Is it time to buy Insurance Australia Group Ltd for its 5% dividend?

As you’ll know if you read our recent results coverage, Australia’s biggest insurers like Insurance Australia Group Ltd (ASX: IAG) (“IAG”), and Medibank Private Ltd (ASX: MPL) are facing headwinds.

Or perhaps it would be more accurate to say that the headwinds have always been there, but recent results provided a reality check after lower interest rates sent share prices on high-yielding insurers skyrocketing.

Shares in IAG rose above $6 for the first time in over a year in anticipation of its August results, before subsequently falling 15% to today’s levels of $5.25. While the company has some attractive traits for dividend and stability-seeking investors, it’s hard to characterise it as a strong buy.

Tough times ahead?

Although management’s latest report appears to presage a renewed focus on operational excellence and delivering value to shareholders, several segments face challenges and, after abandoning its China plans, IAG has limited room to grow internationally.

Ventures in Thailand, Malaysia, and India have some promise but IAG is a minority shareholder in businesses there, and growth from these regions will be a slow burn. With IAG management again forecasting flat premium growth and similar margins in 2017, this shows clearer than anything the average outlook for its core Australian businesses.

One possible outcome is that IAG’s profits soar due to a lower-than-expected claims expense – the company experienced higher levels of natural disaster claims in recent times, so a reduction would be good news. Share prices would likely rise, as they did after Medibank Private forecast higher profits earlier this year, but buying in such a situation would be to overlook the lumpy nature of insurance profits as well as persistent headwinds.

All about the dividends

IAG recently lifted its dividend payout ratio, perhaps reflecting the limited opportunities to reinvest in its own business. Combined with a strong balance sheet and high levels of interest-paying assets, IAG’s ~5% dividend today looks both highly attractive and quite sustainable. While investors should expect its dividend payments to fluctuate in line with insurance profits, IAG does have a certain appeal as a dividend stock.

Aside from that though, I’m not encouraged by IAG’s outlook and am not keen on the company at today’s prices.

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Motley Fool contributor Sean O'Neill has no position in any stocks mentioned. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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