Insurance Australia Group Ltd (ASX: IAG) posted a sharp decline in net profit for the six months ended 31 December 2014, as a result of an "increasingly competitive environment", which also restricted it from increasing its interim dividend.
With few positive surprises to come from the insurer's earnings report, the market reacted accordingly, selling the stock down 7.7% to a low of $5.90.
So What: Insurance Australia Group's net profit fell to $579 million for the first half which represents a 9.8% decline compared to the $642 million profit recorded in the period one year ago. Its insurance profit also declined by 8.6%. On a more positive note however, revenue from ordinary activities jumped 27.3% to $7.95 billion while its gross written premiums (GWP) grew by 17.1% to $5.6 billion. The growth in GWP came largely as a result of its recent acquisition of Wesfarmers Ltd's (ASX: WES) insurance underwriting arm, although it was also negatively impacted by rising levels of competition.
The inclusion of the Wesfarmers business also resulted in a slight decline in Insurance Australia Group's underlying margin which is a key measure of an insurer's profitability. The underlying margin fell to 13.3%, compared to the 13.7% margin produced in the first half of 2014.
In a low interest rate environment, investors were hoping for even a slight increase in its interim dividend. Instead, the Board declared a fully franked dividend of 13 cents per share, which is in line with last year's payment and will be paid on 1 April 2015. The company confirmed that it expects to report an insurance margin between 13.5% and 15.5% for the full-year, although its revenue growth is tipped to come in at the lower end of its 17% and 20% guidance range.
Now What: Although Insurance Australia Group's report was somewhat disappointing, the insurer is still doing a reasonable job of maintaining margins, even though they experienced a slight decline through the period. The synergies from the Wesfarmers business purchase are unlikely to be recognised for at least another year, while the company is also confident it can efficiently respond to the changing business environment.
Despite the challenging conditions facing Insurance Australia Group, the stock still appears to be a reasonable buy. At $5.90, the stock is trading on a price-earnings ratio of just 12.7x this year's forecast earnings, while it's also expected to yield roughly 6.4% fully franked, or 9.1% when grossed up for franking credits.
