A few salient reasons why Insurance Australia Group (ASX: IAG and PINK: IAUGF) is an eminently short-able stock:
The stock trades at 42 times P-E — which is 2 to 3 times as much as its peer group anywhere in the advanced economies; the stock is just plain expensive — both by global and Australian insurance sector standards.
To put things in perspective, on one end of the spectrum, there’s the American Insurance giant AIG (NYSE: AIG) that trades at 3.0 times P-E. On the other end of the insurance sector spectrum for a $1+ billion market cap insurer, there is Insurance Australia.
Even comparing insurers of similar market cap, the Dutch insurance provider Aegon (NYSE: AEG) trades at 12.0 P-E and generates revenues far higher than Insurance Australia (5 times as much in revenues to be precise). Intact Financial (TSE: IFC) — a Canadian insurer of similar market cap — trades at 15.5 P-E.
Whether it is Price-to-Sales or Price-to-Book or any other valuation metric, IAG is dearer than virtually any of its global or regional peers by a distance.
IAG’s Price-to-Sales Ratio is 0.98 vis-a-vis the global insurance industry average of 0.54. The company’s principal Australian peers trade at Price-to-Sales ratios of 0.79 for QBE (ASX: QBE) and 0.73 for Suncorp (ASX: SUN).
IAG’s Price-to-Book Ratio is 2.03 vis-a-vis the global insurance industry average of 1.19. For QBE, this ratio is 1.35 and for Suncorp: 0.83.
So, the company’s global and Australian peers command much lower valuations on both these metrics.
Infact, IAG’s Price-to-Tangible Book Value is a staggering: 3.5 vis-a-vis the Insurance industry’s Price-to-Tangible Book Value of: 1.0.
Net margins are very ordinary: 2.9% — which is discernibly lower than even its immediate Aussie insurance sector peer group: QBE Insurance (3.8%) and Suncorp (4.5%).
In essence, on a relative value basis, IAG offers no major industry-leading data point to justify its premium pricing.
As per data compiled by Reuters, IAG has a long-term debt-to-equity ratio that is nearly twice (38.2) the industry average (22.1).
Compared with a year ago, the insurer’s revenues have grown by 14.7% for the most recent quarter (MRQ). On the other hand, the company’s earnings have shrunk by 29.2% MRQ. Even on a trailing twelve month (TTM) basis, the company’s revenues have risen by 12.8% but its earnings have fallen 17.2% from A$250 million in FY 2011 to A$207 million for FY 2012.
Clearly, the markets are rewarding unprofitable growth. The company’s management would potentially defend unprofitable growth by stating that they have entered fast-growing emerging markets like Indonesia and Vietnam. But as one does more research, one learns that there is brutal price competition and a crowded marketplace for any new entrant to contend with in these Southeast Asian markets.
The stock has also made a dramatic run year-to-date for no apparent positive reason, up 41.2% where S&P/ASX 200 has risen only 6.7%. Meanwhile, IAG’s immediate Australian competitors have been trailing far behind with QBE Insurance (QBE) going sideways down -0.3% YTD and Suncorp (SUN) up 8.5% YTD.
Trading at A$ 4.25, the stock’s been breaching 52-week highs on a regular basis. It hasn’t seen such peaks since May, 2008. We all know what happened next to the global economy and world markets. There is little evidence to support its ascent except the company’s growth rates which have been driven by unprofitable expansion into a significantly more competitive insurance market such as the UK — where by the way, the company has stumbled. Due its poor performance, the company’s UK unit is under review for a possible fire-sale.
Australia’s fortunes are largely tied to those of the world — and particularly to those of emerging Asia. As growth rates stall or even decline in various parts of the world as well as in Asia, Australia’s steady, multi-year run of GDP expansion is poised for a reversal. As goes Australia (and to a lesser extent New Zealand), so goes Insurance Australia Group. As it is, the company’s ‘promising’ Asian operations only account for roughly 5% of the group’s revenues. The UK unit is unprofitable. So, for all intents and purposes, there is enormous ‘concentration risk’ in Insurance Australia’s business.
Of course, there are several other strong reasons to support the ‘Short’ thesis on IAG common stock but we can limit our initial assessment to the above.
The catalyst for the decline in Insurance Australia’s stock price will be the slowdown in the Australian economy that is already underway — which would have a chain reaction on the value and volume of policies issued by Insurance Australia — this would then, in turn, affect margins — and thus impact dividend payouts — until the institutions holding on to IAG’s stock begin to desert their positions seeking a steady yield elsewhere. That’s when the stock will begin to unravel.
How, then, can the high valuation and rising stock price of Insurance Australia be explained?