One of the worst performing stocks on the ASX last week was Insurance Australia Group Ltd (ASX: IAG). Shares in the blue-chip insurer fell 9.1% to $7.68 due to a combination of the overall market sell-off and an earnings report that fell short of the market's expectations.
FY19 result disappoints the market
For the financial year ended 30 June 2019, IAG reported a gross written premium (GWP) rise of 3.1% to $12,005 million. The growth in GWP was at the midpoint of guidance and occurred primarily from higher premiums.
In FY19, IAG's underlying insurance margin rose 250 basis points to 16.6%. The large increase in underlying margin was mainly the result of an uplift from a full year of 12.5% quota shares and benefits from the company's optimisation program. However, the insurer's reported margin fell by 140 basis points to 16.9% due to higher costs from natural disasters and substantially lower prior period reserve releases.
The $200 million plus in profit on the sale of the company's Thailand operations in August 2018 helped net profit after tax rise 16.6% to $1,076 million. Cash earnings, on the other hand, decreased 10.0% to $931 million. As a consequence of the fall in cash earnings, IAG's dividend declined 5.9% to 32.0 cents per share, representing a cash payout ratio of 79.4%.
Outlook
The company provided FY20 guidance of low single digit GWP growth and a reported insurance margin of between 16% to 18%. Shares in IAG had risen to as high as $8.74 in late July and a valuation of around 20 times the consensus earnings per share estimate of 43.59 cents for FY20.
With the low interest rate environment in Australia expected to continue into the near future, the stock offers income-focused investors a 4.2% dividend yield. The search for yield has had a noticeable impact in propelling the share prices of IAG and other blue-chips such as Westpac Banking Corp (ASX: WBC) and the Commonwealth Bank of Australia (ASX: CBA) higher over the last few months.
IAG remains committed to distributing between 60% to 80% of cash earnings on a full-year basis. Investors should note that the company can no longer guarantee fully franked dividend payments and future dividends are expected to have a franking component in the range of 70% to 100%. This has occurred for a number of reasons, including a higher payout policy in recent years, several capital management initiatives that have utilised the company's franking capacity, and a significant part of IAG's earnings are derived in New Zealand where no franking credit is attached.
Is it a buy?
With the fall in IAG's share price last week the stock now trades at a valuation of around 18 times consensus FY20 earnings. However, whilst the stock is cheaper, it is still not cheap in my view. An opportunity to acquire shares of IAG at a better valuation may present itself to more patient investors.
