Security price: $4.90
Industry: Insurance
Forecast distribution: 30 cents per share fully franked
Back in mid-June Insurance Australia Group, which owns brands such as NRMA and AMI, announced a strategic tie-up with legendary billionaire investor Warren Buffett.
The announcement that Buffett would invest in IAG and help stabilise earnings in a tough part of the cycle sent the company’s shares higher. Since then the shares have fallen below $5 after a poor full-year profit result and concerns over its Asian expansion. But at those prices, we think IAG offers good value for income investors, with a fully franked yield of more than 6 per cent.
IAG is facing a tough and competitive domestic insurance market after suffering increased claims expense due to a number of natural disasters hitting margins. That hit the bottom line, with IAG’s net profit in 2015 slumping from $1.2 billion to $728 million.
Investors are also worried about the cost of IAG’s expansion into Asia. IAG has said it’s looking at establishing a “national presence” in China expanding on its existing business, Bohai Insurance. But despite all those challenges the company is still confident about its outlook and its ability to weather the current cycle.
The Buffett deal strengthens IAG’s balance sheet; it also stabilises earnings and gives protection from worsening market conditions. Buffett not only tipped $500m into the company, but Berkshire Hathaway will be entitled to 20 per cent of IAG’s consolidated gross written premiums and will pay 20 per cent of gross claims in return over a 10 year period.
IAG has essentially giving Buffett 20 per cent of its business for an equity stake of 3.7 per cent and greater earnings stability and reduced capital intensity. That provides a solid platform for its China expansion.
IAG cut its total dividend payout for the year significantly from 39c per share in 2014 to 29c.
In 2016, that lower payout is likely to be repeated with a fully franked dividend of 30c per share. That still gives investors a strong yield of 6.1 per cent.
IAG is now expecting a solid 2016, helped by the continued integration of Wesfarmers insurance underwriting business which it bought in June 2014.
At $4.90 IAG is trading significantly below our forecast valuation of $5.78 and its earnings are of a very high quality. With a healthy 6 per cent yield its shares are a good option for income investors.