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Can Insurance Australia Group Limited repeat last year’s 7% dividend yield?

Financial year 2015, is set to be a big year for ASX-listed insurer Insurance Australia Group Limited (ASX: IAG). 2015 will mark the first full-year contribution of IAG’s major acquisition, of Wesfarmers’ insurance underwriting business.  The purchase will increase IAG’s exposure to New Zealand and is expected to boost gross written premiums by around 18% for the year.

Approval Process

The approval process for IAG’s acquisition, is travelling smoothly through the various regulatory authorities. It was given a big tick in March by Australia’s competition regulator, the ACCC, and the same from New Zealand’s competition regulator last week. The next step is approval by New Zealand’s reserve bank, then it will go to Australian Prudential Regulation Authority and finally Australia’s treasurer – Joe Hockey.

Revenue and Profit

As mentioned above, the acquisition is expected to add around 18%, or $1.7 billion, to IAG’s gross written premium (GWP) of $9.5 billion – in 2013. This is expected to boost forecast 2014 earnings per share by 5% and net profit by 10%.

The purchase, for $1.85 billion, was funded from debt and $1.44 billion in new shares, to institutional and retail investors. The purchase is expected to deliver $140 million in cost savings due to integrating the two businesses; however it should be noted that any more or less than this, will directly impact net profit and earnings per share. Shareholders and analysts will likely punish the company if significantly less than this is achieved.

Dividends

In the last few years, IAG has targeted a payout ratio of 50% to 70% of earnings. Based on a payout ratio close to 70%, the dividend payout in financial year 2015, is expected to rise to 37 cents from the 36 cents in 2013. This corresponds to a yield of 6.2% based on the current price, which is grossed up to 8.8%, based on the historical 100% franking rate.

Time to buy?

Investors buying IAG shares now appear to be exposed to more downside risk than upside risk. Organic growth in Australia is lacking and some analysts have expressed doubt at the actual synergy savings potential between the two companies.

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Motley Fool contributor Andrew Mudie does not own shares in any companies mentioned. You can find Andrew on Twitter @andrewmudie

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