Does IAG belong in your portfolio?

IAG (ASX: IAG) is one of a number of general insurers in Australia and New Zealand and has interests in Asia via partnerships with established insurance businesses in the area. IAG has outperformed the ASX 200 by around 45% in the last 12 months, but further business and share price growth may be difficult to achieve from its traditional markets.

The Australian and New Zealand general insurance business is the group’s largest contributor, accounting for around 94% of group gross written premiums (GWP) in the first fiscal half of 2013, but operates in an extremely competitive and crowded market. IAG’s market share is targeted by heavyweight competitors QBE (ASX: QBE), Suncorp (ASX: SUN), Wesfarmers (ASX: WES), Allianz, the major banks, and a number of small private online-only firms.

General insurance is more or less a commoditised product in Australia and New Zealand, whereby the buyers will move to the cheapest supply for generally no switching cost. The increasing competition from online-only companies, with lower costs and higher margins, may see IAG lose market share in coming years if online revenue growth stagnates.

Luckily, the Australian brands owned by IAG — NRMA, SGIO, SGIC, CGU and Swann Insurance — have a strong online presence and should continue to drive online sales growth. Significant growth in margins or overall profitability in the region will be difficult with a slowly growing economy and population. IAG is hoping the Asian expansion will contribute meaningfully to group profit in the medium term.

IAG’s Asian growth strategy is conservative and follows a well worn path followed by Australian companies such as Seek (ASX: SEK) and Carsales (ASX: CRZ) to gain exposure in emerging markets. IAG has acquired minority stakes in insurance companies in Vietnam, Indonesia, India, China, Thailand and Malaysia and provides back office functions as part of the agreement.

The group hopes to generate 10% of GWP from its Asian interests by 2016 and is on the way to achieve this with 6% accountable to Asia in first half 2013. There are however, a couple of questions which should be asked of the expansion into Asia. While the interests give IAG exposure to some of the fastest growing countries in the world, a large proportion of the population will never be able to afford insurance and a minority investment does not give IAG control of company strategy.

The third contributor to group profitability is the circa $13 billion investment portfolio held by the company in short term fixed interest and cash. Group profits are therefore directly related to interest rates and bond yields, meaning a sustained increase in US bond yields may materially improve profitability.

Foolish takeaway

IAG is heavily exposed to mature markets and is expanding cautiously into emerging markets. The company may struggle to achieve meaningful profit growth in the coming years as the Asian strategy takes shape and price competition in Australia and New Zealand restrains revenue and margin growth. Investors may be better rewarded purchasing the competitors of IAG such as QBE or Suncorp who are diversified into overseas and parallel markets.

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Motley Fool contributor Andrew Mudie does not own shares of any companies mentioned in this article.

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