase in GWP). This is a reasonable estimate as 2013-14 has again been a relatively disaster-free period in Australia.
If all things were equal between the years, there's no reason not to believe that the dividend payout of 36 cents could continue. However, the recent purchase of Wesfarmers' Australian underwriting business has complicated the calculation. An additional 255 million shares will be issued in the next few months to finance the purchase, which will add 12% more shares to the register.
Now, if the payout ratio of around 70% is maintained in 2013-14, with the new shares added on the net profit above, a dividend of around 31 cents per share could be paid out. This would represent a yield of 5.5%, which isn't to be sneezed at, in fact it compares well with that offered by the big banks.
Debt
There is one other consideration which may impact the dividend payout. At 30 June 2013, the company had $1.6 billion in debt, representing a gearing ratio of 34.5% of capitalisation, smack bang in the middle of the 30% to 40% target. With $1.4 billion being raised in new shares, and a purchase price of $1.825 billion for the Wesfarmers' business, debt could be increased (in the worst case) by around $400 million.
By my calculations the gearing ratio should not be adversely affected to the point where the company is required to withhold a large amount of profit to pay down debt. However, in 2013 the company was able to reduce gearing from 38.3% to 34.5% and one would imagine the company aims to reduce any increase from that level.
Foolish takeaway
With all things equal and the second-half of the 2013-14 financial-year being similar to the first-half, IAG should comfortably achieve its aim of an insurance margin between 12.5% and 14.5%. Based on this I believe IAG should deliver a dividend around 31 cents-per-share for the financial-year, a 14% decline on 2012-13. This would represent a yield of around 5.5%, which is fully franked. This compares favourably with the best dividend stocks in the country and has scope for some upside if management can deliver a bumper year like 2012-13.
